BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

9 Months Ended

Mar. 31, 2022

BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The unaudited interim Condensed Consolidated Financial Statements of Regis Corporation (the Company) as of March 31, 2022 and for the three and nine months ended March 31, 2022 and 2021, reflect, in the opinion of management, all adjustments necessary to fairly state the consolidated financial position of the Company as of March 31, 2022 and its consolidated results of operations, comprehensive loss, shareholders' equity and cash flows for the interim periods. Adjustments consist only of normal recurring items, except for any discussed in the notes below. The results of operations and cash flows for any interim period are not necessarily indicative of results of operations and cash flows for the full year.

The accompanying interim unaudited Condensed Consolidated Financial Statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP). The unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended June 30, 2021 and other documents filed or furnished with the SEC during the current fiscal year.

COVID-19 Impact:

During the periods ended March 31, 2022 and 2021, the global coronavirus pandemic (COVID-19) had an adverse impact on operations. The COVID-19 pandemic continues to impact salon guest visits and franchisee staffing, resulting in a significant reduction in revenue and profitability. In response to COVID-19, the Canada Emergency Wage Subsidy (CEWS), Canada Emergency Rent Subsidy (CERS) and the U.S. employee retention payroll tax credit were introduced for eligible employers. In fiscal years 2022 and 2021, the Company received $1.9 and $1.6 million, respectively, in CEWS and $1.2 and $0.0 million, respectively, in CERS that partially cover expenses incurred in Canada during those years. In fiscal year 2021, the Company recorded a $1.5 million benefit related to the U.S. employee retention tax credit. Additionally, in December 2021 the Company paid $2.5 million of social security contributions that had been deferred under the CARES Act. Overall, COVID-19 has, and may continue to have, a negative effect on revenue and profitability. The ultimate impact of the COVID-19 pandemic in both the short and long term is not currently estimable due to the uncertainty surrounding the duration of the pandemic, the availability and acceptance of preventative vaccines, the emergence and impact of new COVID-19 variants and changing government restrictions. Additional impacts to the business may arise that we are not aware of currently.

Liquidity:

The Company's debt of $193.8 million is due in March 2023 and management's current projected cash flows do not support the ability to repay this obligation in full at maturity. As a result of the maturity date, our debt is reflected as a current liability at March 31, 2022. Management is working with advisors to determine alternative financing arrangements and believes the ability to refinance alleviates substantial doubt related to the Company's ability to continue as a going concern. If the Company is not able to refinance our debt at terms acceptable to us by the maturity date, the lender would be able to call the debt and pursue other remedies that could be harmful to our business.

Inventories:

The Company has inventory valuation reserves for excess and obsolete inventories or other factors that may render inventories unmarketable at their historical costs. In fiscal year 2021, the Company announced it would transition away from its wholesale product distribution model in favor of a third-party distribution model. As a result, the Company exited its distribution centers in fiscal year 2022 and now stores inventory at a third-party facility. To facilitate the exit of the distribution centers, the Company sold and continues to sell inventory at discounts and dispose of hard-to-sell products. Additionally, the reduction in company-owned salons decreases the Company's ability to redistribute inventory from closed locations to other salons to be sold or used. The inventory valuation reserve as of March 31, 2022 and June 30, 2021 was $14.3 and $11.8 million, respectively. In the three and nine months ended March 31, 2022, the Company recorded total inventory reserve charges of $7.5 and $9.0 million, respectively. In the three months ended March 31, 2022, $6.4 and $1.1 million were recorded in Inventory reserve and Company-owned salon expense, respectively. In the nine months ended March 31, 2022, $6.4 and $2.6 million were recorded in Inventory reserve and Company-owned salon expense, respectively. Included in Company-owned salon expense is an inventory reserve charge of $5.3 and $6.9 million in the three and nine months ended March 31, 2021, respectively.

Long-Lived Asset Impairment Assessments:

The Company assesses impairment of long-lived salon assets and right of use (ROU) assets at the individual salon level, as this is the lowest level for which identifiable cash flows are largely independent of other groups of assets and liabilities, when events or changes in circumstances indicate the carrying value of the assets or the asset grouping may not be recoverable. Factors considered in deciding when to perform an impairment review include significant under-performance of an individual salon in relation to expectations, significant economic or geographic trends, and significant changes or planned changes in the use of the assets. The first step is to assess recoverability, and in doing that, the undiscounted salon cash flows are compared to the carrying value of the salon assets. If the undiscounted estimated cash flows are less than the carrying value of the assets, the Company calculates an impairment charge based on the difference between the carrying value of the asset group and its fair value. The fair value of the long-lived asset group is estimated using market participant methods based on the best information available. See Note 7 of the unaudited Condensed Consolidated Financial Statements for further discussion related to the ROU asset impairment.

