Regis Corporation - 10-K annual report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x                              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2006

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to        

Commission file number 0-11230

Regis Corporation

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

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Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o   No x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes  o   No x

The aggregate market value of the voting common stock held by non-affiliates computed by reference to the price at which common stock was last sold as of the last business day of the Registrant’s most recently completed second fiscal quarter, December 31, 2005, was approximately $1,681,000,000. The Registrant has no non-voting common stock.

The number of outstanding shares of the Registrant’s common stock, par value $.05 per share, as of August 23, 2006 was 45,350,633.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement dated September 20, 2006 are incorporated by reference into Parts III hereof.

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PART I

Item 1.                          Business

Regis Corporation, the Registrant, together with its subsidiaries, is referred to herein as the “Company.”

(a) General Development of Business

In 1922, Paul and Florence Kunin opened Kunin Beauty Salon, which quickly expanded into a chain of value priced salons located in department stores. In 1958, the chain was purchased by their son and renamed Regis Corporation. Regis Corporation is listed on the NYSE under the ticker symbol “RGS.” Discussions of the general development of the business take place throughout this Annual Report on Form 10-K. During fiscal year 2006, there were no significant changes to the Company’s corporate structure or material changes in the Company’s method of conducting business. During fiscal year 2005, the Company purchased Hair Club for Men and Women, in part, to expand the Company’s product and service offerings. Additionally, the Company continues to acquire hair and retail product salons and beauty schools.

(b) Financial Information about Segments

Segment data for the years ended June 30, 2006, 2005 and 2004 are included in Note 11 to the Consolidated Financial Statements in Part II, Item 8, of this Form 10-K.

(c) Narrative Description of Business

The following topical areas are discussed below in order to aid in understanding the Company and its operations:

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Background:

Based in Minneapolis, Minnesota, the Company’s primary business is owning, operating and franchising hair and retail product salons. Over the last four fiscal years, the Company began acquiring and operating beauty schools in North America and internationally. Additionally, in December 2004, the Company acquired Hair Club for Men and Women, a provider of hair restoration services. The Company’s worldwide operations include 11,333 company-owned and franchise salons, 90 hair restoration centers and 54 beauty schools at June 30, 2006. Each of the Company’s salon concepts offer similar salon products and services, concentrate on the mass market consumer marketplace and generally display similar economic characteristics. The Company’s recently acquired beauty school locations offer similar educational services to students. Services are marketed to potential students pursuing post-secondary education alternatives. The Company’s hair restoration centers offer three hair restoration solutions; hair systems, hair transplants and hair therapy, which are targeted at the mass market consumer.

The Company is organized to manage its operations based on significant lines of business—salons, beauty schools and hair restoration centers. Salon operations are managed based on geographical location—North America and International. The Company’s North American salon operations include 7,106 company-owned salons and 2,187 franchise salons operating in the United States and Canada. The Company’s International operations include 453 company-owned salons and 1,587 franchise salons operating throughout Europe, primarily in the United Kingdom, France, Italy and Spain. The Company’s worldwide salon locations operate under concepts such as Regis Salons, Cost Cutters, Jean Louis David, MasterCuts, SmartStyle, Supercuts, Trade Secret and Vidal Sassoon. During fiscal year 2006, the number of customer visits at the Company’s company-owned salons approximated 104 million. The Company had approximately 59,000 corporate employees worldwide during fiscal year 2006.

Industry Overview:

Management estimates that annual revenues of the hair care industry are $53 billion in the United States and $150 billion worldwide. The hair salon, hair restoration and beauty school industries are each highly fragmented with the vast majority of locations independently owned and operated. However, the influence of chains, both franchise and company-owned, has increased substantially in all three industries. Management believes that chains will continue to have a significant influence on these markets and will continue to increase their presence. Management also believes that the demand for salon services, professional products and hair restoration services will continue to increase as the overall population continues to focus on personal health and beauty, as well as convenience.

Salon Business Strategy:

The Company’s goal is to provide high quality, affordable hair care services and products to a wide range of mass market customers that enable the Company to expand in a controlled manner. The key elements of the Company’s strategy to achieve these goals are taking advantage of (1) growth opportunities, (2) economies of scale and (3) maintaining centralized control over salon operations in order to ensure (i) consistent, quality services and (ii) a superior selection of high quality, professional products. Each of these elements is discussed below.

Salon Growth Opportunities.   The Company’s salon expansion strategy focuses on organic (new salon construction and same-store sales growth of existing salons) and salon acquisition growth.

Organic Growth.   The Company executes its organic growth strategy through a combination of new construction of company-owned and franchise salons, as well as same-store sales increases. The square footage requirements related to opening new salons allow the Company great flexibility in securing real estate for new salons.

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The Company’s long-term outlook for organic expansion remains strong. The Company has at least one salon in all major cities in the U.S. and has penetrated every viable U.S. market with at least one concept. However, because the Company has a variety of concepts, it can place several of its salons within any given market. The Company plans to continue expansion not only in North America, but also in the United Kingdom and throughout continental Europe. Opportunities in Asian markets are also being explored.

A key component to successful North American and international organic growth relates to site selection, as discussed in the following paragraphs.

Salon Site Selection.   The Company’s salons are located in high-traffic locations, such as: regional shopping malls, strip centers, lifestyle centers, Wal-Mart Supercenters, high-street locations and department stores. The Company’s financial strength, successful salon operations and international recognition causes the Company to be an attractive tenant to landlords. In evaluating specific locations for both company-owned and franchise stores, the Company seeks conveniently located, visible locations which allow customers adequate parking and quick and easy store access. Various other factors are considered in evaluating sites, including trade area demographics, availability and cost of space, the strength of the major retailers within the area, location of competitors, proximity of other company-owned and franchise salons, traffic count, signage and other leasehold factors in a given center or area.

Because the Company’s different salon concepts target slightly different mass market customer groups, more than one of the Company’s salon concepts may be located in the same real estate development. As a result, there are numerous leasing opportunities for all of its salon concepts.

While same-store sales growth plays an important part in the Company’s organic growth strategy, it is not critical to achieving the Company’s long-term revenue growth objectives. New salon construction and salon acquisitions (described below) are expected to generate low-double-digit revenue growth. Generating annual same-store sales increases in excess of two percent is, however, necessary to achieve the Company’s long-term earnings growth objective of low-to-mid teen earnings per share growth. The Company anticipates low-single-digit same-store sales growth on an annual basis.

Pricing is a factor in same-store sales growth. The Company actively monitors the prices charged by its competitors in each market and makes every effort to maintain prices which remain competitive with prices of other salons offering similar services. Historically, the Company has not depended on price increases to drive same-store sales growth. However, in an effort to stimulate same-store sales growth, the Company increased prices at approximately 2,500 salons during calendar 2005, primarily during the first six months.

Salon Acquisition Growth.   In addition to organic growth, another key component of the Company’s growth strategy is the acquisition of salons. With an estimated two percent world wide market share, management believes opportunities to acquire additional salons remain.

Over the past nearly thirteen years, the Company has added 7,344 locations through acquisitions, expanding in both North America and internationally. When contemplating an acquisition, the Company evaluates the existing salon or salon group with respect to the same characteristics as discussed above in conjunction with site selection for constructed salons (conveniently located, visible, strong retailers within the area, etc.). The Company generally acquires mature strip center locations, which are systematically integrated within the salon concept that it most clearly emulates.

In addition to adding new salon locations each year, the Company has an ongoing program of remodeling its existing salons, ranging from redecoration to substantial reconstruction. This program

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is implemented as management determines that a particular location will benefit from remodeling, or as required by lease renewals. A total of 170 and 205 salons were remodeled in fiscal year 2006 and 2005, respectively.

Recent Salon Additions.   During fiscal year 2006, net of closures and relocations, the Company added over 450 salons through new construction and acquisitions. The Company constructed or franchised 788 new salons (531 company-owned and 257 franchise). Additionally, the Company acquired 290 company-owned salons, including 142 franchise salon buybacks. The Company’s largest fiscal year 2006 salon acquisition consisted of 105 Famous Hair salons.

During fiscal year 2005, net of closures and relocations, the Company added over 700 salons through new construction and acquisitions. The Company constructed or franchised 810 new salons (525 company-owned and 285 franchise). Additionally, the Company acquired 451 salons (444 company-owned and 7 franchise salons). The 444 acquired company-owned salons included 139 franchise salon buybacks. The Company’s largest fiscal year 2005 salon acquisitions included 129 TGF Salons and 67 HeadStart salons.

During fiscal year 2004, net of closures and relocations, the Company added over 500 salons through new construction and acquisitions. The Company constructed or franchised 720 new salons (452 company-owned and 268 franchise). Additionally, the Company acquired 405 company-owned salons, including 206 franchise buybacks. The Company’s most significant fiscal year 2004 acquisition was 153 Holiday Hair Salons (primarily in Pennsylvania).

Salon Closures.   The Company evaluates its salon performance on a regular basis. Upon evaluation, the Company may close a salon for operational performance or real estate issues. In either case, the closures generally occur at the end of a lease term and typically do not require significant lease buyouts. In addition, during the Company’s acquisition evaluation process, the Company may identify acquired salons that do not meet operational or real estate requirements. At the time of acquisition, generally limited value is allocated to these salons, which are usually closed within the first year.

During fiscal year 2006, 407 salons were closed, including 178 company-owned salons and 229 franchise salons (excluding 142 franchise buybacks). In the fourth quarter, the Company decided to close 64 company-owned salon locations and refocus efforts on improving the sales and operations of nearby salons. The salon closures resulted in an aggregate $4.1 million in lease termination fees (recorded within rent expense in the Consolidated Statement of Operations). However, it is not the Company’s typical practice to incur such fees upon salon closure.

During fiscal year 2005, 315 salons were closed, including 147 company-owned salons and 168 franchise salons (excluding 139 franchise buybacks). During fiscal year 2004, 338 salons were closed, including 148 company-owned salons and 190 franchise salons.

Economies of Scale.   Management believes that due to its size and number of locations, the Company has certain advantages which are not available to single location salons or small chains. The Company has developed a comprehensive point of sale system to accumulate and monitor service and product sales trends, as well as assist in payroll and cash management. Economies of scale are realized through the support system offered by the home office. Additionally, due to its size, the Company has numerous financing and capital expenditure alternatives, as well as the benefits of buying retail products, supplies and salon fixtures directly from manufacturers. Furthermore, the Company can offer employee benefit programs, training and career path opportunities that are often superior to its smaller competitors.

