RAINBOW RENTALS INC - 10-Q Quarterly Report

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Table of Contents

Table of Contents

Table of Contents

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

FORM 10-Q


	(Mark One)




	[ X ]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




			For the quarterly period ended June 30, 2003




			OR




	[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




			For the Transition Period From to

Commission File No. 0-24333

RAINBOW RENTALS, INC.
(Exact name of Registrant as specified in its charter)


Ohio (State of Incorporation)		34-1512520 (IRS Employer Identification No.)

3711 Starr Centre Drive
Canfield, Ohio 44406
(Address of principal executive offices)

330-533-5363
(Registrant’s telephone number)

(Former name, former address and former fiscal year,
if changed since last report)

Indicate by checkmark 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 checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities and Exchange Act of 1934). 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.


CLASS	SHARES OUTSTANDING AT JULY 31, 2003
Common stock, no par value		5,929,319

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1: Financial Statements
		BALANCE SHEETS
		STATEMENTS OF INCOME
		STATEMENTS OF SHAREHOLDERS’ EQUITY
		STATEMENTS OF CASH FLOWS
		NOTES TO FINANCIAL STATEMENTS
	Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3: Quantitative and Qualitative Disclosures About Market Risk
	Item 4: Disclosure Controls and Procedures
PART II — OTHER INFORMATION
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EX-10.3 Severance Agreement
EX-10.4 Employment Agreement
EX-31.1 CEO SECTION 302 CERT
EX-31.2 CFO SECTION 302 CERT
EX-32 SECTION 906 CERT

RAINBOW RENTALS, INC.
INDEX


		Page No.

PART I	FINANCIAL INFORMATION





Item 1.	Financial Statements





	Balance Sheets	3





	Statements of Income	4





	Statements of Shareholders’ Equity	5





	Statements of Cash Flows	6





	Notes to Financial Statements	7





Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10





Item 3.	Quantitative and Qualitative Disclosures About Market Risk	14





Item 4.	Disclosure Controls and Procedures	14





PART II	OTHER INFORMATION





Item 4.	Submission of Matters to a Vote of Security Holders	15





Item 6.	Exhibits and Reports on Form 8-K	15





SIGNATURES		16

RAINBOW RENTALS, INC.
BALANCE SHEETS
(Dollars in thousands)


					(unaudited)
					June 30,			December 31,
					2003			2002

				Assets




Current assets




	Cash and cash equivalents				$	1,188		$	1,080




	Rental-purchase merchandise, net					39,079			39,342




	Income tax receivable					1,132			939




	Prepaid expenses and other current assets					2,212			1,926

		Total current assets				43,611			43,287




Property and equipment, net						5,972			5,558




Deferred income taxes						2,079			1,989




Goodwill, net						9,236			9,236




Other assets, net						577			843

		Total assets			$	61,475		$	60,913

			Liabilities and Shareholders’ Equity




Current liabilities




	Deferred revenue				$	1,121		$	1,215




	Accounts payable					1,580			2,175




	Accrued compensation and related costs					2,843			2,402




	Other liabilities and accrued expenses					2,848			2,403




	Deferred income taxes					6,798			6,343

		Total current liabilities				15,190			14,538




Long-term debt						6,750			7,550

		Total liabilities				21,940			22,088




Commitments and contingencies




Shareholders’ equity




	Serial preferred stock, no par value; 2,000,000 shares authorized, none issued					—			—




	Common stock, no par value; 10,000,000 shares authorized, 6,392,610 issued and 5,929,319 outstanding at June 30, 2003 and December 31, 2002					11,039			11,039




	Additional paid-in capital					4			4




	Retained earnings					30,384			29,674




	Treasury stock, at cost, 463,291 shares at June 30, 2003 and December 31, 2002					(1,892	)		(1,892	)

		Total shareholders’ equity				39,535			38,825

		Total liabilities and shareholders’ equity			$	61,475		$	60,913

See accompanying notes to financial statements.