Judgments made by management related to the expected useful lives of long-lived assets and the ability to realize undiscounted cash flows in excess of the carrying amounts of such assets are affected by factors such as changes in economic conditions and changes in operating performance. As the ongoing expected cash flows and carrying amounts of long-lived assets are assessed, these factors could cause the Company to realize material impairment charges.

Goodwill:

The Company assesses goodwill on an annual basis, during the Company's fourth fiscal quarter, and between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting below its carrying value. At the end of the period ended March 31, 2022, the Company determined a triggering event occurred related to a decrease in forecasted revenue due to slower than expected recovery from COVID-19, resulting in a quantitative impairment test performed over goodwill. Accordingly, the Company engaged a third-party valuation specialist to perform an impairment analysis on the Franchise reporting unit of the business as of March 31, 2022. For the goodwill impairment analysis, management utilized a combination of both a discounted cash flows approach and market approach to evaluate the Franchise reporting unit. The discounted cash flows model reflects management's assumptions regarding revenue growth rates, economic and market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results. Management's assumptions related to revenue growth rates were reduced and management increased expected salon closures compared to prior valuations. These changes, along with a decline in value from the market approach, reduced the fair value of the reporting unit from previous valuations. The discount rate of 19.5% was also a key assumption utilized in the discounted cash flows which was an increase of 1% from the second quarter valuation due to an increase in market interest rates.

As a result of the impairment testing as of March 31, 2022, the Franchise reporting unit was determined to have a carrying value in excess of its fair value, resulting in a goodwill impairment charge of $16.0 million in the third quarter. As of March 31, 2022 and June 30, 2021, the Franchise reporting unit had goodwill of $213.4 and $229.6 million, respectively. The Company's projections of future operating performance do not anticipate future salon closures due to the COVID-19 pandemic. However, the ultimate severity and longevity of the COVID-19 pandemic is unknown, therefore; if actual results are not consistent with the estimates and assumptions used in the calculations, the Company may be exposed to future impairment losses that could be material.

The table below contains details related to the Company's goodwill (in thousands):


	Franchise Reporting Unit

Goodwill, net at June 30, 2021	$	229,582
Goodwill impairment	(16,000)
Translation rate adjustments	(220)

Goodwill, net at March 31, 2022	$	213,362

Classification of Revenue and Expenses:

Beginning in the first quarter of fiscal year 2022, the Company adjusted its Statement of Operations for both periods presented to align the presentation of results to its franchise-focused business. Below is a summary of the changes to the financial statement captions. The change does not have a financial impact on the Company's reported revenue, operating loss, reported net loss or cash flows from operations.

Royalties - sales-based royalty received from franchisees. In prior years, these fees were included in Royalties and Fees and disclosed in the footnotes.

Fees - fees received from franchisees and third parties, including franchise fees, software and hardware fees related to Opensalon® Pro and fees received from the third-party distributors.

Product sales to franchisees - wholesale product sales to franchisees. This caption equates to Product sales in the Franchise segment in prior years. The Company is changing its franchise product sales business in fiscal year 2022 from a wholesale distribution model to a third-party distribution model. This revenue is expected to decrease significantly during fiscal year 2022.

Advertising fund contributions - sales-based advertising fund contributions received from franchisees. In prior years, these fees were included in Royalties and Fees and disclosed in the footnotes.

Company-owned salon revenue - service revenue and revenue derived from sales of product in Company-owned salons. This caption equates to revenue reported in the Company-owned segment in prior periods.

Cost of product sales to franchisees - direct cost of inventory and freight and other costs of sales. In prior years, these sales were included in the Franchise segment cost of product and site operating expenses.

Company-owned salon expense - cost of service and product sold to guests in our Company-owned salons and other salon-related costs. In prior years, these costs were classified as Company-owned segment cost of service, cost of product and site operating expenses. Excluded from this caption are general and administrative expense, rent and depreciation and amortization related to company-owned salons.

Depreciation:

Depreciation expense in the three months ended March 31, 2022 and 2021 include $0.3 and $0.8 million, respectively, and for the nine months ended March 31, 2022 and 2021 include $0.9 and $3.4 million, respectively, of asset retirement obligations, which are cash expenses.