Control Over Salon Operations.   The Company manages its expansive salon base through a combination of area and regional supervisors, corporate salon directors and chief operating officers. Each area supervisor is responsible for the management of approximately ten salons. Regional supervisors

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oversee the performance of five area supervisors or approximately 50 salons. Salon directors manage approximately 200 salons while chief operating officers are responsible for the oversight of an entire salon concept. This operational hierarchy is key to the Company’s ability to expand successfully. In addition, the Company has an extensive training program, including the production of training DVDs for use in the salons, to ensure its stylists are knowledgeable in the latest haircutting and fashion trends and provide consistent quality hair care services. Finally, the Company tracks salon activity for all of its company-owned salons through the utilization of daily sales detail delivered from the salons’ point of sale system. This information is used to reconcile cash on a daily basis and is also reported to the Company’s Chief Executive Officer, who is also the Chief Operating Decision Maker.

Consistent, Quality Service.   The Company is committed to meeting its customers’ hair care needs by providing competitively priced services and products with professional and knowledgeable stylists. The Company’s operations and marketing emphasize high quality services to create customer loyalty, to encourage referrals and to distinguish the Company’s salons from its competitors. To promote quality and consistency of services provided throughout the Company’s salons, the Company employs full and part-time artistic directors whose duties are to train salon stylists in current styling trends. The major services supplied by the Company’s salons are haircutting and styling, hair coloring and waving, shampooing and conditioning. During fiscal year 2006, 2005 and 2004, the percentage of company-owned service revenues attributable to each of these services was as follows:

High Quality, Professional Products.   The Company’s salons merchandise nationally recognized hair care and beauty products as well as a complete line of private label products sold under the Regis, MasterCuts and Cost Cutters labels. The retail products offered by the Company are sold only through professional salons. The top selling brands include Matrix, Paul Mitchell, Tigi, Redken, Sebastian, Nioxin, OPI and the Company’s various private label brands.

The Company has launched a product diversion website for the entire industry to use as a measurement tool to track diversion. Diversion involves the selling of salon exclusive hair care products to discount retailers. Diversion is harmful to the consumer because diverted product is often old, tainted or damaged. It is also harmful to the salon owners and stylists because their credibility is questioned, as well as to manufacturers and distributors because their actions are scrutinized.

The Company has the most comprehensive assortment of retail products in the industry, with an estimated share of the North American retail beauty product market of up to 15 percent. Although the Company constantly strives to carry an optimal level of inventory in relation to consumer demand, it is more economical for the Company to have a higher amount of inventory on hand than to run the risk of being under stocked should demand prove higher than expected. The extended shelf life and lack of seasonality related to the beauty products allows the cost of carrying inventory to be relatively low and lessens the importance of inventory turnover ratios. The Company’s primary goal is to maximize revenues rather than inventory turns.

The retail portion of the Company’s business complements its salon services business. The Company’s stylists and beauty consultants are compensated and regularly trained to sell hair care and beauty products to their customers. Additionally, customers are enticed to purchase products after a stylist demonstrates its effect by using it in the styling of the customer’s hair.

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Salon Concepts:

The Company’s salon concepts focus on providing high quality hair care services and professional products, primarily to the middle consumer market. The Company’s North American salon operations consist of 9,293 salons (including 2,187 franchise salons), operating under five concepts, each offering attractive and affordable hair care products and services in the United States, Canada and Puerto Rico. The Company’s International salon operations consist of 2,040 hair care salons, including 1,587 franchise salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. Under each concept below, the number of new salons expected to be opened within the upcoming fiscal year is discussed. In addition to these openings, the Company typically acquires several hundred salons each year. The number of acquired salons, and the concept under which the acquisitions will fall, vary based on the acquisition opportunities which develop throughout the year.

Salon Development

The table on the following pages set forth the number of system wide salons (company-owned and franchise) opened at the beginning and end of each of the last five years, as well as the number of salons opened, closed, relocated, converted and acquired during each of these periods.

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SALON LOCATION SUMMARY

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(1)          Canadian and Puerto Rican salons are included in the Regis Salons, Strip Center, MasterCuts and Trade Secret concepts and not included in the international salon totals.

(2)          Represents primarily the acquisition of franchise networks.

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In the preceding table, relocations represent a transfer of location by the same salon concept and conversions represent the transfer of one concept to another concept.

Regis Salons.   Regis Salons are primarily mall based, full service salons providing complete hair care and beauty services aimed at moderate to upscale, fashion conscious consumers. However, in recent years, the Company has begun to expand its Regis Salons into strip centers. As of June 30, 2006, 140 Regis Salons were located in strip centers. The customer mix at Regis Salons is approximately 75 percent women and both appointments and walk-in customers are common. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. Service revenues represent 83 percent of Regis Salons’ total revenues. The average ticket is approximately $35. Regis Salons compete in their existing markets primarily by emphasizing the high quality of the services provided. Included within the Regis Salons concept are various other trade names, including Carlton Hair, Vidal Sassoon, Jean Louis David (North America), Mia & Maxx Hair Studios, Hair by Stewarts and Heidi’s.

The average initial capital investment required for a new Regis Salon typically ranges from $180,000 to $205,000, excluding average opening inventory costs of approximately $12,000. Average annual salon revenues in a Regis Salon which has been open five years or more are approximately $430,000. During fiscal year 2007, the Company plans to open approximately 25 new Regis Salons.

MasterCuts.   MasterCuts is a full service, mall based salon group which focuses on the walk-in consumer (no appointment necessary) that demands moderately priced hair care services. MasterCuts salons emphasize quality hair care services, affordable prices and time saving services for the entire family. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. The customer mix at MasterCuts is split relatively evenly between men and women. Service revenues compose approximately 79 percent of total revenues for this salon concept. The average sale at MasterCuts salons is approximately $17.

The average initial capital investment required for a new MasterCuts salon typically ranges from $180,000 to $200,000, excluding average opening inventory costs of approximately $12,000. Average annual salon revenues in a MasterCuts salon which has been open five years or more are approximately $300,000. During fiscal year 2007, the Company plans to open approximately ten new MasterCuts salons.

Trade Secret.   Trade Secret salons are designed to emphasize the sale of hair care and beauty products in a retail setting while providing high quality hair care services. Trade Secret salons offer one of the most comprehensive assortments of hair and beauty products in the industry. Trade Secret’s retail selection consists of highly recognized brands, and the products carried change in tandem with changing trends. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. Trade Secret’s primary customer base includes the female head of the household shopping for her entire family, as well as singles shopping for their own beauty products and accessories. Trade Secret salons are primarily mall based; however, in recent years, the Company has begun to expand into strip centers. As of June 30, 2006, 81 company-owned Trade Secret salons were located in strip centers. The average ticket at Trade Secret is approximately $24.

The average initial capital investment required for a new Trade Secret salon typically ranges from $180,000 to $200,000, excluding average opening inventory costs of approximately $45,000. Average annual salon revenues in a Trade Secret salon which has been open five years or more are approximately $465,000. During fiscal year 2007, the Company plans to open approximately 21 new company-owned Trade Secret salons.

SmartStyle.   The SmartStyle salons share many operating characteristics of the Company’s other salon concepts; however, they are located exclusively in Wal-Mart Supercenters. SmartStyle has a walk-in customer base, pricing is promotional and services are focused on the family. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care

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products. In addition, professional retail product sales contribute solidly to overall revenues. The Company also has 164 franchise Cost Cutters salons located in Wal-Mart Supercenters.

Service revenues represent approximately 64 percent of SmartStyle’s total revenues. The average ticket at a SmartStyle salon is approximately $17.

The average initial capital investment required for a new SmartStyle salon typically ranges from $33,000 to $35,000, excluding average opening inventory costs of approximately $12,000. Average annual salon revenues in a SmartStyle salon which has been open five years or more are approximately $260,000. During fiscal year 2007, the Company plans to open approximately 215 new company-owned SmartStyle salons and approximately ten franchise salons in Wal-Mart Supercenters.

Strip Center Salons.   The Company’s Strip Center Salons are comprised of company-owned and franchise salons operating in strip centers across North America under the following concepts:

Supercuts.   The Supercuts concept provides consistent, high quality hair care services and professional products to its customers at convenient times and locations and at a reasonable price. This concept appeals to men, women and children, although male customers account for over 65 percent of total haircuts. Service revenues represent 84 percent of Supercuts’ total company-owned salon revenues. The average sale at a company-owned Supercuts salon is approximately $16.

The average initial capital investment required for a new Supercuts salon typically ranges from $90,000 to $105,000, excluding average opening inventory costs of approximately $7,000. Average annual salon revenues in a company-owned Supercuts salon which has been open five years or more are approximately $270,000. During fiscal year 2007, the Company plans to open approximately 55 new company-owned Supercuts salons, and anticipates that franchisees will open approximately 100 new franchise Supercuts salons.

Cost Cutters (franchise salons).   The Cost Cutters concept is a full service salon concept providing value priced hair care services for men, women and children. These full service salons also sell a complete line of professional hair care products. Franchise revenues from Cost Cutters salons are split relatively evenly between franchise revenues related to royalties and fees and those from product sales to franchisees. During fiscal year 2007, the Company anticipates that Cost Cutters franchisees will open approximately 60 new salons.

In addition to the franchise salons, the Company operates company-owned Cost Cutters salons, as discussed below under Promenade Salons.

Promenade Salons.   Promenade Salons are made up of successful regional company-owned salon groups acquired over the past several years operating under the primary concepts of Hair Masters, Style America, First Choice Haircutters, Best Cuts, Cost Cutters, BoRics, Magicuts, Holiday Hair and TGF, as well as other concept names. Most concepts offer a full range of custom hairstyling, cutting, coloring and waving, as well as hair care products. Hair Masters offers moderately-priced services to a predominately female demographic, while the other concepts primarily cater to time-pressed, value-oriented families. Service revenues represent 85 percent of total company-owned strip center revenues. The average sale for a company-owned strip center salon is approximately $17.

The average initial capital investment required for a new Promenade Salon within this group typically ranges from $75,000 to $90,000, excluding average opening inventory costs of approximately $7,000. Average annual salon revenues in a Promenade Salon which has been open five years or more are approximately $260,000. During fiscal year 2007, the Company plans to open approximately 70 new Promenade Salons.

Other Franchise Concepts.   This group of franchise salons includes primarily First Choice Haircutters, Magicuts and Pro-Cuts. These concepts function primarily in the high volume, value

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priced hair care market segment, with key selling features of value, convenience, quality and friendliness, as well as a complete line of professional hair care products. In addition to these franchise salons, the Company operates company-owned First Choice Haircutters and Magicuts salons, as previously discussed above under Promenade Salons. During fiscal year 2007, the Company anticipates that franchisees will open approximately 20 new franchise strip center salons.