RAINBOW RENTALS, INC.
STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)


				(unaudited)					(unaudited)
				For the three months ended					For the six months ended
				June 30,					June 30,

				2003		2002			2003		2002

Revenues




	Rental revenue			$	24,443	$	23,455		$	48,457	$	46,601




	Fees				677		714			1,315		1,352




	Merchandise sales				655		666			1,749		1,847

			Total revenues		25,775		24,835			51,521		49,800




Operating expenses




	Merchandise costs				7,977		8,380			16,754		17,207




	Store expenses




		Salaries and related			6,733		5,783			13,127		11,807




		Occupancy			2,401		2,230			4,977		4,551




		Advertising			1,897		1,690			3,476		3,276




		Other expenses			3,604		3,488			7,090		6,805

			Total store expenses		14,635		13,191			28,670		26,439

			Total merchandise costs and store expenses		22,612		21,571			45,424		43,646




	General and administrative expenses				2,398		2,116			4,423		3,831




	Amortization of intangible assets				45		44			90		85

			Total operating expenses		25,055		23,731			49,937		47,562

			Operating income		720		1,104			1,584		2,238




Interest expense					154		167			297		352




Other expense, net					57		57			114		115

			Income from continuing operations, before income taxes		509		880			1,173		1,771




Income tax expense					201		355			463		716

			Income from continuing operations		308		525			710		1,055




Discontinued operations




	Loss from operations of discontinued store, net of tax				—		(49	)		—		(51	)

			Net income	$	308	$	476		$	710	$	1,004

Basic earnings per common share:




	Basic earnings per share from continuing operations			$	0.05	$	0.09		$	0.12	$	0.18




	Basic loss per share from discontinued operations				—		(0.01	)		—		(0.01	)

			Basic earnings per share	$	0.05	$	0.08		$	0.12	$	0.17

Diluted earnings per common share:




	Diluted earnings per share from continuing operations			$	0.05	$	0.09		$	0.12	$	0.18




	Diluted loss per share from discontinued operations				—		(0.01	)		—		(0.01	)

			Diluted earnings per share	$	0.05	$	0.08		$	0.12	$	0.17

Weighted average common shares outstanding:




	Basic				5,929,319		5,927,598			5,929,319		5,926,672

	Diluted				5,931,516		5,952,333			5,930,790		5,949,798

See accompanying notes to financial statements.

RAINBOW RENTALS, INC.
STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands)


		Common Stock											Total
						Additional		Retained		Treasury			Shareholders’
		Shares		Cost		Paid-in Capital		Earnings		Stock			Equity

Balance at December 31, 2001			5,925,735	$	11,039	$	—	$	28,033	$	(1,907	)	$	37,165




	Exercise of stock options		3,584		—		4		—		15			19




	Net income		—		—		—		1,641		—			1,641

Balance at December 31, 2002			5,929,319		11,039		4		29,674		(1,892	)		38,825




	Net income (unaudited)		—		—		—		710		—			710

Balance at June 30, 2003 (unaudited)			5,929,319	$	11,039	$	4	$	30,384	$	(1,892	)	$	39,535

See accompanying notes to financial statements.

RAINBOW RENTALS, INC.
STATEMENTS OF CASH FLOWS
(Dollars in thousands)


					(unaudited)
					For the six months ended
					June 30,

					2003			2002

Cash flows from operating activities




	Income from continuing operations				$	710		$	1,055




	Reconciliation of income from continuing operations to net cash provided by operating activities of continuing operations




			Depreciation of property and equipment and amortization of intangibles			1,247			1,248




			Depreciation and write-down of rental-purchase merchandise			13,460			14,027




			Purchases of rental-purchase merchandise			(16,639	)		(14,755	)




			Rental-purchase merchandise disposed, net			3,443			3,212




			Deferred income taxes			365			1,813




			Loss on disposal of property and equipment			20			16




			(Increase) decrease in




				Income tax receivable		(193	)		(1,356	)




