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UNITED STATES
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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COMMISSION FILE NUMBER: 0-22026
RENT-WAY, INC.
PENNSYLVANIA 25-1407782
(STATE OF INCORPORATION) (I.R.S. EIN)
ONE RENTWAY PLACE, ERIE, PENNSYLVANIA 16505
(814)455-5378
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF CLASS NAME OF EXCHANGE ON WHICH REGISTERED
-------------- ------------------------------------
COMMON STOCK, NO PAR VALUE NEW YORK STOCK EXCHANGE, INC.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 [ ].
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of March 28, 2002, was $169,525,089.
The number of shares outstanding of the registrant's common stock as of December
19, 2002 was 25,685,538.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant's definitive proxy statement for its 2003 Annual
Meeting of Shareholders are incorporated by reference into Part III of this
report.
RENT-WAY, INC.
TABLE OF CONTENTS
PAGE
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND FUTURE PROSPECTS............................. 1
PART I
Item 1. Business................................................................................ 2
Item 2. Description of Properties............................................................... 10
Item 3. Legal Proceedings....................................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders..................................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 12
Item 6. Selected Financial Data................................................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............................. 24
Item 8. Financial Statements and Supplementary Data............................................. 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.... 53
PART III
Item 10. Directors and Executive Officers of the Registrant...................................... 54
Item 11. Executive Compensation.................................................................. 54
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 54
Item 13. Certain Relationships and Related Transactions.......................................... 54
Item 14. Controls and Procedures................................................................. 54
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................ 55
SIGNATURES................................................................................................. 56
CERTIFICATIONS............................................................................................. 57
RENT-WAY, INC.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND FUTURE PROSPECTS
This Annual Report on Form 10-K includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding Rent-Way's future prospects. These statements may be
identified by terms and phrases such as "anticipate", "believe", "intend",
"estimate", "expect", "continue", "should", "could", "may", "plan", "project",
"predict", "will" and similar expressions and relate to future events and
occurrences. These forward-looking statements are subject to uncertainties and
other factors that could cause actual results to differ materially from such
statements. Factors that could cause actual results to differ materially from
those expressed or implied in such statements include but are not limited to:
Rent-Way's ability to control and normalize operating expenses and to
continue to realize operating efficiencies.
Rent-Way's ability to make principal and interest payments and to refinance
on acceptable terms its high-level outstanding bank debt.
The outcome of the class action and derivative lawsuits commenced against
Rent-Way and its officers and directors and any proceedings or
investigations involving Rent-Way and its officers and directors conducted
by governmental authorities, including the Securities and Exchange
Commission and the United States Department of Justice.
Rent-Way's ability to develop, implement, and maintain reliable and adequate
internal accounting systems and controls.
Rent-Way's ability to retain existing senior management and attract
additional management employees.
General economic, business, and demographic conditions, including demand for
Rent-Way's products and services.
General conditions relating to the rental-purchase industry and the prepaid
local phone service industry, including the impact of state and federal laws
regulating or otherwise affecting the rental-purchase and prepaid local
phone service transactions.
Competition in the rental-purchase industry and prepaid local phone service
industry, including competition with traditional retailers.
Rent-Way's ability to enter into and to maintain relationships with vendors
of its rental merchandise including its ability to obtain goods and services
on favorable credit terms.
Rent-Way's ability to satisfy the conditions required under and to otherwise
close the transactions contemplated by its definitive agreement with
Rent-A-Center, Inc. to sell 295 stores, and Rent-Way's ability to reduce
corporate-level and other expenses following the closing of such sale.
Given these factors, undue reliance should not be placed on any
forward-looking statements, including statements regarding Rent-Way's future
prospects. These statements speak only as of the date made. Rent-Way undertakes
no obligation to update or revise any forward-looking statements whether as a
result of new information, the occurrence of future events, or otherwise.
PART I
ITEM I. BUSINESS
GENERAL
Rent-Way, Inc. (the "Company" or "Rent-Way") is the second largest operator
of stores in the rental-purchase industry with 1,062 stores in 42 states as of
September 30, 2002. The Company offers quality brand name computers, home
entertainment equipment, furniture, appliances, and jewelry to customers under
full-service, rental-purchase agreements that generally allow the customer to
obtain ownership of the merchandise at the conclusion of an agreed upon rental
period. Management believes that these rental-purchase arrangements appeal to a
wide variety of customers by allowing them to obtain merchandise that they might
otherwise be unable or unwilling to obtain due to insufficient cash resources or
lack of access to credit or because they have a temporary, short-term need for
the merchandise or a desire to rent rather than purchase the merchandise. The
Company also provides prepaid local phone service to consumers on a monthly
basis through dPi Teleconnect LLC ("DPI"), its 70%-owned subsidiary. The Company
operates in two segments: in the rental-purchase industry and, through DPI, in
the prepaid local phone service industry.
The Company's principal executive offices are located at One RentWay Place,
Erie, Pennsylvania 16505; and its telephone number is (814) 455-5378. The
Company's Internet address is http://www.rentway.com. All Company filings with
the SEC, Form 10-K, Form 10-Q and Form 8-K (and all amendments thereto) are
available at no cost through the Company's website.
RECENT DEVELOPMENTS
On December 17, 2002, the Company entered into a definitive purchase
agreement to sell 295 stores to Rent-A-Center, Inc. for $101.5 million, subject
to downward adjustment for store performance prior to closing. The stores are
located in 38 states and had aggregate average monthly revenues for the three
months ended October 31, 2002, of approximately $10.1 million. Closing of the
transaction contemplated by the definitive purchase agreement is subject to
several conditions, including clearance under the Hart-Scott-Rodino Act and
other customary conditions. As required under the Company's credit facility, all
proceeds of the sale, net of transaction, store closing and similar expenses,
will be used to pay outstanding bank debt. Of the approximate $101.5 million
sale price, an aggregate of $10 million is subject to a holdback by
Rent-A-Center to secure the Company's indemnification obligations--$5 million
for 90 days and $5 million for 18 months. A copy of the definitive purchase
agreement is filed as Exhibit 2.11 to this annual report. Following completion
of the sale, the Company will operate 766 stores in 33 states.
BUSINESS HISTORY
Rent-Way was founded in 1981 to operate a rental-purchase store in Erie,
Pennsylvania. In fiscal 1993, the Company was operating 19 stores in three
states and had completed its initial public offering. Over the next five years,
the Company acquired 420 stores in various transactions and opened 13 new
stores. In fiscal 1999, the Company became the second largest company in the
rental-purchase industry as a result of a merger with Home Choice Holdings,
Inc., in which 458 stores were acquired, the acquisition of 250 stores from
RentaVision, Inc. and 21 stores from America's Rent-to-Own Center, Inc. The
Company also opened 12 new stores in fiscal 1999.
In fiscal 2000, the Company acquired 24 stores and opened 68 new stores in
31 states. In addition, the Company entered into a three-year agreement with
Gateway Companies, Inc. in April 2000 to be the exclusive authorized supplier of
Gateway personal computers and related peripherals in the rental-purchase
industry. As part of this transaction, Gateway invested $7.0 million for 348,910
shares of Rent-Way common stock. In January 2000, the Company acquired a 49%
interest in DPI and an additional 21% interest in May 2000 and now owns 70% of
the company. DPI offers prepaid local phone service and offers its services to
customers whose local phone service has been disconnected.
On October 30, 2000, Rent-Way announced that it was investigating certain
accounting matters, including potential accounting improprieties. As a result of
the investigation, the Company restated its previously reported fiscal 1998 and
1999 financial statements and its fiscal 2000 unaudited quarterly financial
statements. In fiscal 2001, the Company acquired two stores, opened 32 new
stores in 21 states, sold 39 stores in several small transactions and closed or
combined 46 stores.
In fiscal 2002, the Company sold 15 stores in several small transactions and
closed or combined ten stores. The Company purchased the rental merchandise and
customer contracts of ten stores and combined them with existing stores.
THE RENTAL-PURCHASE INDUSTRY
Begun in the mid- to late-1960s, the rental-purchase business offers an
alternative to traditional retail installment sales. The rental-purchase
industry provides brand name merchandise to customers generally on a
week-to-week or month-to-month basis under a full service rental agreement,
which in most cases includes a purchase option. The customer may cancel the
rental agreement at any time without further obligation by returning the product
to the rental-purchase operator.
The Association of Progressive Rental Organizations ("APRO"), the industry's
trade association, estimated that at the end of 2001 the U.S. rental-purchase
industry comprised approximately 8,300 stores providing 6.4 million products to
2.8 million households. The Company believes that its customers generally have
annual household incomes ranging from $20,000 to $40,000. Based on APRO
estimates, the rental-purchase industry had gross revenues of $5.6 billion in
2002. Until recently, the rental-purchase industry was highly fragmented. Over
the past five years, the industry has experienced significant consolidation and
maturation. The two largest national rental-purchase chains, Rent-A-Center and
Rent-Way, now operate approximately 45% of total industry stores.
STRATEGY
The Company's strategic focus for 2003 will be optimizing its people and
facilities to more deeply penetrate existing markets, prepare to enter new
markets and gain competitive advantage through the development of name and brand
recognition. The Company believes the execution of this strategy will lead to
sustainable increases in profitability. In order to secure the financial
resources necessary to accomplish this strategy, the Company agreed to sell 295
stores to Rent-A-Center. The Company believes this contraction in its stores
will strengthen it financially and provide a foundation for future growth.
The net proceeds of the sale to Rent-A-Center will be used to pay bank debt
thus improving the Company's leverage and other borrowing ratios and making
possible a refinancing of the Company's outstanding bank debt on more favorable
terms. The Company will seek to arrange sufficient borrowing availability under
any new credit facility to allow it to open new stores in appropriate markets
and grow its remaining stores.
Management believes that the Company's success and its ability to achieve
profitability in fiscal 2003 and thereafter depends on successful execution of
the following business strategies:
Rationalize Corporate Overhead. Management will attempt to reduce corporate
overhead and rationalize its corporate infrastructure to a level appropriate to
support the stores remaining after the Rent-A-Center sale.
