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 requires the payment of real estate taxes, utilities and maintenance. There are optional renewal privileges on most of the 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 stores would be able to relocate without significant difficulty should a particular lease be unable to be renewed. Management also expects that additional space will be readily available at competitive rates for new store openings.
The Company owns the 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.
ITEM 3. LEGAL PROCEEDINGS
As previously reported, following the discovery of accounting improprieties in October 2000, the Company, its independent accountants, and certain of its current and former officers were named in a consolidated class action complaint filed in the U.S. District Court for the Western District of Pennsylvania alleging violations of the securities laws and seeking damages in unspecified amounts purportedly on behalf of a class of shareholders. On April 18, 2003, the Company entered into an agreement settling the class action. The settlement requires the Company to pay the class the sum of $25.0 million, with $21.0 million in cash and $4.0 million in 6% unsecured subordinated notes payable in four equal installments over two years commencing December 31, 2003. Of the $21.0 million payable in cash, $11.0 million has been funded from available insurance proceeds. The settlement agreement provides for the release of the Company and all other defendants except the Company’s former controller and the Company’s independent accountants. The settlement remains subject to Court approval. On September 9, 2003, the Court granted a motion certifying a class and appointing the lead plaintiff, Cramer Rosenthal McGlynn LLC, as class representative. On September 12, 2003, the Court conducted a fairness hearing regarding the settlement. The lead plaintiff’s motion for the Court’s approval of the settlement is pending.
As a further result of the accounting improprieties, the SEC and the U.S. Department of Justice conducted investigations of possible civil and criminal violations. On July 22, 2003, the SEC announced that it had reached a settlement with the Company under which the Company consented to the entry of a final judgment in the U. S. District for the Western District of Pennsylvania that permanently enjoins it from violations of the reporting and books and records provisions of the Securities Exchange Act. In determining to accept the settlement, the SEC considered that the Company undertook remedial actions and cooperated with the SEC staff. The Court entered the final consent judgment on July 23, 2003. The SEC did not seek any financial penalty against the Company, its current officers or directors. The Department of Justice did not bring any charges against the Company or current officers and directors. Based on public statements from the SEC staff and representatives of the Department of Justice, the Company believes the government’s investigations into its past accounting improprieties are concluded and that no action will be taken against any current Company employee or director.
The Company is also subject to litigation in the ordinary course of business. The Company believes the ultimate outcome of any existing litigation, other than the class action lawsuit described above, would not have a material adverse effect on the financial condition, results of operation or cash flows of the Company
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
RENT-WAY, INC.
PART II
ITEM 5.
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.
As of September 30, 2003, there were 335 shareholders of record of Rent-Way’s common stock.
The Company has not paid any cash dividends to common stock shareholders. The declaration of any common stock 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 common stock 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 common stock dividends.
The Company paid cash dividends of $99 to preferred stock shareholders. Dividends are accruing daily at a rate of 8.0% per annum and are payable in the first day of each calendar quarter as required by the agreement on which the Company issued 1,500 shares of convertible preferred stock used to repay the previous senior credit facility.
The Company maintains the 1992, 1995, and 1999 Stock Option Plans. The Company also has options to acquire its 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 three employees covering an aggregate of 60,000 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.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the years ended September 30, 1999, 2000, 2001, 2002 and 2003 were derived from the audited financial statements of the Company for those periods. 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.
(1)
On February 8, 2003, the company sold 295 stores. As a result of such sale, the Company recast the consolidated financial statements to reflect the sale and to treat the operating results of such stores as discontinued operations as required by SFAS 144.
(2)
The adjusted net income (loss) reflects previously reported net loss adjusted to exclude goodwill amortization as if Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (”SFAS No.142”)had been adopted in fiscal years 1999, 2000 and 2001.
(3)
During the year ended September 30, 2000, the Company acquired a 70% interest in DPI, which affects the comparability of the historical information for the periods presented.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Rent-Way currently operates 753 rental-purchase stores located in 33 states, the second largest number of stores in the rental-purchase industry. The Company offers quality brand name home entertainment equipment, furniture, computers, major 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. The Company also provides prepaid local phone service to consumers on a monthly basis through DPI. DPI is a non-facilities based provider of local phone service.
Since late 2000, the Company has focused on improving gross margins, decreasing operating expenses, and reducing debt. To accomplish these objectives, the Company has significantly upgraded its merchandise mix, implemented higher rental rates, and closed, combined, or sold under-performing stores. On June 2, 2003, the Company closed a refinancing of its bank credit facility through the issuance of $205.0 million of senior secured notes, borrowings under a new $60.0 million bank revolving credit facility and the sale of $15.0 million of convertible preferred stock.
The Company generates revenues from three categories: rental revenue, prepaid phone service revenue, and other revenue. The household rental business revenues include both rental revenue and other revenue. Rental revenue consists of revenues derived from rental-purchase agreements. Prepaid phone service revenue represents revenues from DPI. Other revenue includes revenues related to services offered that complement the rental-purchase agreements and the sale of rental merchandise. These revenues include insurance fees, liability damage waiver premiums, Preferred Customer Club fees and revenues from the sale of merchandise.
While there is constant turnover within the portfolio of rental agreements, the total number of rental agreements in a store does not change significantly. This stability in the number of rental agreements facilitates revenue forecasting. The typical store experiences a slight decrease in the number of agreements during the summer months while, on balance, the rest of the year demonstrates growth in agreements.
The major components of the Company’s cost structure are the cost of rental merchandise and personnel and, to a lesser extent, sales and marketing expense and general and administrative costs. Costs associated with rental merchandise are driven by the need to purchase merchandise to maintain the quality and availability of the product mix and to maximize inventory utilization rates. Compensation, incentives, and employee benefits are the main components of personnel costs. Sales and marketing expenses are driven primarily by advertising costs, business development activities, and the development of new service offerings. Other operating expenses include general and administrative costs, which primarily include corporate overhead expenses, costs associated with the information technology infrastructure, and other store related expenses.
The Company considers the rental-purchase business and prepaid telephone services to be two separate business units. Separate business unit information is presented in Note 21 of the notes to the consolidated financial statements. Separate information in this discussion regarding the prepaid telephone service business is not presented except in the discussion of total revenues and cost of prepaid phone service. The Company believes that other items for the prepaid telephone service business are immaterial.
Through sales, closures and combinations, the number of stores operated by the Company has decreased from 1,138 as of September 30, 2000, to 753 as of September 30, 2003. The following table shows the number of stores opened, acquired, sold, closed and/or combined during this three-year period.
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, valuation of deferred taxes, liability for self-insurance, impairment of goodwill, other intangibles and lease obligations, 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 were 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 and computer games. 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 rental merchandise write-offs approximate 3% of revenue from month to month over the prior 2 fiscal years. The Company reviews this analysis on a monthly basis.
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 Consolidated 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 relationship from time to time in making this determination of average estimated life.
Convertible Redeemable Preferred Stock. The Company’s sale of convertible preferred stock in June 2003 resulted in proceeds of $14.1 million, net of issuance costs of $0.9 million, which were used to refinance the previous senior credit facility. The net proceeds are classified outside of permanent equity because of the redemption date and other redemption provisions of the preferred stock, except for $0.1 million classified as an option to purchase additional convertible preferred stock which is included in permanent equity. The Company has determined that the conversion feature of the convertible redeemable preferred stock is a derivative financial instrument that was bifurcated and recorded in temporary equity classification on the balance sheet. This derivative financial instrument is marked to market through other income (expense) in the Company’s Consolidated Statements of Operations.
Closed Store Reserves. From time to time, the Company closes or consolidates 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 lease 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.
Insurance Programs. For fiscal years 2003, 2002 and 2001, the Company is primarily self-insured for health insurance. The self-insurance liability for health costs is determined based on a contracted rate and monthly employee headcount. The contracted rate is determined based on experience, prior claims filed and an estimate of future claims. A retrospective adjustment for over (under) funding of claims is recorded when determinable and probable.
For fiscal years 2003,2002 and 2001, 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 following policy inception and every 12 months thereafter. Retrospective adjustments to loss estimates are recorded when determinable and probable.
For fiscal years 2000 and 1998, the Company was insured under deductible programs with aggregate stop loss coverage on major claims. Claims exceeding the insured deductible limits that were less than stop loss aggregates, were funded as claims developed using AM Best loss development factors and not exceeding policy aggregate. The fiscal 1999 worker’s compensation insurance had no aggregate retention and was funded as claims developed using AM Best loss development factors. Reserves were developed by independent actuaries and totaled $1.5 million and $2.3 million at September 30, 2003 and 2002, respectively.
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 the 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. The Company has provided a valuation allowance for all deferred tax assets.
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, 2003 and 2002, but did recognize $12.7 million of amortization for the fiscal year ended September 30, 2001. During the quarter ended 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). For the year ended September 30, 2003, there was no impairment of goodwill.
RESULTS OF OPERATIONS
On February 8, 2003, the Company completed the sale of 295 stores. Accordingly, the financial statements for all periods presented have been recast to report the results of these stores as discontinued 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, 2003, 2002 and 2001 as a percentage of total revenues.
FISCAL 2003 COMPARED TO FISCAL 2002
Total Revenues. Total revenues decreased $2.1 million or 0.4%, to $491.3 million from $493.4 million. This decrease is attributable to a decrease in revenues of $2.3 million in the prepaid telephone service segment offset by an increase in revenues of $0.3 million in the household rental segment. The $2.4 million decrease in the prepaid telephone service segment is due to a decrease in customers due to an increase in competition. The $0.3 million increase in revenue in the household rental segment is due to a 0.8% increase in same store revenues.
Same store revenues consists of revenues from stores in the household rental segment that have been operating for more than fifteen months and have had no changes affecting operations during that time, i.e. mergers, dispositions or acquisitions. The increase in same store revenues was due to an increase in same store rental revenues and early purchase option sales revenues offset by a decrease in same store fee revenues. Same store rental revenues increased 0.4% as compared to the same period last year. This increase is primarily due to improved collections for the year ended September 30, 2003, as compared to the same period last year. Early purchase option and sales revenue increased 21.0% as compared to the same period last year. This increase is primarily due to more customers exercising the early purchase option as a result of an “120 days same as cash” promotion that offered customers the opportunity to purchase rented merchandise at a discount. In addition, the increase was due to an increase in sales and early purchases of computers prior to the expiration of computer rental-purchase agreements. Fee revenues decreased by 5.5% as compared to the same period last year. This decrease is primarily attributable to fewer rental-purchase agreements in the portfolio and reductions in liability damage waiver fees due to customers shifting to the Preferred Customer Club program. The Preferred Customer Club program is a fee-based membership program that provides special loss and damage protection and, at a discounted rate, an additional one year of service protection on rental merchandise, preferred treatment in the event of involuntary job loss and accidental death and dismemberment insurance.
Depreciation and Amortization. Depreciation expense related to rental merchandise decreased to 24.9% as a percentage of total revenues from 27.0%. 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, and increasing weekly rental rates of personal computers to competitive market rates. The Company continued these efforts in fiscal 2003. 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 other intangibles decreased to 0.3% as a percentage of total revenues from 0.5%. This is due to the expiration of the amortization periods for certain non-compete agreements and customer contracts. Amortization expense decreased $0.9 million as compared to the same period last year. On October 1, 2001, the Company adopted SFAS 142. SFAS 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. Such testing for fiscal 2003 resulted in no impairment. Such testing for fiscal 2002 resulted in an impairment to goodwill in the household rental segment. A goodwill impairment charge was recorded in “Cumulative Effect of Change in Accounting Principle” in the Consolidated Statement of Operations in the amount of $41.5 million (net of $17.4 million in income taxes).
Cost of Prepaid Phone Service. The cost of prepaid phone service decreased to $21.9 million from $23.7 million. Cost of prepaid phone service, as a percentage of prepaid phone service revenues, decreased to 61.8% from 62.8%. This decrease is due to a general decrease in the customer base and a decrease in new customers year over year. This decrease in new customers results in a decrease in activation costs in relation to the revenues recognized.
Salaries and Wages. Salaries and wages increased by $9.5 to $130.7 million from $121.2 million. The Company initiated an employee upgrade program directed at attracting and keeping better talent. This resulted in higher salaries in 2003. Salaries and wages increased to 26.6% as a percentage of total revenues from 24.6%.
Advertising. Advertising expense decreased $4.8 million, from $27.1 million in 2002 to $22.3 million in 2003. This decrease is primarily due to a decrease in television production and local store marketing expenses and the sale of 295 stores to Rent-A-Center, Inc.
Occupancy. Occupancy expense increased to $32.8 million from $31.7 million, or to 6.7% as a percentage of total revenues from 6.4%. The increase is attributable to general rent increases, which approximate 2% per year for new leases entered into with higher rates.
Restructuring Costs. During the second quarter of fiscal 2003, the Company formulated a plan to restructure the corporate office through reductions in the corporate workforce to rationalize corporate costs for the stores remaining subsequent to the sale to Rent-A-Center. As a result of this plan, the Company recorded total pre-tax restructuring charges of $3.0 million in 2003. The restructuring costs include $1.0 million of employee severance and termination benefits and $2.0 million of fixed asset write-offs in the household rental segment.
Other Operating Expense. Other operating expense decreased by $5.2 million to $100.7 million as of September 30, 2003, from $106.0 million and decreased to 20.5% as a percentage of total revenues from 21.5%. This decrease is principally due to income of $4.6 million for an adjustment of ultimate and incurred losses, which was recorded in insurance costs in other operating expense, a $1.5 million downward adjustment to the Company’s personal property tax accruals was recorded as a result of the receipt of finalized actual tax assessments and a reversal of a $1.8 million provision established in prior years related to rental merchandise was determined to be no longer required. These items were offset by $2.7 million of legal and professional and consulting fees, as discussed below.
During 2002, there was a recovery of accounting and legal fees related to the investigation and shareholder litigation in the amount of $1.9 million, which offset $1.3 million of fees for the year. During 2003, there was a recovery of accounting and legal fees related to the investigation and shareholder litigation in the amount of $0.8 million, which offsets $3.5 million of fees for the year.
Settlement of Class Action Lawsuit. The Company reached an agreement to settle the consolidated class action pending against the Company in the U.S. District Court for the Western District of Pennsylvania. Under the settlement, the Company will pay $25.0 million to the class, consisting of $4.0 million in two-year 6% subordinated unsecured notes and $21.0 million in cash, of which $11.0 million is to be funded from available insurance proceeds. The $10.0 million in cash to be funded by the Company is held in escrow and is classified as restricted cash on the balance sheet at September 30, 2003. The net $14.0 million was expensed in the second quarter of fiscal 2003. The Company has funded $10.0 million in cash and the insurance carrier has funded $11.0 million in cash into escrow as of July 1, 2003; the Company has also issued the unsecured notes into escrow.
Interest Expense. Interest expense decreased $6.1 million to $33.1 million from $39.2 million or from 8.0% to 6.7% of total revenues. This decrease is primarily due to a $62.6 million decrease in debt from $277.2 million as of September 30, 2002, to $214.6 million as of September 30, 2003. On June 2, 2003, the Company completed the sale of $205.0 million of senior secured notes, closed a new $60.0 million revolving line of credit and sold $15.0 million in 8% convertible preferred stock though a private placement. The proceeds from these transactions were used to repay all amounts outstanding under the Company’s previous credit facility. See Note 10 and 11 to the Company’s consolidated financial statements appearing at Item 8 of this report.
Amortization and Write-Off of Deferred Financing Costs. Amortization of deferred financing costs decreased to $3.1 million from $5.2 million. This decrease is mainly due to the write-off of $1.1 million in bank fees associated with refinancing the Company’s previous credit facility in fiscal 2003 versus a $3.8 million write-off of deferred financing costs in fiscal 2002. This decrease is partially offset by increased amortization related to an increase in deferred financing costs as a result of the refinancing. Deferred financing cost amortization, excluding write-offs, was $1.9 million and $1.4 million for the years ended September 30, 2003 and 2002, respectively. See Note 10 to the Company’s consolidated financial statements appearing at Item 8 of this report.
Other Income (Expense), Net. Other income was $4.0 million in 2003 compared to $2.4 million in 2002. This change is primarily due to an increase in the positive change in the fair market value of the interest rate swap portfolio, which resulted in income of $4.6 million for 2003, compared to income of $0.6 million for 2002. Other income for 2003 also includes gains on the sale of vehicles under capital leases of $1.2 million. These income items for 2003 were offset by a charge of $1.9 million to record the convertible option derivative liability for the convertible preferred stock at its fair market value as of September 30, 2003. Other income for fiscal 2002 includes a gain on the sale of stores. The Company entered into several small transactions to sell 15 under-performing stores. The Company recognized a net gain of $0.9 million on these store sale transactions.
Income Tax Expense. For 2003, the Company recorded income tax expense of $4.0 million. Deferred tax expense of $4.9 million as a result of the impact of applying SFAS 142 was offset by a tax benefit of $0.9 million primarily as a result of changes in net operating loss carryback rules. SFAS 142 stops the amortization of goodwill for book purposes, but for tax purposes it continues to be deductible and amortizable in accordance with current tax laws. The income tax expense for fiscal 2003 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 2003 and 2002 related to the operating losses due to the uncertainty of their realization. There are approximately $11.1 million of net operating losses that expire during fiscal years 2005 through 2018. Net operating losses approximating $42.6 million, $36.3 million, $48.1 million, $28.2 million and $41.3 million expire during fiscal years 2019, 2020, 2021, 2022 and 2023 respectively. The net deferred tax asset after adjustment for tax deductible goodwill is $73.1 million for fiscal 2003 and the net deferred tax asset of $66.0 million for fiscal 2002 has been fully offset by a valuation allowance based on management’s determination that their realization is uncertain. The Company’s federal and state tax benefit for fiscal 2003 and fiscal 2002 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 SFAS 142. Thus, no amortization for goodwill and indefinite-lived intangibles was recognized in the accompanying consolidated statements of operations for fiscal years 2003 and 2002. During the year ended 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). Testing for fiscal 2003 resulted in no impairment.
Income (Loss) From Discontinued Operations. Loss from discontinued operations was $15.8 million as a result of the sale in 2003, as compared to $0.1 million in 2002. This decrease is mainly due to a $8.4 million charge for lease obligations related to vacated stores, a $7.3 million decrease in operating income of the stores due to transition period costs and interest expense of $3.0 recorded as a result of the sale in 2003.
Net Income (Loss). The Company generated a net loss of $29.4 million in 2003 as a result of the factors described above compared to a net loss of $76.5 million in the same period last year.
Net Income (Loss) Allocable To Common Shareholders. On June 2, 2003, the Company issued 1,500 shares of convertible redeemable preferred stock for $10,000 per share and a one-year option to purchase an additional 500 shares of convertible redeemable preferred stock. See Note 11 to the Company’s consolidated financial statements appearing at Item 8 of this report. The preferred stock dividends and accretion totaled $0.5 million and are charged to accumulated deficit, but reduce net income (loss) allocable to common stockholders.
FISCAL 2002 COMPARED TO FISCAL 2001
Total Revenues. Total revenues decreased $21.9 million or 4.3%, to $493.4 million from $515.3 million. This decrease is attributable to a decrease in revenues of $24.9 million in the household rental segment offset by an increase in revenues of $3.0 million in the prepaid telephone service segment. The $24.9 million decrease in revenue in the household rental segment is due to a 0.5% decrease in same store revenues and the closing or selling of 25 under-performing stores in fiscal 2002.
The 0.5% decrease in same store revenues is attributable to an increase of 0.9% in same store rental revenues offset by a 7.5% decrease in same store processing and insurance fee revenue and a 5.2% decrease in same store early purchase option and sales revenues compared to 2001. The increase in same store rental revenue is primarily due to improved collections and deliveries made in 2002, having better revenue potential than the lower margin items delivered in the past. The decrease in same store processing and insurance revenue is attributed to a reduction in the Company’s collection of liability damage waiver and processing fees. The same store early purchase option and sales revenue decrease is attributed to a significant amount of product sales to eliminate lower-end, lower-margin merchandise from the Company’s product mix in the 2001 fiscal year. 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 27.0% as a percentage of total revenues from 30.1%. In 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.
Amortization of goodwill and other intangibles decreased to 0.5% as a percentage of total revenues from 3.0%. This decrease was due to the adoption of 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 was 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 4.8% of total revenues, from $20.0 million, or 3.9% 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 resulted in higher costs due to ILEC activation fees. This increase is also the result of the FCC allowing the ILECs to increase end user communication line, or 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 $5.8 million due to the Company’s continued efforts to better manage store staffing levels and overtime and the result of a reduction of corporate staffing levels.
Advertising. Advertising expense increased $6.8 million, from $20.3 million in 2001 to $27.1 million in 2002. Included in this increase is an additional expense for air-time, distribution costs, consisting primarily of postage, and the advertising campaign titled “Fall Kickoff Extravaganza”. In addition, there was a reduction in advertising rebates resulting in an increase of net advertising. Offsetting this increase was a decrease in production costs.
Occupancy. Occupancy expense decreased to $31.7 million from $39.4 million, or to 6.4% as a percentage of total revenues from 7.7%. The decrease is primarily attributable to closing or selling of 25 under-performing stores in 2002. The Company also closed or sold 83 under-performing stores in 2001, 43 of which were in the month of September.
Other Operating Expenses. Other operating expense decreased by $24.9 million to $106.0 million from $130.9 million. This decrease is primarily due to lowered rental merchandise losses, lowered service costs, lowered telephone costs, lowered training and conference costs, lowered utilities costs, lowered Club Plan expense, lowered accounting fees and lowered legal and professional fees. 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 $7.3 million from 6.9% to 8.7% of total revenues. The Company’s former credit facility required the Company to accrue additional payment-in-kind interest at a rate of 200 to 500 basis points that was due and payable on the maturity date of the term loans made under the facility. This payment-in-kind interest amounted to $15.0 million in 2002. Offsetting this increase is a decrease in other interest expense of $6.2 million. This decrease was due to a lower effective interest rate.
Other Income (Expense), Net. Other income was $2.4 million in 2002 compared to other expense of $10.8 million in 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 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 also 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 2002, the Company recorded income tax expense of $16.5 million in connection with the adoption of SFAS 142 and recording local income taxes. The net deferred tax asset of $66.0 million for 2002 and the net deferred tax asset of $34.2 million for 2001 have 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 2002 and 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 SFAS 142. Thus, no amortization for goodwill and indefinite-lived intangibles was recognized in the accompanying consolidated statements of operations for 2002, compared to $12.7 million for 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).
Income (Loss) From Discontinued Operations. Loss from discontinued operations was $0.1 million for 2002, as compared to income from discontinued operations of $5.7 million for 2001. This $5.8 million decrease in income from discontinued operations was primarily due to reduced operating revenues from discontinued operations of $6.3 million, offset by an increase in expenses from discontinued operations of $0.5 million.
Net Income (Loss). The Company generated a net loss of $76.5 million for 2002, as a result of the factors described above compared to a net loss of $63.6 million for 2001.
LIQUIDITY AND CAPITAL RESOURCES
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. The Company’s principal sources of liquidity are cash flows from operations, debt capacity available under its revolving credit facility and available cash reserves.
For fiscal 2003, operations used $28.8 million of cash flow compared to operations providing $48.7 million for fiscal 2002. The increase in cash used in operating activities is primarily attributable to an increase in restricted cash, other assets, rental merchandise, cash used in discontinued operations and loss from discontinued operations. The $10.0 million increase in restricted cash relates to the Company’s funding of its portion of the settlement of the shareholder class action into escrow. The $24.4 million increase in rental merchandise during fiscal 2003 is a result of a planned increase in store inventory levels to fuel the agreement growth achieved in fiscal 2003 and anticipated for fiscal 2004. The $3.2 million increase in rental merchandise deposits and credits due from vendors during fiscal 2003 is related to a jewelry return program. The Company returned jewelry with a value exceeding $4.0 million to the vendor for cash and credits to be applied to future purchases. The income tax receivable is subject to an IRS joint committee of taxation audit, which was completed in the first quarter of fiscal 2004. The $15.8 million increase in other assets during fiscal 2003 is attributable to an $11.0 million receivable from insurance proceeds related to the settlement of the class action lawsuit and a $4.5 million receivable from Rent-A-Center holdback. The change in other liabilities was the result of a $25.0 million liability recorded for the settlement of the class action lawsuit, and a $3.6 million increase in vacant facility lease obligations, offset by payments of interest accruals from the re-financing totaling $7.1 million, an increase in the interest rate swap market value of $4.6 million, $1.8 million reversal of a rental merchandise reserve and a $4.6 million reduction to the vehicle capital lease obligation resulting from the sale of vehicles remaining from the Rent-A-Center sale. Portions of interest accrual payments and vacant facility lease obligations are shown as cash used in discontinued operations. Cash used in discontinued operations of $8.9 million relates to transitional payroll and operating expenses for the stores sold to Rent-A-Center. The loss from discontinued operations was $15.8 million, which relates to the operating loss from the 295 stores sold to Rent-A-Center, lease obligations and interest expense. These uses of cash are partially offset by an increase in accounts payable of $10.2 million related to an increase in rental merchandise purchases in the fourth quarter year over year.
Net cash provided by investing activities was $87.2 million for 2003, compared to $10.3 million used in investing activities for 2002. On February 8, 2003, the Company sold 295 stores to Rent-A-Center for net proceeds of $100.4 million. Of the $100.4 million, $10.0 million was being held back by Rent-A-Center to secure the Company’s indemnification obligations; $5.0 million for 90 days following the closing, which the Company received, and $5.0 million for 18 months following the closing. In fiscal 2003, the purchase of property and equipment accounted for $9.6 million. In fiscal 2002 period, the purchase of property and equipment accounted for $11.4 million.
For fiscal 2003, financing activities used $62.4 million as compared to $41.6 million in 2002. In fiscal 2003, the Company borrowed $667.4 million and repaid $730.1 million. This net repayment resulted from the sale proceeds following the sale of the 295 stores to Rent-A-Center. In fiscal 2002, the borrowings were $664.0 million and repayments were $693.4 million. The Company incurred $8.6 million and $2.9 million in deferred financing costs during fiscal fiscal 2003 and 2002, respectively. The Company received net proceeds from the sale of the convertible preferred stock in fiscal 2003 of $14.1 million.
The Company’s senior secured notes have the following material terms. The $205.0 million of senior secured notes bear interest at 11.875%. The interest on the secured notes is payable semiannually on June 15 and December 15 beginning December 15, 2003. The secured notes are guaranteed on a senior basis by all existing and future domestic restricted subsidiaries of the Company other than DPI, which is an unrestricted subsidiary. The Company may redeem the secured notes, in whole or in part, at any time prior to June 15, 2010, at a redemption price equal to the greater of:
a)
100% of the principal amount of the notes to be redeemed; and
b)
the sum of the present values of (i) 100% of the principal amount of the notes to be redeemed at June 15, 2010, and (ii) the remaining scheduled payments of interest from the redemption date through June 15, 2010, but excluding accrued and unpaid interest to the redemption date, discounted to the redemption date at the treasury rate plus 175 basis points;
plus, in either case, accrued and unpaid interest to the redemption date.
In addition, at any time prior to June 15, 2006, up to 25% of the aggregate principal amount of the secured notes may be redeemed at the Company’s option, within 75 days of certain public equity offerings, at a redemption price of 111.875% of the principal amount, together with accrued and unpaid interest. Such redemption can occur provided that after giving effect to any such redemption, at least 75% of the original aggregate principal amount of the notes issued (including any additional notes) remains outstanding.
The secured notes were offered at a discount of $3.6 million, which is being amortized using the effective interest method over the term of the secured notes. Amortization of the discount was $0.01 million for 2003. Costs representing underwriting fees and other professional fees of $6.9 million are being amortized, using the straight-line method, over the term of the secured notes. The secured notes rank senior in right to all of the Company’s existing and future subordinated debt, have a lien position ranking second to the bank revolving credit facility and effectively junior in right of payment to all existing and future debt and other liabilities of the Company’s subsidiaries that are not subsidiary guarantors. The secured notes contain covenants that will, among other things, limit the Company’s ability to incur additional debt, make restricted payments, incur any additional liens, sell certain assets, pay dividend distributions from restricted subsidiaries, transact with affiliates, conduct certain sale and leaseback transactions and use excess cash flow.
Under the indenture for the secured notes, if the Company (a) has any excess cash flow or amounts on deposit in the excess cash flow collateral account, (b) has a leverage ratio equal to or greater than 2.50 to 1.00 or a rent-adjusted leverage ratio equal or greater than 4.00 to 1.00, and (c) has cash and cash equivalents of more than $10.0 million, the Company must repay debt (if any) outstanding under the revolving credit facility in an amount equal to the remainder (if positive) of (1) the amount of such cash and cash equivalents minus (2) the sum of $10.0 million plus such excess cash flow. Thereafter, if the Company (a) has any excess cash flow with respect to such fiscal year plus amounts on deposit in the excess cash flow collateral account of at least $1.0 million in the aggregate and (b) the coverage ratio is equal to or greater than 2.50 to 1.00 or the rent-adjusted leverage ratio is equal to or greater than 4.00 to 1.00, then the Company either must use the excess cash flow plus such amounts on deposit to repay debt (if any) outstanding under the revolving credit facility or, subject to limitations, must use 75% of any excess cash flow plus such amounts on deposit remaining after repayment of debt outstanding under the revolving credit facility to make an offer to purchase notes at a purchase price equal to 104.25% of the aggregate principal amount thereof, plus accrued and unpaid interest to the purchase date. The Company must deposit in the excess cash flow collateral account all of the portion of the 75% of such remaining excess cash flow not used to purchase notes. The Company may use 25% of the excess cash flow remaining with respect to such fiscal year after repayment of debt outstanding under the revolving credit facility. All of the Company’s obligations to use excess cash flow as described above terminate upon the first fiscal year end of the Company at which both (a) the leverage ratio is less than 2.50 to 1.00 and (b) the rent-adjusted leverage ratio is less than 4.00 to 1.00. Under the indenture, “excess cash flow” means for any fiscal year, EBITDA for the Company and its consolidated restricted subsidiaries for such year, adjusted for certain items. “Excess cash collateral account” is an account maintained by the collateral agent in which the Company deposits all of the portion of the 75% of the excess cash flow remaining after payment of debt outstanding under the revolving credit facility. The Company is in compliance with all covenants at September 30, 2003, and will be able to comply with covenants based upon its fiscal 2004 projections.
The Company’s Series A convertible preferred stock has the following material terms. The preferred stock bears dividends at a rate per annum of eight percent of stated value, payable at the Company’s option either in cash or, under specified circumstances, shares of common stock. The preferred stock matures June 2, 2011 and is convertible into shares of common stock at any time at the option of the holders. The initial conversion price of the preferred stock is $6.00 per share, subject to anti-dilution and other adjustments that could result in the issuance of additional shares of common stock. If several conditions are met, the preferred stock will be redeemable at the Company’s option at its stated value plus accumulated but unpaid dividends after June 2, 2008. The holders may require the Company to repurchase the preferred stock at its stated value plus accumulated but unpaid dividends at any time after the six-month anniversary of the date when none of the secured notes and no indebtedness under the new revolving credit facility is outstanding. The holders may also require the Company to repurchase the preferred stock at a premium, subject to the restricted payment limitations imposed by the indenture for the notes, and require any unredeemed preferred stock to accrue dividends at 15.0% per annum, upon the failure of the common stock to be listed on the NYSE or the NASDAQ National Market or upon a change of control. The Company has the right to repurchase the preferred stock at a premium upon a change of control. In the event the Company fails to redeem the preferred stock on notice from the investors, or to convert the preferred stock on a timely basis, in whole or in part, when required, the holders have the option of voiding the related redemption or conversion notice and receiving a downward adjustment, if appropriate, to then applicable conversion price based on the weighted average trading price of common stock in the periods prior to the voiding of the notice. The holders have the option to acquire an additional $5.0 million of preferred stock, having an initial conversion price of $6.65 per share, exercisable until June 2, 2004. See Note 11 to the Company’s consolidated financial statements set forth at Item 8 of this report for more information regarding the convertible preferred stock.
The Company’s new revolving credit facility has the following material terms. The facility is with Harris Trust and Savings Bank, acting as administrative agent, and Bank of Montreal as lead arranger, and provides for National City Bank to act as syndication agent and provides for senior secured revolving loans of up to $60.0 million including a $15.0 million sublimit for standby and commercial letters of credit and a $5.0 million swing line sublimit. The credit facility will expire five years from closing (June 2, 2008). The credit facility is guaranteed by all of the wholly owned domestic subsidiaries and secured by first priority liens on substantially all of the Company’s and subsidiary guarantors’ assets, including rental contracts and the stock held in domestic subsidiaries. The Company may elect that each borrowing of revolving loans be either base rate loans or Eurodollar loans. The Eurodollar loans bear interest at a rate per annum equal to an applicable margin plus LIBOR adjusted for a reserve percentage. Under the base rate option, the Company will borrow money based on the greater of (a) the prime interest rate or (b) the federal funds rate plus 0.50%, plus, in each case, a specified margin. A 0.50% commitment fee will be payable quarterly on the unused amount of the revolving credit facility. Upon a default, interest will accrue at 2% over the applicable rate. The Company will be required to make specified mandatory prepayments upon subsequent debt or equity offerings and asset dispositions.
The financial covenants required under the credit facility are as follows:
The leverage ratio is total funded debt less an amount on deposit in excess cash flow escrow account to EBITDA for the four fiscal quarters then ended. The leverage ratio cannot exceed 5.00 to 1.00 through March 31, 2004, 4.75 to 1.00 from April 1, 2004 though June 30, 2004, 4.50 to 1.00 from July 1, 2004 through September 30, 2004, 4.00 to 1.00 from October 1, 2004 through September 30, 2005, 3.75 to 1.00 from October 1, 2005 though September 30, 2006, 3.25 to 1.00 from October 1, 2006 through September 30, 2007, 2.75 to 1.00 from October 1, 2007 thereafter.
The fixed charge coverage ratio is EBITDA for the four fiscal quarters then ended less capital expenditures not financed by capital leases to fixed charges for the same four fiscal quarters then ended. EBITDA does not include depreciation of rental merchandise and is adjusted for one-time non-cash charges. Fixed charges are the sum of all principal payments made on indebtedness, but excluding payments on revolving credit, plus interest expense, restricted payments, all prepayments on senior notes and income taxes paid or payable. The fixed charge coverage ratio cannot be less 1.20 to 1.00 from October 1, 2003 through March 31, 2004 and 1.25 to 1.00 from April 1, 2004 through June 2, 2008.
The Company cannot allow the book value of rental merchandise under lease to be less than 74% of the total value of rental merchandise held for rent at the end of each calendar month ending September 30, October 31 and November 30 in each fiscal year and 77% for all other calendar months in each fiscal year. The value of jewelry cannot exceed 7.5% of the total value of rental merchandise as measured at the end of each calendar month commencing June 30, 2003.
The Company cannot incur capital expenditures in an amount in excess of $20.0 million in the aggregate during any fiscal year. The $20.0 million maximum is increased for the unused permitted amount in any preceding year, not to exceed $22.5 million in any fiscal year.
Consolidated net worth shall not be less than $85.0 million plus 75% of positive net income with no deduction for losses (for each quarter of each fiscal year ending on or after September 30, 2003), and 90% of any subsequent incremental issuance of new equity securities, other than equities issues in connection with the exercise of employee stock options and capital stock issued to the seller of an acquired business in connection with a permitted acquisition.
The Company cannot permit EBITDA for the twelve consecutive calendar months then ended to be less than:
The Company is in compliance with all covenants at September 30, 2003, and expects be able to comply with covenants based upon its fiscal 2004 projections.
In April 2002, the Company sold one million shares of common stock and warrants to acquire another 100,000 shares of common stock in a private placement to Calm Waters Partnership and two other investors for $6.0 million. The warrants have an exercise price of $9.35 per share, which was reduced to $4.90 per share pursuant to anti-dilution adjustments. The Company re-measured the value of the warrants in accordance with the arrangement and reclassified the change to common stock from warrants. The Company also agreed to issue warrants to purchase additional shares of common stock to the investors if the Company failed to achieve aggregate EBITDA of $80.0 million or more for the 12-month period commencing on April 1, 2002. The warrant exercise price per share was based upon the EBITDA for such period. The Company did not meet this EBITDA target and issued 332,999 additional warrants at an exercise price per share of $1.50 in April 2003, which were subsequently exercised for cash of $0.5 million in June 2003.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is not subject to any off-balance sheet arrangements within the meaning of Rule 303(a)(4) of Regulation S-K.
CONTRACTUAL OBLIGATIONS
The following table presents obligations and commitments to make future payments under contracts and contingent commitments at September 30, 2003:
*Excludes the 401(k) restorative payments program as well as contingent liabilities that cannot be estimated (See Notes 19 and 14, respectively).
(1)
Consists of senior secured notes, net of discount, and outstanding revolving loans. (2) Net of insurance proceeds funded by the insurance carrier.
SEASONALITY AND INFLATION
The Company’s operating results are subject to seasonality. The first quarter typically has a greater number of rental-purchase agreements entered into because of traditional holiday shopping patterns. Management plans for these seasonal variances and takes particular advantage of the first quarter with product promotions and marketing campaigns. 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.
In the event of a prolonged recession, the Company acknowledges the possibility of a decrease in demand, particularly for higher-end products.
During the year ended September 30, 2003, 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 May, 2003, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company has adopted the provisions of this Statement. The classification and measurement provisions in paragraphs 9, 10 and 22 of FAS 150 are deferred for an indefinite period for certain mandatorily redeemable non-controlling interests with finite-lived subsidiaries.
On April 30, 2003, FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. SFAS 149 clarifies 1) the circumstances in which a contract with an initial net investment meets the characteristics of a derivative, 2) when a derivative contains a financing component and amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003. The Company has adopted the provisions of this Statement.
On January 15, 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” The objective of this interpretation is to improve financial reporting by enterprises involved with variable interest entities. This interpretation is effective for financial statements issued after October 9, 2003. The Company has no variable interest entities that are not currently consolidated.
On November 25, 2002, the FASB issued FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, An Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No.34". The Interpretation requires that upon issuance of a guarantee, the entity must recognize a liability for the fair value of the obligation it assumes under that obligation. The Company has evaluated the provisions of this Interpretation and determined it did not have an impact on these financial statements upon its adoption.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company’s major market risk exposure is primarily due to fluctuations in interest rates. The Company manages its exposure to changes in short-term interest rates, particularly to reduce the impact on floating-rate borrowings under its revolving credit facility, by entering into interest rate swap agreements. These swap agreements involve the receipt of amounts by the Company when floating rates exceed fixed rates and the payment of amounts by the Company to the counter parties when fixed rates exceed the floating rates in the agreements over their term. The Company accrues the differential as interest rates change, and recognizes it as an adjustment to the floating rate interest expense related to the debt. The counter parties to these contracts are high credit quality commercial banks, which the Company believes minimizes the risk of counter party default, to a large extent.
At September 30, 2003, the Company had swap agreements with total notional principal amounts of $101.4 million, which effectively fixed the interest rate on obligations in the notional amount of $13.0 million of debt under the $60.0 million revolving credit facility. The swap agreements lock in a LIBOR rate ranging from 5.09% to 6.97% and have maturities ranging from 2003 to 2005. Falling interest rates and/or a flattening of the yield curve will negatively impact the market value of the interest rate swaps. Changes in the valuation of such swap agreements are recorded directly to earnings. The face value of interest rate swap agreements was a liability of approximately $5.1 million at September 30, 2003. A 1% adverse change in the interest rates on variable rate obligations would affect pre-tax earnings by approximately $0.9 million.
The Company does not enter into derivative financial instruments for trading or speculative purposes. As of June 2, 2003, the Company is over-hedged because of the refinancing. The existing interest rate swaps hedged a portion of the previous LIBOR debt. As a result of the refinancing, the only LIBOR debt the Company has is the $60.0 million revolver credit facility, of which $13.0 million was outstanding at September 30, 2003. The Company will reduce its interest rate swap position as they mature through August 2005 because of the current cost to terminate those agreements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
RENT-WAY, INC.
REPORT OF INDEPENDENT AUDITORS
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 58 present fairly, in all material respects, the financial position of Rent-Way, Inc. and its subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003 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 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” effective October 1, 2002, as discussed in Note 5 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 12 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
November 19, 2003
RENT-WAY, INC.
CONSOLIDATED BALANCE SHEETS
(all dollars in thousands, except per share and share data)
The accompanying notes are an integral part of these financial statements.
RENT-WAY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(all dollars in thousands, except per share data)
The accompanying notes are an integral part of these financial statements
RENT-WAY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
(all dollars and shares in thousands)
The accompanying notes are an integral part of these financial statements.
RENT-WAY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(all dollars in thousands, except share and per share data)
The accompanying notes are an integral part of these financial statements.
RENT-WAY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(all dollars in thousands, except share and per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS AND ORGANIZATION. Rent-Way, Inc. is a corporation organized under the laws of the Commonwealth of Pennsylvania. The Company operates a chain of stores that rent durable household products such as home entertainment equipment, furniture, major appliances, computers, and jewelry to consumers on a weekly or monthly basis in thirty-three states. The stores are primarily located in the Midwestern, Eastern and Southern regions of the United States. Commencing January 1, 2000, the Company also provides prepaid local phone service to consumers on a monthly basis through its majority-owned subsidiary, dPi Teleconnect, LLC (“DPI”).
BASIS OF PRESENTATION. The Company presents an unclassified balance sheet to conform to practice in the industry in which it operates. The consolidated financial statements include the accounts of the Company and its wholly owned and majority owned subsidiaries. All significant inter-company transactions and balances have been eliminated.
ACCOUNTING ESTIMATES. The preparation of 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, disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
RESTRICTED CASH. The Company entered into an agreement settling the class action, entered into on April 18, 2003. The settlement requires the Company to pay $25,000 to the class. The $25,000 payment consists of $21,000 in cash and $4,000 in two-year, unsecured subordinated notes payable bearing interest at 6%. Of the $21,000 payable in cash, $11,000 is to be funded from available insurance proceeds. The remaining $10,000, which has been funded into escrow, has been reflected as restricted cash on the Consolidated Balance Sheet at September 30, 2003 (see Note 14).
RENTAL MERCHANDISE, RENTAL REVENUE AND DEPRECIATION. 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. Rental revenue is recognized as collected, 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. At the end of each rental period, the customer can renew the rental agreement.
Merchandise rented to customers or available for rent is classified in the consolidated balance sheet as rental merchandise and is valued at cost on a specific identification method. Write-offs of rental merchandise arising from customers’ failure to return merchandise 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 uses the units of activity depreciation method for all rental merchandise except computers, and computer games. Under the units of activity method, rental merchandise is depreciated as revenue is collected or earned during free-rent promotions. This rental merchandise is not depreciated during periods when it is not on rent and therefore not generating rental revenue. Computers, added to the Company’s product line in June 1999, are principally depreciated on the straight-line basis over 12 months to 24 months, depending on the type of computer. Computer games are depreciated on the straight-line basis over 12 months.
VOLUME REBATES. The Company participates in volume rebate programs with some of its rental merchandise suppliers. On an annual basis, management calculates the amount of the rebate and submits a request for payment. Upon receipt of the rebate, the Company records deferred income. The rebate is amortized on a straight-line basis over 18 to 20 months, the average life of the underlying rental merchandise, commencing on the date cash is received and is recorded as an offset to rental merchandise depreciation expense.
PREPAID PHONE SERVICE. Prepaid phone service is provided to customers on a 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 estimated average life of the customer relationship.
CONVERTIBLE REDEEMABLE PREFERRED STOCK. On June 2, 2003, the Company sold $15,000 in newly authorized convertible redeemable preferred stock through a private placement. The proceeds of $14,119, net of issuance costs of $881, were used to repay the previous senior credit facility. The net proceeds are classified outside of permanent equity because of the mandatory redemption date and other redemption provisions, except for $142 classified as option to purchase convertible preferred stock included in permanent equity (see Note 11).
OTHER REVENUE. Other revenue includes revenue from various services and charges to rental customers, including late fees, liability waiver fees, processing fees, sales of used merchandise and preferred Customer Club membership fees. Other revenue is
recognized as collected. This method of revenue recognition does not produce materially different results than if other revenue was recognized when earned.
COMPREHENSIVE INCOME (LOSS). Comprehensive income (loss) encompasses net income and changes in the components of accumulated other comprehensive income not reflected in the Company’s Consolidated Statements of Operations during the periods presented. Accumulated other comprehensive income (loss) consists of the transition asset recorded at the time of adoption of SFAS No. 133.
STATEMENT OF CASH FLOWS INFORMATION. Cash and cash equivalents consist of cash on hand and on deposit and highly liquid investments with maturities of three months or less when purchased. Cash equivalents are stated at cost, which approximates market value. The Company maintains deposits with several financial institutions. The Federal Deposit Insurance Corporation does not insure deposits in excess of $100 and mutual funds.
Supplemental disclosures of cash flow information for the years ended September 30, 2003, 2002, and 2001, are as follows:
At September 30, 2003 and 2002, book overdrafts of $2,703 and $306, respectively, were included in accounts payable in the accompanying Consolidated Balance Sheets.
PROPERTY AND EQUIPMENT AND RELATED DEPRECIATION AND AMORTIZATION. Property and equipment are stated at cost. Additions and improvements that significantly extend the lives of depreciable assets are capitalized. Upon sale or other retirement of depreciable property, the cost and accumulated depreciation are removed from the related accounts and any gain or loss is reflected in the results of operations. The Company’s corporate headquarters and other buildings are depreciated over periods ranging from 20 to 40 years on a straight-line basis. Depreciation of furniture and fixtures, signs and vehicles is provided over the estimated useful lives of the respective assets (three to five years) on a straight-line or an accelerated basis. Leasehold improvements are amortized over the shorter of the useful life of the asset or the effective term of the lease. Property under capital leases is amortized over the respective lease term on a straight-line basis (see Note 14). The Company incurs repairs and maintenance costs and costs for signage applied to its owned and leased vehicles. The Company has determined that the cost to account for capitalization of certain of these costs is not cost beneficial.
The Company reviews the recoverability of the carrying value of long-term assets using an undiscounted cash flow method. The Company performed a detailed analysis of its property and equipment, and as a result of this analysis, the Company has written-off through an adjustment to other operating expenses, property and equipment of $4,415 for the year ended September 30, 2001. During fiscal 2003 and 2002, the Company believes that no additional impairment of long-lived assets has occurred, and that no reduction of the estimated useful lives is warranted other than the write-offs that occur in the normal course of business.
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 will 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 condensed consolidated statements of operations for fiscal years ended September 30, 2003 and 2002, compared to $13,986 of amortization for the year ended September 30, 2001. The Company calculated an impairment to goodwill of $58,935, recorded in “Cumulative Effect of Change in Accounting Principle” in the amount of $41,527 (net of $17,408 in income taxes) for the fiscal year ended September 30, 2002 (see Note 5).
INTANGIBLE ASSETS. Customer contracts are stated at cost less amortization calculated on a straight-line basis over 18 months. Product exclusivity agreements are stated at cost less amortization calculated on a straight-line basis over 36 months. Deferred financing costs are stated at cost less amortization calculated on a straight-line basis over the term of the related debt agreements, which range from four to ten years. Non-compete agreements and prepaid consulting fees are stated at cost less amortization calculated on a straight-line basis over the terms of the related agreements, which range from two to seven years.
ADVERTISING EXPENSE. The Company incurs three types of advertising costs: production and printing, distribution, consisting primarily of postage, and communication. Advertising costs for production and printing are generally expensed when incurred. Advertising costs for distribution, consisting primarily of postage, are expensed as incurred over the period covered by the promotion. Cost of communicating is expensed as the communication occurs as advertisements.
LEGAL EXPENDITURES. Legal costs are recorded as incurred. The Company’s experience with outside legal counsel is that services rendered are billed within 30 days of the close of the month the work was performed. Legal contingencies are recorded when they are estimable and probable in accordance with SFAS 5, “Accounting for Contingencies.”
The Company executed an interim agreement for reimbursement and advancement of defense costs with its insurance carrier related to the shareholder class action lawsuit. The insurance carrier reimburses the Company for claim defense costs, claim investigative costs, and settlement costs incurred by the Company, its directors and officers. The Company offsets current legal costs with reimbursements when they have been agreed in principle with the insurance carrier.
DEFERRED FINANCING COSTS. Deferred financing costs consists of bond issuance costs and loan origination costs which were incurred in connection with the sale of $205,000 of senior secured notes and a new $60,000 revolving credit facility that was closed June 2, 2003. The bond issuance costs of $6,711 are amortized on a straight-line basis over the seven year term of the bonds. The loan origination costs of $2,040 are amortized on a straight-line basis over the five year bank credit agreement. Deferred financing cost amortization was $1,918 and $1,395 for the years ended September 30, 2003 and 2002, respectively. There was $1,143 of net deferred financing costs written off from the previous credit facility charged to deferred financing costs amortization during June 2003.
COMPANY INSURANCE PROGRAMS. For fiscal years 2003, 2002 and 2001, the Company is primarily self-insured for health insurance. The self-insurance liability for health costs is determined based on a contracted rate and monthly headcount. The contracted rate is determined based on experience, prior claims filed and an estimate of future claims. A retrospective adjustment for over (under) funding of claims is recorded when determinable and probable.
For fiscal years 2003, 2002 and 2001, 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 following policy inception and every 12 months thereafter. Retrospective adjustments to loss estimates are recorded when determinable and probable. For fiscal years 2000 and 1998, the Company was insured under deductible programs with aggregate stop loss coverage on major claims. Claims exceeding the insured deductible limits that were less than stop loss aggregates, were funded as claims developed using AM Best loss development factors and not exceeding policy aggregate. The fiscal 1999 worker’s compensation insurance had no aggregate retention and was funded as claims developed using AM Best loss development factors. Reserves were developed by independent actuaries and totaled $1,500 and $2,300 at September 30, 2003 and 2002, respectively.
LOSS PER COMMON SHARE. Basic loss per common share is computed using losses allocable to common shareholders divided by the weighted average number of common shares outstanding. Diluted loss per common share is computed using losses allocable to common shareholders adjusted for anticipated interest savings, net of related taxes, for convertible subordinated notes and debentures, convert derivative market value adjustment, and the weighted average number of shares outstanding is adjusted for the potential impact of options, warrants and convertible subordinated notes and debentures where the effects are dilutive.
FAIR VALUE DISCLOSURE. Fair values of the Company’s interest rate swap agreements have been determined from information obtained from independent third parties. Fair values of other assets and liabilities including letters of credit, debt and accounts payable are estimated to approximate their carrying values.
DERIVATIVE FINANCIAL INSTRUMENTS. The Company uses derivative financial instruments to reduce the impact on interest expense of fluctuations in interest rates on a portion of its credit facility (see Notes 10 and 12). The Company does not enter into derivative financial instruments for trading or speculative purposes.
STOCK-BASED COMPENSATION. The Company accounts for stock based compensation issued to its employees and directors in accordance with Accounting Principle Board No. 25 and has elected to adopt the “disclosure only” provisions of SFAS 123 as amended by provisions of SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require new permanent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used in reported results.
For SFAS No. 148 purposes, the fair value of each option granted under the 1992 Plan, the 1995 Plan, and the 1999 Plan is estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for options granted in fiscal 2003, 2002 and 2001: expected volatility ranging from 47.41% to 99.98%, risk-free interest rates between 2.87% and 6.81%, and an expected life of five and six years.
If the Company had elected to recognize the compensation cost of its stock option plans based on the fair value of the awards under those plans in accordance with SFAS No. 148, net loss and loss per common share would have been increased to the pro-forma amounts below:
DISCONTINUED OPERATIONS. On February 8, 2003, the Company completed the definitive purchase agreement and sold rental merchandise and related contracts of 295 stores to Rent-A-Center, Inc. Rent-A-Center, Inc. purchased certain fixed assets and assumed related store leases of 125 of these stores. Accordingly, for financial statement purposes, the assets, liabilities, results of operations and cash flows of this component have been segregated from those of continuing operations and are presented in the Company’s financial statements as discontinued operations (see Note 2).
RECLASSIFICATIONS. Certain amounts in the September 30, 2001 and 2002 consolidated financial statements were reclassified to conform to the September 30, 2003 presentation.
2. DISCONTINUED OPERATIONS:
On December 17, 2002, the Company entered into a definitive purchase agreement to sell rental merchandise and related contracts of 295 stores to Rent-A-Center, Inc. for approximately $101,500. These stores are all included in the household rental segment. Rent-A-Center, Inc. purchased certain fixed assets and assumed related store leases of 125 of these stores. The transaction closed on February 8, 2003. The final purchase price for the stores was approximately $100,400. As required under the Company’s credit agreement, all proceeds of the sale, net of transaction costs, store closing and similar expenses, were used to pay existing bank debt. Of the approximate $100,400 purchase price, $10,000 was being held back by Rent-A-Center, Inc., to secure the Company’s indemnification obligations, $5,000 for 90 days following closing, which was refunded to the Company in May, 2003, and an additional $5,000 for 18 months following closing. The Company recorded a receivable for this based upon its ability to fully satisfy the indemnification obligations of the agreement. The $5,000 held back by Rent-A-Center, Inc. for 18 months was discounted by $820 to record at the present value. The $820 discount will be amortized into income over the 18-month hold back period. Also, there was a $24,500 escrow held by National City Bank, which was used to pay transaction costs, store closing and similar expenses. The balance of this escrow, approximately $3,000, was used to pay down debt at the closing of the refinancing on June 2, 2003. The assets sold include rental merchandise, vehicles under capital leases and certain fixed assets. Vehicle lease obligations were paid by the Company out of the proceeds from the sale.
The asset group is distinguishable as a component of the Company and classified as held for sale in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for the Impairment on Disposal of Long-Lived Assets.” Direct costs to transact the sale were comprised of, but not limited to, broker commissions, legal and title transfer fees and closing costs.
In connection with the sale of the stores, the Company has and will continue to incur additional direct costs related to the sale and exit costs related to these discontinued operations. Costs associated with an exit activity include, but are not limited to termination benefits, costs to terminate a contract that is not a capital lease and costs to consolidate facilities or relocate employees, in accordance with Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities.” There was a transition period as defined in the asset purchase agreement comprised of a period of thirty days from the date immediately following the closing date. During this transition period, the Company was liable for certain exit costs attributable to the operation and transition of the purchased stores, including, but not limited to, rent, utilities, costs applicable to office equipment, costs associated with vehicles, employee payroll, health and other employee benefits, workers compensation claims, health care claims and all other costs related to transition personnel. The Company accrued employee separation costs as costs were incurred in accordance with SFAS 146. These costs are included in the results of discontinued operations in accordance with SFAS 144.
Related operating results have been reported as discontinued operations in accordance with SFAS 144. The Company has reclassified the results of operations of the component to be disposed for the prior period in accordance with provisions of SFAS 144. There have been no corporate expenses (including advertising expense) included in expenses from discontinued operations. Interest on debt that is required to be repaid as a result of the disposal transaction is allocated to income (loss) from discontinued operations. The effective interest rate on the outstanding debt of the Company at the end of the period reported is applied to the $68,643 estimated debt pay-down from the proceeds. The amount of interest reclassified to income (loss) from discontinued operations is $3,036, $8,587 and $5,951 for the periods ended September 30, 2003, 2002 and 2001, respectively. Revenues and net income (loss) from the discontinued operations were as follows:
(1)
The Company recorded exit costs associated with the operation and transition of the stores to Rent-A-Center, Inc. for 30 days after closing, and monthly rent and common area maintenance charges until leases are terminated or expired, in accordance with SFAS 146.
(2)
The reserve for future lease payments on vacated stores relates to the 170 stores for which Rent-A-Center, Inc. did not assume the leases. These costs are associated with the exit activity related to the sale of the 295 stores to Rent-A-Center, Inc., and are recorded in accordance with SFAS 146.
Assets and liabilities of the stores held for sale included in the Consolidated Balance Sheet are as follows:
Property and equipment held for sale was comprised of the following:
3. BUSINESS RATIONALIZATION:
The Company periodically closes under-performing stores and takes other actions to maximize its overall profitability. In connection with the closing of stores and taking other actions, it incurs employee severance, fixed asset write offs, lease termination costs, net of sublease revenue, and other direct exit costs related to these activities. Employee severance costs related to the closing of under-performing stores were immaterial in each of the periods reported below. The net amount of these costs charged to income were as follows:
Lease termination costs will be paid according to the contract terms.
During the second quarter of fiscal year 2003, the Company formulated a plan to restructure the corporate office through reductions in the corporate workforce to rationalize corporate costs for the remaining stores and to sublease, assign or terminate operating leases that the Company would no longer operate as a rent-to-own business activity subsequent to the sale to Rent-A-Center. The restructuring costs for year ended September 30, 2003, includes $981 of employee severance and termination benefits and $2,065 of fixed asset write-offs, all of which were incurred in fiscal year 2003.
In addition to lease termination costs incurred in normal operating activities summarized in the table above, the Company incurred an additional lease obligation for the leases of the 170 stores that Rent-A-Center, Inc. did not assume in the sale. The total original gross obligation was $13,491 on February 8, 2003 and was reduced for estimated sublease income of $3,834 and further reduced by $1,286 to reflect the present value of that obligation in accordance with Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. At September 30, 2003, the net obligation is $4,500.
4. NEW ACCOUNTING STANDARDS:
In May, 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company has adopted the provisions of this Statement. The classification and measurement provisions in paragraphs 9, 10 and 22 of FAS 150 are deferred for an indefinite period for certain mandatorily redeemable non-controlling interests with finite-lived subsidiaries.
On April 30, 2003, the FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. SFAS 149 clarifies 1) the circumstances in which a contract with an initial net investment meets the characteristics of a derivative, 2) when a derivative contains a financing component and amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003. The Company has adopted the provision of this Statement.
On January 15, 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” The objective of this interpretation is to improve financial reporting by enterprises involved with variable interest entities. This interpretation is effective for financial statements issued after October 9, 2003. The Company has no variable interest entities that are not currently consolidated.
On November 25, 2002, the FASB issued FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, An Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No.34". The Interpretation requires than upon issuance of a guarantee, the entity must recognize a liability for the fair value of the obligation it assumes under that obligation. The Company has evaluated the provisions of this Interpretation and determined it did not have an impact on these financial statements upon its adoption.
5. GOODWILL - ADOPTION OF STATEMENT 142:
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. SFAS 142 prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment while the second phase, if necessary, measures the impairment. 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 years ended September 30, 2003 and 2002, compared to $13,986 for the year ended September 30, 2001.
In accordance with the provisions of SFAS 142, the Company completed, with the assistance of an independent valuation firm, phase one of the impairment test consisting of a comparison of the fair value with the carrying amount for goodwill and indefinite lived intangibles that existed on the Company’s balance sheet at the date of its adoption. Based upon its analysis from the phase one impairment test, the Company identified indicators of possible impairment resulting from a reduction of forecasted cash flows related to the household rental segment. The total enterprise value, as determined by independent valuation experts, represents a combination of the market multiple, discounted cash flow and comparable transaction approaches.
During the quarter ended September 30, 2002, the Company performed, with the assistance of an independent valuation firm, the phase two impairment test of the carrying value to determine the amount of the write down. This assessment resulted in an impairment write-down of $58,935 recorded in “Cumulative Effect of Change in Accounting Principle” in the amount of $41,527 (net of $17,408 in income taxes). In accordance with the transitional implementation guidance of SFAS 142, the write down was recorded retroactive to the Company’s first quarter results of operations. A reconciliation of the previously reported net loss and loss per share as if SFAS 142 had been adopted as of October 1, 2000, is presented as follows:
The following table shows the net carrying value of goodwill as of September 30, 2003 for the Company’s segments:
The following table reflects the components of amortizable intangible assets at September 30, 2003:
At September 30, 2003, future aggregate annual amortization of amortizable intangible assets is as follows:
Amortization expense of amortizable intangible assets for the year ended September 30, 2003, was $1,361.
The changes in the carrying amount of goodwill for the fiscal years ended September 30 were as follows:
(1)
Reversal of an income tax contingency established as a part of purchase accounting in prior years, which was determined to be no longer needed during the fourth quarter of 2002.
(2)
Disposal of 295 stores to Rent-A-Center on February 8, 2003. (3) Includes goodwill held for sale of $41,291
6. RENTAL MERCHANDISE AND PROPERTY AND EQUIPMENT:
Cost and accumulated depreciation of rental merchandise consists of the following:
The Company uses a direct-ship policy from their vendors to the stores. As a result, the Company has eliminated the need for internal warehousing and distribution. This policy reduces the amount of rental merchandise not on rent. On-rent and held for rent levels of net rental merchandise consists of the following:
The Company uses the direct write-off method in accounting for losses (see Note 1). These losses are recorded in other operating expenses and were incurred as follows:
Property and equipment consists of the following:
7. RENTAL MERCHANDISE CREDITS DUE FROM VENDORS:
The Company had credits due from vendors for the return of merchandise in the amount of $4,156, $995, and $1,642 as of September 30, 2003, 2002 and 2001, respectively. The credits are reduced when the Company purchases additional products from the vendors.
8. OTHER ASSETS:
Other assets consist of the following:
9. OTHER LIABILITIES:
Other liabilities consist of the following:
10. DEBT:
Debt consists of the following:
The Company’s senior secured notes have the following important terms. The $205,000 principal amount of senior secured notes bear interest at 11.875%. The interest on the secured notes is payable semiannually on June 15 and December 15 beginning December 15, 2003. The secured notes are guaranteed on a senior basis by all existing and future domestic restricted subsidiaries of the Company other than DPI, which is an unrestricted subsidiary. The Company may redeem the secured notes, in whole or in part, at any time prior to June 15, 2010, at a redemption price equal to the greater of:
a)
100% of the principal amount of the notes to be redeemed; and
b)
the sum of the present values of (i) 100% of the principal amount of the notes to be redeemed at June 15, 2010, and (ii) the remaining scheduled payments of interest from the redemption date through June 15, 2010, but excluding accrued and unpaid interest to the redemption date, discounted to the redemption date at the treasury rate plus 175 basis points;
plus, in either case, accrued and unpaid interest to the redemption date.
In addition, at any time prior to June 15, 2006, up to 25% of the aggregate principal amount of the secured notes may be redeemed at the Company’s option, within 75 days of certain public equity offerings, at a redemption price of 111.875% of the principal amount, together with accrued and unpaid interest. Such redemption can occur provided that after giving effect to any such redemption, at least 75% of the original aggregate principal amount of the notes issued (including any notes issued in future permitted issuances) remains outstanding.
The secured notes were offered at a discount of $3,583, which is being amortized using the effective interest method, over the term of the secured notes. Amortization of the discount was $104 for 2003 and is recorded as interest expense. Costs representing underwriting fees and other professional fees of $6,711 are being amortized, using the straight-line method, over the term of the secured notes. The secured notes rank senior in right to all of the Company’s existing and future subordinated debt, have a lien position ranking second to the bank revolving credit facility and effectively junior in right of payment to all existing and future debt and other liabilities of the Company’s subsidiaries that are not subsidiary guarantors. The secured notes contain covenants that will, among other things, limit the Company’s ability to incur additional debt, make restricted payments, incur any additional liens, sell certain assets, pay dividend distributions from restricted subsidiaries, transact with affiliates, conduct certain sale and leaseback transactions and use excess cash flow.
Under the indenture for the secured notes, if the Company (a) has any excess cash flow or amounts on deposit in the excess cash flow collateral account, (b) has a leverage ratio equal to or greater than 2.50 to 1.00 or a rent-adjusted leverage ratio equal or greater than 4.00 to 1.00, and (c) has cash and cash equivalents of more than $10,000, the Company must repay debt (if any) outstanding under the revolving credit facility in an amount equal to the remainder (if positive) of (1) the amount of such cash and cash equivalents minus (2) the sum of $10,000 plus such excess cash flow. Thereafter, if the Company (a) has any excess cash flow with respect to such fiscal year plus amounts on deposit in the excess cash flow collateral account of at least $1,000 in the aggregate and (b) the coverage ratio is equal to or greater than 2.50 to 1.00 or the rent-adjusted leverage ratio is equal to or greater than 4.00 to 1.00, then the Company either must use the excess cash flow plus such amounts on deposit to repay debt (if any) outstanding under the revolving credit facility or, subject to limitations, must use 75% of any excess cash flow plus such amounts on deposit remaining after repayment of debt outstanding under the revolving credit facility to make an offer to purchase notes at a purchase price equal to 104.25% of the aggregate principal amount thereof, plus accrued and unpaid interest to the purchase date. The Company must deposit in the excess cash flow collateral account all of the portion of the 75% of such remaining excess cash flow not used to purchase notes. The Company may use 25% of the excess cash flow remaining with respect to such fiscal year after repayment of debt outstanding under the revolving credit facility. All of the Company’s obligations to use excess cash flow as described above terminate upon the first fiscal year end of the Company at which both (a) the leverage ratio is less than 2.50 to 1.00 and (b) the rent-adjusted leverage ratio is less than 4.00 to 1.00. (Under the indenture, “excess cash flow” means for any fiscal year, EBITDA for the Company and its consolidated restricted subsidiaries for such year, adjusted for certain items. “Excess cash collateral account” is an account maintained by the collateral agent in which the Company deposits all of the portion of the 75% of the excess cash flow remaining after payment of debt outstanding under the revolving credit facility.) The Company is in compliance with all covenants at September 30, 2003, and expects to comply with covenants based upon its fiscal 2004 projections.
The Company’s new revolving credit facility has the following material terms. The facility is with Harris Trust and Savings Bank, acting as administrative agent, and Bank of Montreal as lead arranger, and provides for National City Bank to act as syndication agent and provides for senior secured revolving loans of up to $60,000 including a $15,000 sub-limit for standby and commercial letters of credit and a $5,000 swingline sub-limit. The credit facility will expire five years from closing (June 2, 2008). The balance outstanding at September 30, 2003 was $13,000 with $38,300 available at September 30, 2003. Deferred financing costs of $2,027 are being amortized, on a straight-line basis, over the 5-year term of the bank agreement. The credit facility is guaranteed by all of the wholly owned domestic subsidiaries and collateralized by first priority liens on substantially all of the Company’s and subsidiary guarantors’ assets, including rental contracts and the stock held in domestic subsidiaries. The Company may elect that each borrowing of revolving loans be either base rate loans or Eurodollar loans. The Eurodollar loans bear interest at a rate per annum equal to an applicable margin plus LIBOR adjusted for a reserve percentage. Under the base rate option, the Company will borrow money based on the greater of (a) the prime interest rate or (b) the federal funds rate plus 0.50%, plus, in each case, a specified margin. A 0.50% commitment fee will be payable quarterly on the unused amount of the revolving credit facility. Upon a default, interest will accrue at 2% over the applicable rate. The Company will be required to make specified mandatory prepayments upon subsequent debt or equity offerings and asset dispositions.
The financial covenants required under the credit facility are as follows:
The leverage ratio is total funded debt less an amount on deposit in the excess cash flow escrow account to EBITDA for the four fiscal quarters then ended. The leverage ratio cannot exceed 5.00 to 1.00 through March 31, 2004, 4.75 to 1.00 from April 1, 2004 though June 30, 2004, 4.50 to 1.00 from July 1, 2004 through September 30, 2004, 4.00 to 1.00 from October 1, 2004 through September 30, 2005, 3.75 to 1.00 from October 1, 2005 though September 30, 2006, 3.25 to 1.00 from October 1, 2006 through September 30, 2007, 2.75 to 1.00 from October 1, 2007 thereafter.
The fixed charge coverage ratio is EBITDA for the four fiscal quarters then ended less capital expenditures not financed by capital leases to fixed charges for the same four fiscal quarters then ended. EBITDA does not include depreciation of rental merchandise and is adjusted for one-time non-cash charges. Fixed charges are the sum of all principal payments made on indebtedness, but excluding payments on revolving credit, plus interest expense, restricted payments, all prepayments on senior notes and income taxes paid or payable. The fixed charge coverage ratio shall not be less than 1.20 to 1.00 from October 1, 2003 through March 31, 2004 and 1.25 to 1.00 from April 1, 2004 through June 2, 2008.
The Company cannot allow the book value of rental merchandise under lease to be less than 74% of the total value of rental merchandise held for rent at the end of each calendar month ending September 30, October 31 and November 30 in each fiscal year and 77% for all other calendar months in each fiscal year. The value of jewelry cannot exceed 7.5% of the total value of rental merchandise as measured at the end of each calendar month, commencing June 30, 2003.
The Company cannot incur capital expenditures in an amount in excess of $20,000 in the aggregate during any fiscal year. The $20,000 maximum is increased for any unused preceding year permitted amount not to exceed $22,500 in a fiscal year
Consolidated net worth shall not be less than $85,000 plus 75% of positive net income with no deduction for losses (for each quarter of each fiscal year ending on or after September 30, 2003), and 90% of any subsequent incremental issuance of new equity securities, other than equities issues in connection with the exercise of employee stock options and capital stock issued to the seller of an acquired business in connection with a permitted acquisition.
The Company cannot permit EBITDA for the twelve consecutive calendar months then ended to be less than:
The Company is in compliance with all covenants at September 30, 2003, and expects to be able to comply with covenants based upon its fiscal 2004 projections.
11. CONVERTIBLE PREFERRED STOCK:
On June 2, 2003, the Company issued 1,500 shares of its Series A convertible preferred stock, for $10,000 per share (the “convertible preferred stock”) and granted a one-year option to purchase an additional 500 shares of convertible preferred stock (the “additional preferred shares”). The net proceeds from the sale of the convertible preferred stock were used to repay the senior credit facility (see Note 10.). The net proceeds of $14,119 from the issuance of the convertible preferred stock are net of issuance costs of $881, and are classified outside of permanent equity because of the redemption date and other redemption provisions except for $142 classified as option to purchase convertible preferred stock included in permanent equity. The convertible preferred stock is being accreted to its maximum redemption amount possible pursuant to Topic D-98, “Classification and Measurement of Redeemable Securities,” using the effective interest method from the issuance date to the 7-year redemption date.
The terms of the convertible preferred stock include a number of conversion and redemption provisions that represent derivative financial instruments under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) (See Note 12). Certain features of the convertible preferred stock are accounted for as embedded derivative financial instruments. The Company has determined that the option to purchase additional preferred shares is an embedded derivative financial instrument that qualifies for scope exemption under the provisions of EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF-0019”). As such, this derivative was initially required to be bifurcated and recorded at fair value upon issuance but does not require mark to market accounting. The market value of this derivative financial instrument is $142 and is recorded as options to purchase convertible preferred stock in the equity section of the consolidated balance sheet. The Company also has determined the convertible feature of the convertible preferred stock is a derivative financial instrument that does not qualify for scope exemption under EITF 00-19; and, is required to be bifurcated, recorded at fair value, and marked to market. The market value of this derivative financial instrument is $10,509 at September 30, 2003, and is recorded in convertible redeemable preferred stock in the consolidated balance sheet. The fair values of the derivatives were determined with the assistance of an independent valuation firm.
Below is a description of the material terms of the convertible preferred stock.
Dividends. Dividends will accrue daily at a rate of 8.0% per annum. Dividends on the preferred stock will be payable beginning July 1, 2003, and on the first day of each calendar quarter in cash or in shares of Company common stock at the Company’s option; provided, however, that if the Company elects to pay dividends in shares of common stock, (i) a registration statement must be effective with respect to such shares of common stock and (ii) the payment would be at 95% of the arithmetic average of the daily volume weighted average prices of the common stock for the five trading days immediately preceding the second trading day prior to the applicable dividend payment date. The Company is required to pay dividends in cash if a triggering event occurs. Dividends not paid within five business days of the dividend payment date bear interest at 15.0% per annum until paid in full. During the period commencing upon the occurrence of a share liquidity event and ending when such event is cured, the dividend rate shall increase to 15% per annum. Preferred dividends of $399 were accrued and charged to accumulated deficit for the year ended September 30, 2003.
Conversion provisions. Subject to certain limitations, each share of preferred stock is convertible at the holder’s option. Preferred stock is convertible in the Company’s common stock by dividing the stated value of such shares by the conversion price. The conversion price is $6.00 per share for preferred stock issued at the initial closing and $6.65 per share for any additional preferred shares issued, subject to certain anti-dilution adjustments.
Limitation on beneficial ownership. The Company has no obligation to effect any conversion, and no holder of preferred shares has the right to convert any preferred shares, to the extent that after giving effect to such conversion, the beneficial ownership of a number of shares exceeds 4.99% of the number of shares of common stock outstanding immediately after giving effect to such conversion.
Mandatory redemption at maturity. If any preferred shares remain outstanding on the maturity date (June 2, 2011), the Company shall redeem in cash such shares at a redemption price equal to the stated value of such shares plus accrued but unpaid dividends.
Purchase rights. If at any time the Company grants, issues or sells any options, convertible securities or rights to purchase stock, warrants, securities or other property pro rata to the record holders of any class of common stock, then the holders of preferred shares will be entitled to acquire, upon the terms applicable to such purchase rights, the aggregate purchase rights which such holder would have acquired if such holder had held the number of shares of common stock acquirable upon complete conversion of the preferred shares.
Re-organization, reclassification, consolidation, merger or sale. Prior to the sale of all or substantially all of the Company’s assets following which the Company is not a surviving entity, the Company will secure from the person purchasing such assets or the successor, a written agreement to deliver to each holder of preferred shares in exchange for such shares, a security of the acquiring entity similar in form and substance to the preferred shares, including, without limitation, having a stated value and liquidation preference equal to the stated value and liquidation preference of the preferred shares.
Company’s Redemption Provisions. On the date the Company publicly discloses a change of control, the Company has the right, in its sole discretion, to require that all, but not less than all, of the outstanding preferred shares be redeemed at a price per preferred share equal to the applicable change of control redemption price discussed below.
Subject to certain requirements, the Company can redeem the preferred stock at any time from and after June 2, 2008, in whole or in part, for an amount in cash equal to the conversion amount of the preferred shares selected for redemption.
Holder’s Redemption Provisions. Upon a change of control each holder of preferred shares has the option to require the Company to redeem all or a portion of the preferred shares held in cash at a premium determined as follows.
The change of control redemption price is determined as follows:
1)
If the acquiring entity is a publicly-traded entity, the redemption price is the greater of (A) the product of (i) the change of control redemption percentage (discussed below) and (ii) the conversion amount; or (B) the sum of (i) the stated value and (ii) a Black-Scholes valuation amount,
2)
If the acquiring entity is not a publicly-traded entity, the redemption price is the product of (i) the change of control redemption percentage and (ii) the conversion amount.
The change of control redemption percentage is:
1)
125% for the period commencing on the initial issuance date and ending on the second anniversary of the initial issuance date,
2)
120% for the period commencing on the day after the second anniversary and ending on the third anniversary of the initial issuance date,
3)
115% for the period commencing on the date after the third anniversary of the initial issuance date and ending on the maturity date.
At any time on and after the six month anniversary of the repayment, redemption or retirement of all of the senior secured notes and all amounts outstanding under the senior credit facility, each holder has the option to require the Company to redeem at any time all or a portion of such holder’s preferred shares at a price per preferred share equal to the conversion amount.
Voting rights. Holders of preferred shares have no voting rights, except as required by law.
Liquidation. In the event of any liquidation, dissolution or winding up of the Company, the holders of the preferred shares are entitled to receive cash in an amount equal to its stated value plus accrued but unpaid dividends before any amount shall be paid to common stock holders.
Restriction on redemption and cash dividends. Unless all of the preferred shares have been converted or redeemed, the Company shall not, directly or indirectly, redeem, or declare or pay any cash dividend or distribution on its capital stock.
Restriction of Additional Preferred Stock. Without the consent of the holders of the Series A preferred shares, the Company may not issue any other preferred shares that would rank senior to or pari passu with the Series A preferred with respect to payments of dividends or on liquidation.
Registration rights. The Company has filed a registration statement on Form S-3 covering the shares of common stock issuable upon conversion of the preferred stock acquired in the initial closing, which became effective on July 11, 2003. In the event the holders acquire additional shares of preferred stock, the Company is required to file a registration statement on Form S-3 covering the common stock issuable on conversion of the preferred stock so acquired within 30 days of such acquisition and to cause the registration statement to become effective within 90 days thereafter. The Company will pay cash liquidated damages to the holders of the preferred stock in the event the Company does not meet these requirements, and also in the event the registration statement becomes unavailable to the holders for periods beyond specified grace periods.
12. DERIVATIVE FINANCIAL INSTRUMENTS:
On June 2, 2003, the Company issued 1,500 shares of convertible redeemable preferred stock (see Note 11). The terms of this preferred stock include a number of conversion and redemption provisions that represent derivatives under SFAS No. 133. The Company has determined that the option to purchase additional preferred shares is an embedded derivative financial instrument that qualifies for SFAS 133 scope exemption under the provisions of EITF 00-19. As such this derivative was initially bifurcated and recorded in shareholders’ equity. This derivative does not require mark to market accounting and is accreted into convertible redeemable preferred stock over the one-year option period.
The Company also has determined the convertible feature of the convertible redeemable preferred stock is a derivative financial instrument that does not qualify for SFAS 133 scope exemption under EITF 00-19. It was bifurcated and recorded in the temporary equity classification on the balance sheet. The positive change in the fair market value of the convertible feature from issuance on June 2, 2003 to September 30, 2003 was $1,899, which was recorded as an expense to other income (expense) in the Company’s Consolidated Statements of Operations.
At September 30, 2003, the Company had interest rate swaps on a notional debt amount of $101,400 and a fair market value of ($5,597). The variable pay interest rate ranges from 5.09% to 6.97%. The maturity dates run through August 2005.
The Company’s interest rate swaps do not meet the qualifications for hedge accounting treatment under SFAS No. 133. The Company’s positive change in the fair market value of the interest rate swap portfolio was $4,910 for the year ended September 30, 2003. This was recorded to other income in the Company’s Consolidated Statements of Operations.
13. INSURANCE CHARGE AND RECOVERY
In fiscal 2003, the Company recorded income of $4,618 for ultimate and incurred losses related to the Company’s revised estimates for retrospective self-insurance programs, which offset insurance costs included in other operating expense. The adjustment was comprised of income in the amount of $3,597 and $1,055 for the policy years ended December 31, 2002 and 2001, respectively, and, an expense of $34 for the policy year ended December 31, 2000.
The Company recorded in income as a reduction of other operating expense, a reimbursement of defense costs related to the derivative and class action lawsuits in the amount of $800 and $1,900 for the 2003 and 2002 fiscal years respectively. In fiscal 2002 the Company also recorded an expense of $4,600, which consisted of upward adjustments to various of the Company’s retrospective and other insurance programs based upon a change in estimate.
14. COMMITMENTS AND CONTINGENCIES:
The Company leases substantially all of its retail stores under non-cancelable agreements generally for initial periods ranging from three to five years. The store leases generally contain renewal options for one or more periods of three to five years. Most leases require the payment of taxes, insurance, and maintenance costs by the Company. The Company leases certain transportation and satellite equipment under capital leases and, to a lesser extent, operating leases, under arrangements that expire over the next 5 years. At September 30, 2003, future minimum rental payments under non-cancelable capital and operating leases are as follows:
The capital lease agreements have a minimum lease term of one year and permit monthly renewal options and contain residual lease guarantees. The Company has retained the leased vehicles an average of 48 months which represents the period through which renewal of the leases have historically been probable as a result of continuously decreasing costs of operation.
The Company’s investment in equipment under capital leases was as follows:
Rent expense under operating leases for the years ended September 30, 2003, 2002, and 2001 was $23,973, $33,970 and $39,140, respectively.
As previously reported, the Company, its independent accountants, and certain of its current and former officers were named in a consolidated class action complaint filed in the U.S. District Court for the Western District of Pennsylvania alleging violations of the securities laws and seeking damages in unspecified amounts purportedly on behalf of a class of shareholders. On April 18, 2003, the Company entered into an agreement settling the class action. The settlement requires the Company to pay the class the sum of $25,000, with $21,000 in cash and $4,000 in 6% unsecured subordinated notes payable in four equal installments over two years commencing December 31, 2003. Of the $21,000 payable in cash, $11,000 has been funded from available insurance proceeds, the remaining $10,000 has been funded into escrow and is classified as restricted cash on the consolidated balance sheet. The settlement agreement provides for the release of the Company and all other defendants except the Company’s former controller and the Company’s independent accountants. The settlement remains subject to Court approval. On September 9, 2003, the Court granted a motion certifying a class and appointing the lead plaintiff, Cramer Rosenthal McGlynn LLC, as class representative. On September 12, 2003, the Court conducted a fairness hearing regarding the settlement. The lead plaintiff’s motion for the Court’s approval of the settlement is pending.
The Company is subject to legal proceedings and claims in the ordinary course of its business that have not been finally adjudicated. Certain of these cases, exclusive of the class action mentioned above, have resulted in initial claims totaling $8,253. However, all but $1,773 of such claims are, in the opinion of management, covered by insurance policies or indemnification agreements, or create only remote potential of any liability exposure to the Company and therefore should not have a material effect on the Company’s financial position, results of operations or cash flows. Additionally, threatened claims exist for which management is not yet able to reasonably estimate a potential loss. In management’s opinion, none of these threatened claims will have a material adverse effect on the Company’s financial position, results of operations or cash flows.
For fiscal years 2003, 2002 and 2001, the Company is primarily self-insured for health. The self-insurance liability for health costs is determined based on a contracted rate and monthly employee headcount. The contracted rate is determined based on experience, prior claims filed and an estimate of future claims. A retrospective adjustment for over (under) funding of claims is recorded when determinable and probable.
For fiscal years 2003, 2002 and 2001, 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 following policy inception and every 12 months thereafter. Retrospective adjustments to loss estimates are recorded when determinable and probable. For fiscal years 2000 and 1998, the Company was insured under deductible programs with aggregate stop loss coverage on major claims. Claims exceeding the insured deductible limits that were less than stop loss aggregates, were funded as claims developed using AM Best loss development factors and not exceeding policy aggregate. The fiscal 1999 worker’s compensation insurance had no aggregate retention and was funded as claims developed using AM Best loss development factors. Reserves were developed by independent actuaries and totaled $1,500 and $2,300 at September 30, 2003 and 2002, respectively. The Company has obtained letters of credit of $5,950 to guarantee the payment of future claims.
The Company has approximately $466 recorded as deposits held for customers, recorded in other liabilities.
Also, see Note 16 for related party commitments.
15. INCOME TAXES:
The Company’s income tax expense (benefit) consists of the following components:
A reconciliation of the income tax expense (benefit) compared with the amount at the U.S. statutory tax rate of 35% is shown below:
At September 30, 2003 and 2002, the components of the net deferred tax asset (liability) are as follows:
As of September 30, 2003, the Company has net operating loss carryforwards of approximately $208,000 for income tax purposes, the majority of which expire in fiscal years 2018 through 2023. Additionally, as of September 30, 2003, the Company has alternative minimum tax credits of $147.
At September 30, 2002, the valuation allowance was $65,862. At September 30, 2003, the net increase was $7,233, of which $347 is the tax benefit of the transitional swap amount recorded to equity. A portion of this increase was a result of a modification to the operating loss carryforwards based on actual filed tax returns. Approximately $3,499 of the operating loss carryforwards will result in a credit to shareholders’ equity when it is determined they can be utilized.
16. RELATED PARTY TRANSACTIONS:
During fiscal years ended September 30, 2003, 2002, and 2001, the Company leased one location from a company controlled by a principal shareholder. Rent paid during these years related to this lease was $49.
During fiscal 2003, 2002 and 2001 the Company executed notes receivable aggregating $0, $0 and $159, respectively from directors of the Company resulting from the exercise of stock options. The notes are full recourse promissory notes bearing interest at 10% per annum. On November 1, 2000, the Company received a note receivable with a balance of $159 from a director of the Company related to a personal loan. The note is a full recourse promissory note and bears interest at 10% per annum. At September 30, 2003, 2002 and 2000 the Company held notes receivable which were due within one year and unpaid interest thereon of $0, $282 and $924, respectively and interest income was $3, $41 and $77, respectively for the years then ended. The notes are reflected as a reduction to shareholders’ equity in the Company’s Consolidated Balance Sheet.
The Company has entered into a consulting agreement with a director of the Company that provides for the payment of $100 per year for 10 years commencing October 1, 1999.
17. STOCK OPTIONS:
In March 1999, the Board of Directors of the Company adopted, and the shareholders approved, the Rent-Way, Inc. 1999 Stock Option Plan (the “1999 Plan”) which authorizes the issuance of up to 2,500,000 shares of common stock pursuant to stock options granted to officers, directors, key employees, consultants, and advisors of the Company. The option exercise price will be at least equal to the fair market value of the Company’s common stock on the grant date. The 1999 Plan will expire in March 2009 unless terminated earlier by the Board of Directors. The authorized number of shares, the exercise price of outstanding options, and the number of shares under option are subject to appropriate adjustment for stock dividends, stock splits, reverse stock splits, recapitalizations, and similar transactions. The 1999 Plan is administered by the Compensation Committee of the Board of Directors who select the optionees and determine the terms and provisions of each option grant within the parameters set forth in the 1999 Plan.
The Board of Directors of the Company also adopted, and the shareholders have approved the Rent-Way, Inc. 1995 Stock Option Plan (the “1995 Plan”), which authorizes the issuance of up to 2,000,000 shares of common stock pursuant to stock options granted to officers, directors, and key employees of the Company. The 1995 Plan is administered by the Compensation Committee of the Board of Directors and contains terms and provisions substantially identical to those contained in the 1992 Plan.
In June 1992, the Board of Directors of the Company adopted, and the shareholders have approved, the Rent-Way, Inc. Stock Option Plan of 1992 (the "1992 Plan”) which authorizes the issuance of up to 600,000 shares of common stock pursuant to stock options granted to officers, directors, key employees, consultants, and advisors of the Company. The option exercise price will be at least equal to the fair market value of the Company’s common stock on the grant date. The 1992 Plan expired in June 2002. The authorized number of shares, the exercise price of outstanding options and the number of shares under option are subject to appropriate adjustment for stock dividends, stock splits, reverse stock splits, recapitalizations and similar transactions. The 1992 Plan is administered by the Compensation Committee of the Board of Directors who select the optionees and determine the terms and provisions of each option grant within the parameters set forth in the 1992 Plan.
Pursuant to the terms of the merger agreement between Rent-Way and Home Choice, each Home Choice stock option which was outstanding and unexercised at the date of the merger was converted into an option to purchase Rent-Way’s common stock. Home Choice options were converted into Rent-Way options from various plans on November 12, 1999. The number of shares subject to the Home Choice options was equal to the product of the number of shares of Home Choice common stock subject to Home Choice options and 0.588, the exchange ratio.
On June 13, 2002, option holders of the Company (other than officers and directors) were issued new options in replacement of options previously cancelled pursuant to the Company’s exchange offer. The new options were issuable on the date six months and one day after the date of cancellation. The exercise price of the new options is $11.67 per share, which was the closing price of the Company’s common stock on the New York Stock Exchange on June 13, 2002. On December 11, 2001 (the expiration date of the Company’s offer), 1,109,580 options to acquire common stock were cancelled pursuant to the offer. On June 13, 2002, options covering 1,008,272 shares were issued in replacement thereof.
The following is a summary of activity of the Company’s stock options during the years ended September 30, 2003, 2002 and 2001:
At September 30, 2003, stock options representing 2,504,475 shares are exercisable at prices ranging from $2.33 to $33.63 per share and grant dates ranging from July 15, 1995, to August 11, 2003. The weighted-average grant date fair value of options granted during the year ranges from $3.54 to $4.02.
At September 30, 2003, the Company has individual option award agreements outside of these plans with three employees covering an aggregate of 60,000 options to acquire shares of common stock.
For various price ranges, outstanding stock options at September 30, 2003 were as follows:
18. SHAREHOLDERS’ EQUITY:
On April 18, 2002, the Company sold 1.0 million restricted common shares and warrants to acquire 100,000 common shares to Calm Waters Partnership and two other investors for $6,000. The warrants have an exercise price of $9.35 per share, subject to adjustment. The Company re-measured the value of the warrants because the agreement with Calm Waters Partnership contained a clause that the warrants granted to Calm Waters Partnership would be re-measured to any subsequent option grants in which the grant price was below the original $9.35 exercise price of the warrants granted to Calm Waters Partnership. The change in value was reclassified to common stock from warrants. The Company also agreed to issue warrants to purchase additional shares of common stock to the investors if the Company failed to achieve aggregate EBITDA of $80,000 or more for the 12-month period commencing on April 1, 2002. The warrant exercise price per share was based upon the EBITDA for such period. The Company did not meet this EBITDA target and issued 332,999 additional warrants at an exercise price per share of $1.50 in April 2003, which were subsequently exercised for cash of $500 in June 2003.
On April 28, 2000, the Company entered into a three-year agreement with Gateway Companies, Inc. (“Gateway”) to be an authorized supplier of Gateway personal computers and related peripherals in the rental purchase industry. Gateway agreed not to enter into any similar arrangements with any of the Company’s largest industry competitors, but had the option to cancel the exclusivity provisions of the agreement if the Company did not meet specified purchase volume requirements. Although the Company did not meet the purchase volume requirements under the agreement, Gateway has continued to abide by the exclusivity provisions of the agreement. As part of this transaction, Gateway invested $7,000 for 348,910 shares of the Company’s common stock with a fair value of $9,038. In accordance with ETIF 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,” the Company recorded an intangible asset in the amount of $2,038 for the value of the exclusivity agreement, which is fully amortized as of September 30, 2003.
In July 1995, in connection with the Company’s acquisition of McKenzie Leasing Corporation and the issuance of its 10% Convertible Subordinated Notes due 2002, Rent-Way issued warrants to purchase 105,000 shares of common stock at $9.94 per share to Massachusetts Mutual Life Insurance Company and its affiliates. The warrants are exercisable at any time for a period of seven years from their issue dates and were subject to anti-dilution provisions providing for appropriate adjustment in the event of any reclassification, stock dividend, stock split, or similar transactions, and stock issuances below the warrant exercise price. On July 15, 2002, the warrants were exercised.
19. EMPLOYEE BENEFIT PLANS:
Effective January 1, 1994, Rent-Way established the Rent-Way, Inc. 401(k) Retirement Savings Plan (the “RentWay Plan”). Participation in the Plan is available to all Company employees who meet the necessary service criteria as defined in the Plan agreement. Company contributions to the Plan are based on a percentage of the employees’ contributions, as determined by the Board of Directors, and amounted to $0, $0, and $344, in the form of the Company’s common stock for the years ended September 30, 2003, 2002 and 2001, respectively. The Company contributed cash of $1,011 and $1,105, which includes $595 of forfeitures, for the years ended September 30, 2003 and 2002, respectively.
As a result of the significant price drop in Rent-Way stock following disclosure of the accounting investigation, the Company made additional cash contributions of $478, $255 and $366 to the Rent-Way Plan in order to restore a portion of the loss in value of Rent-Way stock held in participant accounts under the plan for the years ended September 30, 2003, 2002 and 2001, respectively. The Company also committed to make an additional contribution in fiscal 2004 to the extent the Rent-Way stock price does not reach certain levels. The Company has also amended the plan to limit the amount of a participant’s contribution that can be invested in Rent-Way common stock.
20. LOSS PER SHARE:
Basic loss per common share is computed using losses available to common shareholders divided by the weighted average number of common shares outstanding. Diluted loss per common share is computed using losses available to common shareholders and the weighted average number of shares outstanding adjusted for the potential impact of options and warrants where the effects are dilutive. Because operating results were at a loss for the years ended September 30, 2003, 2002 and 2001, basic and diluted loss per common share were the same.
The following table discloses the reconciliation of numerators and denominators of the basic and diluted loss per share computation:
(1)
For the years ended September 30, 2003, 2002 and 2001, the number of options that were outstanding but not included in the computation of diluted earnings per common share because their exercise price was greater than the average market price of common stock, and therefore anti-dilutive, was 2,817, 7,843 and 4,167, respectively. The number of stock options that were outstanding but not included in the computation of diluted earnings per common share in which their exercise price was less than the average market price of common stock was 3 for the year ended September 30, 2003. There were also 4,186 contingent warrants not included in the computation of diluted earnings per common share because they were anti-dilutive for the year ended September 30, 2002.
(2)
Including the effects of these items for the year ended September 30, 2003 would be anti-dilutive. Therefore, 752 contingent shares issuable upon exercise of warrants to purchase 8% convertible preferred stock and 2,500 shares issuable upon conversion of 8% convertible preferred stock are excluded from consideration in the calculation of diluted earnings (loss) per share for the year ended September 30, 2003. There were conversion derivative market value adjustments of $1,899, dividends on convertible preferred stock of $399 and accretion to preferred stock redemption in the amount of $113 which were not added back to net income (loss) allocable to common shareholders for basic earnings (loss) per share on the diluted earnings (loss) per share because including the effects of these items would be anti-dilutive.
21. SEGMENT INFORMATION:
Rent-Way is a national rental-purchase chain, which provides a variety of services to its customers including rental of household items and prepaid local telephone service. The Company has determined that its reportable segments are those that are based on the Company’s method of internal reporting, which disaggregates its business by product category. The Company’s reportable segments are household rentals and prepaid telephone service. Its household rental segment rents name brand merchandise such as furniture, appliances, electronics and computers on either a weekly, biweekly, semimonthly or monthly basis. Its prepaid telephone service segment provides a local dial tone on a month-by-month basis.
The financial results of the Company’s segments follow the same accounting policies as described in “Summary of Significant Accounting Policies” (see Note 1).
22. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Fiscal Year 2003:
Fiscal Year 2002:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
A.
Disclosure Controls and Procedures. The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2003, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in Company reports filed or submitted under the Exchange Act is made known to them on a timely basis, and that this information is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
B.
Changes in Internal Control over Financial Reporting. There has not been any change in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
RENT-WAY, INC.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information in response to this Part III is incorporated herein by reference to the Company’s definitive proxy statement for the 2003 Annual Meeting of Shareholders. The Company intends to file the definitive Proxy Statement not later than 120 days after September 30, 2003.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this Part III is incorporated herein by reference to the Company’s definitive proxy statement for the 2003 Annual Meeting of Shareholders. The Company intends to file the definitive Proxy Statement not later than 120 days after September 30, 2003.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this Part III is incorporated herein by reference to the Company’s definitive proxy statement for the 2003 Annual Meeting of Shareholders. The Company intends to file the definitive Proxy Statement not later than 120 days after September 30, 2003.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this Part III is incorporated herein by reference to the Company’s definitive proxy statement for the 2003 Annual Meeting of Shareholders. The Company intends to file the definitive Proxy Statement not later 120 days after September 30, 2003.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Information in response to this Part III is incorporated herein by reference to the Company’s definitive proxy statement for the 2003 Annual Meeting of Shareholders. The Company intends to file the definitive Proxy Statement not later 120 days after September 30, 2003.
RENT-WAY, INC.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)Financial Statements.
See Index to Financial Statements appearing at Item 8 of this Report.
(a)(2) Financial Statement Schedules
Financial Statement schedules have been omitted because they are inapplicable or the information is included in the Company’s financial statements and notes thereto.
(a)(3) Exhibits
See Exhibit Index
(b) Reports on Form 8-K:
The Company filed the following reports on Form 8-K during the quarter ended September 30, 2003:
On August 14, 2003, the Company furnished a Current Report on Form 8-K, which reported the issuance of a press release announcing its financial results for the third quarter ended June 30, 2003.
RENT-WAY, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
RENT-WAY, INC.
By: /s/ William E. Morgenstern
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: November 25, 2003
By: /s/ William A. McDonnell
Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: November 25, 2003
By: /s/ John A. Lombardi
Vice President, Corporate Controller and
Chief Accounting Officer
(Principal Accounting Officer)
Date: November 25, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Gerald A. Ryan Director November 25, 2003
;Gerald A. Ryan
/s/ William E. Morgenstern Director November 25, 2003
William E. Morgenstern
/s/ John W. Higbee Director November 25, 2003
John W. Higbee
/s/ Robert B. Fagenson Director November 25, 2003
Robert B. Fagenson
/s/ Marc W. Joseffer Director November 25, 2003
Marc W. Joseffer
/s/ William Lerner Director November 25, 2003
William Lerner
/s/ Jacqueline E. Woods Director November 25, 2003
Jacqueline E. Woods
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
2.1
Agreement and Plan of Merger among the Company, McKenzie Leasing Corporation, Steve A. McKenzie, Brenda G. McKenzie and others, dated June 9, 1995 (incorporated by reference to an exhibit to the Company's Current Report on Form 8-K filed on August 15, 1995).
2.2
Stock Purchase Agreement by and among the Company, Diamond Leasing Corporation, Kenneth H. Moye and Lee Brady, dated July 20, 1996 (incorporated by reference to exhibit 2.5 to the Company's Current Report on Form 8-K filed on August 8, 1996).
2.3
Stock Purchase Agreement by and among the Company, Bill Coleman TV, Inc. and David Coleman, dated January 2, 1997 (incorporated by reference to exhibit 2.4 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1997 filed on November 6, 1997).
2.4
Stock Purchase Agreement by and among the Company, Perry Electronics, Inc., Robert L. Thomas, Norma J. Thomas, Randall D. Snyder and Niki L. Snyder, dated January 24, 1997 (incorporated by reference to exhibit 2.7 to the Company's Current Report on Form 8-K filed on February 21, 1997).
2.5
Closing Letter Agreement dated February 6, 1997 amending Stock Purchase Agreement by and among the Company, Perry Electronics, Inc., Robert L. Thomas, Norma J. Thomas, Randall D. Snyder and Niki L. Snyder (incorporated by reference to exhibit 2.8 to the Company's Current Report on Form 8-K filed on February 21, 1997).
2.6
Asset Purchase Agreement by and among the Company, South Carolina Rentals, Inc., Paradise Valley Holdings, Inc., L & B Rents, Inc. and James S. Archer, dated November 21, 1997 (incorporated by reference to exhibit 2.1 of the Company's Current Report on Form 8-K filed on January 20, 1998).
2.7
Stock Purchase Agreement by and among the Company, Champion Rentals, Inc., Bill C. Ogle, Sr. and others, dated as of January 30, 1998 (incorporated by reference to exhibit 2.3 to the Company's Current Report on Form 8-K filed on February 19, 1998).
2.8
Agreement and Plan of Merger dated September 1, 1998 between the Company and Home Choice Holdings, Inc. (incorporated by reference to exhibit 2.1 to the Company's Registration Statement on Form S-4 (No. 333-66955) filed on November 6, 1998).
2.9
Stock Purchase Agreement between the Company, Rentavision, Inc. and Robert Natoli dated September 15, 1999 (incorporated by reference to an exhibit to the Company's Current Report on Form 8-K filed on October 12, 1999).
2.10
Asset Purchase Agreement between the Company, Rent-Way of Michigan, Inc., and Rent-Way of TTIG, L.P., and Rent-A-Center, Inc., dated December 17, 2002 (incorporated by reference to Exhibit 2.11 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2002 filed on December 30, 2002).
2.11
Amendment No. 1 to the Asset Purchase Agreement between the Company, Rent-Way of Michigan, Inc., and Rent-Way of TTIG, L.P., and Rent-A-Center, Inc., dated December 21, 2002 (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 21, 2003 filed on February 14, 2003).
2.12
Amendment No. 2 to the Asset Purchase Agreement between the Company, Rent-Way of Michigan, Inc., and Rent-Way of TTIG, L.P., and Rent-A-Center, Inc., dated January 7, 2003 (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 21, 2003 filed on February 14, 2003).
2.13
Amendment No. 3 to the Asset Purchase Agreement between the Company, Rent-Way of Michigan, Inc., and Rent-Way of TTIG, L.P., and Rent-A-Center, Inc., dated February 7, 2003 (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 21, 2003 filed on February 14, 2003)
2.14
Amendment No. 4 to the Asset Purchase Agreement between the Company, Rent-Way of Michigan, Inc., and Rent-Way of TTIG, L.P., and Rent-A-Center, Inc., dated February 10, 2003 (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 21, 2003 filed on February 14, 2003)
3.1
Articles of Incorporation of the Company, as amended (incorporated by reference to exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended September 30, 1997 filed on November 6, 1997).
3.2
Statement with Respect to Shares of Series A Convertible Preferred Stock of the Company dated May 30, 2003 (incorporated by reference to exhibit 3.1 to Amendment No. 5 to the Company's registration statement on Form S-3, No. 333-102525 filed on June 25, 2003).
3.3
By-Laws of the Company, as amended (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended September 20, 2002 filed on July 2, 2001).
4.1
Indenture dated June 2, 2003 among the Company, the subsidiary guarantors (as defined therein) and Manufacturers and Traders Trust Company, as trustee (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed June 3, 2003).
4.2
Form of 11 7/8% Senior Secured Note (incorporated by reference to Exhibit A to the Indenture dated June 2, 2003 among the Company, the subsidiary guarantors (as defined therein) and Manufacturers and Traders Trust Company, as trustee, filed as Exhibit 4.1 to the Company's Current Report on Form 8-K on June 3, 2003).
10.1
Company's 1995 Stock Option Plan (incorporated by reference to an exhibit to the Company's Registration Statement on Form SB-2 (No. 333-116) filed on January 5, 1996).
10.2
Form of Non-Plan Stock Option Agreement (incorporated by reference to an exhibit to the Company's Registration Statement on Form S-18 (No. 33-55562-NY) filed on December 8, 1992).
10.3
Company's 1999 Stock Option Plan (incorporated by reference to the Company's Proxy Statement on Schedule 14A filed on February 12, 1999).
10.4
Employment Agreement between William E. Morgenstern and the Company, dated October 1, 2001 (incorporated by reference to exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 filed on December 28, 2001).
10.5
Engagement Agreement between Gerald A. Ryan and the Company, dated October 1, 1999 (incorporated by reference to exhibit 10.6 of the Company's Annual Report on Form 10-K filed on December 22, 1999).
10.6
Consulting Agreement between the Company and McKenzie Development Corporation, dated July 21, 1995 (incorporated by reference to an exhibit 10.6 to the Company's Registration Statement on Form SB-2 (No. 333-116) filed on January 5, 1996).
10.7
Non-Competition Agreement between the Company and Steve A. McKenzie, dated July 21, 1995 (incorporated by reference to an exhibit to the Company's Registration Statement on Form SB-2 (No. 333-116) filed on January 5, 1996).
10.8
Non-Competition Agreement between the Company and Brenda G. McKenzie, dated July 21, 1995 (incorporated by reference to an exhibit to the Company's Registration Statement on Form SB-2 (No. 333-116) filed on January 5, 1996).
10.9
Non Competition Agreement between the Company and George D. Johnson, Jr. dated September 1, 1998 (incorporated by reference to exhibit 10.1 to the Company's Registration Statement on Form S-4 (No. 333-66955) filed on November 6, 1998).
10.10
Credit Agreement dated September 23, 1999 by and among the Company, the lenders party thereto and National City Bank of Pennsylvania, as administrative agent, Bank of America, as documentation agent and Bank of Montreal and Harris Bank, as syndication agents ("Credit Agreement"), as amended by Amendment No. 1 dated November 19, 1999 (incorporated by reference to the Company's Proxy Statement on Schedule 14A filed on February 12, 1999)
10.11
Non-Compete Agreement between the Company, South Carolina Rentals, Inc. Paradise Valley Holdings, Inc., L & B Rents, Inc. and James S. Archer, dated January 7, 1998 (incorporated by reference to exhibit 10.19 of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998 filed December 30, 1998)
10.17
Purchasing Agreement between Gateway Companies, Inc. and the Company dated April 28, 2000 (incorporated by reference to exhibit 10.27 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2000 filed on July 2, 2001).
10.18
Common Stock Purchase Agreement made as of May 1, 2000, between Gateway Companies, Inc. and the Company (incorporated by reference to exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2000 filed on July 2, 2001).
10.19
Employment Agreement between William McDonnell and the Company dated February 1, 2000 (incorporated by reference to exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2000 filed on July 2, 2001).
10.20
Separation Agreement between Jeffrey A. Conway and the Company dated as of December 28, 2000 (incorporated by reference to exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2000 filed on July 2, 2001).
10.21
Employment Agreement between William Short and the Company dated as of July 1, 2002 (incorporated by reference to exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002 filed on February 14, 2003).
10.23
Common Stock and Warrant Purchase Agreement among the Company and Calm Waters Partnership, Walter H. Morris and Charles A. Paquelet (with form of warrant attached) (incorporated by reference to exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on May 14, 2003 ).
10.24
Registration Rights Agreement between the Company and Calm Waters Partnership, Walter H. Morris and Charles A. Paquelet (incorporated by reference to exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on May 14, 2002)
10.27
Credit Agreement dated as of June 2, 2003 among the Company, the guarantors from time to time parties thereto, the lenders from time to time parties thereto and Harris Trust and Savings Bank, as administrative agent, National City Bank of Pennsylvania, as syndication agent, and BMO Nesbit Burns, as lead arranger (incorporated by reference to exhibit 10.2 to the Company's Current Report on Form 8-K filed June 3, 2003).
10.28
Inter-creditor Agreement dated as of June 2, 2003 among Harris Trust and Savings Bank, as senior agent, Manufacturers and Traders Trust Company, as trustee and collateral agent under the Indenture, and the Company (incorporated by reference to exhibit 10.3 to the Company's Current Report on Form 8-K filed June 3, 2003).
10.29
Registration Rights Agreement dated May 23, 2003 among the Company, Citigroup Global Markets, Inc., as the initial purchaser, and the subsidiary guarantors signatory thereto (incorporated by reference to exhibit 10.1 to the Company's Current Report on Form 8-K filed June 3, 2003).
10.30
Securities Purchase Agreement dated June 2, 2003 among the Company and the investors listed on the schedule of buyers attached thereto (incorporated by reference to exhibit 10.1 to the Company's Current Report on Form 8-K filed June 3, 2003).
10.31
Registration Rights Agreement dated June 2, 2003 among the Company and the buyers of the Series A Convertible Preferred Stock (incorporated by reference to exhibit 10.2 to the Company's Current Report on Form 8-K filed June 3, 2003).
10.32
First Omnibus Amendment to Credit and Security Agreement dated July 2 2003 (incorporated by reference to exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 filed on August 14, 2003).
21.1
Subsidiaries of the Company (incorporated by reference to the exhibit 21.1 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 filed on December 28, 2001).
23.1*
Consent of PricewaterhouseCoopers LLP.
31.1*
Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1*
Certification pursuant to Section 906 of Sarbanes-Oxley Action of 2002
* Filed herewith