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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_________________

FORM 10-Q

_________________

(Mark One)

                          FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

                                                                         OR

_________________

Commission File Number 0-22026

RENT-WAY, INC.

(Exact name of registrant as specified in its charter)

_________________

PENNSYLVANIA                                          25-1407782
(State or other jurisdiction of incorporation)    (I.R.S. EmployerIdentification No.)

ONE RENTWAY PLACE, ERIE, PENNSYLVANIA 16505
(Address ofprincipal executive offices)

(814) 455-5378
(Registrant's telephone number)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

RENT-WAY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(All amounts in thousands, except share data)

        The accompanying notes are an integral part of these financial statements.

RENT-WAY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(All amounts in thousands, except per share data)

(Unaudited)

        The accompanying notes are an integral part of these financial statements.

RENT-WAY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(All amounts in thousands)

(Unaudited)

        The accompanying notes are an integral part of these financial statements.

RENT-WAY, INC.

1.     SUMMARY OF CRITICAL ACCOUNTING POLICIES:

BUSINESS AND ORGANIZATION. Rent-Way, Inc. (the “Company” or “Rent-Way”) 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. 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 accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q, and therefore, do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments have been made, which, except as discussed herein, consist of normal recurring adjustments which are necessary for a fair statement of the financial position, results of operations and cash flows of the Company. The results of operations for the interim periods are not necessarily indicative of the results for the full year.

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.

These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements included in its Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

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 its securities class action on April 18, 2003, which was approved by the court on December 23, 2003. The settlement required the Company to pay $25,000 to the class. The $25,000 payment consisted 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 was funded from available insurance proceeds. The remaining $10,000, which was previously funded into escrow, was reflected as restricted cash on the condensed consolidated balance sheet at September 30, 2003 and was subsequently paid in the first fiscal quarter of fiscal year 2004.

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 $14,161, net of issuance costs of $839, 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 an option to purchase convertible preferred stock included in permanent equity (see Note 9). The carrying value of this option was $142 at September 30, 2003. The option to purchase an additional $5,000 of convertible preferred stock was fully exercised as of June 30, 2004.

STATEMENT OF CASH FLOWS INFORMATION. Cash and cash equivalents consist of cash on hand and on deposit and represent 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 nine-months ended June 30, 2004 and 2003 are as follows:

At June 30, 2004 and September 30, 2003, book overdrafts of $3,929 and $2,703, respectively, were included in accounts payable in the accompanying Consolidated Balance Sheets.

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 game systems. 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, losses due to excessive wear and tear of merchandise and obsolescence 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. 

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 $6,704 are amortized using the effective interest method over the seven-year term of the bonds. The loan origination costs of $2,062 are amortized on a straight-line basis over the five-year bank credit agreement. Deferred financing cost amortization and write-offs were $227 and $1,584 for the three-month period and $748 and $2,720 for the nine-month period ended June 30, 2004 and 2003, respectively.

COMPANY INSURANCE PROGRAMS. For fiscal years 2004, 2003, 2002 and 2001, the Company is primarily self-insured for health insurance, worker’s compensation, automobile and general liability. The self-insurance liability for health costs is determined based on funding factors determined by cost plus rates for a fully insured plan 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.

The self-insurance liability for workers’ compensation, automobile and general liability costs are determined 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. The Company recorded a receivable for the retrospective insurance adjustments of $1,600 and $4,600 at June 30, 2004 and 2003, respectively.

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. The fiscal 1999 worker’s compensation insurance had no aggregate retention and was funded as claims developed using AM Best loss development factors.

DISCONTINUED OPERATIONS. On February 8, 2003, the Company 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 condensed consolidated statement of cash flows for the nine-months ended June 30, 2003, were reclassified to conform to the June 30, 2004 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 were 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 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 and recorded at its 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 included 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 was 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 disposed for the prior periods in accordance with provisions of SFAS 144. There have been no corporate expenses included in expenses from discontinued operations. Interest on debt that was required to be repaid as a result of the disposal transaction was allocated to income (loss) from discontinued operations. The effective interest rate on the outstanding debt of the Company at the time of the disposal was applied to the $68,643 estimated debt pay-down from the proceeds. There was no interest reclassified to loss from discontinued operations for the three-months ended June 30, 2004 and 2003. The amount of interest reclassified to loss from discontinued operations is $0 and $3,036 for the nine-month period ended June 30, 2004 and 2003, respectively. Revenues and net income (loss) from the discontinued operations were as follows:

There were no assets or liabilities held for sale included in the Consolidated Balance Sheet as of June 30, 2004, and September 30, 2003.