Improve Existing Store Performance. The Company intends to continue to focus
on improving store operating margins and cash flow by increasing the existing
number of rental contracts and customers at its stores. In addition, the Company
will continue to focus on improving operating margins by vigorous control of
operating expenditures and the pricing of its rental merchandise. As part of its
strategic plan, management has revised its short and long-term incentive plans.
The new incentive plans, which were put in place October 1, 2002 for fiscal
2003, tie the payment of monthly, quarterly and annual incentives to the actual
performance of stores and regions as compared to their annual plan. The
incentive plans focus on year over year increase of revenue, and store operating
margins. Store staffing level guidelines have been developed to ensure the
stores have adequate numbers of employees during peak business hours while
minimizing overtime and excess payroll.
Enhance Branding and Marketing Efforts. The Company began enhancing its
marketing efforts in October 2002 through increased exposure in electronic and
print media generated by a combination of increased spending and the utilization
of more efficient methods of media distribution. In addition, following the
conversion of all stores to the Rent-Way name, completed in early 2002, the
Company initiated efforts to increase name recognition in its markets. As part
of this effort, the Company entered into an exclusive arrangement with Sony Time
Warner for the rights to use the song "We Are Family" in its advertising for 12
months beginning late September 2002. The company believes the song made popular
by the famous music group Sister Sledge, will help create strong name
recognition for Rent-Way in the market place. Management also believes its
marketing plan will create brand differentiation between the Company and its
competitors. The Company monitors the effectiveness of its marketing efforts by
conducting focus studies and other quantitative and qualitative research
throughout the year.
Customer-Focused Philosophy. Management believes that through the continued
adherence to its "Welcome, Wanted and Important" business philosophy, it should
be able to increase its new and repeat customer base, and thus the number of
units it has on rent, thereby increasing revenues and net income. The "Welcome,
Wanted and Important" philosophy is a method by which the Company seeks to
create a store atmosphere conducive to customer loyalty. The Company attempts to
create this atmosphere through the effective use of advertising and
merchandising strategies, by maintaining the clean and well-stocked appearance
of its stores and by providing a high level of customer service (such as its
toll-free 1-800-RENTWAY complaint and comment line). The Company's advertising
emphasizes brand name merchandise from leading manufacturers. In addition,
merchandise selection within each product category is periodically updated to
incorporate the latest offerings from suppliers. Services provided by the
Company to the customer during the term of the contract include home delivery,
installation, ordinary maintenance and repair services and pick-up at no
additional charge. Store managers also work closely with each customer in
choosing merchandise, setting delivery dates and arranging a suitable payment
schedule. As part of the "Welcome, Wanted and Important" philosophy, store
managers are encouraged and trained to make decisions regarding store operations
subject to certain Company-wide operating guidelines and general policies.
Enhancing the Company's Product Lines--Leveraging Distribution Channel. The
Company seeks to provide the rental-purchase customer with the opportunity to
obtain high quality, state-of-the-art merchandise by maintaining a broad
selection of products representing the latest in technology and style. The
Company also believes it has a unique distribution channel to a consumer that is
underserved. Accordingly, the Company intends to leverage this distribution
channel by identifying opportunities to offer additional higher margin products
and services not traditionally offered to the rental-purchase customer.
Monitoring Store Performance. The Company's management information system
allows store, regional and corporate-level managers to track rental and
collection activity on a daily basis. The system generates detailed reports that
track inventory movement by piece and by product category and the number and
frequency of past due accounts and other collection activity. Significant
upgrades to the store reporting systems were made during fiscal 2001. Timely
reports are now generated at the store, regional and corporate level to monitor
pricing and gross margin. Payroll reports are monitored on a weekly basis to
ensure compliance with mandated store staffing levels.
In 2002, the Company completed the roll out of a new Windows-based point of
sale system in its stores. This upgrade allows the Company's stores to take full
advantage of the Company's Intranet. The Company believes it will be able to
begin using satellite communication before the end of fiscal 2003. Management
believes that, because of the remote locations of some of the Company's stores,
satellite connectivity is the best solution for broadband communications.
Implementation of this system will facilitate the full use and monitoring of the
Company's new computer-based training program.
Physical inventories are regularly conducted at each store to ensure the
accuracy of the management information system data. Senior management monitors
this information to ensure adherence to established operating guidelines. In
addition, each store is provided with a monthly profit and loss statement to
track store performance. Management believes the Company's management and
accounting information systems enhance its ability to monitor and affect the
operating performance of existing stores and to integrate and improve the
performance of newly acquired stores. The Company has an internal audit function
under the supervision of an outside auditing firm, Shaffner, Knight & Minnaugh
of Erie, Pennsylvania. The audit program includes the inspection of a store's
cash, fixed assets, and rental merchandise agreements. In addition, the internal
auditors ensure compliance with certain Company policies and procedures. Upon
the completion of a store audit, a report is generated and circulated to
appropriate management personnel. Follow up responses and visits are scheduled
as appropriate.
Manager Training and Empowerment. The Company constantly updates its
training materials and procedures to reflect changing policies, products and
services. The Company intends to enhance its computer based training, or CBT,
efforts as it completes the implementation of the satellite efforts mentioned
above. The advantage of the CBT format is easy access through the company
intranet and the ease of keeping training materials up to date. All store
personnel are required to complete a variety of job appropriate training
programs. Tests are given at the completion of each stage of training to ensure
that the employee comprehends the material.
OPERATIONS
Company Stores. As of September 30, 2002, the Company operates 1,062 stores
in 42 states as follows:
NUMBER OF NUMBER OF NUMBER OF
LOCATION STORES LOCATION STORES LOCATION STORES
-------- ------ -------- ------ -------- ------
Texas 115 Arkansas 33 Iowa 8
Florida 88 Alabama 27 New Mexico 8
New York 73 Michigan 26 West Virginia 8
South Carolina 60 Kansas 18 Vermont. 6
Pennsylvania 59 Missouri 18 Delaware 5
Ohio 58 Arizona 17 Nevada 5
North Carolina 50 Maryland 15 California 4
Louisiana 39 Mississippi 15 Utah 4
Tennessee 38 Oklahoma 14 Washington 4
Indiana 37 Massachusetts 13 Connecticut 3
Kentucky 37 Maine 12 Oregon 3
Georgia 36 Nebraska 12 Idaho 2
Virginia 36 New Hampshire 9 Rhode Island 2
Illinois 35 Colorado 8 South Dakota 2
The Company's stores average approximately 3,700 square feet in floor space
and are generally located in strip shopping centers in or near low to middle
income neighborhoods. Often, such shopping centers offer convenient free parking
to the Company's customers. The Company's stores are generally uniform in
interior appearance and design and display of available merchandise. The stores
have separate storage areas, but generally do not use warehouse facilities. In
selecting store locations, the Company uses a variety of market information
sources to locate areas of a town or city that are readily accessible to low and
middle income consumers. The Company believes that within these areas, the best
locations are in neighborhood shopping centers that include a supermarket. The
Company believes this type of location makes frequent rental payments at its
stores more convenient for its customers. Generally, the Company refurbishes its
stores every two to five years.
Product Selection. The Company offers Gateway computers, home entertainment
equipment, furniture, major appliances and jewelry. The Company also provides
prepaid local phone service through DPI, its 70% owned subsidiary. Home
entertainment equipment includes television sets, DVDs, VCRs, camcorders and
stereos. Major appliances offered by the Company include refrigerators, ranges,
washers and dryers. The Company's product line currently includes the Toshiba,
Sony, RCA, JVC, Phillips and Panasonic brands in home entertainment equipment,
the Amana, Crosley, Maytag and General Electric brands in major appliances and
the Ashley, Bassett, Howard Miller, Catnapper, Progressive and England Corsair
brands in furniture. The Company closely monitors inventory levels and customer
rental requests and adjusts its product mix accordingly.
For the year ended September 30, 2002, payments under rental-purchase
contracts for home entertainment products including computers accounted for
approximately 53.6%, furniture for 26.5%, appliances for 15.6%, and jewelry for
4.3% of the Company's rental revenues. Customers may rent either new merchandise
or previously rented merchandise. Weekly rentals currently range from $7.99 to
$44.99 for home entertainment equipment, from $6.99 to $41.99 for furniture,
from $10.99 to $31.99 for major appliances and from $9.99 to $25.99 for jewelry.
Gateway computers are offered as low as $14.99 per week. Previously rented
merchandise is typically offered at the same weekly or monthly rental rate as is
offered for new merchandise but with an opportunity to obtain ownership of the
merchandise after fewer rental payments.
Rental-Purchase Agreements. Merchandise is provided to customers under
written rental-purchase agreements that set forth the terms and conditions of
the transaction. The Company uses standard form rental-purchase agreements,
which are reviewed by legal counsel and customized to meet the legal
requirements of the various states in which they are to be used. Generally, the
rental-purchase agreement is signed at the store, but may be signed at the
customer's residence if the customer orders the product by telephone and
requests home delivery. Customers rent merchandise on a week-to-week and, to a
lesser extent, on a month-to-month basis with rent payable in advance. At the
end of the initial and each subsequent rental period, the customer retains the
merchandise for an additional week or month by paying the required rent or may
terminate the agreement without further obligation. If the customer decides to
terminate the agreement, the merchandise is returned to the store and is then
available for rent to another customer. The Company retains title to the
merchandise during the term of the rental-purchase agreement. If a customer
rents merchandise for a sufficient period of time, usually 12 to 24 months,
ownership is transferred to the customer without further payments being
required. Rental payments are typically made in cash or by check or money order.
The Company does not extend credit (See "Government Regulation").
Product Turnover. Generally, a minimum rental term of between 12 and 24
months is required to obtain ownership of new merchandise. Based upon
merchandise returns for the year ended September 30, 2002, the Company believes
that the average period of time during which customers rent merchandise is 17 to
18 weeks. However, turnover varies significantly based on the type of
merchandise being rented, with certain consumer electronic products, such as
camcorders and VCRs, generally being rented for shorter periods, while
computers, appliances and furniture are generally rented for longer periods.
Most rental-purchase transactions require delivery and pickup of the product,
weekly or monthly payment processing and, in some cases, repair and
refurbishment of the product. In order to cover the relatively high operating
expenses generated by greater product turnover, rental-purchase agreements
require larger aggregate payments than are generally charged under installment
purchase or credit plans for similar merchandise.