				Prepaid expenses and other assets		(282	)		365




			Increase (decrease) in




				Accounts payable		(595	)		(2,147	)




				Accrued income taxes		—			(306	)




				Accrued compensation and related costs		441			(55	)




				Deferred revenue and other liabilities and accrued expenses		351			241

				Net cash provided by operating activities of continuing operations		2,328			3,358




				Net cash used in operating activities of discontinued operations		—			(156	)

				Net cash provided by operating activities		2,328			3,202

Cash flows from investing activities




	Purchase of property and equipment					(1,424	)		(1,323	)




	Proceeds from the sale of property and equipment					4			36




	Acquisitions					—			(312	)

				Net cash used in investing activities of continuing operations		(1,420	)		(1,599	)




				Net cash used in investing activities of discontinued operations		—			(2	)

				Net cash used in investing activities		(1,420	)		(1,601	)

Cash flows from financing activities




	Proceeds from long-term debt					16,700			23,914




	Current installments and repayments of long-term debt					(17,500	)		(24,854	)




	Proceeds from stock options exercised					—			19




	Loan fees paid					—			(316	)

				Net cash used in financing activities		(800	)		(1,237	)

Net increase in cash						108			364




Cash at beginning of period						1,080			1,839

Cash at end of period					$	1,188		$	2,203

Supplemental cash flow information




	Net cash paid during the period for




		Interest				243			262




		Income taxes				375			616

See accompanying notes to financial statements.

RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)

1. Basis of Presentation

Rainbow Rentals, Inc. (the “Company”) is engaged in the rental and sale of home electronics, furniture, appliances and computers to the general public. At June 30, 2003 the Company operated 123 stores in 14 states: Connecticut, Georgia, Kentucky, Maryland, Massachusetts, Michigan, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Tennessee and Virginia. The Company’s corporate office is located in Canfield, Ohio.

The financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, certain information and disclosures, normally required with financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. In the opinion of management, the financial statements contain all adjustments (consisting only of normal, recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows of the Company. The results of operations for the periods presented are not necessarily indicative of the results for the entire year. It is suggested these financial statements be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Certain reclassifications have been made to prior year financial data in order to conform to the 2003 presentation.

2. Long-Term Debt

The Company entered into a revolving financing agreement (the “Credit Facility”) in January 2002 that matures in January 2005. The agreement allows the Company to borrow up to $25.0 million; however, borrowings are limited to 32% of the Company’s net rental purchase merchandise, less outstanding letters of credit, which totaled $2.9 million at June 30, 2003. Excess availability at June 30, 2003 was approximately $2.9 million. The Company’s tangible assets, primarily rental purchase merchandise, serve as the security for the debt. The Company can elect interest to be charged on a portion of the outstanding debt balance at the London Interbank Offering Rate (LIBOR) plus a range of 250 – 325 basis points and the remaining debt balance, if any, would be at the prime rate plus a range of 50 – 125 basis points. In addition, the Company must pay a commitment fee equal to a range of 37.5 to 50 basis points per annum on the unused portion of the loan commitment. The interest rate ranges above are all dependent on the Company’s most recent quarterly leverage ratio. Borrowings under the Credit Facility mature three years after the date of the loan. At June 30, 2003, the outstanding loan balance totaled $6.8 million with a weighted average interest rate of 5.78%.

The Credit Facility requires the Company to meet certain quarterly financial covenants and ratios including maximum leverage, minimum interest coverage, minimum net worth, fixed charge coverage and rental merchandise usage ratios. The Credit Facility contains non-financial covenants that limits actions of the Company with respect to additional indebtedness, certain loans and investments, payment of dividends, acquisitions, mergers and consolidations, dispositions of assets or subsidiaries, issuance of capital stock, capital expenditures and leases. At June 30, 2003, the Company was in compliance with the covenants and financial reporting requirements.