International Salons.   The Company’s International Salons are comprised of company-owned and franchise salons operating in Europe primarily under the Jean Louis David, St. Algue, Supercuts, Regis, Trade Secret and Vidal Sassoon concepts. Nearly 80 percent of the 2,040 international salons are franchised under the Jean Louis David and St. Algue concepts. The International Regis, Trade Secret and Supercuts salons operated in the United Kingdom are company-owned. These salons offer similar levels of service as the North American salons previously mentioned. However, the initial capital investment required is typically £120,000 for a Regis Hairstylists salon, £50,000 for a Supercuts UK salon and £120,000 to £130,000 for an international Trade Secret salon. Average annual salon revenues for a salon which has been open five years or more are approximately £257,000 in a Regis Hairstylists salon, £185,000 in a Supercuts UK salon and £440,000 in an international Trade Secret salon. During fiscal year 2007, the Company plans to open approximately 25 new company-owned international salons, as well as approximately 80 new international franchise salons. Certain International salon concepts are further described below.

Vidal Sassoon.   The Company’s International Vidal Sassoon salons are located in the United Kingdom and Germany. Vidal Sassoon is one of the world’s most recognized names in hair fashion and appeals to women and men looking for a prestigious full service hair salon. Salons are usually located on prominent highstreet locations and offer a full range of custom hairstyling, cutting, coloring and waving, as well as professional hair care products. The initial capital investment required is typically over £400,000. The Company is exploring suitable locations for a potential new salon in fiscal year 2007. For a mature Vidal Sassoon salon, the average annual revenues are typically in excess of £550,000.

Jean Louis David (JLD).   These franchise salons offer full service hair care without an appointment. Salons are located in European cities, with populations of more than 20,000 in town centers, high-traffic areas and shopping centers. Jean Louis David salons are located in France, Italy, Spain, Poland, Belgium and Switzerland.

St. Algue.   This concept represents fashion forward, full service franchise salons known for creativity and an emphasis on personal style, and focusing on the walk-in customer. Salons are located in European cities with populations of more than 20,000 in town centers, high-traffic areas and shopping centers. Salons are located mainly in France, with some locations in Switzerland, Portugal and Poland.

Salon Franchising Program:

General.   The Company has various franchising programs supporting its 3,774 franchise salons as of June 30, 2006, consisting mainly of Supercuts, Cost Cutters, First Choice Haircutters, Magicuts, Pro Cuts, St. Algue and JLD. These salons have been included in the discussions regarding salon counts and concepts on the preceding pages.

The Company provides its franchisees with a comprehensive system of business training, stylist education, site approval and lease negotiation, professional marketing, promotion and advertising programs, and other forms of support designed to help the franchisee build a successful business.

Standards of Operations.   The Company does not control the day to day operations of its franchisees, including hiring and firing, establishing prices to charge for products and services, business hours,

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personnel management and capital expenditure decisions. However, the franchise agreements afford certain rights to the Company, such as the right to approve location, suppliers and the sale of a franchise. Additionally, franchisees are required to conform to company established operational policies and procedures relating to quality of service, training, design and decor of stores, and trademark usage. The Company’s field personnel make periodic visits to franchise stores to ensure that the stores are operating in conformity with the standards for each franchising program. All of the rights afforded the Company with regard to the franchise operations allow the Company to protect its brands, but do not allow the Company to control the franchise operations or make decisions that have a significant impact on the success of the franchise salons.

To further ensure conformity, the Company may enter into the lease for the store site directly with the landlord, and subsequently sublease the site to the franchisee. The franchise agreement and sublease provide the Company with the right to terminate the sublease and gain possession of the store if the franchisee fails to comply with the Company’s operational policies and procedures. See Note 6 of “Notes to Consolidated Financial Statements” for further information.

Franchise Terms.   Pursuant to their franchise agreement with the Company, each franchisee pays an initial fee for each store and ongoing royalties to the Company. In addition, for most franchise concepts, the Company collects advertising funds from franchisees and administers the funds on behalf of the concept. Franchisees are responsible for the costs of leasehold improvements, furniture, fixtures, equipment, supplies, inventory and certain other items, including initial working capital.

Additional information regarding each of the major franchisee brands is listed below:

Supercuts (North America)

The majority of existing Supercuts franchise agreements have a perpetual term, subject to termination of the underlying lease agreement or termination of the franchise agreement by either the Company or the franchisee. The agreements also provide the Company a right of first refusal if the store is to be sold. The franchisee must obtain the Company’s approval in all instances where there is a sale of the franchise. The current franchise agreement is site specific and does not provide any territorial protection to a franchisee, although some older franchise agreements do include limited territorial protection. During fiscal year 2001, the Company began selling development agreements for new markets which include limited territory protection for the Supercuts concept. The Company has a comprehensive impact policy that resolves potential conflicts among franchisees and/or the Company regarding proposed salon sites.

Cost Cutters, First Choice Haircutters and Magicuts (North America)

The majority of existing Cost Cutters’ franchise agreements have a 15 year term with a 15 year option to renew (at the option of the franchisee), while the majority of First Choice Haircutters’ franchise agreements have a ten year term with a five year option to renew. The majority of Magicuts’ franchise agreements have a term equal to the greater of five years or the current initial term of the lease agreement with an option to renew for two additional five year periods. All of the agreements also provide the Company a right of first refusal if the store is to be sold. The franchisee must obtain the Company’s approval in all instances where there is a sale of the franchise. The current franchise agreement is site specific. Franchisees may enter into development agreements with the Company which provide limited territorial protection.

Pro Cuts (North America)

The majority of existing Pro Cuts franchise agreements have a ten year term with a ten year option to renew. The agreements also provide the Company a right of first refusal if the store is to be

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sold or transferred. The current franchise agreement is site specific. Franchisees may enter into development agreements with the Company which provide limited territorial protection.

St. Algue and JLD (International)

St. Algue was purchased in connection with the acquisition of the French franchisor, GGG. The majority of St. Algue’s franchise contracts have a five year term with an implied option to renew for a term of three years. All new JLD contracts have five year terms. The franchise agreements for both St. Algue and JLD are site specific and only a small minority of the contracts provide for territorial exclusivity. The agreements provide for the right of first refusal during the period covered by the franchise contract if the salon is to be sold and the franchisee must obtain the Company’s approval before selling of the salon. With regards to the store site, neither St. Algue nor JLD acts as lessor for their franchisees. Additionally, JLD franchise contracts prohibit the franchisee from selling the salon to another major national competitor for one year after the contract term ends.

Franchisee Training.   The Company provides new franchisees with training, focusing on the various aspects of store management, including operations, personnel management, marketing fundamentals and financial controls. Existing franchisees receive training, counseling and information from the Company on a continuous basis. The Company provides store managers and stylists with extensive technical training for Supercuts franchises. For further description of the Company’s education and training programs, see the “Salon Education and Training Programs” section of this document.

Salon Markets and Marketing:

The Company maintains various advertising, sales and promotion programs for its salons, budgeting a predetermined percent of revenues for such programs. The Company has developed promotional tactics and institutional sales messages for each of its concepts targeting certain customer types and positioning each concept in the marketplace. Print, radio, television and billboard advertising are developed and supervised at the Company’s headquarters, but most advertising is done in the immediate market of the particular salon.

Most franchise concepts maintain separate Advertising Funds (the Funds), managed by the Company, that provide comprehensive advertising and sales promotion support for each system. All stores, company-owned and franchise, contribute to the Funds, the majority of which are allocated to the contributing market for media placement and local marketing activities. The remainder is allocated for the creation of national advertising campaigns and system wide activities. This intensive advertising program creates significant consumer awareness, a strong concept image and high loyalty.

Salon Education and Training Programs:

The Company has an extensive hands-on training program for its stylists which emphasizes both technical training in hairstyling and cutting, hair coloring, waving and hair treatment regimes as well as customer service and product sales. The objective of the training programs is to ensure that customers receive a professional and quality service, which the Company believes will result in more repeat customers, referrals and product sales.

The Company has full- and part-time artistic directors who train the stylists in techniques for providing the salon services and instruct the stylists in current styling trends. Stylist training is achieved through seminars, workshops and DVD based programs. The Company was the first in its industry to develop a DVD based training system in its salons and currently has over 50 DVDs designed to enhance technical skills of stylists.

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The Company has a customer service training program to improve the interaction between employees and customers. Staff members are trained in the proper techniques of customer greeting, telephone courtesy and professional behavior through a series of professionally designed video tapes and instructional seminars.

The Company also provides regulatory compliance training for all its field employees. This training is designed to help supervisors and stylists understand employee regulatory requirements and compliance with these standards.

Salon Staff Recruiting and Retention:

Recruiting quality managers and stylists is essential to the establishment and operation of successful salons. In search of salon managers, the Company’s supervisory team recruits or develops and promotes from within those stylists that display initiative and commitment. The Company has been and believes it will continue to be successful in recruiting capable managers and stylists. The Company believes that its compensation structure for salon managers and stylists is competitive within the industry. Stylists benefit from the Company’s high-traffic locations and receive a steady source of new business from walk-in customers. In addition, the Company offers a career path with the opportunity to move into managerial and training positions within the Company.

Salon Design:

The Company’s salons are designed, built and operated in accordance with uniform standards and practices developed by the Company based on its experience. Salon fixtures and equipment are generally uniform, allowing the Company to place large orders for these items with cost savings due to the economies of scale.

The size of the Company’s salons ranges from 500 to 5,000 square feet, with the typical salon having about 1,200 square feet. At present, the cost to the Company of normal tenant improvements and furnishing of a new salon, including inventories, ranges from approximately $25,000 to $210,000, depending on the size of the salon and the concept. Less than ten percent of all new salons fall within a higher bracket and will cost between $200,000 and $400,000 to furnish. Of the total leasehold costs, approximately 70 percent of the cost is for leasehold improvements and the balance is for salon fixtures, equipment and inventories.

The Company maintains its own design and real estate department, which designs and supervises the leasehold installations, furnishing and fixturing of all new company-owned salons and certain franchise locations. The Company has developed considerable expertise in designing salons. The design and real estate staff focuses on visual appeal, efficient use of space, cost and rapid completion times.