Customer Service. The Company offers same-day delivery, installation and
pick-up of its merchandise. The Company also provides any required service or
repair without charge, except for damage in excess of normal wear and tear. If
the product cannot be repaired at the customer's residence, the Company provides
a temporary replacement while the product is being repaired. The customer is
fully liable for damage, loss or destruction of the merchandise, unless the
customer purchases an optional loss/damage waiver. Most of the products offered
by the Company are covered by a manufacturer's warranty for varying periods,
which, subject to the terms of the warranty, is transferred to the customer in
the event that the customer obtains ownership. Repair services are provided
through in-house service technicians, independent contractors or under factory
warranties. The Company offers Preferred Customer Club, a fee-based membership
program that provides special loss and damage protection and, at a discounted
rate, an additional one year of service protection plan on rental merchandise,
preferred treatment in the event of involuntary job loss, accidental death and
dismemberment insurance and discounted emergency roadside assistance, as well as
other discounts on merchandise and services.
COLLECTIONS
Management believes that effective collection procedures are important to
the Company's success. The Company's collection procedures increase the revenue
per product with minimal associated costs, decrease the likelihood of default
and reduce charge-offs. Senior management, as well as store managers, uses the
Company's computerized management information system to monitor cash collections
on a daily basis. In the event a customer fails to make a rental payment when
due, store management will attempt to contact the customer to obtain payment and
re-instate the contract or will terminate the account and arrange to regain
possession of the merchandise. However, store managers are given latitude to
determine the appropriate collection action to be pursued based on individual
circumstances. Depending on state regulatory requirements, the Company charges
for the reinstatement of terminated accounts or collects a delinquent account
fee. Such fees are standard in the industry and may be subject to state law
limitations. See "--Government Regulation." Despite the fact that the Company is
not subject to the federal Fair Debt Collection Practices Act, it is the
Company's policy to abide by the restrictions of this law in its collection
procedures. Charge-offs due to lost or stolen merchandise and discards were
approximately 3.4%, 4.6% and 3.9% of the Company's revenues for the years ended
September 30, 2002, 2001, and 2000, respectively. The charge-off rate for chains
with over 40 stores reporting to APRO in 2001 was 2.7%.
MANAGEMENT
The Company's stores are organized geographically with several levels of
management. At the individual store level, each store manager is responsible for
customer relations, deliveries, pick-ups, inventory management, staffing and
certain marketing efforts. A Company store normally employs one store manager,
one assistant manager, two account managers, and one full-time delivery and
installation technician. The staffing of a store depends on the number of
rental-purchase contracts serviced by the store.
In September 2002, the Company reorganized its field management structure.
Each store manager reports to one regional manager, who typically oversees seven
to ten stores. Regional managers are primarily responsible for monitoring
individual store performance and inventory levels within their respective
regions. The Company's regional managers, in turn, report to a divisional
vice-president who monitors the operations of their divisions and, through their
regional managers, individual store performance. The divisional vice-presidents
report to one of two Executive Vice-Presidents, who monitor the overall
operations of their assigned geographic area. The Executive Vice-Presidents
report to the corporate-level Senior Vice-President of Operations who is
responsible for overall Company-wide store operations. Senior management at the
Company's headquarters directs and coordinates purchasing, financial planning
and controls, management information systems, employee training, personnel
matters, advertising, and acquisitions. Headquarters personnel also evaluate the
performance of each store.
In July 2002, the Company promoted William Short, formerly an Executive Vice
President of Operations, to be the new Senior Vice-President of Operations at
the corporate level.
MANAGEMENT INFORMATION SYSTEM
The Company believes that its proprietary management information system
provides it with a competitive advantage over many small rental-purchase
operations. The Company uses an integrated computerized management information
and control system to track each unit of merchandise, each rental-purchase
agreement, and each customer. The Company's system also includes extensive
management software and report generating capabilities specifically tailored to
the Company's operating procedures. Senior management reviews reports for all
stores daily and any issues are addressed the following business day. Each store
has the ability to track individual components of revenue, idle items, items on
rent, product on order, delinquent accounts and other account and customer
information. Management electronically gathers each day's activity report.
Company management has access to operating and financial information about any
store location or region in which the Company operates and generates management
reports on a daily, weekly, month-to-date and year-to-date basis. Utilizing the
management information system, senior management, regional managers and store
managers can closely monitor the productivity of stores under their supervision
as compared to Company-prescribed guidelines.
PURCHASING AND DISTRIBUTION
The Company's general product mix is determined by senior management based
on an analysis of customer rental patterns and introduction of new products on a
test basis. Individual store managers are responsible for determining the
particular product selection for their store from a list of products approved by
senior management. Store managers order products on-line using the Company's
intranet. These electronic purchase orders are reviewed, approved and executed
through regional managers, divisional vice presidents and the Company's
purchasing department to ensure that inventory levels and mix at the store level
are appropriate. Merchandise is generally shipped by vendors directly to each
store and held for rental at the individual locations. The Company purchases its
merchandise directly from manufacturers or distributors. The Company generally
does not enter into written contracts with its suppliers. Although the Company
currently expects to continue its existing relationships, management believes
there are numerous sources of products available to the Company and does not
believe that the success of the Company's operations is dependent on any one or
more of its present suppliers.
MARKETING AND ADVERTISING
The Company promotes its products and services through direct mail, network
radio and television advertising and, to a lesser extent, through local
broadcast and secondary print media advertisement. The Company also solicits
business from former and prospective customers via telemarketing. The Company's
advertisements emphasize product and brand name selection, prompt delivery and
repair, and the absence of any down payment, credit investigation or long-term
obligation. Advertising expense as a percentage of revenue for the years ended
September 30, 2002, 2001 and 2000 were 4.5%, 3.2% and 3.4%, respectively. In
addition to the Company's national advertising efforts, the Company manages a
local store-marketing plan to allow the stores to leverage market specific
knowledge. As the Company obtains new stores in its existing markets, the
advertising expenses of each store in the market is reduced by listing all
stores in the same market-wide advertisement.
COMPETITION
The rental-purchase industry is highly competitive. The Company competes
with other rental-purchase businesses and, to a lesser extent, with rental
stores that do not offer their customers a purchase option. Competition is based
primarily on rental rates and terms, product selection and availability, and
customer service. With respect to consumers who are able to purchase a product
for cash or on credit, the Company also competes with department stores,
discount stores and retail outlets that offer an installment sales program or
offer comparable products and prices. The Company is the second largest operator
of stores in the rental-purchase industry. Rent-A-Center, the largest, has
significantly greater financial and operating resources and name recognition
than does the Company.
PERSONNEL
As of September 30, 2002, the Company had 5,154 employees, 221 of which are
located at the corporate headquarters in Erie, Pennsylvania. None of the
Company's employees are represented by a labor union.
GOVERNMENT REGULATION
Forty-seven states have enacted legislation for the express purpose of
regulating rental-purchase transactions. All of these state laws other than
Alaska and Montana were enacted five or more years ago. These laws generally
require certain contractual and advertising disclosures concerning the nature of
the rental-purchase transaction and also provide varying levels of substantive
consumer protection, such as requiring a grace period for late payments and
providing contract reinstatement rights in the event a rental-purchase agreement
is terminated for non-payment. No federal legislation has been enacted
regulating the rental-purchase transaction.
All of the states in which the Company operates, except North Carolina,
impose some type of statutory disclosure requirements either in rental-purchase
agreements or in advertising or both. Rental-purchase legislation or other
statutes in the majority of these states distinguish rental-purchase
transactions from credit sales. Court decisions in the remaining states except
Minnesota, New Jersey and Wisconsin have characterized rental-purchase
transactions as leases rather than credit sales. Court decisions in Minnesota,
New Jersey and Wisconsin have created a regulatory environment in those states
that is prohibitive to traditional rental-purchase transactions. The Company
does not operate in those states.
The Company instructs its operations personnel in procedures required by
applicable laws through policy manuals and on-the-job training. Management
believes that the Company's operations and point-of-sale systems are in
compliance with the requirements of applicable laws in all material respects.
Management believes there is little likelihood of state or federal
legislation re-characterizing rental-purchase transactions as credit sales. The
Company, in conjunction with the rental-purchase industry's trade association,
closely monitors legislative and judicial activity and is working to
legislatively resolve issues created by unfavorable court decisions in
Minnesota, New Jersey and Wisconsin.
SERVICE MARKS
The Company has registered the "Rent-Way" service mark and related designs
under the Lanham Act. The Company believes that these marks have acquired
significant market recognition and goodwill in the communities in which its
stores are located.
BUSINESS OF dPi TELECONNECT LLC
DPI provides local prepaid telephone service on a month-to-month basis to
subscribers who have been disconnected by the local telephone company.
Generally, this is because they have previously failed to pay a local or long
distance phone bill or, due to poor credit, are asked to remit a deposit to
their local telephone company, which they are unable to do. Because DPI does not
require credit checks or deposits, it is an attractive alternative to these
customers.
DPI was formed in late 1998. The Telecommunications Act of 1996, which
encouraged the establishment of competitive local exchange carriers, or CLECs,
made this business possible. DPI currently operates in a niche segment of the
CLEC industry. CLECs compete with the regional Bell operating companies or their
established, or incumbent local telephone service providers, or ILECs. The
market for DPI's prepaid local telephone services is principally consumers whose
credit rating or whose prior payment history with the ILEC is poor. Although not
identical, the Company believes DPI's potential customer base overlaps
significantly with Rent-Way's customer base.
In order to conduct its business, DPI is required to obtain governmental
authorization in each state in which it provides local telephone service. At the
present time, DPI has obtained or has pending such authorization in 41 states.