3. Earnings Per Share

Basic earnings per common share are computed using net income available to common shareholders divided by the weighted average number of common shares outstanding. For computation of diluted earnings per share, the weighted average number of common shares outstanding is increased to give effect to stock options considered to be common stock equivalents.

The following table shows the amounts used in computing earnings per share.


		For the three months ended				For the six months ended
		June 30,				June 30,

		2003		2002		2003		2002

Numerator:




	Net income available to common shareholders	$	308	$	476	$	710	$	1,004




Denominator:




	Basic weighted average shares		5,929,319		5,927,598		5,929,319		5,926,672




	Effect of dilutive stock options		2,197		24,735		1,471		23,126

	Diluted weighted average shares		5,931,516		5,952,333		5,930,790		5,949,798

Basic earnings per share		$	0.05	$	0.08	$	0.12	$	0.17

Diluted earnings per share		$	0.05	$	0.08	$	0.12	$	0.17

Stock options of 408,700 and 289,000 shares for the three months ended June 30, 2003 and 2002, respectively, were not included in diluted earnings per share because their effects were anti-dilutive. For the six months ended June 30, 2003 and 2002, stock options of 429,950 and 299,250, respectively, were not included in diluted earnings per share because their effects were anti-dilutive.

4. Stock-Based Compensation

The Company sponsors a stock option and incentive plan for the benefit of its employees. In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, which amended SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 requires companies electing not to expense stock options to provide the pro forma net income and earnings per share information not only annually, but also on a quarterly basis. No stock-based compensation costs are reflected in net income since all stock options were granted with an exercise price equal to the market price on the date of grant, consistent with the provisions of Accounting Principles Board (APB) 25.

The following table illustrates the effect on net income and earnings per share had compensation costs for stock options been measured using SFAS No. 123:


		(unaudited)				(unaudited)
		For the three months ended				For the six months ended
		June 30,				June 30,
		2003		2002		2003		2002

Net income




	As reported	$	308	$	476	$	710	$	1,004




	Pro forma		259		444		628		941




Basic and diluted earnings per common share




	As reported		0.05		0.08		0.12		0.17




	Pro forma		0.04		0.07		0.11		0.16

5. Severance Agreement

On May 7, 2003, the Company announced the departure of its Chief Operating Officer (COO), who also served as a director. The Company entered into a severance agreement with its former COO that will pay him $329 in salary and other compensation through May 2004. Current accounting pronouncements required the Company to expense the fair value of the severance agreement during the second quarter of 2003. The net effect of the severance agreement decreased basic and diluted earnings per share $0.03.

Forward-Looking Statements

Statements made in this Form 10-Q, other than those concerning historical information, or, in future filings by Rainbow Rentals, Inc. with the Securities and Exchange Commission (SEC), in the Company’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, and are made pursuant to the “safe harbor” provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements use such words as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “estimates”, “believes”, “thinks”, “continues”, “indicates”, “outlook”, “looks”, “goals”, “initiatives”, “projects”, or variations thereof. Forward-looking statements are based on management’s current beliefs and assumptions regarding future events and operating performance and speak only as of the date made. These statements are likely to address the Company’s growth strategy, future financial performance (including sales and earnings), strategic initiatives, marketing and expansion plans and the impact of operating initiatives. Forward-looking statements are subject to a number of risks, uncertainties and other factors, many of which are outside the control of the Company that could cause the Company’s actual results to differ materially from those expressed or implied in such statements. These risks and uncertainties include the following: risks associated with general economic conditions; failure to adequately execute plans and unforeseen circumstances beyond the Company’s control in connection with development, implementation and execution of new business processes, procedures and programs; greater than expected expenses associated with the Company’s activities; the effects of new accounting standards; and other risks and uncertainties described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, and in other reports and exhibits to reports filed with the SEC. You are strongly urged to review such filings for a more detailed discussion of such risks and uncertainties. The Company’s SEC filings are available, at no charge, at www.sec.gov through the Company’s web site at www.rainbowrentals.com. The foregoing list of important factors is not exclusive. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

Rental-purchase merchandise is rented to individuals under flexible agreements that allow customers to own the merchandise after making a specified number of rental payments, which generally occur over a period ranging from 12 to 30 months. Customers have the option to return the merchandise at any time without further obligation, and also have the option to purchase the merchandise at any time during the rental term.