Salon Management Information Systems:

At all of its company-owned salons, the Company utilizes a point-of-sale (POS) information system to collect daily sales information. Salon employees deposit cash receipts into a local bank account on a daily basis. The POS system sends the amount expected to be deposited to the corporate office, where the amount is reconciled daily with local deposits transferred into a centralized corporate bank account. The salon POS information is consolidated into several management systems maintained at the corporate office. The information is also used to generate payroll information, monitor salon performance, manage salon staffing and payroll costs, and generates customer data to identify and anticipate industry pricing and staffing trends. The corporate information systems deliver online information of product sales to improve its inventory control system, including recommendations for each salon of monthly product replenishments.

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Management believes that its information systems provide the Company with operational efficiencies as well as advantages in planning and analysis which are generally not available to competitors. The Company continually reviews and improves its Information Systems to ensure systems and processes are kept up to date and that they will meet the growing needs of the Company. The goal of Information Systems is to maximize the overall value to the business while improving the output per dollar spent by implementing cost-effective solutions and services.

Salon Competition:

The hair care industry is highly fragmented and competitive. In every area in which the Company has a salon, there are competitors offering similar hair care services and products at similar prices. The Company faces competition within malls from companies which operate salons within department stores and from smaller chains of salons, independently owned salons and, to a lesser extent, salons which, although independently owned, are operating under franchises from a franchising company that may assist such salons in areas of training, marketing and advertising.

Significant entry barriers exist for chains to expand nationally due to the need to establish systems and infrastructure, recruitment of experienced hair care management and adequate store staff, and leasing of quality sites. The principal factors of competition in the affordable hair care category are quality, consistency and convenience. The Company continually strives to improve its performance in each of these areas and to create additional points of differentiation versus the competition. In order to obtain locations in shopping malls, the Company must be competitive as to rentals and other customary tenant obligations.

Beauty School Business Strategy:

Operating beauty schools is complementary to the salon business as it allows the Company to attract, train and retain valuable employees. The Company expects to open and acquire additional beauty schools in the future in order to take advantage of this opportunity, although we expect to moderate our acquisition activity in fiscal year 2007. The principle activity of the beauty schools is the teaching of beauticians to prepare for their licensing. The activities also include clinic and school sales of products to students and customers and other miscellaneous sales. Subjects available for enrollment include cosmetology, nail art and esthetic programs. Most schools are certified by the U.S. Department of Education (ED) for participation in Federal Title IV Student Financial Assistance Programs. As of June 30, 2006, the Company operated 49 such facilities. The for-profit beauty school industry represents approximately 1,000 schools generating an estimated $1 billion annually. Given the attractive unit economics and the fact that Regis Corporation is the largest employer of beauty school graduates, the Company seeks to be the largest operator of beauty schools.

Following is a summary of the Company’s beauty school locations:

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Beauty School Growth Opportunities.   During fiscal year 2007, the Company expects to moderate its acquisitions activity. However, in the long-term, the Company will continue to evaluate acquisition targets. In addition, the Company is considering plans to supplement acquisition growth with new school construction as permitted by the Department of Education (ED).

Beauty School Organic Growth.   Initially, organic growth from beauty schools will come primarily from increases in enrollment and tuition increases. Longer-term, organic growth will be supplemented with new school construction.

Given the recent trends in the domestic unemployment rate, the Company believes that the post-secondary education market will remain attractive for the foreseeable future. Additionally, the Company believes students will be attracted to its schools for reasons unique to Regis Corporation. Given its long history of educating stylists, the Company seeks to improve curriculum and training techniques in its schools. Also, as the largest employer in the beauty industry, the Company believes these schools may provide a continuous pipeline of strong job applicants upon graduation.

Beauty School Acquisition Growth.   To date, the Company has acquired all 54 beauty schools that it currently operates. The Company’s first beauty school acquisition was part of the fiscal year 2003 acquisition of Vidal Sassoon which included five beauty schools. In June 2004, the Company acquired six Blaine Beauty Career Schools operating in the Massachusetts market. During fiscal year 2005, the Company acquired 13 schools in four transactions; these included, five Pierre’s School of Cosmetology in Maine, four Natural Motion Member Schools in New Jersey, three Scot Lewis schools in Minnesota and one Arthur Angelo School in Rhode Island. Finally, the Company acquired 30 beauty schools in five transactions during fiscal year 2006 as follows; five Martin’s Schools in Wisconsin, six Hair Design Schools in Kentucky, three Chic Schools of Cosmetology in Michigan, 15 Artistic Schools in Arizona and Colorado, and one Warwick Academy of Beauty Culture in Rhode Island.

The beauty school industry is highly-fragmented and dominated by small, independent operators. For this reason, the Company believes numerous acquisition candidates remain.

Title IV Eligible Beauty Schools

During fiscal year 2004, the Company purchased its first Title IV eligible beauty schools and, as indicated above, purchased additional schools in fiscal year 2005 and 2006. While the majority of the Company’s beauty schools are Title IV eligible, Vidal Sassoon Academies are not and, therefore, the discussions of accreditation and licensing, financing student education and regulation below do not apply to Vidal Sassoon Academies.

Accreditation and Licensing

The Company’s beauty schools are subject to numerous regulations including oversight, approvals and licensing by the ED, accrediting agencies, state education bodies and program specific agencies. The ED authorizes legislation regarding student loans, grants and other funding. In addition, the ED approves accrediting agencies and conducts periodic compliance reviews of institutions. Accrediting agencies verify that institutions meet specific standards established by the respective agency including completion and placement rates. State education bodies approve institutions eligibility to operate in their state, process student complaints and provide oversight concerning state education regulations.

The beauty schools are accredited through accreditation associations recognized by the ED. Accreditation by an accrediting body recognized by the ED is necessary for a school to be eligible to participate in federally sponsored financial aid programs.

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Financing Student Education

Most students attending the beauty schools utilize federal government grants and/or the Federal Family Education Loan programs available under the Higher Education Act of 1965 (HEA), and various programs administered thereunder to finance their tuition. Currently, each beauty school is an eligible institution for some or all of the following federally funded programs: Federal Pell Grant (Pell), Federal Supplemental Education Opportunity Grant (SEOG), Federal Perkins Loan, Federal Parent Loan for Undergraduate Students (PLUS), Federal Subsidized Stafford Loan, Federal Unsubsidized Stafford Loan, and Veterans benefits. Also, some students are eligible for assistance under the Department of Labor’s Workforce Investment Act. State grants are sometimes offered to students enrolled in educational programs of the type offered by the Company’s schools. However, many restrictions typically apply in qualifying and maintaining eligibility for participation in these state programs.

Regulation

Both federal and state financial aid programs contain numerous and complex regulations which require compliance not only by the recipient student but also by the institution which the student attends. The Company monitors compliance through periodic visits to the individual beauty schools by Home Office staff, external auditors and outsourced internal audit. Failure to materially comply with such regulations at any of the Campuses could have serious consequences, including limitation, suspension, or termination of the eligibility of that Campus to participate in the funding programs. Additionally, these aid programs require accreditation by the schools.

Hair Restoration Business Strategy:

In December 2004, the Company acquired Hair Club for Men and Women (Hair Club), the largest U.S. provider of hair loss solutions and the only company offering a comprehensive menu of proven hair loss products and services. The Company leverages its strong brand, best-in-class service model and comprehensive menu of hair restoration alternatives to build an increasing base of repeat customers that generate recurring cash flow for the Company. From its traditional non-surgical hair replacement systems, to hair transplants, hair therapies and hair care products and services, Hair Club offers a solution for anyone experiencing or anticipating hair loss. The Company’s operations consist of 90 locations (42 franchise) in the United States and Canada. The domestic hair restoration market is estimated to generate over $4 billion annually. The competitive landscape is highly fragmented and comprised of approximately 4,000 locations. Hair Club and its franchisees have the largest market share, with approximately 5 percent based on customer count.

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In an effort to provide privacy to its customers, Hair Club offices are located primarily in office and professional buildings within larger metropolitan areas. Following is a summary of the company-owned and franchise hair restoration centers in operation at June 30, 2006 and 2005:

Hair Restoration Growth Opportunities.   The Company’s hair restoration center expansion strategy focuses on organic growth (successfully converting new leads into customers at existing centers, broadening the menu of services and products at each location and to a lesser extent, new center construction) and acquisition growth.

Organic Growth.   The hair restoration centers’ business model is driven by productive lead generation that ultimately produces recurring customers. The primary marketing vehicle is direct response television in the form of infomercials that create leads into the hair restoration centers’ telemarketing center. Call center employees receive calls and schedule a consultation at a local hair restoration company-owned or franchise center. At the consultation, sales consultants assess the needs of each individual client and educate them on the hair restoration centers’ suite of hair loss solutions.

The Company’s long term outlook for organic expansion remains strong due to several factors, including favorable industry dynamics, addressing new market opportunities, menu expansion, developing new locations and new cross marketing initiatives. The aging “baby boomer” population is expanding the number of individuals within the hair restoration centers’ target market. This group of individuals is entering their peak years of disposable income and has demonstrated a willingness to improve their physical appearance.

In 2003, Hair Club began marketing to women and changed its name to Hair Club for Men and Women. This represents a large and relatively untapped market. Women now represent approximately 50 percent of new customers.

Currently, all locations offer hair systems, hair therapy and hair care products. Among the hair restoration centers’ product offerings are hair transplants. The hair restoration centers employ a hub and spoke strategy for hair transplants. As of June 30, 2006, 13 locations were equipped and staffed to perform the procedure. Currently, a total of 30 hair restoration centers offer this service to their customers, as these persons will travel for this surgical procedure. The Company plans to add the capability to conduct hair transplants to more centers in future periods.

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The Company’s company-owned and franchise hair restoration centers are located in markets representing 72 percent of all U.S. television (TV) households. The Company’s hair restoration centers advertise on cable TV to over 93 million households, or 85 percent of the total U.S. TV households. There is an opportunity to add a limited number of new centers in under penetrated markets. Additionally, the Company is currently investigating international expansion opportunities.

Hair Restoration Acquisition Growth.   The Company plans to supplement organic growth with opportunistic acquisition activity. The hair restoration industry is comprised of a highly-fragmented group of 4,000 locations. This landscape provides an opportunity for consolidation. Given the existing coverage of Hair Club locations, it is anticipated that transactions may involve the acquisition of customer lists, rather than physical locations.

Corporate Trademarks:

The Company holds numerous trademarks, both in the United States and in many foreign countries. The most recognized trademarks are “Regis Salons,” “Supercuts,” “MasterCuts,” “Trade Secret,” “SmartStyle,” “Cost Cutters,” “Hair Masters,” “Jean Louis David,” “Saint Algue,” “First Choice Haircutters,” “Magicuts” and “Hair Club for Men and Women.”

“Vidal Sassoon” is a registered trademark of Procter & Gamble. The Company has a license agreement to use the Vidal Sassoon name for existing salons and academies, and new salon development.