DPI's licenses must be renewed on a periodic basis. In addition to governmental
approval, DPI must enter into a resale contract with an ILEC to purchase service
for resale. Under applicable federal law, all ILECs are required to negotiate
these contracts with CLECs. At the present time, DPI has resale agreements in
place with all existing major ILECs and is moving forward on agreements with
several smaller regional ILECs. DPI markets and sells its services through a
network of agents. The Company, with 780 stores now offering the service, is
DPI's largest agent. Customers generally pay the Company and other agents of DPI
between $30.00 and $65.00 per month for prepaid local telephone services,
depending on area retail pricing and additional feature services. Under the
Company's contract with DPI, the Company is entitled to retain 10% of the
customer's payments as its agent's fee, which is consistent with the fees
retained by DPI's other agents. As of September 30, 2002, DPI had approximately
55,400 customers.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company leases substantially all of its store facilities under operating
leases that generally have terms of three to five years and require the Company
to pay real estate taxes, utilities and maintenance. The Company has optional
renewal privileges on most of its leases for additional periods ranging from
three to five years at rental rates generally adjusted for increases in the cost
of living. There is no assurance that the Company can renew the leases that do
not contain renewal options or that if it can renew them, the terms will be
favorable to the Company. Management believes that suitable store space is
generally available for lease and that the Company would be able to relocate any
of its stores without significant difficulty should it be unable to renew a
particular lease. Management also expects that additional space will be readily
available at competitive rates for new store openings. The Company owns its
corporate headquarters located in Erie, Pennsylvania, which comprises 74,000
square feet. The Company also owns an office building in Erie, Pennsylvania,
which is used for record retention and comprises approximately 8,200 square
feet.
ITEM 3. LEGAL PROCEEDINGS
Investigations. There are currently pending federal governmental
investigations by the Securities and Exchange Commission and the United States
Attorney involving the Company's financial reporting. Rent-Way is cooperating
fully in these investigations. The investigations are ongoing and the Company
cannot predict their outcomes. If Rent-Way or any of its officers were convicted
of any crime or subjected to sanctions, or if substantial penalties, damages or
other monetary remedies are assessed against Rent-Way, this could have a
material adverse effect on the Company's results of operations, financial
condition and cash flows.
Securities Litigation. The Company, its firm of independent accountants, and
certain of its current and former officers have been served with a consolidated
class action complaint filed in the U.S District Court for the Western District
of Pennsylvania. The complaint alleges that, among other things, as a result of
accounting irregularities, the Company's fiscal 1998, 1999, and 2000 financial
statements were materially false and misleading thus constituting violations of
federal securities laws by the Company, by its firm of independent accountants
and by certain officers. The action alleges that the defendant violated Sections
10(b) and/or Section 20(a) of the Securities Exchange Act and Rule 10b-5
promulgated thereunder. The action seeks damages in unspecified amounts. The
action purports to be brought on behalf of purchasers of the Company's common
stock during various periods, all of which fall between December 10, 1998, and
October 27, 2000. Rent-Way filed a motion to dismiss the complaint, which was
denied. Discovery regarding class certification issues has begun and is
continuing.
Certain of Rent-Way's officers and directors and Rent-Way, as nominal
defendant, have been sued in a shareholder derivative action brought on behalf
of Rent-Way in the U.S. District Court for the Western District of Pennsylvania.
The derivative complaint purports to assert claims on behalf of Rent-Way against
the defendants for violation of duties asserted to be owed by the defendants to
Rent-Way and which relate to the events which gave rise to the purported class
actions described above. All proceedings in the derivative case have been stayed
pending the resolution of the class action lawsuit.
Rent-Way is presently unable to predict or determine the final outcome of,
or to estimate the amounts or potential range of loss with respect to, the
investigations and the securities litigation described above. Management
believes that an adverse outcome with respect to such proceedings could have a
material adverse impact on the Company's financial position, results of
operations or cash flows.
Pursuant to its bylaws, the Company is obligated under certain circumstances
to indemnify its officers and directors for the costs they incur as a result of
the investigations and lawsuits, as well as, liability for related claims.
Rent-Way is also subject to litigation in the ordinary course of business.
In the opinion of management, the ultimate outcome of any existing litigation,
other than the investigations and the lawsuits described above, would not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
RENT-WAY, INC.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange under
the symbol "RWY." The following table sets forth, for the periods indicated, the
high and low sales prices per share of the common stock as reported on New York
Stock Exchange.
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
--------------------- ------------------
HIGH LOW HIGH LOW
First Quarter......... $ 6.97 $5.40 $30.25 $2.6875
Second Quarter........ 8.45 5.27 8.27 4.00
Third Quarter......... 13.28 8.40 10.90 5.01
Fourth Quarter........ 12.30 3.00 9.60 5.25
As of September 30, 2002, there were 278 record shareholders of Rent-Way's
common stock.
The Company has not paid any cash dividends to shareholders. The declaration
of any cash dividends will be at the discretion of the board of directors and
will depend upon earnings, capital requirements and the financial position of
the Company, general economic conditions and other pertinent factors. The
Company does not intend to pay any cash dividends in the foreseeable future.
Management intends to use earnings, if any, to repay bank debt and, to the
extent permitted by the Company's bank lenders, to develop and expand the
Company's business. The Company's bank credit facility prohibits the payment of
dividends.
The Company maintains the 1992, 1995, and 1999 Stock Option Plans pursuant
to which options to purchase shares of common stock are outstanding and may be
granted in the future. The Company also has options to acquire common stock
outstanding under stock option plans assumed in connection with the Company's
acquisition of Home Choice Holdings, Inc. in December 1998. The Company also has
individual option award agreements outside of these plans with four employees
covering an aggregate of 80,000 options to acquire shares of common stock. These
non-plan options are evidenced by written agreements and have the following
terms: expiration is five years from option grant date (June 13, 2002), vesting
is one-half on grant date, one-half on first anniversary of grant date; the
options terminate immediately on termination of employment except in the event
of death, disability or involuntary termination, in which case they are
exercisable (to the extent exercisable at termination) for an additional three
months.
Number of securities
remaining available for
future issuance under equity
Number of securities to be compensation plans
issued upon exercise of Weighted-average exercise price of (excluding securities
outstanding options, outstanding options, warrants and reflected
Plan category warrants and rights rights in column (a))
------------- ------------------- ------ --------------
(a) (b) (c)
Equity compensation plans approved
by security holders............... 3,577,231 $ 13.22 848,411
Equity compensation plans not approved
by security holders........... 80,000 $ 11.67 --
---------- --------
Total............................. 3,657,231 $ 13.98 848,411
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the years ended September 30,
1998, 1999, 2000, 2001 and 2002, were derived from the audited financial
statements of the Company for those periods. All periods prior to the year ended
September 30, 1999, reflect the Company's merger with Home Choice in December
1998, which was accounted for as a pooling of interests. The years ended
September 30, 1998 and 1999, have been restated to reflect adjustments described
in Note 19 to the Company's financial statements included in the Company's Form
10-K/A dated August 23, 2001. The historical financial data are qualified in
their entirety by, and should be read in conjunction with, Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
financial statements of the Company and notes thereto included elsewhere in this
report.
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------------
1998(1)(2) 1999(3) 2000(4) 2001 2002
---------- ------- ------- ---- ----
(Dollars in millions, except per share data)
STATEMENT OF OPERATIONS DATA:
Total revenues........................................ $436,031 $ 494,352 $ 592,686 $ 654,618 $ 626,429
Operating profit (loss)............................... 8,589 24,674 596 (10,237) 31,850
Income (loss) before cumulative effect of change in
accounting principle and extraordinary item............. (5,819) (246) (28,041) (63,625) (31,577)
Net income (loss)..................................... (5,819) (765) (28,041) (63,625) (76,472)
Adjusted net income (loss) (5)........................ 5,429 9,072 (14,471) (50,934) (76,472)
Basic:
Income (loss) before cumulative effect of change in
accounting principle and extraordinary item............. $ (0.29) $ (0.01) $ (1.20) $ (2.60) $ (1.26)
Net income (loss)................................... $ (0.29) $ (0.04) $ (1.20) $ (2.60) $ (3.06)
Adjusted net income (loss) (5)...................... $ .27 $ .43 $ (.62) $ (2.08) $ (3.06)
Diluted:
Income (loss) before cumulative effect of change in
accounting principle and extraordinary item............. $ (0.29) $ (0.01) $ (1.20) $ (2.60) $ (1.26)
Net income (loss)................................... $ (0.29) $ (0.04) $ (1.20) $ (2.60) $ (3.06)
Adjusted net income (loss) (5)...................... $ .30 $ .47 $ (.62) $ (2.08) $ (3.06)
Weighted average shares outstanding (in thousands):
Basic............................................... 20,283 21,341 23,314 24,501 25,021
Diluted............................................. 20,283 21,341 23,314 24,501 25,021
BALANCE SHEET DATA:
Rental merchandise, net............................... $175,085 $ 196,510 $ 282,052 $ 218,973 $ 196,064
Total assets.......................................... 487,536 609,658 766,311 628,177 510,794
Debt.................................................. 179,603 288,130 387,852 307,009 277,207
Shareholders' equity.................................. 244,090 258,487 267,822 206,042 136,597
1) The year ended September 30, 1998, reflects the combination of the
preceding twelve-month financial periods for each of Rent-Way and Home
Choice.
2) During the year ended September 30, 1998, the Company acquired 250
rental-purchase stores, 50 of which were acquired in January 1998 from Ace
Rentals and 145 of which were acquired in February 1998 from Champion,
which affects the comparability of the historical financial information for
the periods presented.
3) During the year ended September 30, 1999, the Company acquired 275
rental-purchase stores, 250 of which were acquired in September 1999 from
RentaVision, which affects the comparability of the historical financial
information for the periods presented.
4) During the year ended September 30, 2000, the Company acquired 24
rental-purchase stores and a 70% interest in DPI, which affects the
comparability of the historical financial information for the periods
presented.
