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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended         Decmber 31, 2002   

OR

For the transition period from  ________________________   to _____________________

________________

Commission file number       011230

Regis Corporation

(952)947-7777

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 the number of shares outstanding of each of the issuer’s classes of common stock as of February 7, 2003:

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REGIS CORPORATION

INDEX

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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements

REGIS CORPORATION
CONSOLIDATED BALANCE SHEET
as of December 31, 2002 and June 30, 2002
(Dollars in thousands, except par value)

The accompanying notes are an integral part of the unaudited Consolidated Financial Statements.

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REGIS CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
for the three months ended December 31, 2002 and 2001
(Dollars in thousands, except per share amounts)

The accompanying notes are an integral part of the unaudited Consolidated Financial Statements.

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REGIS CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
for the six months ended December 31, 2002 and 2001
(Dollars in thousands, except per share amounts)

The accompanying notes are an integral part of the unaudited Consolidated Financial Statements.

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REGIS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
for the six months ended December 31, 2002 and 2001
(Dollars in thousands)

The accompanying notes are an integral part of the unaudited Consolidated Financial Statements.

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REGIS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.		BASIS OF PRESENTATION OF UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS:
		The unaudited interim Consolidated Financial Statements of Regis Corporation (the Company) as of December 31, 2002 and for the three and six months ended December 31, 2002 and 2001, reflect, in the opinion of management, all adjustments necessary to fairly present the consolidated financial position of the Company as of December 31, 2002 and the consolidated results of its operations and its cash flows for the interim periods. The results of operations and cash flows for any interim period are not necessarily indicative of results of operations and cash flows for the full year.
		The Consolidated Balance Sheet data for June 30, 2002 was derived from audited Consolidated Financial Statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The unaudited interim Consolidated Financial Statements should be read in conjunction with the Company’s Consolidated Financial Statements for the year ended June 30, 2002.
		With respect to the unaudited financial information of the Company for the three and six month periods ended December 31, 2002 and 2001 included in this Form 10-Q, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their separate report dated January 21, 2003 appearing herein, states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.
		Cost of Product Used and Sold: On an interim basis, product costs are determined by applying estimated gross profit margins to service and product revenues which are based on historical factors including semi-annual physical inventories. A physical inventory count was performed in the fall of fiscal 2003, producing a favorable overall physical inventory result that contributed approximately $2.8 million to reported net income for the three month period ended December 31, 2002, or approximately $.06 per diluted share. The favorable physical inventory result was accounted for as a change in estimate associated with inventory gross profit margins, and thus reduced the cost of service and product sales.
		Reclassifications: Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on net income or shareholders’ equity as previously presented.

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2.		NEW ACCOUNTING PRONOUNCEMENTS:
		Effective July 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards (FAS) No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The initial adoption of this Statement did not have a material impact on the Consolidated Statement of Operations for the period ended December 31, 2002 or the Consolidated Balance Sheet as of December 31, 2002.
		In June 2002, the Financial Accounting Standards Board (FASB) issued FAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires that a liability for costs associated with exit or disposal activities be recognized and measured initially at fair value when the liability is incurred. The provisions of the standard are effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect the adoption of FAS 146 to have a material impact on the Consolidated Statement of Operations.
		In November, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” The Interpretation requires a guarantor to recognize a liability for the fair value of newly issued guarantees. The recognition provisions of this Interpretation apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect the Interpretation to have a material impact on the Consolidated Statement of Operations.
		On December 31, 2002, the FASB issued FAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” The standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the standard amends the disclosure requirements of FAS No. 123, “Accounting for Stock Based Compensation,” to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The initial adoption of FAS 148 will have no impact on the Consolidated Statement of Operations, although it will result in the addition of disclosures included as part of the Consolidated Financial Statements for the period ending March 31, 2003, summarizing the effects of stock-based compensation on interim operating results.