Although the Company believes the use of these trademarks is an element in establishing and maintaining its reputation as a national operator of high quality hairstyling salons, and is committed to protecting these trademarks by vigorously challenging any unauthorized use, the Company’s success and continuing growth are the result of the quality of its salon location selections and real estate strategies.

Corporate Employees:

During fiscal year 2006, the Company had approximately 59,000 full- and part-time employees worldwide, of which an approximately 52,000 employees were located in the United States. None of the Company’s employees are subject to a collective bargaining agreement and the Company believes that its employee relations are amicable.

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Executive Officers:

Information relating to Executive Officers of the Company follows:

Myron Kunin served as Chairman of the Board of Directors of the Company from 1983 to 2004, as Chief Executive Officer of the Company from 1965 until July 1, 1996, as President of the Company from 1965 to 1987 and as a director of the Company since its formation in 1954. Concurrent with his resignation as Chairman of the Board of Directors in 2004, he was elected Vice Chairman. He is also Chairman of the Board and holder of the majority voting power of Curtis Squire, Inc., a 2.4 percent shareholder. Further, he is a director of Nortech Systems Incorporated.

Paul D. Finkelstein has served as President, Chief Operating Officer and as a director of the Company since December 1987, as Executive Vice President of the Company from June 1987 to December 1987 and has served as Chief Executive Officer since July 1, 1996. During 2004, he was elected Chairman of the Board of Directors.

Randy L. Pearce was elected Senior Executive Vice President in 2006, and served as Executive Vice President from 1999 to 2006. During fiscal year 2006, he was also elected Director and Audit Committee Chair of Dress Barn, Inc., which operates a chain of women’s apparel specialty stores. He has served as Chief Administrative Officer since 1999 and as Chief Financial Officer since 1998. Additionally, he was Senior Vice President, Finance from 1998 to 1999, Vice President of Finance from 1995 to 1997 and Vice President of Financial Reporting from 1991 to 1994.

Eric A. Bakken oversees the Company’s legal affairs and acts as corporate secretary. He joined the Company in 1994 as a lawyer, becoming Vice President, Law in 1998, and General Counsel in 2004. During 2006, he was promoted to Senior Vice President, Law.

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Melissa Boughton has served as Senior Vice President of Real Estate since December 2002, and has been in the shopping center industry for over 20 years. Prior to joining the Company, she served as Vice President of Real Estate at Best Buy, Inc.

Bruce Johnson was elected a Senior Vice President of Design and Construction in 1997 and has served as Vice President from 1988 to 1997.

Mark Kartarik has served as Senior Vice President of Regis Corporation since 1994 and as Vice President from 1989 to 1994. He was elected President of Supercuts, Inc. in 1998 and served as Chief Operating Officer of Supercuts, Inc. from 1997 to April 2001.

Gordon Nelson has served as Senior Vice President, Fashion, Education and Marketing of the Company since 1994 and as Vice President from 1989 to 1994. During 2006, he was promoted to Executive Vice President, Fashion, Eduction and Marketing.

Kris Bergly was elected Executive Vice President of Regis Salons, Promenade Salon Concepts and MasterCuts, as well as Chief Operating Officer of Regis Salons. He has served as Chief Operating Officer of Promenade Salon Concepts since April 1998 and of MasterCuts since June 2005, as well as Vice President of Salon Operations from 1993 to 1998.

C. John Briggs was elected Chief Operating Officer, SmartStyle in March 1999 and Senior Vice President in July 2006. He served as Vice President, Regis Operations since 1988.

Norma Knudsen was elected Chief Operating Officer, Trade Secret in February 1999 and Senior Vice President, Trade Secret Operations in July 2006. She served as Vice President, Trade Secret Operations since 1995.

Andrew Cohen was elected Chief Operating Officer, International in April 2002 and has served as Vice President, Salon Operations since 1998.

Raymond Duke was elected Senior Vice President, International Managing Director, U.K. in February, 1999 and has served as Vice President since 1992.

Fraser Clarke has served as President and Chief Executive Officer, Hair Club for Men and Women since 2005 and as Chief Operating and Financial Officer from 2002 to 2004. Mr. Clarke is a Chartered Accountant and Chartered Financial Analyst.

Darryll Porter has served as Chief Operating and Financial Officer, Hair Club for Men and Women since 2005 and as Chief Financial Officer from 2000 to 2002. From 2003 to 2004 he served as Chief Financial Officer for a national staffing company.

Corporate Community Involvement:

Many of the Company’s stylists volunteer their time to support charitable events for breast cancer research. Proceeds collected from such events are distributed through the Regis Foundation for Breast Cancer Research. The Company’s community involvement also includes a major sponsorship role for the Susan G. Komen Twin Cities Race for the Cure. This 5K run and one mile walk is held in Minneapolis, Minnesota on Mother’s Day to help fund breast cancer research, education, screening and treatment. Through its community involvement efforts, the Company has helped raise millions of dollars in fundraising for breast cancer research.

Governmental Regulations:

The Company is subject to various federal, state, local and provincial laws affecting its business as well as a variety of regulatory provisions relating to the conduct of its beauty related business, including health and safety.

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In the United States, the Company’s franchise operations are subject to the Federal Trade Commission’s Trade Regulation Rule on Franchising (the FTC Rule) and by state laws and administrative regulations that regulate various aspects of franchise operations and sales. The Company’s franchises are offered to franchisees by means of an offering circular/disclosure document containing specified disclosures in accordance with the FTC Rule and the laws and regulations of certain states. The Company has registered its offering of franchises with the regulatory authorities of those states in which it offers franchises and in which such registration is required. State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states and, in certain cases, apply substantive standards to this relationship. Such laws may, for example, require that the franchisor deal with the franchisee in good faith, may prohibit interference with the right of free association among franchisees, and may limit termination of franchisees without payment of reasonable compensation. The Company believes that the current trend is for government regulation of franchising to increase over time. However, such laws have not had, and the Company does not expect such laws to have, a significant effect on the Company’s operations.

In Canada, the Company’s franchise operations are subject to both the Alberta Franchise Act and the Ontario Franchise Act. The offering of franchises in Canada occurs by way of a disclosure document, which contains certain disclosures required by the Ontario and Alberta Franchise Acts. Both the Ontario and Alberta Franchise Acts primarily focus on disclosure requirements, although each requires certain relationship requirements such as a duty of fair dealing and the right of franchisees to associate and organize with other franchisees.

Governmental regulations surrounding franchise operations in Europe are similar to those in the United States. The Company believes it is operating in substantial compliance with applicable laws and regulations governing all of its operations.

Beauty schools derive a significant portion of their revenue from student financial assistance originating from the U.S. Department of Education’s Title IV Higher Education Act of 1965. For the students to receive financial assistance at the school, the beauty schools must maintain eligibility requirements established by the U.S. ED. The Company thoroughly researches each potential acquisition to ensure they remain in good standing with the U.S. Department of Education. The Company believes all of its existing schools are compliant.

(d) Financial Information about Foreign and North American Operations

Financial information about foreign and North American markets is incorporated herein by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 and segment information in Note 11 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

(e) Available Information

The Company is subject to the informational requirements of the Securities and Exchange Act of 1934 (Exchange Act). The Company therefore files periodic reports, proxy statements and other information with the Securities and Exchange Commission (SEC). Such reports may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street NW, Washington, D.C. 20549, or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

Financial and other information can be accessed in the Investor Information section of the Company’s website at www.regiscorp.com. The Company makes available, free of charge, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those

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reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC.

Item 1A.                  Risk Factors

Impact of Acquisition and Real Estate Availability

The key driver of our revenue and earnings growth is the number of salons we acquire or construct. While we believe that substantial future acquisition and organic growth opportunities exist, any inability to identify and successfully complete future acquisitions or increase our same-store sales would have a material adverse effect on our revenue and earnings growth.

Impact of the Economic Environment

Changes to the United States, Canadian, United Kingdom and other European economies have an impact on our business. Visitation patterns to our salons and hair restoration centers can be adversely impacted by changes in unemployment rates and discretionary income levels.

Impact of Key Relationships

We maintain key relationships with certain companies, including Wal-Mart. Termination or modification of any of these relationships could have an adverse impact on our ability to grow or future operating results.

Impact of Fashion

Changes in consumer tastes and fashion trends can have an impact on our financial performance.

Impact of Changes in Regulatory and Statutory Laws

With more than 11,000 locations and approximately 59,000 employees world wide, our financial results can be adversely impacted by regulatory or statutory changes in laws.

Impact of Competition

Competition on a market by market basis remains strong. Therefore, our ability to raise prices in certain markets can be adversely impacted by this competition.

Impact of Changes in Manufacturers’ Choice of Distribution Channels

The retail products that we sell are licensed to be carried exclusively by professional salons. Should the various product manufacturers decide to utilize other distribution channels, such as large discount retailers, it could negatively impact the revenue earned from product sales.

Impact of Changes to Interest Rates and Foreign Currency Exchange Rates

Changes in interest rates will have an impact on our expected results from operations. Currently, we manage the risk related to fluctuations in interest rates through the use of variable rate debt instruments and other financial instruments. See discussion in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” for additional information.

Changes in foreign currency exchange rates will have an impact on our reported results from operations. The majority of the revenue and costs associated with the performance of our foreign operations are denominated in local currencies such as the Canadian dollar, Euro and British pound. Therefore, we do not have significant foreign currency transaction risk; however, the translation at different exchange rates from period to period may impact the amount of reported income from our

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international operations. Refer to the constant currency discussion within Management’s Discussion and Analysis in the Item 7 for a detailed analysis.

Impact of Seasonality

Our business is not subject to substantial seasonal variations in demand. However, the timing of Easter may cause a quarterly variation in the third and fourth quarters. Historically, our revenue and net earnings have generally been realized evenly throughout the fiscal year. The service and retail product revenues associated with our company-owned salons, as well as our franchise revenues, are of a replenishment nature. We estimate that customer visitation patterns are generally consistent throughout the year.

Product diversion could have a material adverse impact on our product revenues.

The retail products that we sell are meant to be sold exclusively by professional salons. However, incidents of product diversion occur. Diversion involves the selling of salon exclusive hair care products to discount retailers, and the diverted product is often old, tainted or damaged. Diversion could result in adverse publicity that harms the commercial prospects of our products, as well as lower product revenues should consumers choose to purchase diverted product from discount retailers rather than purchasing from one of our salons.

The results of operations from our hair restoration centers may be adversely affected if we are unable to anticipate and adapt to rapidly changing technology.