5) The adjusted net income (loss) reflects previously reported net loss
adjusted for goodwill amortization added back as if SFAS 142 had been
adopted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT DEVELOPMENTS
On December 17, 2002, the Company entered into a definitive purchase
agreement to sell 295 stores to Rent-A-Center, Inc. for $101.5 million, subject
to downward adjustment for store performance prior to closing. The stores are
located in 38 states and had aggregate average monthly revenues for the three
months ended October 31, 2002, of approximately $10.1 million. Closing of the
transaction contemplated by the definitive purchase agreement is subject to
several conditions, including clearance under the Hart-Scott-Rodino Act and
other customary conditions. As required under the Company's credit facility, all
proceeds of the sale, net of transaction, store closing and similar expenses,
will be used to pay outstanding bank debt. Of the approximate $101.5 million
sale price, an aggregate of $10 million is subject to a holdback by
Rent-A-Center to secure the Company's indemnification obligations--$5 million
for 90 days and $5 million for 18 months. A copy of the definitive purchase
agreement is filed as Exhibit 2.11 to this annual report. Following completion
of the sale, the Company will operate 766 stores in 33 states.
OVERVIEW
Rent-Way is the second largest operator in the rental-purchase industry with
1,062 stores in 42 states as of September 30, 2002. The Company offers quality
brand name home entertainment equipment, furniture, appliances, computers, and
jewelry to customers under full-service rental-purchase agreements that
generally allow the customer to obtain ownership of the merchandise at the
conclusion of an agreed upon rental period. The Company also provides prepaid
local phone service to consumers on a monthly basis through DPI. Segment
information for the Company is presented in Note 19 of the notes to the
financial statements included in this report. The Company has not presented
separate information in this Item 7 regarding its prepaid telephone service
segment except in the discussion of total revenues and operating income. The
Company believes that other items for its prepaid telephone service segment are
immaterial.
The results of operations are affected by the current economic conditions.
Business is also driven, in part, by the level of spending by our customers. The
ability to identify and capitalize on market changes early in their cycles is a
key driver of performance. The Company's cost-management strategy is to
anticipate changes in demand for services and to identify cost-management
initiatives in order to manage costs as a percentage of revenues.
Revenues are driven by the ability to both expand current customer base by
securing new agreements with new customers while maintaining existing customer
agreements. The ability to add value to customers, and therefore drive revenues,
depends in part on the ability to offer quality, market-leading products and to
serve customers with a skilled team of professionals.
Cost of services is primarily driven by the cost of rental merchandise and
the cost of personnel, the latter of which consists mainly of compensation and
benefits. Cost of rental merchandise as a percentage of revenues is driven by
maintaining quality product mix, availability and keeping rental merchandise on
active rental agreements. Sales and marketing expense is driven primarily by
business development activities; the development of new service offerings; the
level of concentration of customers in a particular market; and
customer-targeting, image-development and brand-recognition activities. General
and administrative costs primarily include costs for personnel who do not work
directly with the customer, information systems and office space. The Company
seeks to manage these areas in line with changes in activity levels in the
business.
Current economic conditions continue to cause pricing pressures from
competitors. The Company believes these conditions have also resulted in a
higher than anticipated number of customers being unable to continue their
rental contracts for personal financial reasons. The Company is positioning to
achieve revenue growth through improved product selection and competitive
marketing initiatives. Further, the long-term impact of the current economic
environment and pricing pressures of the competitive markets can not be
predicted. The Company strives to improve management of costs.
The Company's cost-management strategy is to anticipate changes in demand
for services and to identify initiatives that may generate cost management as a
percentage of revenues. Store-count is managed to meet the anticipated demand,
and programs have been implemented to enable the Company to maintain or improve
consolidated operating margins, excluding one-time charges.
Rental-Purchase Acquisitions and Store Openings. Through sales, closures and
combinations, the number of stores operated by the Company has decreased from
1,138 as of September 30, 2000, to 1,062 as of September 30, 2002. The following
table shows the number of stores opened, acquired, sold, closed and/or combined
during this three-year period.
YEARS ENDED SEPTEMBER 30,
STORES 2000 2001 2002
-------------------------- ------------- ------------- ---------
Open at Beginning of Period................ 1,114 1,138 1,087
Opened..................................... 68 32 0
Acquired................................... 24 2 0
Locations Sold............................. (4) (39) (15)
Closed or Combined......................... (64) (46) (10)
--------- --------- ---------
Open at End of Period...................... 1,138 1,087 1,062
========= ========== =========
Fiscal 2002 Acquisitions. The Company did not open any new stores or make
any new store acquisitions during fiscal 2002.
Fiscal 2002 Store Sales, Swaps and Closures or Combinations. During fiscal
2002, the Company sold six stores in several transactions in exchange for $0.8
million in cash. The Company recognized a gain of $0.4 million and sold assets
with a net book value of $0.4 million as a result of these transactions.
The Company also entered into asset purchase and exchange agreements whereby
the Company exchanged nine stores and approximately $0.1 million in cash for the
rental merchandise and rental contracts of ten stores. The Company recognized a
gain of approximately $0.5 million and exchanged assets with a net book value of
$0.8 million.
In October 2001, the Company purchased, in exchange for $0.3 million in
cash, customer agreements and active rental merchandise that were combined with
an existing store. There was no gain or loss on the transaction.
In addition to the store information discussed above, the following matters
should be considered in connection with the discussion of results of operations
and financial condition:
o The Company incurred substantial accounting and legal fees in fiscal 2001 in
connection with its accounting investigation and fiscal 2000 audit. The
Company incurred $7.9 million of these expenses in fiscal 2001. In fiscal
2002 there was a $1.9 million reimbursement of accounting and legal fees as
a result of an insurance recovery. This recovery offset fiscal 2002 expenses
of $1.3 million, resulting in income of $0.6 million. The Company
anticipates incurring additional legal and other expenses in connection with
the class action litigation and governmental investigations which are
ongoing.
o The Company took actions in fiscal 2001, which had the effect of
significantly reducing operating income, but which management believes were
necessary. Among the actions taken were (1) identifying store merchandise
that did not generate normal industry margins and disposing of it, by
lowering cash purchase prices or rental rates and terms, (2) writing off
approximately $2.1 million of store merchandise that could not be sold or
rented on these lower terms or met certain age or condition criteria, (3)
closing or combining 46 stores which resulted in charges for early
termination of store leases and fixed asset write-offs of approximately $4.3
million.
o The Company recorded changes in its interest rate swap portfolio of $0.5
million gain and ($12.6) million loss in fiscal 2002 and fiscal 2001,
respectively, in accordance with Statement of Financial Standard No. 133
(See Note 10 to the Company's financial statements at Item 8).
o Effective October 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets." Thus, no amortization for such goodwill and indefinite-lived
intangibles was recognized in the accompanying Consolidated Statements of
Operations for fiscal year ended September 30, 2002, compared to $12.7
million for the year ended September 30, 2001. At September 30, 2002, the
Company calculated an impairment to goodwill of $58.9 million, recorded in
"Cumulative Effect of Change in Accounting Principle" in the amount of $41.5
million (net of $17.4 million in income taxes). (See Note 4 to the Company's
financial statements at Item 8).
USE OF ESTIMATES IN FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the 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. Actual results could differ
from those estimates. On an ongoing basis, management reviews its estimates,
including those related to litigation, liability for self-insurance, impairment
of goodwill and other intangibles, based on currently available information.
Changes in facts and circumstances may result in revised estimates.
SIGNIFICANT ACCOUNTING POLICIES
Revenue. Rental merchandise is rented to customers pursuant to rental
agreements, which provide for either weekly, biweekly, semi-monthly or monthly
rental payments collected in advance. Revenue is recognized as collected, not
over the rental term, since at the time of collection the rental merchandise has
been placed in service and costs of installation and delivery have been
incurred. This method of revenue recognition does not produce materially
different results than if rental revenue was recognized over the weekly,
biweekly, semi-monthly or monthly rental term.
Rental Merchandise Depreciation. The Company uses the units of activity
depreciation method for all rental merchandise except computers. Under the units
of activity method, rental merchandise is depreciated as revenue is collected or
earned during free-rent promotions. Thus rental merchandise is not depreciated
during periods when it is not on rent and therefore not generating rental
revenue. Personal computers, added to the Company's product line in June 1999,
are principally depreciated on the straight-line basis beginning on acquisition
date over 12 months to 24 months, depending on the type of computer. Write-offs
of rental merchandise arising from customers' failure to return merchandise,
obsolescence and losses due to excessive wear and tear of merchandise are
recognized using the direct write-off method, which is materially consistent
with the results that would be recognized under the allowance method. The
Company reviews this analysis from time to time in order to make this
determination.
Prepaid Phone Service. Prepaid phone service is provided to customers on a
prepaid month-to-month basis. Prepaid phone service revenues are comprised of
monthly service revenues and activation revenues. Monthly service revenues are
recognized on a straight-line basis over the related monthly service period,
commencing when the service period begins. The cost of monthly service is also
recognized over the monthly service period and is included in "cost of prepaid
phone service" in the Statement of Operations. Activation revenues and costs are
recognized on a straight-line basis over the average estimated life of the
customer relationship. The Company reviews the average estimated life of the
customer from time to time in making this determination.
Closed Store Reserves. From time to time, the Company closes or consolidates
retail stores. An estimate is recorded of the future obligation related to
closed stores based upon the present value of the future lease payments and
related commitments, net of estimated sublease income. If the estimates related
to sublease income are not correct, the actual liability may be more or less
than the liability recorded, and the Company adjusts the liability accordingly.
Company Insurance Programs. The Company is primarily self-insured for
health, workers' compensation, automobile, and general liability costs. The
self-insurance liability for health costs is determined actuarially based on
claims filed and an estimate of claims incurred but not yet reported. The
self-insurance liability for workers' compensation, automobile and general
liability costs are determined actuarially based on claims filed and company
experience. Losses in the workers' compensation, automobile and general
liability programs are pre-funded based on the insurance company's loss
estimates. Loss estimates will be adjusted for developed incurred losses at 18
months from policy inception and every 12 months thereafter. Retrospective
adjustments to loss estimates are recorded when determinable and probable.
Income Taxes. Deferred income taxes are recorded to reflect the tax
consequences on future years of differences between the tax and financial
statement basis of assets and liabilities at year end using income tax rates
under existing legislation expected to be in effect at the date such temporary
differences are expected to reverse. A valuation allowance is provided for
deferred tax assets if it is more likely than not that these items may expire
before the Company is able to realize their benefit, or that future
deductibility is uncertain. Deferred income taxes are adjusted for tax rate
changes as they occur.