New Store Openings

The Company’s primary method of growth is through the opening of new store locations. New stores have a maturation period of approximately three years and generally are dilutive to earnings during the first year of operation as they build a customer base and develop a recurring revenue stream. The timing and performance of new store openings and the number of stores in various stages of the three-year maturation process will have an affect on quarterly comparisons. During the first six months of 2003, the Company opened four stores and closed three stores, which were consolidated into existing Rainbow locations. The Company anticipates opening two more stores in 2003, for an aggregate six stores in 2003. The Company has elected to defer opening additional stores until completion of its previously disclosed strategic planning initiative.

Results of Operations

The following table sets forth, for the periods indicated, certain Statements of Income data as a percentage of total revenues.


				(unaudited)						(unaudited)
				For the three months ended						For the six months ended
				June 30,						June 30,
				2003			2002			2003			2002

Revenues




	Rental revenue				94.8	%		94.4	%		94.0	%		93.6	%




	Fees				2.6			2.9			2.6			2.7




	Merchandise sales				2.6			2.7			3.4			3.7

			Total revenues		100.0			100.0			100.0			100.0




Operating expenses




	Merchandise costs				30.9			33.7			32.5			34.6




	Store expenses




		Salaries and related			26.1			23.3			25.4			23.7




		Occupancy			9.3			9.0			9.7			9.1




		Advertising			7.4			6.8			6.7			6.6




		Other expenses			14.0			14.0			13.8			13.7

			Total store expenses		56.8			53.1			55.6			53.1

			Total merchandise costs and store expenses		87.7			86.8			88.1			87.7




	General and administrative expenses				9.3			8.5			8.6			7.7




	Amortization of intangible assets				0.2			0.2			0.2			0.2





			Total operating expenses		97.2			95.5			96.9			95.6

			Operating income		2.8			4.5			3.1			4.4




Interest expense					0.6			0.7			0.6			0.7




Other expense, net					0.2			0.3			0.2			0.2

			Income from continuing operations, before income taxes		2.0			3.5			2.3			3.5




Income tax expense					0.8			1.4			0.9			1.4

			Income from continuing operations		1.2			2.1			1.4			2.1




Loss on discontinued operations, net of tax					—			(0.2	)		—			(0.1	)

			Net income		1.2	%		1.9	%		1.4	%		2.0	%

Comparison of Three Months Ended June 30, 2003 and 2002

Total revenues from continuing operations increased $940,000, or 3.8%, to $25.78 million for the three months ended June 30, 2003, compared to $24.84 million for the comparable 2002 period. Revenue increased $976,000 from the nine stores opened after April 1, 2002 (not including the four stores opened in late-June 2003). Revenue from comparable stores, or stores in operation the entire three month periods ended June 30, 2003 and 2002, declined $54,000, or 0.2%. Comparable store revenue, although relatively flat, was mainly affected by the following two factors: (a) there was a comparable quarter decline in units on rent, mainly computer and furniture accessories; and (b) offsetting the decline in units on rent was an increase in average rental rates, which included changes in product mix.

Merchandise costs from continuing operations decreased $403,000, or 4.8%, to $7.98 million for the three months ended June 30, 2003 compared to $8.38 million for the three months ended June 30, 2002. Merchandise costs totaled 30.9% and 33.7% of total

revenues for the three months ended June 30, 2003 and 2002, respectively. The decrease in merchandise costs from continuing operations as a percentage of total revenue from continuing operations was primarily the result of increased rental rates, lower costs of new merchandise and changes in product mix. To a lesser extent, merchandise costs were positively affected by a $157,000 adjustment to depreciation of rental purchase merchandise.