The hair loss industry, including surgical procedures, is characterized by rapidly changing technology. The introduction of new technologies and products could render our current product and service selection obsolete or unmarketable. We must continually anticipate the emergence of, and adapt our products and services to, new technologies.

Failure to comply with extensive regulations could have a material adverse effect on our beauty school business and failure of our beauty school campuses to comply with extensive regulations could result in financial penalties, loss or suspension of federal funding.

A number of our beauty schools’ students pay tuition and other fees with funds received through student assistance financial aid programs under Title IV of The Higher Education Act (HEA). To participate in such programs, an institution must obtain and maintain authorization by the appropriate state agencies, accreditation by an accrediting agency recognized by the ED, and certification by the ED. As a result, our beauty schools are subject to extensive regulation by these agencies. These regulatory agencies periodically revise their requirements and modify their interpretations of existing requirements. If one or more of our beauty schools were to violate any of these regulatory requirements, the regulatory agencies could place limitations on or terminate such beauty schools’ receipt of federal student financial aid funds, which could have a material adverse effect on our beauty school business, results of operations or financial condition.

Item 1B.                  Unresolved Staff Comments

None.

Item 2.                          Properties

The Company’s corporate offices are headquartered in a 170,000 square foot, three building complex in Edina, Minnesota owned by the Company. On May 2, 2005, the Company entered into a ten year operating lease agreement for a 102,448 square foot building, also located in Edina. The Company began

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to expand into this fourth building during the latter half of fiscal year 2006. This new lease agreement includes an option to purchase the property or extend the original term for two successive periods of five years. The Company also operates small offices in Toronto, Canada, Coventry and London, England, Paris, France and Boca Raton, Florida. These offices are occupied under long-term leases.

The Company owns distribution centers located in Chattanooga, Tennessee and Salt Lake City, Utah. The Chattanooga facility currently utilizes 250,000 square feet while the Salt Lake City facility utilizes 210,000 square feet. The Salt Lake City facility was originally leased, but was purchased by the Company during the fourth quarter of fiscal year 2003. The Salt Lake City facility may be expanded to 290,000 square feet to accommodate future growth.

The Company operates all of its salon locations under leases or license agreements. Substantially all of its North American locations in regional malls are operating under leases with an original term of at least ten years. Salons operating within strip centers and Wal-Mart Supercenters have leases with original terms of at least five years, generally with the ability to renew, at the Company’s option, for one or more additional five year periods. Salons operating within department stores in Canada and Europe operate under license agreements, while freestanding or shopping center locations in those countries have real property leases comparable to the Company’s domestic locations.

The Company also leases the premises in which certain franchisees operate and has entered into corresponding sublease arrangements with the franchisees. These leases have a five year initial term and one or more five year renewal options. All lease costs are passed through to the franchisees. Remaining franchisees, who do not enter into sublease arrangements with the Company, negotiate and enter into leases on their own behalf.

None of the Company’s salon leases is individually material to the operations of the Company, and the Company expects that it will be able to renew its leases on satisfactory terms as they expire. See Note 6 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Item 3.                          Legal Proceedings

The Company is a defendant in various lawsuits and claims arising out of the normal course of business. Like certain other large retail employers, the Company has been faced with allegations of purported class-wide wage and hour violations. Litigation is inherently unpredictable and the outcome of these matters cannot presently be determined. Although company counsel believes that the Company has valid defenses in these matters, it could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on its results of operations in any particular period. In June, 2006, without admitting any liability, the Company settled the collective action lawsuit in which violations of the Fair Labor Standards Act (FLSA) were alleged.

Item 4.                          Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5.                          Market for the Registrant’s Common Equity and Related Stockholder Matters

(a)          Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters

Regis common stock is listed and traded on the New York Stock Exchange under the symbol “RGS.”

The accompanying table sets forth the high and low closing bid quotations for each quarter during the previous two fiscal years as reported by the New York Stock Exchange (under the symbol “RGS”). The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.

As of August 24, 2006, Regis shares were owned by approximately 20,500 shareholders based on the number of record holders and an estimate of individual participants in security position listings. The common stock price was $34.63 per share on August 24, 2006.

The Company paid quarterly dividends of $0.04 per share in fiscal years 2006 and 2005. The Company expects to continue paying regular quarterly dividends for the foreseeable future.

(c)           Share Repurchase Program

In May 2000, the Company’s Board of Directors (BOD) approved a stock repurchase program. Originally, the program allowed up to $50.0 million to be expended for the repurchase of the Company’s stock. The BOD elected to increase this maximum to $100.0 million in August 2003, and then to $200.0 million on May 3, 2005. The timing and amounts of any repurchases will depend on many factors, including the market price of the common stock and overall market conditions. The repurchases to date have been made primarily to eliminate the dilutive effect of shares issued in conjunction with acquisitions, restricted stock grants and stock option exercises. As of June 30, 2006, 2005, and 2004, a total accumulated 3.0, 2.4, and 1.8 million shares have been repurchased for $96.8, $76.5 and $53.4 million, respectively. All repurchased shares are immediately retired. This repurchase program has no stated expiration date.

Repurchases of the Company’s common stock during the quarter ended June 30, 2006 were primarily part of this repurchase program. In addition, 9,480 shares of restricted stock were withheld during May 2006 to pay taxes due upon the vesting of that restricted stock. These shares are included within the total number of shares purchased and the average price paid per share in the table below, which shows the monthly, fourth quarter fiscal year 2006 stock repurchase activity:

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Item 6.                          Selected Financial Data

The following table sets forth, in thousands (except per share data), for the periods indicated, selected financial data derived from the Company’s Consolidated Financial Statements in Item 8.

(a)          Revenues from salons, schools or hair restorations centers acquired each year were $165.7, $181.2, $122.3, $152.9 and $46.8 million during fiscal years 2006, 2005, 2004, 2003 and 2002, respectively.

(b)          The following significant items affected both operating and net income:

·       An impairment charge of $4.3 million ($2.8 million net of tax) related to a cost method investment was recorded in fiscal year 2006. An impairment charge of $38.3 million ($38.3 million net of tax) related to goodwill associated with the Company’s European business was recorded in fiscal year 2005.

·       A net settlement gain of $33.7 million ($21.7 million net of tax) was recognized during fiscal year 2006 stemming from a termination fee collected from Alberto-Culver Company due to the terminated Merger Agreement for Sally Beauty Company. The termination fee gain is net of direct transaction related expenses associated with terminated Merger Agreement.

·       Charges of $8.4 ($5.4 net of tax), $3.6 ($2.4 net of tax), $3.2 ($2.0 net of tax), $3.1 ($2.0 net of tax), and $1.3 ($0.8 net of tax) million related to the impairment of property and equipment at underperforming locations were recorded during fiscal years 2006, 2005, 2004, 2003 and 2002, respectively.

·       A $6.5 million ($4.2 million net of tax) charge associated with disposal charges and lease termination fees related to the closure of salons other than in the normal course of business was recorded in fiscal 2006.

·       Fiscal year 2006 includes a $2.8 million ($1.8 million net of tax) charge related to the settlement of a wage and hour lawsuit under the Fair Labor Standards Act (FLSA). Fiscal year 2003 includes a $3.2 million ($2.0 net of tax) charge related to the settlement of an Equal Employment Opportunity Commission (EEOC).

c)                Effective July 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), as amended, using the prospective transition method. Effective July 1, 2005, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), using the modified prospective method of application. Total compensation cost for stock-based payment arrangements totaled $4.9, $1.2 and $0.2 million ($4.1, $0.8 and $0.1 million after tax) during fiscal years 2006, 2005 and 2004, respectively. Prior to the adoptions of these Statements, no compensation cost for stock-based payment arrangements was recognized in earnings. Refer to Note 1 to the Consolidated Financial Statements for further discussion.

d)               An income tax benefit related to the implementation of certain tax strategies increased reported net income by approximately $1.8 million in fiscal year 2002. The majority of the nonrecurring benefit was realized through the amendment of previous tax filings.

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Item 7.                          Management’s Discussion and Analysis of Financial Condition and Results of Operation

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in 5 sections:

·       Management’s Overview

·       Critical Accounting Policies

·       Overview of Fiscal Year 2006 Results

·       Results of Operations

·       Liquidity and Capital Resources

MANAGEMENT’S OVERVIEW

Regis Corporation (RGS) owns or franchises beauty salons, hair restoration centers and educational establishments. As of June 30, 2006, our worldwide operations included 11,333 system wide North American and international salons, 90 hair restoration centers and 54 beauty schools. Each of our salon concepts offer generally similar products and services and serves mass market consumers. Our salon operations are organized to be managed based on geographical location. Our North American salon operations include 9,293 salons, including 2,187 franchise salons, operating in the United States, Canada and Puerto Rico primarily under the trade names of Regis Salons, MasterCuts, Trade Secret, SmartStyle, Supercuts and Cost Cutters. Our international salon operations include 2,040 salons, including 1,587 franchise salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. In December 2004, we purchased Hair Club for Men and Women. This enterprise includes 90 North American locations, including 42 franchise locations. Our beauty schools are managed in aggregate, regardless of geographical location, and include 50 locations in the United States and four locations in the United Kingdom. During fiscal year 2006, we had approximately 59,000 corporate employees worldwide.

Our growth strategy consists of two primary, but flexible, components. Through a combination of organic and acquisition growth, we seek to achieve our long-term objective of eight to 12 percent annual revenue growth. We anticipate that going forward, the mix of organic and acquisition growth will be roughly equal. However, depending on several factors, including the ability of our salon development program to keep pace with the availability of real estate for new construction, student enrollment, hair restoration lead generation, the availability of attractive acquisition candidates and same-store sales trends, this mix will vary from year to year. We believe achieving revenue growth of eight to 12 percent, including same-store sales increases in excess of two percent, will allow us to increase annual earnings at a low-double-digit growth rate. We anticipate expanding our presence in both North America and Europe. Additionally, we desire to enter the Asian market within the next five years.

Maintaining financial flexibility is a key element in continuing our successful growth. With strong operating cash flow and balance sheet, we are confident that we will be able to financially support our long-term growth objectives.

Salon Business

The strength of our salon business is in the fundamental similarity and broad appeal of our salon concepts that allow flexibility and multiple salon concept placements in shopping centers and neighborhoods. Each concept generally targets the middle market customer, however, each attracts a different demographic. We anticipate expanding all of our salon concepts. In addition, we anticipate testing and developing new salon concepts to complement our existing concepts.