Goodwill. Effective October 1, 2001, the Company adopted Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets." SFAS 142 requires that intangible assets not subject to
amortization and goodwill be tested for impairment annually, or more frequently
if events or changes in circumstances indicate that the carrying value may not
be recoverable. Amortization of goodwill and intangible assets with indefinite
lives, including such assets recorded in past business combinations, ceased upon
adoption. Thus, no amortization for such goodwill and indefinite-lived
intangibles was recognized in the accompanying Consolidated Statements of
Operations for fiscal year ended September 30, 2002, compared to $12.7
millionfor the year ended September 30, 2001. At September 30, 2002 the Company
calculated an impairment to goodwill of $58.9 million, recorded in "Cumulative
Effect of Change in Accounting Principle" in the amount of $41.5 million (net of
$17.4 million in income taxes). (See Note 4.)
RESULTS OF OPERATIONS
As an aid to understanding the Company's operating results, the following
table expresses certain items of the Company's Consolidated Statements of
Operations for the years ended September 30, 2002, 2001 and 2000 as a percentage
of total revenues.
YEARS ENDED SEPTEMBER 30,
2002 2001 2000
------------ ------------ ----------
Revenues:
Rental................................................. 81.3% 80.8% 84.2%
Prepaid phone service................................. 6.0 5.3 1.5
Other................................................. 12.7 13.9 14.3
---------- ---------- ----------
Total revenues..................................... 100.0 100.0 100.0
Costs and operating expenses:
Depreciation and amortization:
Rental merchandise.................................. 28.0 30.7 26.6
Property and equipment.............................. 4.2 4.8 4.3
Amortization of intangibles......................... 0.4 2.2 2.3
Cost of prepaid phone service......................... 3.8 3.1 1.0
Salaries and wages.................................... 24.6 24.3 25.5
Advertising, net...................................... 4.5 3.2 3.4
Occupancy............................................. 7.1 7.8 7.7
Other operating expense............................... 22.5 25.5 29.1
---------- ---------- ----------
Total costs and operating expenses................. 95.1 101.6 99.9
Operating income (loss)............................... 4.9 (1.6) 0.1
Interest expense...................................... (7.7) (6.3) (5.0)
Interest income....................................... 0.1 -- --
Equity in loss of subsidiary.......................... -- -- (0.1)
Amortization--deferred financing costs................ (0.2) (0.2) (0.1)
Other income (expenses), net.......................... 0.4 (1.6) 0.3
---------- ---------- ----------
(Loss) before income taxes, cumulative effect of change
in accounting principle and extraordinary item.... (2.5) (9.7) (4.8)
Income tax expense (benefit).......................... 2.6 -- (0.1)
---------- ---------- ----------
(Loss) before cumulative effect of change in accounting
principle and extraordinary item.................. (5.1) (9.7) (4.7)
Cumulative effect of change in accounting principle... (6.6) -- --
Extraordinary item.................................... (0.5) -- --
---------- ---------- ----------
Net (loss)......................................... (12.2)% (9.7)% (4.7)%
========== ========== ==========
FISCAL 2002 COMPARED TO FISCAL 2001
Total Revenues. Total revenues decreased $28.2 million or 4.5%, to $626.4
million from $654.6 million. This decrease is attributable to a decrease in
revenues of $31.2 million in the household rental segment offset by an increase
in revenues of $3.0 million in the prepaid telephone service segment. The $31.2
million decrease in revenue in the household rental segment is due to a 1.9%
decrease in same store revenues and the closing or selling of 25
under-performing stores since September 30, 2001.
Same store rental revenues decreased 0.7% as compared to the same period
last year. This decrease is primarily due to a decrease in total deliveries for
the year ended September 30, 2002, as compared to the same period last year. It
should be noted that the deliveries made in the year ended September 30, 2002,
have better revenue potential than the lower-end items delivered in the past.
Same store processing and insurance fee revenues decreased 8.9% as compared to
the prior year. This is attributed to reductions in the Company's collection of
liability damage waiver and processing fees. Same store early purchase option
and sales revenue decreased 5.2% as compared to the same period last year. The
prior fiscal year had a significant amount of product sales to eliminate
lower-end, lower-margin merchandise from the Company's product mix. The Company
lowered cash purchase prices on merchandise identified as generating margins
lower than industry norms.
Depreciation and Amortization. Depreciation expense related to rental
merchandise decreased to 28.0% as a percentage of total revenues from 30.7%. In
fiscal 2002, the Company took steps to increase gross profit margins on rental
contracts. These steps included introducing higher-end, higher-margin
merchandise to the stores, increasing rental rates on certain core products to
competitive market rates, increasing weekly rental rates of personal computers
to competitive market rates, and implementing a program to eliminate free
Internet service by replacing it with a prepaid, unlimited Internet product. The
Company expects depreciation expense as a percentage of total revenues to
continue decreasing as product margins improve due to enhanced rental rates and
turns as a result of the factors discussed above.
Amortization of goodwill and other intangibles decreased to 0.4% as a
percentage of total revenues from 2.2%. This decrease is due to the adoption of
Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"). SFAS No.
142 requires the cessation of amortization of goodwill and other
indefinite-lived intangibles on the balance sheet. Goodwill and other indefinite
lived intangibles on the balance sheet must then be tested for impairment at
least annually. The Company completed step one, the transitional goodwill
impairment test and determined that goodwill is impaired in the household rental
segment. Such testing resulted in a goodwill impairment charge recorded in
"Cumulative Effect of Change in Accounting Principle" in the Consolidated
Statement of Operations as a loss of $41.5 million (net of $17.4 million in
income taxes).
Cost of Prepaid Phone Service. The cost of prepaid phone service increased
to $23.7 million, or 3.8% of total revenues, from $20.0 million, or 3.1% as a
percentage of total revenues. Cost of prepaid phone service, as a percentage of
prepaid phone service revenues, increased to 62.8% from 57.5%. This increase is
primarily due to the growth in the number of customer lines serviced and an
increase in the mix of new customers to the total customer base. The increase in
new customers results in higher costs due to ILEC activation fees. This increase
is also the result of the FCC allowing the ILECs to increase EUCL monthly
charges for residential lines during mid-year calendar 2001. The Company has
reacted to the EUCL increases by adjusting retail prices to the customer based
on targeted margins. These price increases were implemented in the first quarter
of fiscal 2002.
Salaries and Wages. Salaries and wages decreased by $5.0 million due to the
Company's continued effort to better manage store staffing levels and overtime
and the result of a reduction of corporate staffing levels.
Advertising. Advertising expense increased $7.1 million, from $20.8 million
in 2001 to $27.9 million in 2002. Included in this increase is an additional
$4.4 million for air-time, $2.7 million in distribution costs, consisting
primarily of postage, and $1.5 million for the advertising campaign titled "Fall
Kickoff Extravaganza". In addition, there was a reduction in advertising rebates
resulting in an increase of net advertising costs by $2.2 million. Offsetting
this increase was a decrease in production costs of $3.7 million.
Other Operating Expenses. Other operating expense decreased by $23.5 million
to $140.8 million from $164.3 million. This decrease is primarily due to lowered
rental merchandise losses of $8.6 million, lowered service costs of $3.1
million, lowered telephone costs of $1.3 million, lowered training and
conference costs of $1.0 million, lowered utilities costs of $1.8 million,
lowered Club Plan expense of $1.3 million, lowered accounting fees of $1.7
million, and lowered legal and professional fees of $8.2 million. For fiscal
2002 and 2001, accounting fees, legal fees and consulting fees related to the
fiscal 2000 audit and investigation were $1.3 and $7.9 million, respectively.
During fiscal 2002, the Company was reimbursed $1.9 million as a result of an
insurance recovery.
The decrease in other operating expense was partially offset by a charge of
$4.6 million against income consisting of a $3.6 million retrospective upward
adjustment of the Company's fiscal 2001 property/casualty insurance premium and
a $1.0 million upward adjustment of the Company's pre-2001 property/casualty
insurance premium reserves.
Interest Expense. Interest expense increased $6.5 million from 6.3% to 7.7%
of total revenues. The Company's credit facility requires the Company to accrue
additional payment-in-kind interest at a rate of 200 to 500 basis points that is
due and payable on the maturity date of its term loans. This payment-in-kind
interest amounted to $15.0 million in fiscal 2002. Offsetting this increase is a
decrease in other interest expense of $6.2 million. This decrease is due to a
lower effective interest rate. In the comparable period in fiscal 2001, the
Company was in default under the bank credit facility and operated under a
forbearance agreement.
Other Income (Expense), Net. Other income was $2.4 million in fiscal 2002
compared to other expense of $10.8 million for fiscal 2001. This change is
primarily due to a positive change in the fair market value of the interest rate
swap portfolio, which resulted in income of $0.5 million for the year ended
September 30, 2002, compared to an adverse change of $12.6 million for 2001.
Other income for fiscal 2002 includes gain on the sale of stores. The Company
entered into several small transactions to sell fifteen under-performing stores.
The Company recognized a net gain of $0.9 million on these store sale
transactions.
Income Tax Expense. For the year ended September 30, 2002, the Company
recorded income tax expense of $16.5 million in connection with the adoption of
SFAS 142 and recording local income taxes. SFAS 142 stops the amortization of
goodwill for book purposes, but for tax purposes it continues to be deductible
and amortizable in accordance with the current tax laws. The income tax expense
for fiscal 2002 attributable to the impact of SFAS 142 adoption results from an
increase to the valuation allowance because the Company can no longer look to
the reversal of the deferred tax liability associated with the tax deductible
goodwill to offset its deferred tax assets in accordance with SFAS 109
"Accounting for Income Taxes." The impact of the continued tax-deductible
goodwill will result in tax expense in future years to the extent the Company
has a full valuation allowance. The Company recorded no income tax benefit for
fiscal 2002 and 2001 related to the operating losses due to the uncertainty of
its realization. There was no tax benefit since all opportunities for loss
carrybacks have been previously utilized. The net deferred tax asset of $63.9
million for fiscal 2002 and the net deferred tax asset of $34.2 million for
fiscal 2001 has been fully offset by a valuation allowance based on management's
determination that it is more likely than not that the deferred tax assets may
not be realized. The Company's federal and state tax benefit for fiscal 2002 and
fiscal 2001 is lower than the statutory rate primarily due to the deferred tax
valuation allowance and nondeductible goodwill.