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 obligation (termination) costs 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 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, Inc. There was $0 and $1,214 of restructuring costs for the three-months ended June 30, 2004 and 2003, respectively. There was $48 and $3,429 of restructuring costs for the nine-months ended June 30, 2004 and 2003, respectively.

4.     EARNINGS (LOSS) PER COMMON SHARE:

Basic earnings (loss) per common share is computed using income (loss) allocable to common shareholders divided by the weighted average number of common shares outstanding. Diluted earnings (loss) per common share is computed using income (loss) allocable to common shareholders and the weighted average number of shares outstanding adjusted for the potential impact of options, warrants, conversion of convertible redeemable preferred stock, convertible preferred stock conversion derivative, dividends on convertible preferred stock and accretion of convertible preferred stock discount where the effects are dilutive. Because operating results were a loss for the nine-months ended June 30, 2003, 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 earnings (loss) per share computation:

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 condensed consolidated statements of operations for the three-and nine-months ended June 30, 2004 and 2003. On an annual basis and when there is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and a write down may be necessary.

The Rent-A-Center transaction (see Note 2) was an event that triggered an impairment assessment under the provisions of SFAS 142. The Company performed an impairment test of the carrying value of goodwill remaining after allocation of the fair value of goodwill to the assets held for sale as set forth in the Rent-A-Center purchase agreement as of December 17, 2002, the date of the agreement. There was no impairment of goodwill as a result of this assessment.

The following table shows the net carrying value of goodwill for the Company’s segments:

The following tables reflect the components of amortizable intangible assets at June 30, 2004 and September 30, 2003:

        At June 30, 2004, future aggregate annual amortization of amortizable intangible assets is as follows:

Amortization expense was $86 and $262 for the three-months ended June 30, 2004 and 2003; and, $310 and$1,214 for the nine-months ended June 30, 2004 and 2003, respectively. There were no changes to the amortization methods and lives of the amortizable intangible assets.

6.     OTHER ASSETS:

Other assets consist of the following:

7.     OTHER LIABILITIES:

        Other liabilities consist of the following:

8.     DEBT:

        Debt consists of the following:

The Company’s senior secured notes have the following material terms. The $205,000 principal amount of senior secured notes bears interest at 11.875% and are due June 15, 2010. The interest on the secured notes is payable semiannually on June 15 and December 15. 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:

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 $90 and $261 for the three-and nine-month period ending June 30, 2004, respectively, and is recorded as interest expense. Costs representing underwriting fees and other professional fees of $6,704 are being amortized over the seven-year term of the bonds using the effective interest method of amortization. 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.

The Company is in compliance with covenants at June 30, 2004, and expects to comply with covenants based upon its fiscal 2004 projections.

The Company’s bank 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 June 30, 2004 was $18,000 with $37,080 available at June 30, 2004. Deferred financing costs of $2,062 are being amortized 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 may 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 is 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 Company’s note payable for lawsuit settlement was agreed to in the settlement of the class action lawsuit. The note payable consists of a $4,000 unsecured subordinated note, which bears interest at 6% annually and payable in four equal installments over two years on June 30 and December 31. The first $1,000 was paid on December 31, 2003 and the second $1,000 was paid on June 30, 2004. The remaining balance at June 30, 2004 was $2,000.

9.     CONVERTIBLE REDEEMABLE 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 Company’s prior senior credit facility. The net proceeds of $14,161 from the issuance of the convertible preferred stock are net of issuance costs of $839, and are classified outside of permanent equity because of the redemption date and other redemption provisions, except the option to purchase additional convertible preferred stock which was included in permanent equity. During March 2004, an option was exercised for the purchase of 133 additional shares in the amount of $1,330. The value of the option to purchase convertible preferred stock was reduced by $38 as a result of the March 2004 exercise. During April and May 2004, the remaining options to purchase additional shares were exercised. The value of the option to purchase convertible preferred stock was reduced to $0 as a result of the April and May 2004 exercises. 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 June 2, 2011, 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 was an embedded derivative financial instrument that qualified 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 00-19”). As such, this derivative was initially required to be bifurcated and recorded at fair value in the equity section of the consolidated balance sheet upon issuance but does not require mark to market accounting. The carrying value of this derivative financial instrument was reduced to $0 during the quarter ended June 30, 2004 due to the exercise of the remaining options. 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 $20,573 at June 30, 2004, 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.