Store expenses from continuing operations increased $1.44 million, or 10.9%, to $14.63 million for the three months ended June 30, 2003 compared to $13.19 million for the three months ended June 30, 2002. Store expenses associated with stores opened after April 1, 2002 (non-comparable stores) accounted for $644,000 of the increase. Comparable store salaries and related expenses increased $642,000 and comparable store advertising expenses increased $100,000. The increase in comparable store salaries and related expenses was due to increased wages (due to additional store staffing and higher pay rates), workers’ compensation premium costs and medical expenses. The increase in comparable store advertising expenses was the result of management’s decision to utilize advertising spending earmarked for the third quarter of 2003 in the second quarter. This decision was based on maintaining the momentum of increasing units on rent throughout the second quarter. Store expense from continuing operations totaled 56.8% and 53.1% of total revenue from continuing operations for the three months ended June 30, 2003 and 2002, respectively. Comparable store expenses as a percentage of comparable store revenue totaled 55.2% and 52.2%, respectively, for the three months ended June 30, 2003 and 2002.

General and administrative expenses increased $282,000, or 13.3%, to $2.40 million for the three months ended June 30, 2003 compared to $2.12 million for the three months ended June 30, 2002. The increase in general and administrative expenses was primarily attributable to $329,000 in severance costs associated with the departure of the Company’s Chief Operating Officer in May 2003, which was partially offset by a decline in legal expenses. General and administrative expenses totaled 9.3% and 8.5% of total revenues from continuing operations for the three months ended June 30, 2003 and 2002, respectively.

Income tax expense from continuing operations decreased $154,000 to $201,000 for the three months ended June 30, 2003, from $355,000 for the three months ended June 30, 2002. This decrease was attributable to a decline in income from continuing operations as well as a decline in the Company’s effective tax rate to 39.5% for the three months ended June 30, 2003 from 40.3% for the comparable 2002 period due to a higher proportion of state taxable income in states with lower income tax rates.

Comparison of Six Months Ended June 30, 2003 and 2002

Total revenues from continuing operations increased $1.72 million, or 3.5%, to $51.52 million for the six months ended June 30, 2003, compared to $49.80 million for the six months ended June 30, 2002. Revenue increased $2.26 million from the 11 store openings in 2002. This was partially offset by a $544,000, or 1.1%, decline in revenue from comparable stores, or stores in operation the entire six-month periods ended June 30, 2003 and 2002. The decline in comparable store revenue was mainly attributable to a decline in units on rent, which was partially offset by an increase in average rental rates, which included changes in product mix.

Merchandise costs from continuing operations decreased $453,000, or 2.6%, to $16.75 million for the six months ended June 30, 2003 compared to $17.21 million for the six months ended June 30, 2002. Merchandise costs totaled 32.5% and 34.6% of total revenues for the six months ended June 30, 2003 and 2002, respectively. The decrease in merchandise costs from continuing operations as a percentage of total revenue from continuing operations was primarily the result of increased rental rates and lower costs of new merchandise.

Store expenses from continuing operations increased $2.23 million, or 8.4%, to $28.67 million for the six months ended June 30, 2003 compared to $26.44 million for the six months ended June 30, 2002. Store expenses associated with stores opened after January 1, 2002 (non-comparable stores) accounted for $1.46 million of the increase. Store expenses were also affected by an increase in comparable store salaries and related expenses totaling $666,000, which was due to increased wages (due to additional store staffing and higher pay rates) and higher workers’ compensation premium costs. To a lesser extent, comparable occupancy expense increased $73,000 due primarily to lease buy-outs associated with two underperforming stores that were closed during the first quarter of 2003. Store expense from continuing operations totaled 55.6% and 53.1% of total revenue from continuing operations for the six months ended June 30, 2003 and 2002, respectively. Comparable store expenses as a percentage of comparable store revenue totaled 54.7% and 52.7%, respectively, for the six months ended June 30, 2003 and 2002.