Cumulative Effect of Change in Accounting Principle. Effective October 1,
2001, the Company adopted Statement of Financial Accounting Standards No. 142
("SFAS 142"), "Goodwill and Other Intangible Assets." SFAS 142 requires that
intangible assets not subject to amortization and goodwill be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the carrying value may not be recoverable. Amortization of
goodwill and intangible assets with indefinite lives, including such assets
recorded in past business combinations, ceased upon adoption. Thus, no
amortization for such goodwill and indefinite-lived intangibles was recognized
in the accompanying Consolidated Statements of Operations for fiscal year ended
September 30, 2002, compared to $12.7 million for the year ended September 30,
2001. At September 30, 2002 the Company calculated an impairment to goodwill of
$58.9 million, recorded in "Cumulative Effect of Change in Accounting Principle"
in the amount of $41.5 million (net of $17.4 million in income taxes).
Extraordinary Item. The Company amended its credit facility due to the
refinancing of its senior credit facility on October 5, 2001. As a result of
amending the credit facility, the Company wrote off a portion of the bank fees
associated with previous amendments to the credit facility. The amount of $3.4
million was the deferred finance cost related to the term loans and was recorded
as an extraordinary item in fiscal 2002.
FISCAL 2001 COMPARED TO FISCAL 2000
Total Revenues. Total revenues increased $61.9 million, or 10.4%, to $654.6
million from $592.7 million. The increase is attributable to the inclusion of a
full year's results for the stores acquired and opened in fiscal 2000, a full
year's results for DPI, and increased revenues in the Company's core stores. DPI
revenue accounted for $25.5 million, or 41.2%, of the increase. Stores acquired
in fiscal 2000 acquisitions accounted for $5.7 million, or 9.2%, of the
increase. Stores opened in fiscal 2000 and 2001 accounted for $30.3 million, or
48.9%, of the increase. The Company's core stores accounted for $13.7 million,
or 22.1%, of the increase. These increases were offset by a loss of $14.0
million in revenue that resulted from closed, combined, and sold stores. Same
store revenues increased 2.0%. This increase in same store revenues is primarily
due to increased computer revenues, prepaid phone service revenues, and
merchandise sales revenue.
Depreciation and Amortization. Depreciation expense related to rental
merchandise increased to 30.7% as a percentage of total revenues from 26.5%.
This increase is primarily due to the depreciation expense related to computers
and the merchandise reduction initiatives undertaken by the Company. Computers
(Gateway computers were added to the Company's product line in June 2000) are
depreciated on a straight-line basis over 12 to 24 months, depending on the type
of computer. In late fiscal 2001, the Company undertook merchandise reduction
sales initiatives to rid the system of lower margin merchandise. As a result of
this initiative, the margin on merchandise sales decreased. In fiscal 2001, the
Company recorded merchandise sales of $14.2 million with a remaining value on
items sold of $18.4 million, or a loss of ($4.2) million. In fiscal 2000, the
Company recorded sales of $12.3 million with a remaining value of $10.9 million,
or a margin of $1.4 million. The remaining value of merchandise sold is included
in depreciation expense.
Depreciation expense related to property and equipment increased to 4.8% as
a percentage of total revenues from 4.3%. This increase is due to the build-outs
for new stores and remodels for stores acquired since June 2000.
Salaries And Wages. Salaries and wages increased by $8.0 million to $158.9
million from $150.9 million primarily due to the addition of a full year's
salaries and wages for stores opened and acquired in 2000. Salaries and wages
decreased to 24.3% as a percentage of total revenues from 25.5%. This decrease
is due to the Company's efforts to better manage store staffing levels and
overtime. It is also the result of a reduction in corporate staffing levels.
Occupancy. Occupancy expense increased to $51.3 million from $45.8 million
primarily due to the addition of the stores opened and acquired in fiscal 2001.
This increase is also due to $3.0 million recorded in association with lease
terminations for the stores closed, combined or sold.
Other Operating Expenses. Other operating expenses decreased by $5.7 million
and decreased to 25.5% as a percentage of total revenue from 29.1%. The decrease
in other operating expenses includes decreases in write-offs of property and
equipment, payroll taxes, state and local taxes, training and conference
expenses, and postage. Offsetting these reductions in other operating expenses
are increased accounting, legal and professional fees. The Company has incurred
greater fees for these services as a result of the investigations into the
accounting improprieties. These accounting and legal fees amounted to $7.9
million in 2001.
Operating Income (Loss). Operating income declined to a loss of $10.2
million in 2001 as compared to operating income of $0.6 million in 2000. The
household rental segment had an operating loss of $14.0 million while the
prepaid telephone service segment had an operating income of $3.8 million. The
cumulative decrease is the result of the factors discussed above.
Interest Expense. Interest expense increased to 6.5% from 5.0% of total
revenues. $10.6 million of this increase is due to a higher effective interest
rate charged during the period the Company was in default under its bank credit
facility and $2.6 million was forbearance fees expense.
Other Income (Expense), Net. Other expense was $10.8 million in fiscal 2001
compared to income of $1.7 million in fiscal 2000. In fiscal 2001, the Company
adopted SFAS No. 133. Under SFAS No. 133, the Company was required to record the
fair value of its interest rate swaps as an asset. On October 1, 2000, an asset
was recorded in the amount of $2.5 million. An adverse change in fair value of
the interest rate swap portfolio amounting to $12.6 million for the year ended
September 30, 2001, was charged to other expense. Offsetting this amount are
gains on the sale of stores. The Company entered into several small transactions
to sell 39 under-performing stores. The Company recognized a net gain of $2.1
million on the store sale transactions.
Income Tax Expense. In fiscal 2001, the tax benefit for losses has been
fully offset by the valuation allowance. There is no tax benefit since all
opportunities for loss carry backs have been previously utilized. In fiscal
2000, a tax benefit of $.2 million was recorded. The net deferred tax asset of
$34.2 million for fiscal 2001 and the net deferred tax asset of $10.0 million
for fiscal 2000 have been fully offset by a valuation allowance based on
management's determination that it is more likely than not, that the net
deferred tax assets may not be realized. The Company's federal and state tax
benefit in fiscal 2001 and fiscal 2000 is lower than the statutory rate
primarily due to the deferred tax valuation allowance and nondeductible
goodwill.
LIQUIDITY AND CAPITAL RESOURCES
The Company announced on December 17,2002, that it had entered into a
definitive purchase agreement to sell 295 of its stores to Rent-A-Center, Inc.
The transaction is expected to close in the second quarter of fiscal 2003. All
proceeds from the sale, net of transaction costs, store closing and similar
expenses, will be used to pay existing bank debt. This sale will allow the
Company to significantly reduce debt and improve its leverage and cash flow
ratios. The Company believes that this transaction will improve its ability to
refinance its outstanding bank debt on more favorable terms.
The Company's capital requirements relate primarily to purchasing additional
rental merchandise and replacing rental merchandise that has been sold or is no
longer suitable for rent. Our principal sources of liquidity are cash flows from
operations, debt capacity available under the credit facility and available cash
reserves. Cash flow generated by operating activities in fiscal 2002 was $48.7
million. Cash and cash equivalents totaled $7.3 million and total debt was
$277.2 million at September 30, 2002.
The Company generated $48.7 million in cash from operating activities in
fiscal 2002 compared to $94.6 million in cash in fiscal 2001. This decrease is
principally due to an increase in the net loss of ($12.9) million adjusted for
non-cash items in fiscal 2002. The adjustments result in net cash provided of
$18.5 million. The fiscal 2002 non-cash items consist of goodwill impairment
charge of $58.9 million, decrease in depreciation and amortization of ($42.7)
million and a write off of deferred financing costs of $3.8 million. This $5.6
million provided by operations was offset by increased rental merchandise
purchasing activity ($11.2) million, decrease in vendor deposits used ($29.3)
million, reduction in tax refunds received ($8.4) million, and reduction in
proceeds from year over year ($2.1) million.
Net cash used in investing activities increased $8.4 million to $10.3
million in fiscal 2002 compared to $1.9 million in fiscal 2001. In fiscal 2002,
the Company used $11.4 million for the purchase of property and equipment. This
was offset by proceeds from the sale of assets of $2.2 million. In fiscal 2001,
capital expenditures included the acquisition of two stores, the opening of 21
stores and the selling of 39 stores in several transactions. The Company funded
this project with borrowings on its senior credit facility.
The Company used $41.6 million in cash in financing activities in fiscal
2002 compared to $92.8 million in fiscal 2001. The Company used operating cash
flow to pay down debt.
During early fiscal 2001, as a result of the accounting improprieties, the
Company became in default of several of the covenants contained in its bank
credit facility including, without limitation, the covenants regarding maximum
leverage ratio, minimum interest coverage ratio, minimum net worth, fixed charge
coverage ratio, and rental merchandise usage and the covenants regarding
delivery of monthly, quarterly and annual financial statements. The Company
operated under forbearance agreements with its bank lenders through October 5,
2001. The Company's ability to borrow funds under these forbearance agreements
was limited. The Company obtained an amended credit facility on October 5, 2001,
that provided the Company with sufficient borrowing capacity and revised loan
covenants through December 2003.
The amended credit facility, co-led by National City Bank, acting as
administrative agent, Bank of America, N.A., acting as documentation agent, and
Bank of Montreal and Harris Trust and Savings Bank, acting as syndication
agents, provided for loans and letters of credit up to $363.5 million consisting
of revolving loans and letters of credit of up to a maximum of $75.0 million and
varying based on the applicable period, and two term loans designated as Term
Loan A for $117.5 million and Term Loan B for $171.0 million. Borrowings under
the credit facility bear interest at the Company's option either at a base rate
or a euro-rate. The credit facility expires December 31, 2003. Under the
euro-rate option, the Company borrows money based on the London Interbank
Offered Rate plus 550-600 basis points. Under the base rate option, the Company
borrows money based on the prime interest rate plus 4.5% to 5.5%. In addition,
payment-in-kind interest at a rate of 200 to 500 basis points per annum is due
and payable in cash on the maturity date of the term loans. The payment-in-kind
margin is determined based on the ratio of debt to cash flows from operations
during the period. The credit facility requires the Company to meet certain
financial covenants and ratios including maximum leverage, minimum interest
coverage, minimum tangible net worth, fixed charge coverage, and rental
merchandise usage ratios. In addition, in the event that the leverage ratio as
measured at June 30, 2003, for the four fiscal quarters then ended, is equal to
or greater than 2.25 to 1.00, the Company will issue warrants to the lenders for
the purchase of the Company's common stock. The shares of common stock which
will be obtained by the lenders upon the exercise of the warrants shall equal
15% of the total outstanding voting power of all the outstanding shares of the
Company immediately prior to the exercise of the warrants.