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We execute our salon growth strategy by focusing on real estate. Our salon real estate strategy is to add new units in convenient locations with good visibility and customer traffic, as well as appropriate trade demographics. Our various salon and product concepts operate in a wide range of retailing environments, including regional shopping malls, strip centers and Wal-Mart Supercenters. We believe that the availability of real estate will augment our ability to achieve the aforementioned long-term growth objectives. In fiscal 2007, although we have tempered our outlook for constructed salons to between 350 to 400 units, we still expect to add between 500 and 700 net locations through a combination of organic, acquisition and franchise growth. Our long-term outlook anticipates that we will add between 800 to 1,000 net locations each year through a combination of organic, acquisition and franchise growth.

Organic salon revenue growth is achieved through the combination of new salon construction and salon same-store sales increases. Each fiscal year, we anticipate building several hundred company-owned salons. We anticipate our franchisees will open several hundred salons as well. Older, unprofitable salons will be closed or relocated. Our long-term outlook for our salon business is for annual consolidated low single digit same-store sales increases. Based on current fashion and economic cycles (i.e., longer hairstyles and lengthening of customer visitation patterns), we project our annual fiscal year 2007 consolidated same-store sales increase to be one to two percent.

Historically, our salon acquisitions have varied in size from as small as one salon to over one thousand salons. The median acquisition size is approximately ten salons. From fiscal year 1994 to fiscal year 2006, we acquired 7,344 salons, net of franchise buybacks. We anticipate adding several hundred company-owned salons each year from acquisitions. Some of these acquisitions may include buying salons from our franchisees.

Hair Restoration Business

In December 2004, we acquired Hair Club for Men and Women. Hair Club for Men and Women is a provider of hair loss solutions with an estimated five percent share of the $4 billion domestic market. This industry is comprised of numerous locations domestically and is highly fragmented. As a result, we believe there is an opportunity to consolidate this industry through acquisition. Expanding the hair loss business organically and through acquisition would allow us to add incremental revenue which is neither dependent upon, nor dilutive to, our existing salon and school businesses.

Our organic growth plans for hair restoration include the construction of a modest number of new locations in untapped markets domestically and internationally. However, the success of our hair restoration business is not dependent on the same real estate criteria used for salon expansion. In an effort to provide confidentiality for our customers, hair restoration centers operate primarily in professional or medical office buildings. Further, the hair restoration business is more marketing intensive. As a result, organic growth at our hair restoration centers will be dependent on successfully generating new leads and converting them into hair restoration customers. Our growth expectations for our hair restoration business are not dependent on referral business from, or cross marketing with, our hair salon business, but these concepts will be evaluated closely for additional growth opportunities.

Beauty School Business

The beauty school business often participates in governmental programs designed to encourage education. We believe there is an opportunity to place graduates in our various salon concepts which may provide us with another competitive advantage. Similar to the salon and hair loss industries, the beauty school industry is highly fragmented. As a result, we believe there is an opportunity to consolidate this industry through acquisition. Capitalizing on these opportunities would allow us to add incremental revenue without cannibalizing our existing salon or hair restoration center businesses. During

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fiscal year 2007, we expect to moderate our acquisitions activity. However, in the long-term the Company will continue to evaluate acquisition targets.

The success of a beauty school location is not dependent on good visibility or strong customer traffic; however, access to parking and/or public transportation is important. The success of existing and newly constructed schools is dependent on effective marketing and recruiting to attract new enrollees.

CRITICAL ACCOUNTING POLICIES

The Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the Consolidated Financial Statements, we are required to make various judgments, estimates and assumptions that could have a significant impact on the results reported in the Consolidated Financial Statements. We base these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Changes in these estimates could have a material effect on our Consolidated Financial Statements.

Our significant accounting policies can be found in Note 1 to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. We believe the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations.

Goodwill

Goodwill is tested for impairment annually or at the time of a triggering event in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. We consider our various concepts to be reporting units when testing for goodwill impairment because that is where we believe goodwill resides. Fair values are estimated based on our best estimate of the expected present value of future cash flows and compared with the corresponding carrying value of the reporting unit, including goodwill. Our impairment review process is based on a discounted future cash flow approach that uses estimates of revenues for the reporting units, driven by assumed organic growth rates, estimated future gross margin and expense rates, as well as acquisition integration and maturation, and appropriate discount and tax rates. These estimates are consistent with the plans and estimates that are used to manage the underlying businesses. Charges for impairment of goodwill for a reporting unit may be incurred if the reporting unit fails to achieve its assumed revenue growth rates or assumed gross margin, or if interest rates increase significantly. Consistent with prior years, during the third quarter of fiscal year 2006, goodwill was tested for impairment in this manner. The net book value of our European business approximated its fair value because we recorded a partial impairment during fiscal year 2005, as described below. In addition, the net book value of our beauty schools approximates fair value since a significant number of those schools were acquired during the past 24 months. The fair value of the North American salons and hair restoration centers exceeded their carrying amounts. No impairment charges were recorded during fiscal year 2006.

During the quarter ending March 31, 2005 (our fiscal year 2005), we reduced our expectations for the European business based on recent growth trends. Based on the results of our third quarter fiscal year 2005 goodwill impairment testing, which factored in these revised growth trend expectations, we wrote down the carrying value of the European business to reflect its estimated fair value. As a result, we recorded a pre-tax, non-cash charge of $38.3 million during fiscal year 2005. Two of the most significant assumptions underlying the determination of fair value of goodwill for our European business are discount and tax rates. In connection with the measurement we performed during fiscal year 2005, a 100 basis point

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increase in the discount rate we used would have resulted in an impairment charge of approximately $42.1 million instead of $38.3 million, while a 100 basis point decrease in the discount rate would have resulted in an impairment charge of approximately $34.5 million. Additionally, a five percent increase in the tax rate would have resulted in an impairment charge of approximately $40.3 million instead of $38.3 million, while a five percent decrease in the tax rate would have resulted in an impairment charge of approximately $37.3 million.

Long-Lived Assets, Excluding Goodwill

We assess the impairment of long-lived assets annually or when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Our impairment analysis is performed on a salon by salon basis. 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 our use of the assets. Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying amount of the asset to the related total estimated future net cash flows. If an asset’s carrying value is not recoverable through those cash flows, the asset grouping is considered to be impaired. The impairment is measured by the difference between the assets’ carrying amount and their fair value, based on the best information available, including market prices or discounted cash flow analysis. During fiscal years 2006, 2005 and 2004, $8.4, $3.6 and $3.2 million of impairment was recorded within depreciation and amortization in the Consolidated Statement of Operations.

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 the ongoing maintenance and improvement of the assets, 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 us to realize material impairment charges.

Purchase Price Allocation

We make numerous acquisitions. The purchase prices are allocated to assets acquired, including identifiable intangible assets, and liabilities assumed based on their estimated fair values at the dates of acquisition. Fair value is estimated based on the amount for which the asset or liability could be bought or sold in a current transaction between willing parties. For our acquisitions, the majority of the purchase price that is not allocated to identifiable assets, or liabilities assumed, is accounted for as residual goodwill rather than identifiable intangible assets. This stems from the value associated with the walk-in customer base of the acquired salons, the value of which is not recorded as an identifiable intangible asset under current accounting guidance and the limited value of the acquired leased site and customer preference associated with the acquired hair salon brand. Residual goodwill further represents our opportunity to strategically combine the acquired business with our existing structure to serve a greater number of customers through our expansion strategies. Identifiable intangible assets purchased in fiscal year 2006, 2005 and 2004 acquisitions totaled $17.3, $136.2 and $15.0 million, respectively. The residual goodwill generated by fiscal year 2006, 2005 and 2004 acquisitions totaled $127.3, $219.7 and $79.5 million, respectively.

Revenue Recognition

Company-owned salon revenues, certain beauty school revenues and certain hair restoration center revenues that do not require us to perform any future services or deliver any future products are recorded at the time of sale. This accounting treatment results in revenue recognition at the time that services are provided or products are delivered and the customer’s payment is received. There are minimal accounting judgments and uncertainties affecting the application of this policy. Based on historical results, refunds to

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the customer represent less than one percent of total company-owned revenues. The vast majority of returns and refunds occur within a matter of days of the original sales transaction.

The majority of beauty school tuition payments are originally recorded as deferred revenues. The earnings process is culminated once we perform under the terms of the contract (i.e., instruct a class). Therefore, revenue is recognized proportionally based on actual or scheduled class hours. Based on this practice, little judgment is exercised related to recognizing beauty school tuition revenues. However, we must estimate our expected exposure to refunds and uncollectible accounts, which are recorded as a reduction to tuition revenues or charged to expense based on estimated amounts at the time of sale and at the time of occurrence of these events. A significant variance between expected and actual refunds could have a material impact on revenues disclosed in the Consolidated Financial Statements.

Payments for services performed under customer contracts covering a specified time span in the hair restoration centers are originally recorded as deferred revenues. The earnings process is culminated, and revenue is recognized, once we perform under the terms of the contract. Our policy is to recognize revenue on a straight-line basis over the course of a customer’s contract period, which could vary slightly from the actual timing of services performed under the contract.

Cost of Product Used and Sold

Product costs are determined by applying estimated gross profit margins to service and product revenues, which are based on historical factors including product pricing trends and estimated shrinkage. In addition, the estimated gross profit margin is adjusted based on the results of physical inventory counts performed at least twice a year and the monthly monitoring of factors that could impact our usage rates estimates. These factors include mix of service sales, discounting and special promotions. During fiscal year 2006, we performed physical inventory counts beginning in September, February and May, and adjusted our estimated gross profit margin to reflect the results of the observations. Significant changes in product costs, volumes or shrinkage could have a material impact on our gross margin.

Self-insurance Accruals

We use a combination of third party insurance and self-insurance for a number of risks including workers’ compensation, health insurance and general liability claims. The liability reflected on our Consolidated Balance Sheet represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. In estimating this liability, we utilize loss development factors prepared by independent third party actuaries. These development factors utilize historical data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claims settlements and reported claims. Although we do not expect the amounts ultimately paid to differ significantly from the estimates, self-insurance accruals could be affected if future claims experience differs significantly from the historical trends and actuarial assumptions. During fiscal year 2006, 2005 and 2004, our insurance costs were $37.6, $37.1 and $31.5 million, respectively.

Stock-based Compensation Expense

Compensation expense for stock-based compensation is estimated on the grant date using the lattice (binomial) option-pricing model. During fiscal years 2006, 2005 and 2004, stock-based compensation expense totaled $4.9, $1.2 and $0.2 million, respectively. Our specific weighted average assumptions for the risk free interest rate, expected term, expected volatility and expected dividend yield are documented in Note 1 to the Consolidated Financial Statements. Additionally, under SFAS No. 123R, we are required to estimate pre-vesting forfeitures for purposes of determining compensation expense to be recognized. Future expense amounts for any particular quarterly or annual period could be affected by changes in our assumptions or changes in market conditions.