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		On January 17, 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” The Interpretation expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity, referred to as a variable interest entity. As discussed in Note 6 to the Consolidated Financial Statements in the Company’s June 30, 2002 Annual Report to Shareholders, the Company entered into a five-year operating lease agreement in June 2000 relating to its Salt Lake distribution center. Based on the Company’s interpretation of the new statement, the current operating lease structure is with a variable interest entity. Under Interpretation No. 46, if no modifications are made to the existing lease structure, the Company will be required to consolidate the leased asset and the related debt in its Consolidated Balance Sheet effective July 1, 2003. In addition, if no modifications are made to the lease structure, the Company will be required to record a loss of approximately $0.8 million on July1, 2003. The loss, which represents the cumulative effect of a change in accounting, is effectively the cumulative amount of depreciation that would have been recorded had the asset been consolidated at the commencement of the lease. At this time, the Company expects to modify the existing lease structure prior to the July 1, 2003, deadline and therefore, does not expect Interpretation No. 46 to result in a cumulative effect of a change in accounting or have a significant impact on its Consolidated Statement of Operations or Consolidated Balance Sheet.
3.		DERIVATIVE INSTRUMENTS:
		In the normal course of business, the Company is exposed to market risk related to changes in interest rates and foreign currency exchange rates. The Company has established policies and procedures that govern the management of these exposures. By policy, the Company does not enter into such contracts for the purpose of speculation. The following details the Company’s policies and use of financial instruments.
		Interest Rate Risk: The Company has established an interest rate management policy that attempts to minimize its overall cost of debt, while taking into consideration the earnings implications associated with the volatility of short-term interest rates. As part of this policy, the Company has elected to maintain a combination of floating and fixed rate debt. The Company has entered into the following financial instruments:
		Interest Rate Swap Contracts:      (Pay fixed rates, receive variable rates) The Company had interest rate swap contracts to pay fixed rates of interest (ranging from 5.1 to 7.2 percent during the first half of fiscal 2003 and 2002) and receive variable rates of interest based on the three-month LIBOR rate (ranging from 1.4 to 2.0 percent during the first half of fiscal 2003 and 2.0 to 4.8 percent during the first half of fiscal 2002) on a $66.8 million notional amount. The $66.8 million is composed of $55.0 million of floating rate debt and an $11.8 million variable rate operating lease obligation. The interest rate swap contracts are scheduled to mature between April 2003 and June 2005. See Item 3, Quantitative and Qualitative Disclosures about Market Risk, for additional information and a detailed maturity schedule. These contracts have been designated as cash flow hedges.
		The Company’s cash flow swaps are recorded at fair value within other noncurrent liabilities in the Consolidated Balance Sheet, with a corresponding offset, net of tax, in other comprehensive income within shareholders’ equity. The net gain recorded in other comprehensive income, net of tax, was $.5 and $.2 million during the second quarter of fiscal 2003 and 2002, respectively. The net gain recorded in other comprehensive income, net of tax, was $.5 during the first half of fiscal 2003 and the net loss recorded in other comprehensive income, net of tax, was $.8 million during the first half of fiscal 2002.