On June 24, 2002, the Company amended its credit facility to modify the
maximum leverage ratio, the minimum interest coverage ratio and the fixed charge
coverage ratio covenants.
On December 13, 2002, the Company amended its credit facility to modify the
maximum leverage ratio, the minimum interest coverage ratio, the minimum
consolidated net worth and the fixed charge coverage ratio covenants for periods
after September 30, 2002. In consideration for the amendment to the credit
facility, the Company will pay 17.5 basis points to approving lenders as an
amendment fee. The amendment fee shall be payable the earlier of the receipt of
proceeds from material asset sales or December 31, 2003. In the event the
Company fails to comply with its covenants in the credit facility, it would be
unable to borrow under the facility. The Company expects to comply with
covenants based on its 2003 projections.
On April 18, 2002, the Company sold 1 million restricted common shares and
warrants (valued according to the Black Scholes valuation method) to acquire
100,000 common shares to Calm Waters Partnership and two other investors (the
"Investors") for $6,000. The warrants have an exercise price of $9.35 per share,
subject to adjustment. In addition, the agreement calls for the Investors to
purchase an additional 2,640,000 common shares for $16,500 and to receive a
warrant to purchase 250,000 shares of common stock at an exercise price equal to
the greater of 105% of the last reported sale price of common stock on the day
preceding the second closing date or $1.50. The Investors' obligation to
purchase the additional shares is subject to certain conditions including that a
replacement of the Company's existing credit facility occur on or prior to
December 31, 2002, conditions related to the Company's existing class action
litigation and ongoing investigations, quarterly aggregate EBITDA, among others.
The Company has also agreed to issue a warrant to purchase 333,000 shares of
common stock to the Investors if the Company fails to achieve aggregate EBITDA
of $80 million or more for the 12-month period commencing on April 1, 2002. The
warrant exercise price per share is based upon the Company's EBITDA for such
period.
The Company also incurred substantial accounting and legal fees in fiscal
2001 in connection with the process of reviewing its financial reporting
matters, the investigations of the accounting improprieties and the preparation
of its audited financial statement for fiscal 2000. The Company incurred $7.9
million of these expenses in fiscal 2001. In fiscal 2002 there was a $1.9
million reimbursement of accounting and legal fees as a result of an insurance
recovery. This recovery offset fiscal 2002 expense of $1.3 million, resulting in
income of $0.6 million. The Company anticipates incurring additional legal and
other expenses in connection with the class action litigation and governmental
investigations which are ongoing.
The following table presents obligations and commitments to make future
payments under contracts and contingent commitments at September 30, 2002.
Contractual Cash Due in less than Due in 1-3 Due in 4-5 Due after
Obligation* Total one year years years 5 years
---------- ----- -------- ----- ----- -------
Long-term debt (1) $277,121 $31,817 $245,304 00 00
Capital lease obligations 18,080 9,311 8,733 36 --
Operating leases 125,384 32,908 65,883 16,809 9,784
Notes Payable 86 16 68 2 --
-------- ------- -------- ------- ------
Total cash obligations $420,671 $74,052 $319,988 $16,847 $9,784
======== ======= ======== ======= ======
*Excludes the 401(k) restorative payments program as well as contingent
liabilities including shareholder/derivative lawsuits as these items cannot be
estimated.
(1) Consists of Term Notes A, Term Notes B and revolving notes.
Amount of Commitment Expiration Per Period
Total
Other Commercial Amounts Less than 1
Commitments Committed year 1-3 years 4-5 years Over 5 years
----------- --------- ---- --------- --------- ------------
Lines of credit 00 00 00 00 00
Standby letters of credit $8,770 $8,770 - - -
Guarantees - - - - -
------ ------ ------- ------- ------
Total commercial commitments $8,770 $8,770 $ - $ - $ -
====== ====== ======= ======= =======
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's major market risk exposure is primarily due to possible
fluctuations in interest rates. As of September 30, 2002, the Company had $277.1
million in loans with floating interest rates indexed to current LIBOR and prime
rates. Because the floating rates expose the Company to the risk of increased
interest cost if interest rates rise, the Company began a policy in 1998 of
managing interest rate risk by utilizing interest rate swap agreements to
convert a portion of the floating interest rate loans to fixed interest rates.
As of September 30, 2002, the Company has $163.1 million in interest rate swap
agreements that fix in a LIBOR rate ranging from 5.09% to 6.97%. This
effectively fixes the interest rate on $163.1 million of loans, thus hedging a
significant portion of this risk. These interest rate swap agreements have
maturities ranging from 2003 to 2005.
Given the Company's current capital structure, including interest rate swap
agreements, there is $114.1 million, or 41.2% of the Company's total debt, in
floating rate loans. A hypothetical 100 basis point change in the LIBOR rate
would affect pre-tax earnings by approximately $1.1 million. As of September 30,
2002, the fair value of the interest swaps was $9.7 million, which is recorded
as a liability.
The Company does not enter into derivative financial instruments for trading
or speculative purposes. The interest rate swap agreements are entered into with
major financial institutions thereby minimizing the risk of credit loss.
SEASONALITY AND INFLATION
Management believes that operating results may be subject to seasonality. In
particular, the fiscal fourth quarter generally exhibits a slight tightening of
customer spending habits commensurate with summer vacations, back-to-school
needs and other factors. Conversely, the first quarter typically has a greater
percentage of rentals because of traditional holiday shopping patterns.
Management plans for these seasonal variances and takes particular advantage of
the first quarter with product promotions, marketing campaigns, and employee
incentives. Because many of the Company's expenses do not fluctuate with
seasonal revenue changes, such revenue changes may cause fluctuations in the
Company's quarterly earnings.
During the year ended September 30, 2002, the costs of rental merchandise,
store lease rental expense and salaries and wages have increased modestly. These
increases have not had a significant effect on the Company's results of
operations because the Company has been able to charge commensurately higher
rental for its merchandise. This trend is expected to continue in the
foreseeable future.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 address
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This
Statement is effective for exit or disposal activities that are initiated after
December 31, 2002. The Company is currently evaluating the provisions of this
statement.
In April 2002, FASB issued Statement of Financial Accounting Standards No.
145 "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 updates,
clarifies, and simplifies existing accounting pronouncements. The Company is
currently evaluating the provisions of this Statement. The Standard will require
reclassification of the current year extraordinary item to other operating
expenses upon adoption.
In August 2001, FASB issued Statement of Financial Accounting Standards No.
144" Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. This Statement is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
In June 2001, FASB issued Statement of Financial Accounting Standard No. 143
"Accounting for Asset Retirement Obligations ("SFAS No. 143"). SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This statement is effective for financial statements issued for fiscal
years beginning after June 15, 2002.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
Index to Financial Statements
Report of Independent Accountants.........................................................................28
Financial Statements:
Consolidated Balance Sheets, September 30, 2002 and 2001................................................29
Consolidated Statements of Operations, Years Ended September 30, 2002, 2001, 2000.......................30
Consolidated Statements of Shareholders' Equity, Years Ended September 30, 2002, 2001, 2000.............31
Consolidated Statements of Cash Flows, Years Ended September 30, 2002, 2001, 2000.......................32
Notes to Consolidated Financial Statements..............................................................33
RENT-WAY, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF RENT-WAY, INC.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 55 present fairly, in all material
respects, the financial position of Rent-Way, Inc. and its subsidiaries at
September 30, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended September 30, 2002 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 4 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" effective October 1, 2001, and as discussed in Note 10 to the
consolidated financial statements, the Company adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," effective October 1, 2000.
PricewaterhouseCoopers LLP
Cleveland, Ohio
December 19, 2002
RENT-WAY, INC.
CONSOLIDATED BALANCE SHEETS
(all dollars in thousands)
SEPTEMBER 30,
2002 2001
---------- ----------
ASSETS
Cash and cash equivalents.................................. $ 7,295 $ 10,515
Prepaid expenses........................................... 10,361 13,534
Income tax receivable...................................... 4,191 8,239
Rental merchandise, net.................................... 196,064 218,973
Rental merchandise deposits and credits due from vendors... 995 2,486
Deferred income taxes, net of valuation allowance of $63,944
and $34,198, respectively.............................. -- --
Property and equipment, net................................ 54,316 68,792
Goodwill................................................... 229,790 292,084
Deferred financing costs, net of accumulated amortization of
$1,816 and $853, respectively........................... 1,870 4,136
Intangible assets, net of accumulated amortization of $3,981
and $2,205, respectively................................... 1,700 2,774
Other assets............................................... 4,212 6,644
-------- ---------
$510,794 $ 628,177
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable........................................... $ 17,643 $ 24,212
Other liabilities.......................................... 79,347 90,914
Debt....................................................... 277,207 307,009
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374,197 422,135
Shareholders' equity:
Preferred stock, without par value; 1,000,000 shares
authorized; no shares issued and outstanding at September 30,
2002 and 2001, respectively............................. -- --
Common stock, without par value; 50,000,000 shares
authorized; 25,685,538 and 24,509,978 shares issued and
outstanding, respectively............................... 302,218 295,610
Common stock warrants; 100,000 outstanding................. 644 --
Loans to shareholders...................................... (282) (924)
Accumulated other comprehensive income..................... 787 1,654
Retained earnings (accumulated deficit).................... (166,770) (90,298)
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Total shareholders' equity............................... 136,597 206,042
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$ 510,794 $ 628,177
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The accompanying notes are an integral part of these financial statements.