General and administrative expenses increased $592,000, or 15.4%, to $4.42 million for the six months ended June 30, 2003 compared to $3.83 million for the six months ended June 30, 2002. The increase in general and administrative expenses was attributable to a number of factors including severance costs associated with the departure of the Company’s Chief Operating Officer in May 2003, expenses related to reorganizing the Company’s regional management team, and training costs associated with enhancing

store associates’ and regional managers’ skills and preparing potential managers for future store openings and replacements. General and administrative expenses totaled 8.6% and 7.7% of total revenues from continuing operations for the six months ended June 30, 2003 and 2002, respectively.

Interest expense decreased $55,000 comparing the six months ended June 30, 2003 and 2002 primarily due to lower average outstanding debt.

Income tax expense from continuing operations decreased $253,000 to $463,000 for the six months ended June 30, 2003, from $716,000 for the six months ended June 30, 2002. This decrease was attributable to a decline in income from continuing operations as well as a decline in the Company’s effective tax rate to 39.5% for the six months ended June 30, 2003 from 40.4% for the comparable 2002 period due to a higher proportion of state taxable income in states with lower income tax rates.

Liquidity and Capital Resources

The Company’s primary requirements for capital consist of purchasing additional and/or replacement rental-purchase merchandise, expenditures related to new store openings, acquisitions and working capital requirements for new and existing stores. The primary sources of liquidity and capital are from operations and borrowings.

For the six months ended June 30, 2003 and 2002, cash provided by operations of continuing operations totaled $2.33 million and $3.36 million, respectively. The decrease in cash provided by operations was primarily affected by increased purchases of rental purchase merchandise and a decline in income from operations, which was partially offset by changes in accounts payable (due mainly to the timing of inventory purchases). Cash used in investing activities totaled $1.42 million and $1.60 million for the six months ended June 30, 2003 and 2002, respectively. The decrease in cash used in investing activities was mostly due to acquisitions of customer accounts in 2002, which was partially offset by an increase in property and equipment purchases in 2003. Cash used in financing activities totaled $800,000 and $1.24 million for the six months ended June 30, 2003 and 2002, respectively. This change was mainly attributable to loan fees paid during 2002.

In January 2002, the Company refinanced its debt with a $25.0 million revolving loan agreement (the “Credit Facility”) that matures in January 2005. A borrowing base ($12.5 million at June 30, 2003) measured against rental purchase merchandise limits borrowings under the Credit Facility to 32% of rental purchase inventory, less outstanding letters of credit, which totaled $2.9 million at June 30, 2003. Excess availability was approximately $2.9 million at June 30, 2003. The agreement requires the Company to meet certain quarterly financial covenants and ratios including maximum leverage, minimum interest coverage, minimum net worth, fixed charge coverage and rental merchandise usage ratios. In addition, the Company must meet requirements regarding monthly, quarterly and annual financial reporting. The agreement also contains non-financial covenants that limit actions of the Company with respect to additional indebtedness, certain loans and investments, payment of dividends, acquisitions, mergers and consolidations, dispositions of assets or subsidiaries, issuance of capital stock, capital expenditures and leases.

The Company opened four stores (two stores each in two new markets) in June 2003 and plans to open two additional stores during the remainder of 2003 with cash provided by operations. The Company believes it will continue to have the opportunity to increase the number of its stores and rental-purchase agreements through selective acquisitions. Potential acquisitions may vary in size and the Company may consider larger acquisitions that could be material to the Company. To provide any additional funds necessary for the continued pursuit of its growth strategies, the Company may use cash flow from operations, borrow additional amounts under its Credit Facility, or use its own equity securities, the availability of which will depend upon market and other conditions. There can be no assurance that such additional financing will be available to the Company.

New Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The application of this Interpretation is not expected to have an effect on the Company’s financial position or results of operations.

In April 2003, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies accounting for derivative instruments and hedging activities under SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 provides guidance relating to decisions made (a) as part of the Derivatives Implementation Group process, (b) in connection with other FASB projects

dealing with financial instruments and (c) regarding implementation issues raised in the application of the definition of a derivative and the characteristics of a derivative that contains financing components. SFAS No. 149 is effective for contracts entered into or modified and for hedging relationships designated after June 30, 2003. The application of this Statement is not expected to have an effect on the Company’s financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments and Characteristics of both Liabilities and Equity, which requires freestanding financial instruments such as mandatorily redeemable shares, forward purchase contracts, written put options to be reported as liabilities by their issuers as well as related new disclosure requirements. The provisions of SFAS No. 150 are effective for instruments entered into or modified after May 31, 2003 and pre-existing instruments as of the beginning of the first interim period that commences after June 15, 2003. The application of this Statement is not expected to have an effect on the Company’s financial position or results of operations.

Item 3: Quantitative and Qualitative Disclosures About Market Risk

There were no material changes in information about market risk from that provided in the 2002 Annual Report on Form 10-K.

Item 4: Disclosure Controls and Procedures

The Company evaluated the design and operation of its disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission. This evaluation was made under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer within the 90-day period prior to the filing of this Quarterly Report on Form 10-Q. The principal executive officer and principal financial officer have concluded, based on their review, that the Company’s disclosure controls and procedures, as defined at Exchange Act Rules 13a-14(c) and 15d-14(c), are effective to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. No significant changes were made to the Company’s internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II — OTHER INFORMATION
RAINBOW RENTALS, INC.
JUNE 30, 2003

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

The Company held its annual meeting of shareholders on May 14, 2003. The matters approved by the shareholders at the annual meeting and the voting results as to each matter are set forth below.

Election of Directors for a one-year term:


Name	For		Withheld

Wayland J. Russell		5,581,924		317,150




Michael J. Viveiros		5,581,924		317,150




Brian L. Burton		5,798,074		101,000




Ivan J. Winfield		5,798,074		101,000




Robert A. Glick		5,798,074		101,000

Ratification of the appointment of KPMG LLP as auditors for the year ended December 31, 2003:

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit 10.3 – Severance Agreement by and between Lawrence S. Hendricks and the Company

Exhibit 10.4 – Employment Agreement by and between the Company and S. Robert Harris

Exhibit 31.1 – CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 – CFO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32 – CEO and CFO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports of Form 8-K

Report on Form 8-K dated April 30, 2003 to report the results of operations for the three months ended March 31, 2003.

Report on Form 8-K dated May 7, 2003 announcing the departure of Lawrence S. Hendricks as Chief Operating Officer of the Company and the appointment of Robert Harris as Chief Operating Officer of the Company.

SIGNATURES

In accordance with the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



		RAINBOW RENTALS, INC. (Registrant)

		/s/ WAYLAND J. RUSSELL Wayland J. Russell, Chairman and Chief Executive Officer (Principal Executive Officer) Date: August 12, 2003

		/s/ MICHAEL A. PECCHIA Michael A. Pecchia, Chief Financial Officer (Principal Financial and Accounting Officer) Date: August 12, 2003

Withheld

Abstain


	Exhibit 10.3 – Severance Agreement by and between Lawrence S. Hendricks and the Company

	Exhibit 10.4 – Employment Agreement by and between the Company and S. Robert Harris

	Exhibit 31.1 – CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	Exhibit 31.2 – CFO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	Exhibit 32 – CEO and CFO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


	Report on Form 8-K dated April 30, 2003 to report the results of operations for the three months ended March 31, 2003.

	Report on Form 8-K dated May 7, 2003 announcing the departure of Lawrence S. Hendricks as Chief Operating Officer of the Company and the appointment of Robert Harris as Chief Operating Officer of the Company.