10.     STOCK OPTIONS:

The Company accounts for stock based compensation issued to its employees and directors in accordance with APB No. 25 “Accounting for Stock Issued to Employees,” and has elected to adopt the “disclosure only” provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS 148 amends SFAS No. 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 employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require new prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on 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 years 2000 through 2004: expected volatility ranging from 47.41% to 99.61%, risk-free interest rates between 2.91% and 6.81%, and an expected life of five 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 income (loss) and income (loss) per common share would have been increased to the pro-forma amounts below:

There were 100 options granted during fiscal year 2004 through June 30, 2004; 45 granted October 1, with a grant price of $5.34, expiring in 2008, 35 granted October 29, with a grant price of $5.80, expiring in 2009, and 20 granted June 1, with a grant price of $9.32, expiring in 2010.

11.     SHAREHOLDERS’ EQUITY:

On April 18, 2002, the Company sold 1.0 million restricted common shares and warrants to receive 100,000 common shares to Calm Waters Partnership and two other investors (the “Investors”) for $6,000. The warrants had 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. These warrants were exercised in November 2003.

12.     DERIVATIVE FINANCIAL INSTRUMENTS:

On June 2, 2003, the Company issued 1,500 shares of convertible redeemable preferred stock (see Note 9). The terms of this preferred stock include a number of conversion and redemption provisions that represent derivatives under SFAS No. 133. The Company determined that the option to purchase additional preferred shares was an embedded derivative financial instrument that qualified 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 did not require mark to market accounting.

The Company also has determined the conversion 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 change in the fair market value of the conversion feature was $(233) and $5,469 for the three-months and nine-months ended June 30, 2004, respectively.

At June 30, 2004, the Company had interest rate swaps on a notional debt amount of $50,350 and a fair market value of ($2,127). The variable pay interest rate ranges from 6.73% 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 $1,111and $3,009 for the three- and nine-months ended June 30, 2004. This was recorded to other income in the Company’s condensed consolidated statements of operations.

13.     COMPREHENSIVE INCOME:

Comprehensive income encompasses net income and changes in the components of accumulated other comprehensive income not reflected in the Company’s condensed consolidated statements of operations during the periods presented. Accumulated other comprehensive income consists of the transition asset recorded at the time of adoption of SFAS No. 133.

14.     CONTINGENCIES:

As previously reported, the Company, its former 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 required 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 was funded into escrow and was classified as restricted cash on the consolidated balance sheet at September 30, 2003. The settlement agreement provided for the release of the Company and all other defendants except the Company’s former controller and the Company’s former independent accountants. The settlement received court approval and became final by virtue of an order dated December 22, 2003.

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 $6,032. However, all but $241 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.

The Company is primarily self-insured for health insurance. The self-insurance liability for health costs is determined based on funding factors determined by cost plus rates for a fully insured plan and monthly headcounts. 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 2004, 2003, 2002 and 2001, the self-insurance liability for workers’ compensation, automobile and general liability costs are determined 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. The Company recorded a receivable for the retrospective insurance adjustments of $1,600 and $4,600 at June 30, 2004 and 2003, respectively.

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.

15.     INCOME TAXES:

During the first nine-months of fiscal 2004, the Company recorded income tax expense and a deferred tax liability of $4,185 because the Company can no longer look to the reversal of the deferred tax liability associated with tax-deductible goodwill to offset a portion of its deferred tax asset, following the adoption of SFAS 142. The deferred tax asset, net of liabilities excluding goodwill, decreased from $73,095 at September 30, 2003 to $69,197 at June 30, 2004. This decrease of $3,898 for the nine-months ended June 30, 2004, is the tax effect of income before income taxes. A full valuation allowance has been provided against the net deferred tax asset.

16.     SEGMENT INFORMATION:

Rent-Way is a national rental-purchase chain that provides a variety of services to its customers including rental of household items and prepaid local telephone service on a week-by-week or a month-by-month basis. 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 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).