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		As interest or rental payments are made on the underlying hedged items, an adjustment to interest or rental expense based on the net settlement amounts on the swaps is recorded in the Consolidated Income Statement. Effectively, the net settlement amounts are transferred out of other comprehensive income to earnings at each interest or rental payment date, as the net gain or loss recorded within other comprehensive income is based on estimated future cash flows of net settlement amounts. The cash flow swaps resulted in charges to interest and rental expense of approximately $.9 and $.7 million during the second quarter of fiscal 2003 and 2002, respectively. During the first half of fiscal 2003 and 2002, the cash flow swaps resulted in charges to interest and rental expense of approximately $1.7 and $1.1 million, respectively. As of December 31, 2002, the Company estimates, based on current interest rates, that approximately $1.6 million of charges to interest and rental expense will be recorded in the Consolidated Income Statement during the next twelve months. During the first half of fiscal 2003 and 2002, the cash flow swaps were fully effective.
		(Pay variable rates, receive fixed rates) During the third quarter of fiscal 2002, the Company entered into interest rate swap contracts to pay variable rates of interest based on the three-month and six-month LIBOR rates plus a credit spread (ranging from 2.4 to 6.3 percent during the six months ended December 31, 2002) and receive fixed rates of interest (ranging from 6.7 to 8.2 percent) on an aggregate $111.0 million notional amount, with maturation dates between December 2002 and March 2009. These swaps were designated as hedges of a portion of the Company’s senior term notes (in order to mitigate exposure to interest rate risk related to the fixed-rate notes), and are being accounted for as fair value swaps.
		During the second quarter of fiscal 2003, the Company terminated certain of these interest rate swap contracts, thereby lowering the aggregate notional amount by $20.0 million. The termination resulted in the Company realizing a gain of $1.5 million, which is deferred in other noncurrent liabilities in the Consolidated Balance Sheet and will be amortized against interest expense over the remaining life of the underlying debt, which will mature in March 2009.
		The Company’s fair value swaps are recorded at fair value within other assets in the Consolidated Balance Sheet, with a corresponding adjustment to the underlying senior term note within long-term debt of $7.9 million at December 31, 2002. No hedge ineffectiveness occurred during the quarter or year-to-date. As a result, the fair value swaps did not have a net impact on earnings.
		Foreign Currency Exchange Risk: The majority of the Company’s revenue, expense and capital purchasing activities are transacted in United States dollars. However, because a portion of the Company’s operations consists of activities outside of the United States, the Company has transactions in other currencies, primarily the Canadian dollar, British pound and Euro. As part of its risk management strategy, the Company frequently evaluates its foreign currency exchange risk by monitoring market data and external factors that may influence exchange rate fluctuations. As a result, Regis may engage in transactions involving various derivative instruments to hedge assets, liabilities and purchases denominated in foreign currencies. The Company has entered into the following financial instruments:

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		Hedge of the Net Investment in Foreign Subsidiaries The Company has a cross-currency swap with a notional amount of $21.3 million to hedge a portion of its net investments in its foreign operations. The purpose of this hedge is to protect against adverse movements in exchange rates. The cross-currency swap hedges approximately 11 percent of the Company’s net investments in foreign operations at December 31, 2002 and June 30, 2002. The Company’s cross-currency swap is recorded at fair value within other noncurrent liabilities in the Consolidated Balance Sheet. The corresponding offset, net of tax, is charged to the cumulative translation adjustment account, which is a component of other comprehensive income. For the quarter ended December 31, 2002 and 2001, $1.2 million of loss, net of tax, and $.1 million of gain, net of tax, related to this derivative was charged to the cumulative translation adjustment account, respectively. For the six months ended December 31, 2002 and 2001, $.9 and $.2 million of loss, net of tax, related to this derivative was charged to the cumulative translation adjustment account.
4.		SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME:
		Additional Paid-In Capital The Company recorded an increase in equity of $13.9 million during the first half of fiscal 2003, which is comprised of $19.0 million primarily related to shares issued in connection with salon acquisitions, $4.2 million related to shares held in the Company’s equity compensation plans and $0.9 million related to the tax benefit realized upon exercise of stock options, partially offset by $10.2 million related to shares repurchased under the Company’s stock repurchase program.
		Comprehensive Income Components of comprehensive income for the Company include net income, changes in fair market value of financial instruments designated as hedges of interest rate exposure and changes in foreign currency translation recorded in the cumulative translation account within shareholders’ equity. Comprehensive income for the three and six months ended December 31, 2002 and 2001 were as follows:

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5.		NET INCOME PER SHARE:
		Stock options covering approximately 317,707 and 3,000 shares for the second quarter of fiscal 2003 and 2002, respectively, and 332,830 and 9,900 shares for the first six months of fiscal 2003 and 2002, respectively, were excluded from the shares used in the computation of diluted earnings per share since they were anti-dilutive.
		The following table sets forth a reconciliation of shares used in the computation of basic and diluted earnings per share:

6.		TRANSACTION AND RESTRUCTURING LIABILITIES:
		As of June 30, 2002, the Company’s restructuring liability related to the October 31, 1999 merger with Supercuts UK totaled approximately $713,000. During the first six months of fiscal 2003, such liabilities were reduced by cash payments of $155,000 and increased by $23,000 related to translation rates, resulting in balance of $581,000 at December 31, 2002. This remaining amount will be satisfied through periodic contractual payments ending in June of 2004.
7.		SEGMENT INFORMATION:
		The Company operates or franchises 7,166 domestic salons and 2,147 international salons. The Company executes its domestic operations through five primary concepts: Regis Salons, MasterCuts, Trade Secret, SmartStyle and Strip Center (primarily Supercuts and Cost Cutters) salons. Each of the concepts offers similar products and services, concentrates on the mass-market consumer marketplace and have consistent distribution channels. All of the salons within the North American concepts are located within high traffic destination retail shopping locations and the individual salons generally display similar economic characteristics. The Company’s international operations, which are primarily in Europe, are located in salons operating in malls, leading department stores, mass merchants and high-street locations. Based on the way the Company manages its business, it has presented its domestic and international operations as two reportable operating segments, domestic and international.

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Summarized financial information concerning the Company’s reportable operating segments is shown in the following table for the periods ended December 31, 2002 and 2001:

		* Includes franchise revenues less franchise direct costs.
8.		ACQUISITIONS:
		During the six month periods ended December 31, 2002 and 2001, the Company made numerous acquisitions. These acquisitions have been recorded using the purchase method of accounting. Accordingly, the purchase prices have been allocated to assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition. These acquisitions individually and in the aggregate are not material to the Company’s operations. Operations of the acquired companies have been included in the operations of the Company since the date of the respective acquisition.
		Based upon purchase price allocations, which may have components representing preliminary allocations, the components of the aggregate purchase prices of the acquisitions made during the periods ended December 31, 2002 and 2001, and the allocation of the purchase price, were as follows:

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The Company has guaranteed that stock issued in certain acquisitions will reach a certain market price. If the stock should not reach this price during the agreed-upon time frame, the Company is obligated to issue additional shares to the sellers. Once the agreed-upon stock price is met or exceeded for a period of five consecutive days, the contingency is met and the Company is no longer liable. Based on the December 31, 2002 market price, the Company would be liable for an additional 213,007 shares, which have been included in the calculation of diluted earnings per share for the three and six months ended December 31, 2002.

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REVIEW REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Directors of Regis Corporation:

We have reviewed the accompanying consolidated balance sheet of Regis Corporation as of December 31, 2002 and the related consolidated statements of operations for the three and six month periods ended December 31, 2002 and 2001 and of cash flows for the six months ended December 31, 2002 and 2001. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of June 30, 2002, and the related consolidated statements of operations, of changes in shareholders’ equity and of cash flows for the year then ended (not presented herein), and in our report dated August 27, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the accompanying consolidated balance sheet information as of June 30, 2002, is fairly stated, in all material respects in relation to the consolidated balance sheet from which it has been derived.

PRICEWATERHOUSECOOPERS LLP

Minneapolis, Minnesota
January 21, 2003

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Item 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Summary

Regis Corporation (the Company), based in Minneapolis, Minnesota, is the world’s largest owner, operator, franchisor and acquirer of hair and retail product salons. The Company’s worldwide operations include 9,313 salons at December 31, 2002 operating in two reportable operating segments: domestic and international. Each of the Company’s concepts have generally similar products and services. The Company is organized to manage its operations based on geographical location. The Company’s domestic segment includes 7,166 salons, including 2,196 franchised salons, operating in North America primarily under the trade names of Regis Salons, MasterCuts, Trade Secret, SmartStyle, Supercuts and Cost Cutters. The Company’s international operations include 2,147 salons, including 1,744 franchised salons, located throughout Europe, primarily in the United Kingdom, France, Italy and Spain. The Company has over 43,000 employees worldwide.

Second quarter fiscal 2003 revenues grew to a record $414.8 million, including franchise revenues of $26.1 million, a 15.7 percent increase over the second quarter of fiscal 2002. Revenues for the first half of fiscal 2003 grew to a record $814.0 million, including franchise revenues of $52.0 million, a 14.9 percent increase over the first half of fiscal 2002.

Operating income in second quarter of fiscal 2003 increased to $43.2 million, a 32.7 percent increase over the corresponding period of fiscal 2002. Operating income in the first six months of fiscal 2003 increased to $79.6 million, a 26.9 percent increase over the corresponding period of fiscal 2002.

Net income in the second quarter of fiscal 2003 increased to $23.6 million, or $.52 per diluted share, a net income and earnings per share increase of 38.9 and 33.3 percent, respectively, from second quarter fiscal 2002. During the first half of fiscal 2003, net income increased 33.9 percent to $43.3 million and earnings per diluted share increased 28.0 percent to $.96 as compared to the corresponding period of fiscal 2002.

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Results of Operations

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

(1)		Computed as a percent of company-owned revenues.
(2)		Computed as a percent of service revenues.
(3)		Computed as a percent of product revenues.
(4)		Computed as a percent of franchise revenues.

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CRITICAL ACCOUNTING POLICIES

The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases these estimates on historical experience and other assumptions believed to be reasonable under the circumstances. However, actual results could differ from these estimates.

Management believes the Company’s critical accounting policies and areas that require more significant judgments and estimates used in the preparation of its Consolidated Financial Statements to be:

•		useful lives assigned to long-lived and intangible assets;
•		recoverability of long-lived and intangible assets, including goodwill;
•		allocation of the purchase price to acquired assets and liabilities, including intangibles, and the residual to goodwill;
•		various commitments and contingencies; and
•		product costs.

Depreciation and amortization are recognized using the straight-line method over the long-lived assets’ estimated useful lives. The Company estimates useful lives based on historical data and industry trends. The Company periodically reassesses the estimated useful lives of its long-lived and intangible assets. Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in earnings and potentially the need to record an impairment charge.

The Company reviews long-lived and intangible assets, including goodwill, for impairment annually, or at any time events or circumstances indicate that the carrying value of such assets may not be fully recoverable. For long-lived assets and amortizable intangible assets, an impairment is evaluated based on the sum of undiscounted estimated future cash flows expected to result from use of the assets compared to its carrying value. For goodwill, if an impairment were to be recognized, the carrying value of the impaired asset would be reduced to its fair value based on discounted estimated future cash flows. The Company generally considers its brands to be reporting units when it tests for goodwill impairment because that is where the Company believes goodwill naturally resides. Goodwill is evaluated for impairment based on the fair value of the brand concept to which the goodwill relates. The Company performs its annual goodwill impairment testing during its fiscal third quarter.

The Company makes numerous acquisitions that are recorded using the purchase method of accounting. Accordingly, the purchase prices are allocated to assets acquired, including 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. The majority of the purchase price 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 and the limited value and customer preference associated with acquired hair salon brand identity. Residual goodwill further represents the Company’s opportunity to strategically combine the acquired business with the Company’s existing structure to serve a greater number of customers through our expansion strategies.

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In the normal course of business, the Company must make continuing estimates of potential future loss accruals related to legal, tax, self-insurance accruals and uncollectible accounts. These accruals require the use of management’s judgment on the outcome of various issues. Management’s estimates for these items are based on the best available evidence, but due to changes in facts and circumstances, the ultimate outcomes of these accruals could be different than management estimates.

On an interim basis, product costs are determined by applying an estimated gross profit margin to product and service revenues. The estimated gross profit margins are based primarily on historical factors. Management also incorporates into the margin its best estimate of the current product mix impact. On a semi-annual basis, the Company performs physical inventories and adjusts product costs to actual as determined under the lower of cost or market determined on a weighted average basis, and updates its gross profit margins accordingly.

RESULTS OF OPERATIONS