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Contingencies

We are involved in various lawsuits and claims that arise from time to time in the ordinary course of our business. Accruals are recorded for such contingencies based on our assessment that the occurrence is probable, and where determinable, an estimate of the liability amount. Management considers many factors in making these assessments including past history and the specifics of each case. However, litigation is inherently unpredictable and excessive verdicts do occur, which could have a material impact on our Consolidated Financial Statements. During fiscal year 2006, we incurred a charge of $2.8 million related to the settlement of a wage and hour lawsuit under the FLSA.

Income Taxes

In determining income for financial statement purposes, management must make certain estimates and judgments. Certain of these estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense.

Management must assess the likelihood that deferred tax assets will be recovered. If recovery is not likely, we must increase our provision for taxes by recording a reserve, in the form of a valuation allowance, for the deferred tax assets that will not be ultimately recoverable. Should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which it is determined that the recovery is not probable.

In addition, the calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. Management recognizes potential liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our estimate of whether and the extent to which additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. In the United States, fiscal years 2003 and after remain open for federal tax audit. For state tax audits, the statute of limitations generally spans three to four years, resulting in a number of states remaining open for tax audits dating back to fiscal year 2002. Internationally (including Canada), the statute of limitations for tax audits varies by jurisdiction, but generally ranges from three to five years.

OVERVIEW OF FISCAL YEAR 2006 RESULTS

The following summarizes key aspects of our fiscal year 2006 results:

·       Revenues increased 10.8 percent to $2.4 billion and consolidated same-store sales increased 0.4 percent during fiscal year 2006. Same-store sales were negatively impacted by the long hair cycle, as customers tend to cut their hair less often than when they have a short or “shaped” look.

·       Earnings per share increased to $2.36 per diluted share, up from $1.39 per diluted share in fiscal year 2005.

·       On April 5, 2006, our Board of Directors announced the termination of the Merger Agreement, dated January 10, 2006, whereby one of our subsidiaries was to merge with the Sally Beauty Company business unit of Alberto-Culver Company. The Merger Agreement was terminated following Alberto-Culver’s announcement that the Alberto-Culver Board of Directors had withdrawn its recommendation to the stockholders of Alberto-Culver that they approve the transactions contemplated by the Merger Agreement. As a result of the terminated merger, fiscal year 2006 earnings included a $33.7 million ($21.7 million net of tax) net gain representing the

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receipt of a $50.0 million termination fee, net of acquisition related expenses incurred prior to the acquisition.

·       We recognized $8.4 million ($5.4 million net of tax) of impairment charges, primarily related to impaired long-lived salon assets associated with underperforming salons.

·       We recorded a $4.3 million ($2.8 million net of tax) impairment loss related to an investment that we had recorded under the cost method.

·       An aggregate $6.5 million ($4.2 million net of tax) of expense was recognized during the fourth quarter stemming from our decision to close 64 underperforming company-owned salon locations and refocus efforts on improving the sales and operations of nearby salons. The salon closures resulted in $4.1 million, or $2.7 million tax-effected, in lease termination fees (recorded within rent expense in the Consolidated Statement of Operations), as well as $2.4 million, or $1.5 million tax-effected, in losses on the disposal of the salons’ property and equipment (recorded within depreciation and amortization in the Consolidated Statement of Operations).

·       Included in the fourth quarter general and administrative expenses within the Consolidated Statement of Operations is $2.8 million ($1.8 million net of tax) related to the settlement of a Fair Labor Standards Act (FLSA) lawsuit over wage and hour disputes.

·       Total debt at the end of the fiscal year 2006 was $622.3 million and our debt-to-capitalization ratio, calculated as total debt as a percentage of total debt and shareholder’s equity, improved 130 basis points to 41.7 percent as compared to the prior fiscal year.

RESULTS OF OPERATIONS

Consolidated Results of Operations

The following table sets forth, for the periods indicated, certain information derived from our Consolidated Statement of Operations in Item 8, expressed as a percent of revenues. The percentages are computed as a percent of total revenues, except as noted.

(1)          Computed as a percent of service revenues and excludes depreciation expense.

(2)          Computed as a percent of product revenues and excludes depreciation expense.

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Consolidated Revenues

Consolidated revenues primarily include revenues of company-owned salons, product and equipment sales to franchisees, beauty schools revenues, hair restoration center revenues, and franchise royalties and fees. As compared to the prior fiscal year, consolidated revenues increased 10.8 percent to a record $2.4 billion during fiscal year 2006 and 14.1 percent to $2.2 billion during fiscal year 2005. The following table details our consolidated revenues by concept. All service revenues, product revenues (which include product and equipment sales to franchisees), and franchise royalties and fees are included within their respective concept within the table.

(1)          Includes aggregate franchise royalties and fees of $77.9, $79.5 and $73.6 million in fiscal years 2006, 2005 and 2004, respectively. North American salon franchise royalties and fees represented 50.4, 50.6 and 56.2 percent of total franchise revenues in fiscal years 2006, 2005 and 2004, respectively.

(2)          Salon same-store sales increases or decreases are calculated on a daily basis as the total change in sales for company-owned salons which were open on a specific day of the week during the current period and the corresponding prior period. Annual salon same-store sales increases are the sum of the same-store sales increases computed on a daily basis. Relocated salons are included in same-store sales as they are considered to have been open in the prior period. International same-store sales are calculated in local currencies so that foreign currency fluctuations do not impact the calculation. Management believes that same-store sales, a component of organic growth, are useful in order to help determine the increase in salon revenues attributable to its organic growth (new salon construction and same-store sales growth) versus growth from acquisitions.

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The 10.8 and 14.1 percent increases in consolidated revenues during fiscal year 2006 and 2005, respectively, were driven by the following:

We acquired 290 and 444 company-owned salons during the fiscal years ended June 30, 2006 and 2005, respectively, including 142 franchise buybacks during fiscal year 2006 and 139 during fiscal year 2005. Additionally, we acquired 30 and 13 beauty schools in fiscal year 2006 and 2005, respectively, as well as eight (seven of which were franchise buybacks) and 42 company-owned hair restoration centers in fiscal year 2006 and 2005, respectively. The organic growth stemmed primarily from the construction of 531 and 525 company-owned salons during the twelve months ended June 30, 2006 and 2005, respectively, as well as consolidated same-store sales increases. During fiscal year 2006, the foreign currency impact was driven by the strengthening of the United States dollar against the British pound and Euro as compared to the prior fiscal year’s exchange rates, partially offset by the continued weakening of the United States dollar against the Canadian dollar. During fiscal year 2005, the foreign currency impact was driven by the weakening of the United States dollar against the British pound, Euro and Canadian dollar as compared to the prior periods’ exchange rates. The impact of foreign currency was calculated by multiplying current year revenues in local currencies by the change in the foreign currency exchange rate between the current fiscal year and the prior fiscal year.

Consolidated revenues are primarily composed of service and product revenues, as well as franchise royalties and fees. Fluctuations in these three major revenue categories were as follows:

Service Revenues.   Service revenues include revenues generated from company-owned salons, tuition and service revenues generated within our beauty schools, and service revenues generated by hair restoration centers. Total service revenues were as follows:

The growth in service revenues in fiscal year 2006 and 2005 were driven primarily by acquisitions (including the acquisition of the hair restoration centers at the end of the second quarter of fiscal year 2005) and organic growth in our salons (new salon construction and same-store sales growth). During fiscal year 2004 and continuing into fiscal years 2005 and 2006, same-store service sales in our salons continued to be modest due to a slight lengthening of customer visitation patterns stemming from a fashion trend towards longer hairstyles.

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Product Revenues.   Product revenues are primarily sales at company-owned salons, beauty schools, hair restoration centers, and sales of product and equipment to franchisees. Total product revenues were as follows:

The growth in fiscal year 2006 product revenues was primarily due to acquisitions. Fiscal year 2006 and 2005 product revenue percentage increases were not as robust as the prior fiscal years primarily due to lower same-store product sales increases in our company-owned salons; same-store product sales increased 0.1 percent in fiscal year 2006 and were flat in fiscal year 2005. The large increase in same-store product sales during fiscal year 2004 was primarily driven by a trend towards sales of higher priced beauty tools, such as flat irons and the introduction of the Matrix product line to Trade Secret salons.

Franchise Royalties and Fees.   Total franchise revenues, which include royalties and franchise fees, were as follows:

Total franchise locations open at June 30, 2006 and 2005 were 3,816 (including 42 franchise hair restoration centers) and 3,951 (including 49 franchise hair restoration centers), respectively. The decreased number of franchise locations during fiscal year 2006 was primarily due to franchise buybacks, and strip center and international franchise salon closures. During fiscal year 2005, the number of franchise locations grew modestly, as new salon construction and the acquisition of the hair restoration centers were largely offset by franchise buybacks and closures. We purchased 142 and 139 of our franchise salons during the twelve months ended June 30, 2006 and 2005, respectively. Additionally, we purchased seven of our franchise hair restoration centers during fiscal year 2006. A total of 229 and 168 franchise salons were closed during the twelve months ended June 30, 2006 and 2005, respectively.

The decrease in consolidated franchise revenues during fiscal year 2006 was primarily due to unfavorable foreign currency exchange rate fluctuations. Exclusive of foreign currency fluctuations, consolidated franchise revenues decreased 0.6 percent over the prior fiscal year, stemming from our purchase of 142 franchise salons and seven franchise hair restoration centers during fiscal year 2006.

Favorable foreign currency exchange rate fluctuations caused 3.3 percent of the 8.0 percent increase in consolidated franchise revenues during the year ended June 30, 2005. Exclusive of the effect of this favorable currency fluctuation, consolidated franchise revenues increased 4.7 percent in the year ended June 30, 2005. The fiscal year 2005 increase was primarily due to the acquisition of 49 franchise hair restoration centers, as well as opening more new international franchise salons during fiscal year 2005 as compared to the prior fiscal year.

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Gross Margin (Excluding Depreciation)

Our cost of revenues primarily includes labor costs related to salon employees, beauty school instructors and hair restoration center employees, the cost of product used in providing services and the cost of products sold to customers and franchisees. The resulting gross margin was as follows:

(1)          Represents the basis point change in total margin as a percent of service and product revenues as compared to the corresponding period of the prior fiscal year.

Service Margin (Excluding Depreciation).   Service margin was as follows: