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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended: December 31, 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.
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(Exact name of Registrant as specified in its charter)
Ohio 34-1512520
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3711 Starr Centre Drive, Canfield, OH 44406
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(Address of principal executive offices)
330-533-5363
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No par Value
--------------------------
(Title of Class)
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 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.
[X] Yes [ ] No
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by 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]
The aggregate market value of voting stock held by nonaffiliates of the
Registrant was approximately $12.3 million at June 30, 2003. The number of
common shares outstanding at March 1, 2004 was 5,931,819.
RAINBOW RENTALS, INC.
INDEX
PART I
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 20
Item 8. Financial Statements and Supplementary Data 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 20
Item 9A. Controls and Procedures 20
PART III
Item 10. Directors and Executive Officers of the Registrant 21
Item 11. Executive Compensation 22
Item 12. Security Ownership of Certain Beneficial Owners and Management 25
Item 13. Certain Relationships and Related Transactions 26
Item 14. Principal Accountant Fees and Services 26
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 27
Signatures 44
2
PART I
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-K, 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 the proposed merger
("Merger") with a subsidiary of Rent-A-Center, Inc., general economic
conditions; failure, in the event the Merger does not occur, 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; and the effects of new accounting standards. 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 and 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 1. BUSINESS
GENERAL
Founded in 1986 with six stores, the Company, as of December 31, 2003,
operated 125 rental-purchase stores under the Rainbow Rentals trade name in
Connecticut, Georgia, Indiana, Kentucky, Maryland, Massachusetts, Michigan, New
York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina,
Tennessee and Virginia. The Company has opened 105 of these 125 locations, with
the balance of the locations having been acquired. The Company offers quality,
name brand, durable merchandise, including home electronics, furniture,
appliances and computers. Generally, 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 (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.
During 2003, Rainbow opened 6 new stores (all in new markets) and
consolidated three stores into existing locations. In 2004 through the date of
this report, Rainbow consolidated one store into an existing location.
On February 4, 2004 the Company entered into an Agreement and Plan of
Merger (Merger Agreement) with Rent-A-Center, Inc., (RAC) the industry's largest
rent-to-own operator. Under the terms of the Merger Agreement, which is expected
to close during the second quarter of 2004, RAC will acquire 100% of the
outstanding stock of the Company for a purchase price of $16.00 per share.
Pursuant to such Merger Agreement, the Company will not open any stores until
the time the Merger is consummated or the agreement is terminated.
INDUSTRY OVERVIEW
The rental-purchase industry provides an alternative to traditional
retail installment sales, appealing to individuals with a need for acquiring the
use of household products who cannot afford a cash purchase, may be unable to
qualify for credit, and are unwilling or unable to wait until they can save for
a purchase. Others may value the flexibility and services offered by the rental
transaction, which allows for the return of merchandise at any time without
obligation for further payments. In addition, the industry serves customers
having short-term needs or seeking to try products, such as computers, before
committing to purchase them. Rental-purchase transactions include delivery and
pick-up service as well as a repair warranty.
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Rental-purchase transactions are made on a week-to-week or month-to-month basis
and provide customers with the opportunity for ownership if the merchandise is
rented for a continuous term, generally 12 to 30 months. Customers may cancel
agreements at any time without further obligation by returning the merchandise
or requesting its pick-up by the store. Returned merchandise is held for
re-rental or sale. Rental renewal payments are generally made in person, in
cash, by check or money order, or by mail.
According to its 2003 Rental-Purchase Industry Survey, the Association
of Progressive Rental Organizations (APRO), the industry's trade association,
estimates there are approximately 8,300 rent-to-own stores in the United States.
According to APRO, industry-wide revenues were approximately $6.0 billion in
2002, the latest year for which statistics are available. APRO also estimates
there were approximately 2.9 million households served during 2002. Management
believes the industry's four largest public companies currently operate
approximately 4,650 stores, or 56% of the total rental-purchase stores in
operation.
The rental-purchase industry serves a highly diverse customer base.
According to APRO, approximately 92% of rental purchase customers have annual
household incomes between $15,000 and $49,999. Estimates also show that the
majority of rental-purchase customers are between the ages of 25 and 44 and over
93% of rental-purchase customers are high school graduates. The U.S. Census
Bureau reported that in 2000 there were approximately 44 million households with
annual income between $15,000 and $49,999. Management believes the
rental-purchase industry remains under-penetrated, providing growth
opportunities via new store openings or acquisitions for companies that are well
capitalized and have access to both debt and equity capital.
RISK FACTORS
Risk Associated with delay in completion of the Merger, or Termination
of Merger Agreement. During the transition period until the Merger is completed
or terminated, the Company's ability to attract and retain key personnel could
be impaired due to the uncertainty involved with the transaction and associates'
concern about job security. However, to mitigate this risk, the Company has
implemented severance agreements and stay bonus agreements for key personnel who
stay with the Company that will be vested and paid when the Merger is
completed. Moreover, the Merger Agreement contains customary restrictions on
the Company's ability to operate the business pending completion of the Merger,
which includes delaying implementation of the Company's strategic plan. If the
merger is not consummated, such delay, as well as the legal, accounting,
investment banking and other fees incurred in connection with the transaction
could have an adverse impact on the Company's operating results.
Risk Associated with the Rental-Purchase Business. The operating
success of the Company, like other participants in the rental-purchase industry,
depends upon a number of factors. These factors include the ability to maintain
and increase the number of units on rent, the collection of the rental payments
when due and the control of inventory and other costs. In addition, the failure
of the Company's management information systems to monitor the stores, the
failure of the Company's operational internal audit personnel to adequately
detect any problems with a store, or the failure of store managers to follow
operating guidelines, could have a material adverse affect on the Company's
business, financial condition or results of operations. The rental-purchase
industry is also affected by changes in consumer confidence, preferences and
attitudes, as well as general economic factors. Failure to respond to changing
market trends could adversely affect the Company's business, financial condition
or results of operations. In addition, the failure of the Company to react to
changes in consumer preferences and technological advancements could adversely
affect the value of the Company's inventory and the Company's business,
financial condition or results of operations.
Competition. The rental-purchase industry is extremely competitive. The
Company competes with other rental-purchase businesses, as well as rental stores
that do not offer their customers a purchase option. Competition is based
primarily on rental rates and terms, product selection and availability and
customer service. With respect to customers that are able to purchase a product
for cash or on credit, the Company also competes with department stores,
discount stores and other retail outlets. Several competitors in the
rental-purchase business are national or regional in scope. The Company has
generally strived to open new stores in markets with a lower concentration of
rental-purchase stores. As the Company's competitors expand geographically into
the Company's existing markets, the Company's competition in those markets may
increase and there will be relatively fewer underserved areas available for
penetration by the Company.
Government Regulation. The Company believes there are 47 states that
have enacted laws specifically regulating rental-purchase transactions,
including all of the states in which the Company operates. These laws generally
require certain contractual and advertising disclosures and also provide varying
levels of substantive consumer protection, such as requiring a grace period for
late fees and contract reinstatement rights in the event a rental-purchase
agreement is terminated. If the Company acquires or opens new stores in states
in which it does not currently operate, the Company will become subject to the
rental-purchase laws of such states, if any. Furthermore, there can be no
assurance that new or revised rental-purchase laws will not have a material
adverse affect on the Company's business, financial condition and results of
operations.
4
No federal legislation has been enacted regulating or otherwise
governing rental-purchase transactions. Currently, the industry has sponsored
two bills that have been introduced in Congress. Both bills would amend the
Consumer Credit Protection Act to include favorable treatment of rental-purchase
contracts. The Senate version (S.884), which has 21 co-sponsors, has been
referred to the Committee on Banking, Housing and Urban Affairs. The House
version (H.R. 996) also has 82 co-sponsors and has been referred to the
Committee on Financial Services. There is no assurance that either bill will be
enacted.
Expansion Risks. The inability of the Company to execute its expansion
plans, make new stores profitable or improve the profitability of acquired
stores could have a material adverse affect on the Company's business, financial
condition and results of operations. Accomplishing the Company's expansion plans
will depend on a number of factors, the most important of which is the Company's
ability to hire, train and retain managers and other personnel who satisfy the
Company's standards for performance, professionalism and service. Other risk
factors associated with the opening of new stores, some of which are beyond the
control of the Company, include: locating and obtaining acceptable sites,
securing favorable financing, obtaining necessary zoning or other regulatory
approvals, avoiding unexpected delays in opening due to construction delays or
the failure of vendors to deliver equipment, fixtures or rental-purchase
merchandise, incurring significant start-up costs before the viability of the
stores is established and integrating new stores into the Company's systems and
operations. Generally, new stores operate at a loss for up to 12 months after
opening. There can be no assurance that future new stores will obtain
profitability in the expected time frame, if at all. In addition, the Company's
growth strategy will place significant demands on the Company's management. With
respect to acquisitions, there can be no assurance that the Company will be able
to locate or acquire suitable acquisition candidates, or that any operations,
once acquired, can be effectively and profitably integrated into the Company's
existing operations. Additionally, acquisitions may negatively impact the
Company's operating results, particularly during the period immediately
following an acquisition. The Company may acquire operations that are
unprofitable or have inconsistent profitability.
Volatility of Share Price; Potential Fluctuations in Quarterly Results.
The Company believes that various factors such as general economic conditions
and changes or volatility in the financial markets, changing market conditions
in the rental-purchase industry and quarterly or annual variations in the
financial results of other public companies that are part of the rental-purchase
industry, all of which may be unrelated to the Company's performance, could
cause the market price of the Common Stock to fluctuate substantially.
Additionally, quarterly revenues and operating income are difficult to forecast.
The Company's expense levels are based, in part, on its expectations as to
future revenues and timing of new store openings. If revenue levels are below
expectations, the Company may be unable or unwilling to reduce expenses
proportionately and operating results would likely be adversely affected. As a
result, the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Due to all of the foregoing factors, it is
likely that in some future quarter the Company's operating results will differ
from the expectations of public market analysts and investors. In such event,
the market price of the Common Stock would likely be materially adversely
affected.
Litigation. Due to the consumer-oriented nature of the rental-purchase
industry and the application of certain laws and regulations, industry
participants may be named as defendants in litigation alleging violations of
state laws and regulations and consumer tort law, including fraud. Many of these
actions involve alleged violations of consumer protection laws. While the
Company currently has no material litigation pending, in the event a significant
judgment is rendered in the future against the Company or others within the
rental-purchase industry in connection with any such litigation, such judgment
could have a material adverse affect on the Company's business, financial
condition or results of operations.
OPERATING STRATEGY
The following narrative of the Company's Operating Strategy is based
upon the assumption that the Company will continue as a stand-alone entity and
the Merger will not occur. If the Merger does occur, it is possible RAC will
modify or change the Company's operating strategy.
During the fourth quarter of 2003, the Company completed a strategic
planning process that identified several key initiatives to support the
Company's core operating strategy of operating high volume, high profit store
locations. These initiatives are aimed at improving the Company's competitive
position by i) increasing customer retention; ii) increasing new customers per
store; and iii) increasing revenue and profit per customer. The strategic
process also identified the need for the Company to accelerate its growth plan
in order to achieve economies of scale in areas such as advertising and
purchasing as well as leveraging its corporate infrastructure. Prior to the
implementation of any of these initiatives, on February 4, 2004, the Company
entered into the Merger Agreement with RAC mentioned in the "General" section
above. If the Merger
5
Agreement is terminated, the Company will implement its strategic plan and will
disclose the details of such plan in a subsequent filing with the Securities and
Exchange Commission.
The Company's operating strategy is to operate high volume store
locations with core stores (stores opened three or more years) averaging a
minimum of $1.0 million in annual revenue in conjunction with generating store
level operating income ranging from 20% to 22%. Annual revenues from continuing
operations per store, including core and non-core stores, were approximately
$821,000 during 2003, which management believes is one of the highest in the
industry. The Company anticipates executing its strategy by maintaining a high
Average Monthly Rental Rate (AMRR) on its rental-purchase agreements, a high
number of customers per store and a high level of customer referrals and repeat
business, all accompanied by a low level of delinquencies. The Company seeks to
achieve these objectives by applying its "More, Better, Different" philosophy to
its customers and associates by utilizing the following operating techniques.
Customer Service. Management believes the rental-purchase
industry is a neighborhood business built on the relationship
between the customer and store personnel. Beginning with the
store manager and ending with the account manager, the
Company's customer service policy is to treat all customers at
all times with "Respect and Dignity". Bilingual associates are
employed in many stores to serve the needs of Spanish-speaking
customers and regional managers handle all customer service
calls directly to ensure prompt follow-up and dispute
resolution. In addition, the Company focuses on customer
convenience by locating stores on main arteries near national
discount retailers or grocery stores and by setting renewal
payment dates based on the customer's wage or other income
schedule. By not imposing many of the fees that are standard
in the industry, such as club, waiver, processing and delivery
fees, the Company enables its customers to afford higher
quality merchandise with additional features and benefits.
Quality Merchandise. The Company's merchandising strategy is
to offer its customers a wide range of new and pre-rented,
quality, name brand, and durable merchandise. Management
recognizes that its customers desire many of the higher end
products found in the large national electronic, appliance and
furniture stores. Accordingly, the Company provides its
customers with items such as large screen televisions, leather
furniture and computers with nationally recognized brand names
and other popular features. This strategy has enabled the
Company to maintain a high AMRR. In addition, by providing
name brand and durable products that maintain their quality
throughout the rental period, the Company has maintained a
high level of repeat and referral business.
Store Environment. The Company believes it is essential that
its stores provide an appealing and attractive shopping
environment while conveying a sense of quality, safety and
convenience. Company stores are generally located on main
arteries, near residential or commercial areas and in strip
shopping centers near national discount retailers or grocery
stores. The Company generally maintains a uniform store size
(4,750 square feet, on average), color scheme, store layout
and display signs. Stores are intended to provide an appealing
retail environment and are modeled to resemble a quality
furniture and electronics showroom.
Experienced Associates. The Company's operations and
profitability are largely dependent on the services of its
store-level personnel, senior management and executive
officers (collectively, the "associates"). The Company's
regional managers and store managers have extensive experience
in the industry and have worked with the Company for an
average of approximately 12 and five years, respectively
(excluding managers from newly opened and acquired stores).
The Company's executive officers have over 80 combined years
in the rental-purchase industry and the CEO and President
co-founded the Company in 1986. The Company attempts to
attract and retain its quality associates through compensation
and benefits that meet or exceed industry averages and through
various ongoing proprietary training programs. Management
believes its associate development programs enhance the
Company's operations by ensuring conformity to established
operating standards, reducing associate turnover, enhancing
associate productivity and improving associate morale.
Management. The Company's management approach provides store
managers with a certain degree of autonomy and accountability.
Within guidelines set by the Company, store managers are
responsible for developing customer relationships, managing
customer service, maintaining appropriate levels, quality and
mix of merchandise inventory and meeting operational
benchmarks. The Company supports its structure with strong
regional supervision, management information systems,
operational audit procedures, operating guidelines and
experienced associates.
As the Company continues to grow, a key element to ensure
the quality of its store operations is the Regional Management
team. Currently, the Company employs 12 regional managers and
one regional vice president, who are generally promoted from
within the Company. Regional managers generally live within
their geographic area to
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reduce travel time and expense. Senior management is able to
stay in touch with store operations through regular
communication with the regional managers by either telephone
conferences or quarterly meetings. Management intends on
maintaining an average region size of approximately 10 stores.
GROWTH STRATEGY
During the fourth quarter of 2003, the Company completed a strategic
planning process that identified the need for the Company to pursue an
aggressive strategic growth plan, which proposed both organic growth and an
aggressive acquisition strategy. Prior to the implementation of any of the
initiatives of the strategic plan, the Company entered into a Definitive
Agreement and Plan of Merger with Rent-A-Center, Inc. on February 4, 2004,
mentioned in the "General" section above. If the merger does not occur, the
Company will implement its strategic plan and will disclose the details of such
plan in a subsequent filing with the Securities and Exchange Commission.
STORES
As of December 31, 2003, Rainbow operated 125 stores in fifteen states,
as set forth in the following table:
Location Number of Stores
-------- ----------------
Ohio 27
Pennsylvania 22
Massachusetts 11
Michigan 11
South Carolina 8
Tennessee 8
Connecticut 7
North Carolina 7
Virginia 7
New York 5
Kentucky 4
Rhode Island 3
Indiana 2
Maryland 2
Georgia 1
Rainbow's primary method of growth is through the opening of new store
locations. New stores have a maturation period of approximately three years and
are generally dilutive to earnings for the first 12 months as the Company builds
a customer base and develops a recurring revenue stream. If the Merger with RAC
does not occur, Rainbow plans to open approximately five additional stores
during 2004.
In investigating a new market, the Company reviews demographic
statistics, cost of advertising and the number and nature of competitors. In
addition, the Company investigates the regulatory environment of the state in
which the new market exists. It is the Company's policy to operate in those
states where there is an absence of unfavorable legislation regarding
rental-purchase transactions.
MERCHANDISE
Rainbow's merchandising strategy is to carry a wide variety of quality,
name brand, durable merchandise in four major categories, including home
electronics, furniture, appliances and computers. Choices of merchandise reflect
the Company's belief that customers want to rent the same quality of merchandise
that is available from more traditional retailers, and that customers are
willing to pay for value and quality. In addition, by focusing on its
manufacturers' mid-point and better range products, the Company avoids frequent
service problems associated with inferior products. The Company purchases
merchandise directly from the manufacturers and through distributors generally
through volume price discounts.
As of December 31, 2003, rental-purchase agreements for home
electronics accounted for approximately 33%; furniture accounted for 35%;
appliances accounted for 19%; and computers accounted for 13% of the Company's
total units on rent.
RETENTION, TRAINING AND EMPOWERMENT OF ASSOCIATES
Management believes a key to its success in retaining quality
associates is its policy of promoting many of its store
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managers from within. However, to ensure the strength of its store level
management team, the Company also hires experienced managers from other
rent-to-own chains. These experienced managers are introduced to Rainbow's
culture of customer service and store operating system through its "Fast Track"
training program.
The Company places great importance on training, both in terms of
initial training for potential managers and continued education of its current
management team. The Company has developed a formal training program that each
associate must successfully complete before becoming eligible for promotion to
store manager. This training program for potential managers consists of a three
to six month curriculum involving formal classroom training as well as on-site
store training. After an associate becomes a store manager, the training
continues. Manager meetings are conducted twice per year and all store managers,
regional managers, department heads and executive management of the Company are
required to attend. At such sessions, prior performance is critiqued, operating
procedures are reviewed and revised, new merchandise is showcased and managers
receive eight to ten hours of classroom training in the areas of financial
management, product information, inventory management, customer service, credit
management, personnel management and other areas of store operations. In
addition, the Company holds training sessions for store personnel below the
level of manager in areas such as customer service, collection techniques, sales
training and safety. The Company also produces training videos to assist in the
on-going training of store associates.
The Company believes open communication with regional and store level
management is essential to understanding existing markets, increasing associate
morale and retaining associates. In order to facilitate open lines of
communication, the Company has a committee comprised of top performing managers
to serve as a sounding board for new concepts and innovative operational and
sales techniques.
MARKETING
The Company uses advertising mediums such as printed circulars, radio,
television, and direct mail to introduce and reinforce the benefits of its
rental-purchase program to potential and existing customers and to make such
customers aware of new products and promotions.
The Company advertises in both English and Spanish to reach the diverse
segments of its customer base. Advertising focuses on things such as superior
customer service, quality name brand products, the ease of a hassle-free
ordering process, and promotional offers. Some of the supporting elements to
these concepts include a toll-free phone number that automatically connects the
caller with the store nearest them, a website for online ordering and
information about products and locations, and a toll-free number to a customer
service representative who forwards messages directly to one of the Company's
regional managers who answers questions and resolves problems.
Direct mail is employed to target specific households that match up
with the established demographics of our customer base. These programs are
tailored to both active customers at various points in their rental life cycle,
and to inactive customers to encourage them to again enjoy the products and
services the Company has to offer. In addition, the Company holds "customer
appreciation" events at its store locations during various times of the year to
foster better customer relations.
APPROVAL PROCESS
The Company does not conduct a formal credit review. The Company's
order approval process is designed to verify a customer's stability in his or
her community and serves as a successful method of loss prevention. Since
merchandise is rented rather than purchased, the Company focuses on a customer's
credibility, not the customer's credit history. The approval process is designed
to take less than one hour. Merchandise is generally delivered on the same day
that the order is received.
THE RENTAL-PURCHASE AGREEMENT
Merchandise is provided to customers under written rental-purchase
agreements that set forth the terms and conditions of the transaction in a
straightforward and understandable manner. The Company has developed its own
agreements, which have been reviewed by legal counsel and meet the legal
requirements of the state in which they are used. The Company's flexible rental
program allows a customer to choose weekly, bi-weekly, semi-monthly, or monthly
rental periods with rent paid in advance. At the end of each rental period, the
customer can renew the agreement by making a renewal payment, terminate the
agreement, or purchase the merchandise for a price based upon a predetermined
formula. If the customer elects to terminate the agreement, the merchandise is
returned to the store and made available for rent to another customer. The
Company retains title to the merchandise during the term of the rental-purchase
agreement. If the customer renews the agreement for a specified number of rental
periods, ownership is transferred to the customer upon receipt of the last
renewal payment.
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CUSTOMER SERVICE AND MANAGEMENT
In addition to the enjoyment of quality products, customers are
afforded many services provided by well-trained customer management personnel
who treat customers with "Respect and Dignity". The Company does not impose many
of the fees standard in the industry, such as waiver fees, club fees, processing
or delivery fees, and provides additional services under the rental-purchase
agreement at no additional cost. Such services include delivery and
installation, product training, maintenance to ensure the product continues to
perform, "loaner" merchandise if a product is being serviced, and pick-up
service to return the merchandise, if requested. Rental income represented 94.3%
of the Company's total revenue in 2003 with an additional 3.1% in merchandise
sales. In addition, customers are able to upgrade products, reinstate a
previously terminated agreement and are given free service for a reasonable
period, generally 90 days, beyond the rental term.
Management's philosophy is "customers will pay you because they want
to, not because they have to" and every renewal date offers the opportunity to
sell the customer on the benefits of maintaining a good account with the
Company. Management believes a thorough understanding by the customer of all the
terms of the rental agreement is the first step of successful customer
management. A large majority of all renewal payments are made timely without the
involvement of store personnel and renewal payments are generally made at the
store by cash, check or money order or by mail. Customer management personnel
are given extensive training to assist the customer in maintaining a good
account with the Company. Customer management begins upon delivery of the
merchandise in the customer's home.
MANAGEMENT INFORMATION SYSTEMS
The Company has operated its current internal network for a number of
years, which is a Windows NT 4.0 based environment supporting approximately 40
local users and 140 remote users. The Company utilizes a proprietary Windows
based point-of-sale system to support its store operations. The system provides
store managers with all of the relevant store-level financial and operational
data as well as individual profiles on each store's customers. This same data is
also readily available to senior management for performance and trend analysis.
COMPETITION
The rental-purchase industry is highly competitive. The Company
competes with other national, regional and local rental-purchase businesses, as
well as rental stores that do not offer their customers a purchase option. With
respect to customers desiring to purchase merchandise for cash or on credit, the
Company competes with department stores, consumer electronic stores and discount
stores. The Company's three largest competitors, Rent-A-Center, Inc., Rent-Way,
Inc., and Aaron Rents, Inc., have greater financial and operating resources and
name recognition than Rainbow.
PERSONNEL
As of March 2004, the Company had approximately 872 associates of which
653 of them were full-time. Approximately 45 associates are located at the
Company's corporate headquarters in Canfield, Ohio. None of the Company's
associates are represented by a labor union. Management believes its relations
with its associates are good.
GOVERNMENT REGULATION
The Company believes there are 47 states that have legislation
regulating rental-purchase transactions. The Company's policy is to operate in
states where there is an absence of unfavorable legislation regarding
rental-purchase transactions. There can be no assurance against the enactment of
new or revised rental-purchase laws that would have a material adverse affect on
the Company. No federal legislation has been enacted regulating or otherwise
governing rental-purchase transactions. See Government Regulation under Risk
Factors.
The Company instructs its managers in procedures required by applicable
law through training seminars and policy manuals and believes that it has
operated in compliance with the requirements of applicable law in all material
respects.
SERVICE MARKS
The Company owns the federally registered service mark "Rainbow
Rentals." The Company believes that the Rainbow Rentals mark has acquired
significant market recognition and goodwill in the communities in which its
stores are located.
9
ITEM 2. PROPERTIES
The Company leases all of its stores under operating leases that
expire at various times through 2010. Store leases generally provide for fixed
monthly rental payments, plus payment for real estate taxes, insurance and
common area maintenance. Most of these leases contain renewal options for
additional periods ranging from three to five years at rates generally
adjusted for increases in the cost of living. There is no assurance the
Company can renew the leases that do not contain renewal options,or if it can
renew them, that the terms will be favorable to the Company. Store sizes range
from approximately 3,200 to 9,830 square feet, and average approximately 4,750
square feet. Management believes suitable store space is generally available
for lease and the Company would be able to relocate any of its stores without
significant difficulty should it be unable or unwilling to renew a particular
lease. Management also believes additional store space is available to meet the
requirements of its new store opening program.
The Company leases its corporate office located at 3711 Starr Centre
Drive, Canfield, Ohio from a corporation owned by two of its executive officers
and a former officer (see "Related Party Transactions"). The corporate office
consists of approximately 10,000 square feet and is leased through January 31,
2006, however, in the event the Merger is consummated, the lease will terminate
90 days after the effective date of the Merger. In 2003, the rental amount was
$130,000. The Company believes the rental is at market rate and the other
provisions of the lease are on terms no less favorable to the Company than could
be obtained from unrelated parties.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings and claims that
arise in the ordinary course of business. The Company believes the amount of any
ultimate liability with respect to these actions will not have a material
adverse affect on the Company's liquidity, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The common stock of Rainbow Rentals, Inc. trades on The Nasdaq Stock
Market under the symbol "RBOW". As of March 1, 2004, there were 5,931,819 shares
outstanding held by approximately 90 shareholders of record. The Company
believes there are approximately 300 persons or entities holding stock in
nominee or street name through various brokerage firms or other institutional
holders.
The following table shows the quarterly high and low trade prices of
the common shares for the years ended 2003 and 2002.
2003 2002
----------------- -----------------
High Low High Low
------- ------- -------- -------
Quarter ended March 31 $ 6.04 $ 4.05 $ 8.25 $ 6.25
Quarter ended June 30 6.13 4.93 10.24 6.56
Quarter ended September 30 6.85 5.40 7.24 4.35
Quarter ended December 31 8.31 6.05 7.47 4.26
DIVIDEND POLICY
The Company has never paid cash dividends on its shares of common
stock. The Company currently intends to retain all earnings from its operations
to finance the growth and development of its business and, consequently, does
not expect to pay dividends on its shares of common stock in the foreseeable
future. The payment of future dividends will be at the sole discretion of the
Company's Board of Directors and will depend on, among other things, future
earnings, capital requirements, the general financial condition of the Company
and general business conditions. In addition, the payment of dividends by the
Company is limited by certain covenants in the Company's Credit Facility. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information as of December 31, 2003,
regarding shares outstanding and available for issuance under the Company's
existing stock option plan:
(a) (b) (c)
------------------------------------------------------------------------------------------------
Number of securities to be
issued upon exercise of Weighted average exercise Number of securities
outstanding options, warrants price of outstanding options, remaining available for future
Plan category and rights warrants and rights issuance
- -----------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 583,034 $ 7.95 10,882
Equity compensation plans
not approved by security holders - - -
------- ----------------- ------
Total 583,034 $ 7.95 10,882
======= ================= ======
11
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below under the captions
"Statement of Income Data" and "Balance Sheet Data" for, and as of the end of,
each of the years in the five-year period ended December 31, 2003, are derived
from the financial statements of the Company. The data presented below should be
read in conjunction with Management's Discussion and Analysis of Financial
Condition and Results of Operations, and the Financial Statements and the
related notes thereto included elsewhere in this annual report.
Year Ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share amounts)
Statement of Income Data:
Revenues
Rental revenue $ 96,826 $ 93,239 $ 88,770 $ 86,099 $ 75,932
Fees 2,679 2,728 2,697 2,849 2,639
Merchandise sales 3,168 3,300 3,088 2,947 2,287
---------- ---------- ---------- ---------- ----------
Total revenues 102,673 99,267 94,555 91,895 80,858
Operating expenses
Merchandise costs 33,346 33,995 33,310 30,775 26,758
Store expenses
Salaries and related 26,849 24,393 22,713 21,774 18,374
Occupancy 10,022 9,480 8,607 7,464 6,027
Advertising 6,884 6,167 5,928 4,430 3,662
Other expenses 14,397 13,494 13,258 12,388 10,719
---------- ---------- ---------- ---------- ----------
Total store expenses 58,152 53,534 50,506 46,056 38,782
---------- ---------- ---------- ---------- ----------
Total merchandise costs and
store expenses 91,498 87,529 83,816 76,831 65,540
General and administrative expenses 8,765 7,706 7,160 6,340 5,176
Amortization of goodwill and noncompete
agreements 160 175 689 608 456
---------- ---------- ---------- ---------- ----------
Total operating expenses 100,423 95,410 91,665 83,779 71,172
---------- ---------- ---------- ---------- ----------
Operating income 2,250 3,857 2,890 8,116 9,686
Interest expense 570 632 689 933 697
Other expense, net 227 228 227 284 361
---------- ---------- ---------- ---------- ----------
Income from continuing
operations, before income
taxes 1,453 2,997 1,974 6,899 8,628
Income taxes 574 1,184 800 2,794 3,580
---------- ---------- ---------- ---------- ----------
Income from continuing
operations 879 1,813 1,174 4,105 5,048
Discontinued operations
Loss from operations of discontinued
store including loss on disposal,
net of tax - (172) - - -
---------- ---------- ---------- ---------- ----------
Net income $ 879 $ 1,641 $ 1,174 $ 4,105 $ 5,048
========== ========== ========== ========== ==========
Basic and diluted earnings
per common share from
continuing operations $ 0.15 $ 0.31 $ 0.20 $ 0.69 $ 0.85
========== ========== ========== ========== ==========
Basic and diluted earnings
per common share $ 0.15 $ 0.28 $ 0.20 $ 0.69 $ 0.85
========== ========== ========== ========== ==========
Weighted average common shares
outstanding:
Basic 5,929,435 5,928,006 5,925,735 5,925,735 5,925,735
Diluted 5,940,598 5,940,606 5,940,999 5,930,157 5,930,887
Pro forma net income data:
Net income as reported $ 879 $ 1,641 $ 1,174 $ 4,105 $ 5,048
Pro forma adjustment for goodwill
amortization, net - - 312 287 212
---------- ---------- ---------- ---------- ----------
Pro forma net income $ 879 $ 1,641 $ 1,486 $ 4,392 $ 5,260
========== ========== ========== ========== ==========
Pro forma basic and diluted income per
common share $ 0.15 $ 0.28 $ 0.25 $ 0.74 $ 0.89
========== ========== ========== ========== ==========
Operating Data:
Stores open at end of period 125 122 113 110 92
Comparable store revenue growth (1) (1.0%) 1.4% (4.3%) 1.7% 4.4%
(1) Comparable store revenue growth is the percentage increase (decrease) in
revenue from the same number of stores over a two-year period. Only stores
that have been open 12 months in both periods are included in the
comparison.
12
SELECTED FINANCIAL DATA, CONTINUED
Year Ended December 31,
-----------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- --------- ---------
(Dollars in thousands)
Balance Sheet Data:
Rental-purchase merchandise, net $ 40,545 $ 39,342 $ 39,330 $ 36,545 $ 33,042
Total assets 63,651 60,913 60,121 58,429 50,324
Total long-term debt 6,154 7,550 9,440 12,340 10,522
Total liabilities 23,930 22,088 22,956 22,438 18,438
Shareholders' equity 39,721 38,825 37,165 35,991 31,886
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to assist in the understanding of
the Company's financial position as of December 31, 2003 and 2002 and results of
operations for the years ended December 31, 2003, 2002 and 2001. This discussion
should be read in conjunction with the Company's financial statements and notes
thereto included herein.
GENERAL
At December 31, 2003, the Company operated 125 rental-purchase stores
in 15 states, providing quality, name brand, durable merchandise, including home
electronics, furniture, appliances and computers. Generally, 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 (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.
RECENT DEVELOPMENTS
On February 4, 2004 the Company entered into an Agreement and Plan of
Merger (Merger Agreement) with Rent-A-Center, Inc., (RAC) the industry's largest
rent-to-own operator. Under the terms of the Merger Agreement, which is expected
to close during the second quarter of 2004, RAC will acquire 100% of the
outstanding stock of the Company for a purchase price of $16.00 per share.
CRITICAL ACCOUNTING POLICIES
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" discusses our financial statements that have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amount of assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period.
On an on-going basis, the Company evaluates its estimates and
judgments. The Company bases its estimates and judgments on historical
experience and on various other factors that management believes to be
reasonable under the circumstances. The results of these estimates and judgments
form the basis for making conclusions about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. Our
significant estimates and assumptions are reviewed by management on a quarterly
basis and required adjustments are recorded, if necessary
A critical accounting policy is one that is both important to the
portrayal of the Company's financial condition and results of operations and
requires management to make estimates about the effects of matters that are
inherently uncertain. Management believes the following critical accounting
policies affect its more significant judgments and estimates in the preparation
of its financial statements:
- Rental-purchase merchandise, including depreciation and
impairment;
- Revenue recognition;
- Accounting for income taxes;
- Valuation of long-lived and intangible assets; and
- Valuation of goodwill
13
Rental-purchase merchandise, including depreciation and impairment.
Rental-purchase merchandise is stated at historical cost, net of accumulated
depreciation. The Company depreciates inventory on rent using the units of
activity method. Under the units of activity method, merchandise on rent is
depreciated in the proportion of rents earned to total expected rents to be
provided over the rental contract term. The Company believes the units of
activity method more accurately matches the recognition of depreciation expense
with the estimated timing of revenue earned over the rental-purchase agreement
period. The units of activity method is recognized in the rental-purchase
industry and does not consider salvage value. In addition, the Company
depreciates certain older rental-purchase merchandise held for rent over its
remaining useful life.
The Company monitors the value of rental-purchase merchandise for
possible impairment. An impairment loss is recognized when the carrying amounts
cannot be recovered by the estimated undiscounted cash flows they will receive.
Revenue recognition. Merchandise is rented to customers pursuant to
rental-purchase agreements, which generally provide for weekly or monthly rental
terms. Rental revenue is recognized over the lease term. Deferred revenue is
recognized for cash received for which revenue is not yet earned. A customer may
elect to renew the rental-purchase agreement for a specified number of
continuous terms and has the right to acquire title either through payment of
all required rentals or through an early purchase option. Amounts received from
such early purchase options, as well as sales of new and used merchandise
available for rent in the stores, are included in merchandise sales.
Accounting for income taxes. As part of the process of preparing the
Company's financial statements, management is required to estimate income taxes
in each of the jurisdictions in which it operates. This process involves
estimating the Company's actual current tax exposure together with assessing
temporary differences resulting from differing treatment of items. These
differences result in deferred tax assets and liabilities, which are included
within the Company's balance sheet. The Company must then assess the likelihood
that deferred tax assets will be recovered from future taxable income, and if
the Company assesses that recovery is not likely, a valuation allowance must be
established.
Management judgment is required in determining the Company's provision
for income taxes, deferred tax assets and liabilities and any valuation
allowance that may be deemed necessary.
Valuation of long-lived and intangible assets. The Company assesses the
impairment of identifiable intangible assets and long-lived assets whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. Factors the Company considers important that could trigger an
impairment review include the following:
- significant underperformance relative to expected historical
or projected future operating results;
- significant changes in the manner of the Company's use of
the acquired assets or its strategy for the overall
business; and
- significant negative industry or economic trends
When the Company determines that the carrying value of intangibles and
long-lived assets may not be recovered based upon the existence of one or more
of the above factors, impairment is measured based on a projected undiscounted
cash flow method.
Valuation of goodwill. Goodwill is the cost in excess of the fair value
of net assets of acquired businesses. These assets are stated at cost and are no
longer amortized, but evaluated at least annually for impairment in accordance
with Statement of Financial Accounting Standards (SFAS) No. 142.
The Company is required to test all existing goodwill for impairment
annually on a "reporting unit" basis. A fair value approach is used to test
goodwill for impairment. An impairment charge is recognized for the amount, if
any, by which the carrying amount of goodwill exceeds its implied fair value.
The fair value of a reporting unit and the related implied fair value of the
respective goodwill are established using comparative market multiples, namely a
combination of the Company's market capitalization and average monthly revenues.
Should the Company's stock price and/or average monthly revenues fall such that
the carrying amount of goodwill would not be recoverable, an impairment loss
would be recognized. During the fourth quarter of 2003, we performed an
impairment assessment of our goodwill, and determined that no impairment
existed.
14
COMPONENTS OF INCOME AND EXPENSES
Revenues. The Company collects rental renewal payments in advance,
under weekly, biweekly, semi-monthly and monthly rental-purchase agreements.
Rental revenue is recognized over the lease term. Fees include amounts for
reinstatement of expired agreements and amounts for in-home collection. Fees are
recognized when earned. Rental-purchase agreements generally include an early
purchase option. Merchandise sales include amounts received upon sales of
merchandise pursuant to such early purchase options and upon the sale of new or
used rental merchandise. These amounts are recognized as revenue when the
merchandise is sold.
Merchandise Costs. Merchandise costs include depreciation of
rental-purchase merchandise under the units of activity depreciation method.
Rental-purchase merchandise is depreciated as revenue is earned. Merchandise
costs also include the remaining book value of merchandise sold or otherwise
disposed, the cost of replacement parts and accessories and other miscellaneous
merchandise costs. The Company monitors the value of rental-purchase merchandise
for possible impairment and, if necessary, reduces the carrying value of the
related asset to fair value.
Salaries and Related. Salaries and related expenses include all
salaries and wages paid to store level associates, related benefits, taxes and
workers' compensation claims and premiums.
Occupancy. Occupancy includes rent, repairs, maintenance and security
of the physical store locations, utility costs and depreciation of store
leasehold improvements. The Company has no leases that include percentage rent
provisions.
Advertising. Costs incurred for producing and communicating advertising
are charged to expense the first time advertising takes place.
Other Expenses. Other expenses include delivery expenses, insurance,
costs associated with maintaining rental-purchase merchandise, telephone
expenses, store computer and office expenses and personal property taxes, among
other items.
General and Administrative Expenses. General and administrative
expenses include all personnel, occupancy and other operating expenses
associated with the Company's corporate-level support departments and regional
store supervision. In addition, all costs associated with training, legal and
professional fees, charitable contributions and state taxes not based on income,
are included.
Amortization Expense. Amortization expense includes the amortization of
non-compete agreements and other identifiable intangible assets with definitive
lives. Effective January 1, 2002, with the adoption of SFAS No. 142, goodwill is
no longer amortized.
Income Tax Expense. Income tax expense includes the combined effect of
all federal, state and local income taxes imposed upon the Company by various
taxing jurisdictions.
15
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
Statements of Income data as a percentage of total revenues.
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Revenues
Rental revenue 94.3% 93.9% 93.9%
Fees 2.6 2.8 2.8
Merchandise sales 3.1 3.3 3.3
----- ----- -----
Total revenues 100.0 100.0 100.0
Operating expenses
Merchandise costs 32.5 34.2 35.2
Store expenses
Salaries and related 26.1 24.6 24.0
Occupancy 9.8 9.5 9.1
Advertising 6.7 6.2 6.3
Other expenses 14.0 13.6 14.0
----- ----- -----
Total store expenses 56.6 53.9 53.4
----- ----- -----
Total merchandise costs and store expenses 89.1 88.1 88.6
General and administrative expenses 8.5 7.8 7.6
Amortization of goodwill and noncompete agreements 0.2 0.2 0.7
----- ----- -----
Total operating expenses 97.8 96.1 96.9
----- ----- -----
Operating income 2.2 3.9 3.1
Interest expense 0.6 0.6 0.7
Other expense, net 0.2 0.2 0.2
----- ----- -----
Income from continuing operations, before income
taxes 1.4 3.1 2.2
Income taxes 0.5 1.2 0.9
----- ----- -----
Income from continuing operations 0.9 1.9 1.3
Loss on discontinued operations, net of tax - (0.2) -
----- ----- -----
Net income 0.9 1.7 1.3
Pro forma adjustment for goodwill amortization, net of tax - - 0.3
----- ----- -----
Pro forma net income 0.9 1.7 1.6
===== ===== =====
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND
2002
Total revenues increased $3.4 million, or 3.4%, to $102.7 million for
the year ended December 31, 2003 compared to $99.3 million for the year ended
December 31, 2002. Revenue from comparable stores, or stores in operation for
each of the entire years ended December 31, 2003 and 2002, decreased $1.0
million, or 1.0%. This decrease was primarily attributable to a 4.9% decline in
average units on rent due largely to management's decision to discontinue
rentals of accessory items in 2003, which are less profitable than regular
rental purchase merchandise items. Average accessory units on rent at comparable
stores fell 27.8% during 2003, and, to a lesser extent, average regular units on
rent fell 1.4%. Collection performance at comparable stores declined 44 basis
points. Partially offsetting the declines in comparable units on rent and
collection performance was a 1.25% increase in average price per unit charged to
customers on regular rental purchase merchandise. Revenues from stores opened
during 2002 increased $3.8 million as these stores continued to build their
customer base. Revenues from the six stores opened during 2003 totaled $656,000.
Merchandise costs decreased $649,000, or 1.9%, to $33.3 million for the
year ended December 31, 2003 compared to $34.0 million for the year ended
December 31, 2002. Comparable store merchandise costs declined $2.3 million, or
6.8%, which was partially offset by an increase in merchandise costs for stores
opened in 2002 and 2003. As a percentage of revenue, merchandise costs declined
to 32.5% from 34.2% for the years ended December 31, 2003 and 2002,
respectively. The decrease in merchandise costs as a percentage of revenues is
attributable to better pricing on the purchase of rental merchandise and, to a
lesser extent, an increase in average rental rates.
Store expenses increased $4.6 million, or 8.6%, to $58.1 million for
the year ended December 31, 2003 compared to $53.5 million for the year ended
December 31, 2002. Store expenses associated with stores opened after January 1,
2002 (non-comparable stores) accounted for $3.1 million, or nearly 68% of the
increase. Store expenses were also affected by an
16
increase in comparable store salaries and related expenses totaling $1.0
million, which was attributable to increased wages (primarily staffing), higher
workers' compensation costs, and, to a lesser extent, an increase in group
insurance costs due to higher self-insurance claims, primarily in the fourth
quarter of 2003. Advertising and other store expenses at comparable stores
increased $350,000 and $352,000, respectively. Advertising increased primarily
in the fourth quarter of 2003 in an attempt to increase customer traffic. The
increase in other store expenses was due to higher inventory repairs, in
addition to increases in insurance premiums and vehicle claims. Comparable store
occupancy expense declined $226,000 predominantly due to a lease buy-out and
asset write-offs recorded during 2002 associated with the consolidation of a
store. Store expenses totaled 56.6% and 53.9% of total revenue for the years
ended December 31, 2003 and 2002, respectively. Comparable store expenses as a
percentage of comparable store revenue totaled 54.9% and 52.6% for the years
ended December 31, 2003 and 2002, respectively.
General and administrative expenses increased $1.1 million, or 13.7%,
to $8.8 million for the year ended December 31, 2003 compared to $7.7 million
for the year ended December 31, 2002. The increase in general and administrative
expenses was partially attributable to $329,000 in severance costs associated
with the departure of the Company's Chief Operating Officer in May 2003. Also
contributing to the increase were higher payroll-related costs totaling
$409,000, which included reorganizing and training the Company's regional and
store managers, higher corporate payroll due primarily to additional personnel,
and severance costs related to closing the Company's construction department
during the fourth quarter of 2003. Other increases included $100,000 in
consulting fees, primarily due to strategic planning initiated during the fourth
quarter of 2003, and $66,000 in higher director and officer insurance premiums.
General and administrative expenses totaled 8.5% and 7.8% of total revenues for
the years ended December 31, 2003 and 2002, respectively.
Interest expense decreased $62,000 comparing the years ended December
31, 2003 and 2002, due to lower average outstanding debt.
Income tax expense decreased $610,000 to $574,000 for the year ended
December 31, 2003 from $1.2 million for the year ended December 31, 2002, and
was attributable to a decline in income from operations. The Company's effective
tax rate was 39.5% for both the years.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND
2001
Total revenues from continuing operations increased $4.7 million, or 5.0%,
to $99.3 million for the year ended December 31, 2002 compared to $94.6 million
for the year ended December 31, 2001. Revenue from comparable stores, or stores
in operation on January 1, 2001, increased $1.3 million, or 1.4%, and was
primarily attributable to an increase in average rental rates and, to a lesser
extent, an increase in collection performance. The increase in average rental
rates was mainly the effect of raising rental rates on pre-rented merchandise
during the second quarter of 2002 towards historical levels as the quality of
such merchandise improved over the previous year. Changes in product mix and
increased average rental rates on new merchandise also contributed to the
increase in comparable store revenue. Partially offsetting the increase in
comparable store revenue was a modest decline in average units on rent comparing
2002 to 2001, which was due to a decline in average customers per comparable
store. Revenue from the 17 stores opened after January 1, 2001 accounted for
$3.6 million of the increase in total revenue from continuing operations as
these stores continue to build a customer base and develop a recurring revenue
stream. Revenues in 2001 included the activity of an underperforming store sold
in 2001.
Merchandise costs from continuing operations increased $685,000, or 2.1%,
to $34.0 million for the year ended December 31, 2002 compared to $33.3 million
for the year ended December 31, 2001. Merchandise costs totaled 34.2% and 35.2%
of revenue for the years ended December 31, 2002 and 2001, respectively. The
decrease in merchandise costs from continuing operations as a percentage of
revenues from continuing operations was primarily the result of higher rental
margins. During mid-2001, the Company lowered rental rates in order to move
older, pre-rented merchandise. The Company began raising rental rates during the
second quarter of 2002 towards historical levels as the quality of older,
pre-rented merchandise improved.
Store expenses from continuing operations increased $3.0 million, or 6.0%,
to $53.5 million for the year ended December 31, 2002 compared to $50.5 million
for the year ended December 31, 2001. This increase was mainly attributable to
the 17 stores opened after January 1, 2001, as total store expenses for
comparable stores remained flat. To a lesser extent, costs associated with the
consolidation of two stores contributed to the increase in store expenses from
continuing operations. A modest increase in salaries and related expenses at
comparable stores, in addition to normal scheduled rent increases, were offset
by cost savings as operational efficiencies and spending controls were
implemented during 2002. As a result of the above-mentioned cost savings, total
comparable store expenses as a percentage of comparable store revenue improved
from 52.4% for the year ended December 31, 2001 to 51.8% for the year ended
December 31, 2002. Store expenses from
17
continuing operations totaled 53.9% and 53.4% of total revenues from continuing
operations for the years ended December 31, 2002 and 2001, respectively.
Amortization expense from continuing operations decreased $514,000 to
$175,000 for the year ended December 31, 2002 compared to $689,000 for the year
ended December 31, 2001. With the adoption of SFAS No. 142 on January 1, 2002,
goodwill is no longer amortized, but evaluated at least annually for impairment.
For the year ended December 31, 2001, amortization of goodwill totaled $525,000.
General and administrative expenses from continuing operations
increased $546,000, or 7.6%, to $7.7 million for the year ended December 31,
2002 from $7.2 million for the year ended December 31, 2001. The increase in
general and administrative expenses from continuing operations was mostly
attributable to higher costs associated with the Company's manager trainee
program due to both new store openings and preparing potential managers for
future store openings and replacements. In addition, higher regional manager
compensation and increased legal costs contributed to the increase. General and
administrative expenses increased to 7.8% from 7.6% of revenues, respectively,
comparing the years ended December 31, 2002 to December 31, 2001 due to slower
revenue growth than anticipated.
Interest expense decreased $57,000 comparing the years ended December
31, 2002 to 2001, and was due to lower average outstanding debt and lower
interest rates during 2002.
Income tax expense from continuing operations increased $384,000 from
$800,000 for the year ended December 31, 2001 to $1.2 million for the year ended
December 31, 2002. This increase was attributable to an increase in income from
continuing operations, but was partially offset by a decline in the Company's
effective tax rate to 39.5% for 2002 from 40.5% for 2001 due to a higher
proportion of state taxable income in states with lower income tax rates.
During the fourth quarter of 2002, the Company sold an under-performing
store, which was accounted for as a discontinued operation. Loss from
discontinued operations totaled $172,000, net of an income tax benefit and
included a $90,000 loss, net of tax, from operations of the store and an $82,000
loss, net of tax, on the disposal of the store. There were no restatements
necessary for years prior to 2002 since the Company opened this store in 2002.
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. The Merger Agreement with RAC contains customary
provisions limiting the Company's capital expenditures including the opening of
new stores.
For the years ended December 31, 2003 and 2002, cash provided by
operating activities totaled $3.6 million and $4.2 million, respectively. The
decrease in cash provided by operating activities was affected by a decline in
income from operations and increased purchases of rental purchase merchandise,
which was partially offset by changes in accounts payable (due mainly to the
timing of inventory purchases). Cash used in investing activities decreased to
$2.2 million for the year ended December 31, 2003 from $2.8 million for the year
ended December 31, 2002, and was primarily due to acquisitions of customer
accounts in 2002 and a decline in purchases of property and equipment purchases
in 2003. Cash used in financing activities decreased to $1.8 million for the
year ended December 31, 2003 from $2.2 million for the year ended December 31,
2002 and was mainly attributable to loan fees paid in 2002.
During 2002, Congress passed the Job Creation and Workers Assistance
Act of 2002, which provided an additional first-year "bonus" depreciation
deduction of 30% on property acquired after September 10, 2001, but before
September 11, 2004, if there was no written binding contract for the
acquisition of the property in effect before September 11, 2001. Additionally,
Congress passed the Jobs and Growth Tax Reconciliation Act of 2003, which
increased the additional first-year "bonus" depreciation from 30% to 50% for
most capital assets acquired new after May 5, 2003 and before 2005. These acts
have a significant impact on the Company as all rental purchase merchandise and
a portion of the fixed assets qualify for these accelerated deductions. The
above has resulted in the Company receiving an amount of $730,000 in the
current year from the federal government, net of estimated income tax payments.
The Company expects that these bonus depreciation amounts will result in
significant tax savings through 2005, which is when the benefits expire.
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 ($13.0 million at December 31, 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 December 31, 2003. Excess availability was approximately $4.4
million at December 31, 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 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.
18
The following table summarizes the Company's approximate obligations
and commitments to make future payments under contractual obligations as of
December 31, 2003:
Less than More than
1 year 1 - 3 years 3 - 5 years 5 years Total
- ---------------------------------------------------------------------------------------------------------------------
Operating lease obligations $ 8,805 $ 11,557 $ 4,468 $ 609 $ 25,439
Long-term debt - 5,725 - - 5,725
Debt from variable interest entity - 429 - - 429
--------- --------- --------- -------- ---------
$ 8,805 $ 17,711 $ 4,468 $ 609 $ 31,593
========= ========= ========= ======== =========
If the Merger Agreement is terminated and the Company would continue as
a stand-alone entity, management believes it would be able to open six new
stores in 2004, as well as 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, should the Merger not occur, 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 or its current lender.
Capital spending amounted to approximately $2.3 million for the year
ended December 31, 2003 and, subject to changes resulting from the Merger, is
expected not to change materially for 2004. If the Merger Agreement is
terminated, spending will be focused on leasehold improvements for new and
existing stores in addition to completion of a point-of-sale software upgrade.
NEW ACCOUNTING PRONOUNCEMENTS
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 does not 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 does not have an effect on the Company's financial position or
results of operations.
In November 2002, the Emerging Issues Task Force (EITF) issued a final
consensus on EITF Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables, which addresses how to account for arrangements that may
involve the delivery or performance of multiple products, services, and/or
rights to use assets. EITF Issue No. 00-21 is effective prospectively for
arrangements entered into in fiscal periods beginning after June 15, 2003. The
application of this statement does not have and effect on the Company's
financial position or results of operations.
In December 2003, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, which clarifies
existing SEC guidance regarding revenues for contracts that contain multiple
deliverables to make it consistent with EITF Issue No. 00-21. The adoption of
SAB No. 104 did not have an effect of the Company's financial position or
results of operations.
19
SEASONALITY
Management believes that the Company's operating results are subject to
seasonality. The third quarter generally shows a small reduction of customer
spending habits because of circumstances such as summer vacations and back to
school needs. On the other hand, the fourth quarter generally shows increased
rental activity because of traditional holiday shopping patterns. Many of the
Company's expenses do not fluctuate with seasonal revenue changes; therefore,
such revenue changes may cause fluctuations in the Company's quarterly results.
INFLATION
During the years ended December 31, 2003, 2002 and 2001, lease expense
and salaries and wages have increased modestly, which have not had a significant
effect on the Company's results of operations.
MARKET RISK
The Company manages interest rate risk with the use of variable rate
borrowings under its committed and uncommitted Credit Facility. Variable rate
borrowings under the Credit Facility totaled $5.7 million at December 31, 2003.
A one percent increase or decrease in interest rates would have resulted in an
increase or decrease in interest expense of approximately $62,000.
The Company does not purchase or hold any derivative financial
instruments.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See the Market Risk Section under the Management's Discussion and
Analysis.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 15 of this Form 10-K for the
information required by Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. 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 made timely 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 prior to the filing of this Annual Report on Form 10-K. 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 during the fourth quarter of 2003 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
20
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
NAME OF PRINCIPAL OCCUPATION PAST FIVE YEARS, DIRECTOR
DIRECTOR/OFFICER AGE OTHER DIRECTORSHIPS SINCE
------------------------ --- ------------------- -----
Wayland J. Russell 52 Chairman of the Board and Chief Executive Officer of the Company since 1986
February 1997, having previously served as the Company's President
since its inception in 1986.
Michael J. Viveiros 48 President of the Company since February 1997, having previously served 1986
as Vice President since the Company's inception in 1986.
Brian L. Burton 63 Business Consultant and Executive Vice President and Chief Financial 1998
Officer of KST Coatings Manufacturing, Inc. since 2002, a manufacturer
of roofing products. Prior thereto, Mr. Burton was President of
Vertical Merchandising Systems, a distributor of impulse merchandising
systems to supermarkets, for over five years.
Ivan J. Winfield 69 Associate Professor at Baldwin-Wallace College, Cleveland, Ohio, and 1998
business consultant since 1995. Prior thereto, Mr. Winfield was
Managing Partner of Coopers & Lybrand, Cleveland, Ohio from 1978 to
1994. He is a director of Boykin Lodging Co. and HMI Industries, Inc.
Robert A. Glick 57 Chairman and Chief Executive Officer of Dots, LLC., a retailer of 2001
women's apparel. He is a director of the National Retail Federation and
Chairman of the Advisory Board of the Shannon Rodgers and Jerry
Silverman School of Fashion Design and Merchandising at Kent State
University.
S. Robert Harris 56 Chief Operating Officer of the Company since May 2003, having N/A
previously served as Regional Supervisor since joining the Company in
January 2003. Prior thereto, Mr. Harris served as Chairman and Chief
Executive Officer of Texas Shamrock Homes, a retailer of manufactured
housing in Texas.
Michael A. Pecchia 43 Chief Financial Officer of the Company since February 1997, having N/A
previously served as Treasurer since June 1991.
21
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE OFFICERS' COMPENSATION
The following table sets forth certain information with respect to the
compensation earned during the years ended December 31, 2003, 2002 and 2001,
respectively, by the Chief Executive Officer and all other named Executive
Officers of the Company whose annual salary and bonus exceeded $100,000:
SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation
-------------------------------------- ------------------------------
Other Annual Option All Other
Name and Principal Position Year Salary Bonus Compensation(1) Awards(#) Compensation(2)
---- ------ ----- --------------- --------- ---------------
Wayland J. Russell 2003 $322,008 $58,879 $33,894 0 $ 6,348
Chief Executive Officer 2002 322,563 58,724 41,978 0 6,727
2001 322,008 50,000 21,258 0 9,805
S. Robert Harris 2003 153,545 0 10,561 40,000 1,990
Chief Operating Officer
Michael J. Viveiros 2003 219,000 44,637 16,317 0 2,168
President 2002 223,277 43,850 23,619 0 2,595
2001 243,000 44,000 17,197 0 3,827
Michael A. Pecchia 2003 140,000 18,750 19,320 0 243
Secretary and 2002 125,000 18,750 18,577 0 243
Chief Financial Officer 2001 125,000 18,750 19,602 0 1,237
Lawrence S. Hendricks (3) 2003 81,000 18,750 13,110 0 1,805
Chief Operating Officer 2002 243,243 37,500 21,903 0 2,340
2001 243,000 41,600 13,994 0 3,557
(1) Includes the value of perquisites reported as taxable wages, including
for 2003 amounts for the Company's annual business meeting, personal use of
automobiles, country clubs, professional services and other miscellaneous items.
For Messrs. Russell, Harris, Viveiros, Pecchia and Hendricks the value of the
foregoing perquisites were as follows: annual business meeting -- $7,100,
$3,470, $5,742, $4,204 and $6,492, respectively; automobile -- $9,769, $3,103,
$6,605, $8,272 and $321, respectively; country club -- $7,707, $3,418, $0,
$6,640 and $3,322, respectively; professional services -- $9,318, $0, $2,169, $0
and $2,975, respectively; and other miscellaneous items -- $0, $570, $1,801,
$204 and $0, respectively. Also included for Mr. Hendricks is severance related
compensation -- $11,536.
(2) Included in this column are amounts paid by the Company for life
insurance coverage for the benefit of the Executive Officers. Life insurance
premiums paid on behalf of Messrs. Russell, Harris, Viveiros, Pecchia and
Hendricks were $6,348, $1,990, $2,168, $243, and $1,805, respectively.
(3) In May 2003 Mr. Hendricks retired as the Company's Chief Operating
Officer, in which he received a severance agreement that paid him $149,536
through December 31, 2003.
STOCK OPTIONS
The table below provides information concerning individual grants of
stock options made during 2003 to each of the Company's executive officers named
in the Summary Compensation Table. The Company has never granted any stock
22
appreciation rights. Unless otherwise indicated, the exercised prices represent
the fair market value of the common stock on the grant date.
The amounts shown as potential realizable value represent hypothetical
gains that could be achieved for the respective options if exercised at the end
of the option term. These amounts represent certain assumed rates of
appreciation in the value of the Company's common stock. The 5% and 10% assumed
annual rates of compounded stock price appreciation are mandated by rules of the
Securities and Exchange Commission and do not represent the Company's estimate
or projection of the future price of its common stock. The potential realizable
value is calculated based on the ten-year term of the option at its time of
grant. It is calculated based on the assumption that the Company's common stock
appreciates at the indicated annual rate compounded annually for the entire term
of the option and that the option is exercised and sold on the last day of its
term for the appreciated stock price. Actual gains, if any, on stock option
exercises depend on the future performance of the Company's common stock. The
amounts reflected in the table may not necessarily be achieved.
The Company granted these options under its 1998 Stock Option Plan.
Each option has a maximum of ten years, subject to earlier termination if the
optionee's services are terminated. The percentage of total options granted to
the Company's employees in the last fiscal year is based on options to purchase
the aggregate of 129,500 shares of common stock granted during 2003. The
following table sets forth information concerning the individual grants to each
of the Company's named executive officers in 2003.
OPTION GRANTS IN 2003
Number of Individual Grants Potential Realizable Value
Securities Percent of Total of Assumed Annual Rates
Underlying Options Granted of Stock Price Appreciation
Options to Employees in Exercise for Option Term
Granted Fiscal 2003 Price Expiration ----------------------------
Name (1) (#) (2) (%) Per Share Date 5% 10%
- -----------------------------------------------------------------------------------------------------------------------------
S. Robert Harris 10,000 7.7 $5.24 4/1/2013 $ 32,954 $ 83,512
S. Robert Harris 30,000 23.2 $5.35 5/14/2013 $100,938 $255,795
(1) No other executive officers in the Summary Compensation Table were granted
stock options in 2003.
(2) Unless otherwise noted, 33 1/3 of these shares vest after one year of
service from the date of the grant, and the remaining options vest in two
equal annual installments thereafter. Each option expires on the earlier of
ten years from the date of grant or within a specified period following
termination of the optionee's employment with the Company.
Shown below is information with respect to the unexercised options to
purchase the Company's Common Shares under the Company's Stock Option Plan held
by the Executive Officers listed in the Summary Compensation Table at December
31, 2003. None of the Executive Officers listed in the Summary Compensation
Table exercised any stock options during 2003.
Number of Securities Value of Unexercised
Shares Underlying Unexercised In-the-Money Options
Acquired Value Options at 12/31/03 (#) at 12/31/03 ($) (1)
on Exercise Realized -------------------------------------------------------------
Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------
Wayland J. Russell 0 0 0 0 0 0
Michael J. Viveiros 0 0 0 0 0 0
S. Robert Harris 0 0 0 40,000 0 $91,100
Michael A. Pecchia 0 0 60,000 0 0 0
Lawrence S. Hendricks 0 0 0 0 0 0
(1) Calculated in the basis of the fair market value of the underlying
securities at December 31, 2003, minus the exercise price.
23
On May 5, 2003, the Company entered into a severance agreement and
mutual release with Lawrence S. Hendricks, the Company's former Chief Operating
Officer. Under the agreement, the Company agreed to pay an aggregate of
$280,500, an amount representing one year's salary and bonus, over a twelve
monthly period. In addition, the Company agreed to continue certain fringe
benefits, including insurance and country club dues, for a one-year period and
payment of Mr. Hendricks car lease for a two-year period. The severance payment
was to continue for a second year, in the event, Mr. Hendricks (i) failed to
gain full time employment either with a new employer or through commencement of
a substantial business venture; provided that there was no "change-in-control"
of the Company. Mr. Hendricks has commenced a new business venture that will
result in the Company having no obligation to make the second year severance
payment. Moreover, the Company's obligation to continue severance payments
terminates on the effective date of the purchase of the Company by
Rent-A-Center.
24
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as March 1, 2004 or as
of the date specified, with respect to the beneficial ownership of the Common
Shares. Unless otherwise indicated below, the persons named below have the sole
voting and investment power with respect to the number of Common Shares set
forth opposite their names. All information with respect to beneficial ownership
has been furnished by the respective Director, Officer or 5% or greater
shareholder, as the case may be.
Names and, where necessary, Number of Shares Ownership
addresses of Beneficial Owners (1) Beneficially Owned Percentage
- ------------------------------ ------------------ ----------
Wayland J. Russell 2,536,675 42.7%
Michael J. Viveiros 255,620 4.3%
S. Robert Harris 3,334 (2)
Michael A. Pecchia 60,000 (3) 1.0%
Ivan J. Winfield 12,000 (4) *
Brian L. Burton 15,000 (4) *
Robert A. Glick 7,667 (5) *
Wasatch Advisors, Inc. 951,301 (6) 16.0%
150 Social Hall Ave.
Salt Lake City, UT 84111
Lawrence S. Hendricks
550 Boardman-Poland Road 548,240 9.2%
Boardman, Ohio 44512
Aaron Rents, Inc. 474,500 (7) 8.0%
309 E. Paces Ferry Road
Atlanta, GA 30305-2377
All Directors and Executive Officers
of the Company (7 Persons) 2,890,296 (8) 47.9%
- ------------------------------
*Less than one percent
(1) Unless otherwise indicated, the address of all persons listed above is
c/o Rainbow Rentals, Inc., 3711 Starr Centre Drive, Canfield, Ohio
44406.
(2) Includes 3,334 shares subject to options that are currently
exercisable.
(3) Includes 60,000 shares subject to options that are currently
exercisable.
(4) Includes 10,000 shares subject to options that are currently
exercisable.
(5) Includes 6,667 shares subject to options that are currently
exercisable.
(6) As of December 31, 2003, based on a Schedule 13G filed with the SEC on
February 18, 2004.
(7) Based on a Schedule 13D, as amended, filed with the SEC on January 22,
2003.
(8) Includes 90,001 shares subject to options that are currently
exercisable.
25
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Act of 1934 requires the Company's
Directors, Executive Officers and persons who own 10% or more of the Company's
Common Shares to file reports of ownership and changes of ownership with the
Securities and Exchange Commission and the Company. Based upon a review of these
filings and written representations from such individuals, the Company
understands that all such filers have adhered to all applicable filing
requirements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CERTAIN TRANSACTIONS
The Company's headquarters facility is leased from an entity owned by
Messrs. Russell, Hendricks and Viveiros under a ten-year triple-net lease, with
three two-year options. In 2003, the rental amount was $130,000. The Company
believes that the rental is at market rates and that the other provisions of the
lease are on terms no less favorable to the Company than could be obtained from
unrelated parties.
An amendment to the lease relating to the Company's headquarters has
been executed providing for (i) a payment by the acquiror (Rent-A-Center, or
"RAC") of $100,000 to the lessor and (ii) RAC's agreement to abandon to lessor
all furniture, fixtures and equipment not related to the rent-to-own business,
in exchange for an early termination of the lease. In lieu of expiring on
January 31, 2006, the lease will now expire ninety days after the Effective Date
of the Merger.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During 2003, the Company retained its independent public accountants,
KPMG LLP, to provide services in the following categories and amounts:
2003 2002
---------- ----------
Audit Fees $ 165,000 $ 133,000
Tax Fees 5,000 2,000
---------- ----------
Total $ 170,000 $ 135,000
========== ==========
Audit Fees. This category relates to services rendered in connection
with the audits of the Company's annual financial statements for the years ended
December 31, 2003 and 2002, for the reviews of the financial statements included
in the Company's quarterly reports on Form 10-Q during 2003 and 2002 and for
services that are normally provided by independent public accountants in
connection with statutory and regulatory filings or engagements for the relevant
years.
Tax Fees. This category includes the aggregate fees billed in each of
the last two years for professional services rendered by the independent public
accountants for tax compliance. Such tax compliance services consisted of
assistance with federal income tax returns.
The Audit Committee has considered the compatibility of the non-audit
services performed by and fees paid to KPMG LLP in 2003 and determined that such
services and fees were compatible with the independence of the public
accountants. During 2003, KPMG LLP did not utilize any personnel in connection
with the audit other than its full-time, permanent employees.
All services provided by the Company's independent public accountants,
both audit and non-audit, must be pre-approved by the Audit Committee. The
Chairman of the Audit Committee has the authority to approve any additional
audit services and permissible non-audit services, provided the Chairman informs
the Audit Committee of such approval at its next regularly scheduled meeting.
26
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements:
Independent Auditors' Report 28
Consolidated Balance Sheets as of December 31, 2003 and 2002 29
Consolidated Statements of Income for the Years Ended
December 31, 2003, 2002 and 2001 30
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001 31
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001 32
Notes to Consolidated Financial Statements 33
(a) (2) Financial Statement Schedules:
All financial statement schedules have been omitted because
they are not applicable or because required information is
included in the Company's consolidated financial statements
and notes thereto.
(a) (3) Exhibits:
See the Index to Exhibits included on page 45.
(b) Reports on Form 8-K:
Report on Form 8-K dated October 29, 2003 to report the
results of operations for the three and nine months ended
September 30, 2003.
Report on Form 8-K dated February 4, 2004 to announce a
definitive merger agreement between the Company and
Rent-A-Center, Inc.
27
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Rainbow Rentals, Inc.:
We have audited the accompanying consolidated balance sheets of Rainbow
Rentals, Inc. as of December 31, 2003 and 2002, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the years
in the three-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Rainbow
Rentals, Inc. as of December 31, 2003 and 2002, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
/s/ KPMG LLP
- -----------------
KPMG LLP
Cleveland, Ohio
February 26, 2004
28
RAINBOW RENTALS, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31,
------------------------
2003 2002
-------- --------
ASSETS
Current assets
Cash and cash equivalents $ 669 $ 1,080
Rental-purchase merchandise, net 40,545 39,342
Income tax receivable - 939
Prepaid expenses and other current assets 2,264 1,926
-------- --------
Total current assets 43,478 43,287
Property and equipment, net 6,374 5,558
Deferred income taxes 4,230 1,989
Goodwill 9,236 9,236
Other assets, net 333 843
-------- --------
Total assets $ 63,651 $ 60,913
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Deferred revenue $ 1,075 $ 1,215
Accounts payable 1,550 2,175
Accrued compensation and related costs 2,971 2,402
Other liabilities and accrued expenses 3,209 2,403
Deferred income taxes 8,888 6,343
-------- --------
Total current liabilities 17,693 14,538
Long-term debt 6,154 7,550
Minority interest 83 -
-------- --------
Total liabilities 23,930 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, 5,931,819 outstanding at December 31,
2003 and 5,929,319 outstanding at December 31, 2002 11,039 11,039
Additional paid-in capital 11 4
Retained earnings 30,553 29,674
Treasury stock, at cost, 460,791 shares at December 31, 2003
and 463,291 shares at December 31, 2002 (1,882) (1,892)
-------- --------
Total shareholders' equity 39,721 38,825
-------- --------
Total liabilities and shareholders' equity $ 63,973 $ 60,913
======== ========
See accompanying notes to consolidated financial statements.
29
RAINBOW RENTALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
------------------------------------------------------
2003 2002 2001
----------- ----------- -----------
Revenues
Rental revenue $ 96,826 $ 93,239 $ 88,770
Fees 2,679 2,728 2,697
Merchandise sales 3,168 3,300 3,088
----------- ----------- -----------
Total revenues 102,673 99,267 94,555
Operating expenses
Merchandise costs 33,346 33,995 33,310
Store expenses
Salaries and related 26,849 24,393 22,713
Occupancy 10,022 9,480 8,607
Advertising 6,884 6,167 5,928
Other expenses 14,397 13,494 13,258
----------- ----------- -----------
Total store expenses 58,152 53,534 50,506
----------- ----------- -----------
Total merchandise costs and store expenses 91,498 87,529 83,816
General and administrative expenses 8,765 7,706 7,160
Amortization of intangibles 160 175 689
----------- ----------- -----------
Total operating expenses 100,423 95,410 91,665
----------- ----------- -----------
Operating income 2,250 3,857 2,890
Interest expense 570 632 689
Other expense, net 227 228 227
----------- ----------- -----------
Income from continuing operations,
before income taxes 1,453 2,997 1,974
Income tax expense 574 1,184 800
----------- ----------- -----------
Income from continuing operations 879 1,813 1,174
Discontinued operations
Loss from operations of discontinued store,
including loss on disposal, net of tax - (172) -
----------- ----------- -----------
Net income $ 879 $ 1,641 $ 1,174
=========== =========== ===========
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Basic earnings per share from continuing operations $ 0.15 $ 0.31 $ 0.20
Basic loss per share from discontinued operations - (0.03) -
----------- ----------- -----------
Basic earnings per share $ 0.15 $ 0.28 $ 0.20
=========== =========== ===========
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Diluted earnings per share from continuing operations $ 0.15 $ 0.31 $ 0.20
Diluted loss per share from discontinued operations - (0.03) -
----------- ----------- -----------
Diluted earnings per share $ 0.15 $ 0.28 $ 0.20
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 5,929,435 5,928,006 5,925,735
=========== =========== ===========
Diluted 5,940,598 5,940,606 5,940,999
=========== =========== ===========
PRO FORMA NET INCOME DATA:
Net income as reported $ 879 $ 1,641 $ 1,174
Pro forma adjustment for goodwill amortization, net of tax - - 312
----------- ----------- -----------
Pro forma net income $ 879 $ 1,641 $ 1,486
=========== =========== ===========
PRO FORMA EARNINGS PER COMMON SHARE:
Basic $ 0.15 $ 0.28 $ 0.25
=========== =========== ===========
Diluted $ 0.15 $ 0.28 $ 0.25
=========== =========== ===========
See accompanying notes to consolidated financial statements.
30
RAINBOW RENTALS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
----------------------------------------------------------------------------------------------
COMMON STOCK TOTAL
------------ ADDITIONAL RETAINED TREASURY SHAREHOLDERS'
SHARES COST PAID-IN CAPITAL EARNINGS STOCK EQUITY
------ ---- --------------- -------- ----- ------
Balance at December 31, 2000 5,925,735 $ 11,039 $ - $ 26,859 $ (1,907) $ 35,991
Net income - - - 1,174 - 1,174
---------- --------------- -------------- -------------- ----------- ----------
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
Exercise of stock options 2,500 - 7 - 10 17
Net income - - - 879 - 879
---------- --------------- -------------- -------------- ----------- ----------
Balance at December 31, 2003 5,931,819 $ 11,039 $ 11 $ 30,553 $ (1,882) $ 39,721
========== =============== ============== ============== =========== ==========
See accompanying notes to consolidated financial statements.
31
RAINBOW RENTALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
-------- -------- --------
Cash flows from operating activities
Income from continuing operations $ 879 $ 1,813 $ 1,174
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 2,444 2,480 2,990
Depreciation and write-down of rental-purchase merchandise 26,550 27,635 26,950
Purchases of rental-purchase merchandise (34,847) (34,030) (36,169)
Rental-purchase merchandise disposed, net 7,094 6,511 6,414
Deferred income taxes 304 1,924 212
Write-off of goodwill from sale of store - - 260
(Gain) loss on disposal of assets (3) 128 (100)
(Increase) decrease in
Income tax receivable 939 (826) 778
Prepaid expenses and other assets (330) 296 (450)
Increase (decrease) in
Accounts payable (625) (1,742) 1,514
Accrued income taxes - (306) 306
Accrued compensation and related costs 569 320 557
Deferred revenue and other liabilities and accrued expenses 666 210 840
-------- -------- --------
Net cash provided by operating activities of continuing operations 3,640 4,413 5,276
Net cash used in operating activities of discontinued operations - (197) -
-------- -------- --------
Net cash provided by operating activities 3,640 4,216 5,276
-------- -------- --------
Cash flows from investing activities
Purchase of property and equipment, net (2,290) (2,494) (2,017)
Proceeds from the sale of assets 39 98 349
Cash from consolidation of Rainbow Properties, Ltd. 8 - -
Acquisitions - (315) (245)
-------- -------- --------
Net cash used in investing activities of continuing operations (2,243) (2,711) (1,913)
Net cash used in investing activities of discontinued operations - (58) -
-------- -------- --------
Net cash used in investing activities (2,243) (2,769) (1,913)
-------- -------- --------
Cash flows from financing activities
Proceeds from long-term debt 30,475 35,164 27,070
Current installments and repayments of long-term debt (32,300) (37,054) (29,970)
Proceeds from stock option exercises 17 19 -
Loan fees paid - (335) (50)
-------- -------- --------
Net cash used in financing activities (1,808) (2,206) (2,950)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (411) (759) 413
Cash and cash equivalents at beginning of period 1,080 1,839 1,426
-------- -------- --------
Cash and cash equivalents at end of period $ 669 $ 1,080 $ 1,839
======== ======== ========
Supplemental cash flow information
Net cash paid (received) during the period for
Interest $ 469 $ 488 $ 694
Income taxes (730) 560 (348)
See accompanying notes to consolidated financial statements.
32
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of Rainbow Rentals, Inc. ("Rainbow"
or "Company"), which are summarized below, are consistent with accounting
principles generally accepted in the United States of America and reflect
practices appropriate to the industry in which the Company operates.
The Company is engaged in the rental and sale of home electronics,
furniture, appliances, and computers to the general public. At December 31,
2003, Rainbow operated 125 stores in 15 states: Connecticut, Georgia, Indiana,
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.
PRINCIPLES OF CONSOLIDATION: The Company's financial statements include
the accounts of Rainbow Rentals, Inc. and Rainbow Properties, Ltd., a variable
interest entity.
VARIABLE INTEREST ENTITIES: During the fourth quarter of the year
ended December 31, 2003, the Company adopted FASB Interpretation No. 46 and
No. 46 Revised (FIN 46), Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. FIN 46 addresses consolidation by business
enterprises of variable interest entities (VIE's) that do not have sufficient
equity investment at risk to permit the entity to finance its activities
without subordinated financial support or which the equity investors lack an
essential characteristic of a controlling financial interest. The Company has
one VIE, Rainbow Properties, Ltd., which is a special purpose entity.
Rainbow Properties, Ltd. ("LLC") is majority-owned by two of the
Company's officers and directors and primarily consists of land, building and
the related debt. The building is leased to the Company as an operating lease
and houses the Company's corporate headquarters. All the assets and liabilities
of the LLC are used for the purpose of operating the building. The two officers
of the Company that own the majority of the LLC have personally guaranteed the
debt. The LLC meets the criteria of a variable interest entity as the related
party relationship creates the presumption that the Company has provided an
implicit guarantee of the officers' investments and of the officers' personal
guarantees. The implicit guarantee is the Company's variable interest, and the
Company is considered the primary beneficiary of the LLC as the activities of
the LLC are most closely associated with the Company.
As the Company is considered the primary beneficiary of the LLC, the
assets and liabilities of the LLC are included in the Company's consolidated
balance sheet. The difference between the assets and liabilities of the LLC is
considered a minority interest of the Company of $83. As of December 31, 2003,
the balance sheet of the LLC consisted of cash, property and equipment and debt
of $8, $504 and $429, respectively.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash and
money market funds with original maturities of three months or less at the date
of purchase.
RENTAL-PURCHASE MERCHANDISE: Rental-purchase merchandise consists of
merchandise rented to customers or in the stores available for rent or sale.
Merchandise is rented to customers pursuant to rental-purchase agreements, which
generally provide for weekly or monthly rental terms with rental renewal
payments collected in advance. The customers may terminate the rental-purchase
agreements at any time, at which time the merchandise is returned to the
Company.
Rental-purchase merchandise is stated at historical cost, net of
accumulated depreciation. The Company depreciates inventory on rent using the
units of activity method. Under the units of activity method, merchandise on
rent is depreciated in the proportion of rents earned to total expected rents to
be provided over the rental contract term. The Company believes the units of
activity method more accurately matches the recognition of depreciation expense
with the estimated timing of revenue earned over the rental-purchase agreement
period. The units of activity method is recognized in the rental-purchase
industry and does not consider salvage value. In addition, the Company
depreciates certain older rental-purchase merchandise held for rent over its
remaining useful life.
The Company monitors the value of rental-purchase merchandise for
possible impairment. An impairment loss is recognized when the carrying amounts
cannot be recovered by the estimated undiscounted cash flows they will receive.
PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost,
net of accumulated depreciation. Depreciation is computed using the
straight-line method over the estimated useful lives of the respective assets,
which range from three to five years for personal property and thirty-nine years
for real estate. Leasehold improvements are amortized over the shorter of the
term of the applicable leases or useful life of the assets.
GOODWILL: Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 establishes accounting and reporting standards for acquired
goodwill and other intangible assets in that goodwill and other intangible
assets that have indefinite useful lives will not be amortized but rather will
be tested at least annually for impairment, or more frequently if events or
changes in circumstances indicate that the carrying value may not be
recoverable. Intangible assets that have finite useful lives will continue to be
amortized over their useful lives. For the year ended December 31, 2001,
earnings per diluted share of $0.20 included goodwill amortization of $312, net
of tax. Amortization expense related to goodwill was $525 for the year ended
December 31, 2001.
Under SFAS No. 142, the Company was required to test all existing
goodwill for impairment as of January 1, 2002, on a "reporting unit" basis. A
fair value approach is used to test goodwill for impairment. An impairment
charge is recognized for the amount, if any, by which the carrying amount of
goodwill exceeds its implied fair value. The fair value of a reporting unit and
the related implied fair value of the respective goodwill were established using
comparative market multiples.
33
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In January 2002, the Company completed the transitional goodwill
impairment test in accordance with SFAS No. 142, which resulted in no impairment
charge. The Company performed the annual impairment test as of November 30, 2003
and 2002, resulting in no impairment.
OTHER ASSETS: Other assets consist primarily of noncompete agreements
and loan fees. These costs are amortized over their respective agreement lives.
LONG-LIVED ASSETS: In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the Company evaluates all
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amounts may not be recoverable. Impairment is
recognized when the carrying amounts of such assets cannot be recovered by the
undiscounted net cash flows they are expected to generate.
RENTAL REVENUE: Merchandise is rented to customers pursuant to
rental-purchase agreements, which generally provide for weekly or monthly rental
terms. Rental revenue is recognized over the lease term. Deferred revenue is
recognized for cash received for which revenue is not yet earned. A customer may
elect to renew the rental-purchase agreement for a specified number of
continuous terms and has the right to acquire title either through payment of
all required rentals or through an early purchase option. Amounts received from
such early purchase options, as well as sales of new and used merchandise
available for rent in the stores, are included in merchandise sales.
STOCK-BASED COMPENSATION: The Company has elected to apply Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25), and related interpretations in accounting for its stock-based compensation.
In addition, the disclosures required under SFAS No. 123, Accounting for
Stock-Based Compensation are contained below and in Note 12 to the financial
statements.
Pro forma information for net income and basic and diluted earnings per
common share is required by SFAS No. 123 and has been determined as if the
Company had accounted for its stock options under the fair value method of that
statement. The weighted average fair value of stock options granted during 2003,
2002 and 2001 was $3.08, $4.66 and $3.15 per share, respectively. The fair value
for these stock options was estimated at the date of grant using the
Black-Scholes option-pricing model using the following assumptions for 2003,
2002 and 2001:
2003 2002 2001
-------- -------- ------
Risk-free interest rate 4.16% 4.42% 4.25%
Expected life of options 7.1 years 7.8 years 7 years
Expected stock price volatility 44% 60% 55%
Dividend yield 0% 0% 0%
The Company did not recognize any compensation expense related to the
issuance of stock options during the years ended December 31, 2003, 2002 and
2001. Had compensation cost for stock options been measured using SFAS No. 123,
the pro forma amounts for the years ended December 31, 2003, 2002 and 2001 are
indicated below.
2003 2002 2001
- ------------------------------------------------------------------------------------------
Net income
As reported $ 879 $ 1,641 $ 1,174
Pro forma 726 1,444 923
Basic and diluted earnings per common share
As reported 0.15 0.28 0.20
Pro forma 0.12 0.24 0.16
ADVERTISING COSTS: Costs incurred for producing and communicating
advertising are charged to expense the first time advertising takes place.
INCOME TAXES: Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
EARNINGS PER COMMON SHARE: Basic earnings per common share are based on
the weighted average number of common shares outstanding during each year.
Diluted earnings per common share are based on the weighted average number of
common shares outstanding during each year, plus the assumed exercise of stock
options.
34
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
USE OF 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 based on available
information. These estimates and assumptions affect the amounts reported in the
financial statements and the disclosures provided.
RECLASSIFICATIONS: Certain reclassifications have been made to prior
years financial data in order to conform to the 2003 presentation.
(2) ACQUISITIONS
During the years ended December 31, 2002 and 2001, the Company made
acquisitions of stores, rental purchase merchandise and rental purchase
agreements. All acquisitions made were accounted for using the purchase method
of accounting. Accordingly, all identifiable tangible and intangible assets were
recorded at their estimated fair market value at the date of acquisition. The
excess of the acquisition cost over the estimated fair value of the net assets
acquired was recorded as goodwill and is being assessed for impairment annually.
Assets acquired, other than goodwill, consisted primarily of rental-purchase
merchandise, property and equipment, non-compete agreements and other intangible
assets such as customer lists.
Acquisition activity for the years ended December 31, 2003, 2002 and
2001 is as follows:
2003 2002 2001
- --------------------------------------------------------------------------
Goodwill $ -- $ 138 $ 93
Rental-purchase merchandise -- 127 127
Other -- 50 25
------ ------ ------
Purchase price $ -- $ 315 $ 245
====== ====== ======
(3) RENTAL-PURCHASE MERCHANDISE
Following is a summary of rental-purchase merchandise at December 31,
2003 and 2002:
2003 2002
- ------------------------------------------------------------------------------
On rent
Original cost $ 59,666 $ 58,091
Less accumulated depreciation 27,568 27,131
--------- ---------
32,098 30,960
Held for rent
Original cost 11,944 12,150
Less accumulated depreciation 3,497 3,768
--------- ---------
8,447 8,382
--------- ---------
Total rental purchase merchandise, net $ 40,545 $ 39,342
========= =========
35
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(4) PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following at December 31, 2003
and 2002:
2003 2002
- --------------------------------------------------------------------------------
Land $ 169 $ -
Buildings 425 -
Vehicles 284 286
Leasehold improvements 10,088 8,656
Computer equipment 1,805 1,574
Office equipment 3,551 3,193
------- ----------
16,322 13,709
Less accumulated depreciation 9,948 8,151
------- ----------
$ 6,374 $ 5,558
======= ==========
(5) 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 rental purchase merchandise, less outstanding letters of
credit, which totaled $2.9 million at December 31, 2003. Excess availability at
December 31, 2003 was approximately $4.4 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
December 31, 2003, the outstanding loan balance totaled $5.7 million with a
weighted average interest rate of 5.78%. Long-term debt also included $429 in
mortgage debt from the consolidation of Rainbow Properties, Ltd., a variable
interest entity, with an interest rate of 8.0%. The above outstanding loans
mature in 2005.
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 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. At December 31, 2003, the Company was in compliance
with the covenants and financial reporting requirements.
(6) RELATED PARTY TRANSACTIONS
The building that serves as Rainbow's corporate office is leased from
Rainbow Properties, Ltd. ("LLC"), the variable interest entity owned by Messrs.
Russell, Hendricks and Viveiros, two of who are executive officers of the
Company. The Company entered into a 10-year building lease agreement, expiring
January 2006, at a rental rate that approximates market rates. However, on
February 19, 2004, the LLC and the Company entered into a lease termination
agreement contingent upon the completion of the Merger Agreement with
Rent-A-Center, dated February 4, 2004. If the Merger Agreement with
Rent-A-Center is completed, the Company's lease obligation will cease 90 days
after the Merger completion date.
Rent paid to the partnership in 2003, 2002 and 2001 was $130, $126 and
$121, respectively. The future minimum lease payments under this lease are
included in the total lease obligations disclosed in Note 9.
36
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(7) INCOME TAXES
The provision for income taxes for the years ended December 31, 2003,
2002 and 2001 consists of the following components:
2003 2002 2001
- ----------------------------------------------------------------------
Current
Federal $ - $ (816) $ 467
State and local 270 76 121
------ ------- -------
270 (740) 588
Deferred
Federal 497 1,798 205
State and local (193) 126 7
------ ------- -------
304 1,924 212
------ ------- -------
Income tax expense $ 574 $ 1,184 $ 800
====== ======= =======
A reconciliation between income tax expense reported and income tax
expense computed by applying the federal statutory rate is as follows:
2003 2002 2001
- ------------------------------------------------------------------------------------
Income from continuing operations, $ 1,453 $ 2,997 $ 1,974
before income taxes
Federal statutory tax rate 34% 34% 34%
------- ------- ------
494 1,019 671
State and local income taxes, net of
Federal income tax benefit 51 133 84
Meals and entertainment and officers'
life insurance premiums 28 22 19
Other 1 10 26
------- ------- ------
$ 574 $ 1,184 $ 800
======= ======= ======
37
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The tax effects of principal temporary differences and the resulting
deferred tax assets and liabilities at December 31, 2003 and 2002 are as
follows:
2003 2002
-------- --------
Deferred tax assets
Property and equipment $ 1,109 $ 1,369
Intangibles 516 428
Employee benefit programs 341 256
Charitable contributions 329 258
Minimum tax credits 280 280
Net operating loss carryforward 1,995 -
Other 8 22
-------- --------
Total deferred tax assets 4,578 2,613
Deferred tax liabilities
Rental purchase merchandise (8,567) (6,621)
Intangibles (642) (346)
Other (27) -
-------- --------
Total deferred tax liabilities (9,236) (6,967)
-------- --------
Net deferred tax liability $ (4,658) $ (4,354)
======== ========
For the years ended December 31, 2003 and 2002, deferred tax assets of
$348 and $278, respectively, were classified as current and were netted with the
deferred tax liability.
At December 31, 2003, the Company had a net operating loss carryforward
(NOL) of approximately $5.9 million and an alternative minimum tax credit
carryforward of $280. The NOL will expire in 2023 if the Company is unable to
use the amounts to offset taxable income in the future. The alternative minimum
tax credit carryforward does not have an expiration date. No valuation allowance
was considered for the years ended December 31, 2003 and 2002 as management
expects to generate future taxable income to utilize these amounts.
(8) DISCONTINUED OPERATIONS
The Company adopted SFAS No. 144, which superceded the accounting and
reporting provisions of APB Opinion 30, Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144
establishes a single accounting model for long-lived assets to be disposed of by
sales and broadens the presentation of an entity (rather than segment of a
business). A component of an entity comprises of operations and cash flows that
can be clearly distinguished from the rest of the entity. SFAS No. 144 also
requires that discontinued operations be measured at the lower of the carrying
amount or fair value, less cost to sell. The adoption of SFAS No. 144 resulted
in the Company having a discontinued operation as a result of the sale of its
Newark, Delaware store. There are no restatements necessary for 2003 and 2001
since the Company opened and sold this store in 2002.
38
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Operating results of discontinued operations were as follows for the
year ended December 31, 2002:
DECEMBER 31,
2002
------------
Total revenues $ 41
Operating expenses
Merchandise costs 10
Store expenses
Salaries and related 56
Occupancy 41
Advertising 48
Other expenses 35
------
Total store expenses 180
------
Total merchandise costs and store expenses 190
------
Operating loss before income taxes (149)
Income tax benefit (59)
------
Net loss from discontinued store (90)
Loss on disposal of discontinued store, net of tax (82)
------
Net loss from discontinued operations $ (172)
======
Basic and diluted loss per share from
discontinued operations $(0.03)
======
(9) LEASES
The Company operates its retail stores and offices under noncancelable
operating leases with terms extending to 2010 with additional option periods
renewable at the request of the Company. The Company also leases its delivery
and general use vehicles under operating lease arrangements. Rental expense
charged to operations totaled $9,078, $8,987 and $8,133 for the years ended
December 31, 2003, 2002 and 2001, respectively. Future minimum lease payments
under noncancelable operating leases (with initial or remaining lease terms in
excess of one year) as of December 31, 2003 are as follows:
Year ending December 31,
- ----------------------------
2004 $ 8,805
2005 6,881
2006 4,676
2007 2,807
2008 1,661
Thereafter 609
--------
Total minimum lease payments $ 25,439
========
39
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(10) RETIREMENT PLAN
The Company maintains a qualified defined contribution retirement plan
under Section 401(k) of the Internal Revenue Code. The plan, which covers
substantially all employees, provides for the Company to make discretionary
contributions based on salaries of eligible employees plus additional
contributions based upon voluntary employee salary deferrals. Payments upon
retirement or termination of employment are based on vested amounts credited to
individual accounts. During 2003, 2002 and 2001, the Company contributed $32,
$23 and $32, respectively.
(11) OTHER ASSETS
Following is a summary of other assets, net of accumulated
amortization:
2003 2002
------ ------
Non-compete agreements, net $ 188 $ 576
Loan fees, net 111 223
Deposits and other 34 44
------ ------
Other assets, net $ 333 $ 843
====== ======
Amortization expense related to other assets totaled $500, $530 and
$448 respectively, for the years ended December 31, 2003, 2002 and 2001.
Estimated amortization expense of non-compete agreements and loan fees are $262,
$32, $4 and $1 for the years ended December 31, 2004, 2005, 2006 and 2007,
respectively.
(12) STOCK OPTION PLAN
Rainbow sponsors a stock option and incentive plan for the benefit of
the employees and directors of the Company. A total of 600,000 shares of common
stock have been reserved under the plan, which provides for the grant of
options, which may qualify as either incentive stock options or nonqualified
stock options. Because all stock options were granted with an exercise price
equal to the market price on the date of grant, no compensation expense has been
recognized, consistent with the provisions of APB 25. Stock options granted
become exercisable over a three or four-year vesting period and expire ten years
from the date of grant.
Following is activity under the plan during the years ended December
31, 2003, 2002 and 2001:
2003 2002 2001
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------------- ------------------- -------------------
Outstanding, beginning of year 522,366 $ 8.30 425,800 $ 8.58 359,800 $ 9.79
Granted 129,500 5.88 114,500 6.92 121,000 5.24
Exercised (2,500) 6.97 (3,584) 5.05 - -
Forfeited (66,332) 6.72 (14,350) 6.39 (55,000) 9.21
------- ------- -------
Outstanding, end of year 583,034 $ 7.95 522,366 $ 8.30 425,800 $ 8.58
======= ======== ======= ======== ======= ========
Exercisable at end of year 360,495 320,788 256,602
======= ======= =======
Available for grant at end of year 10,882 74,050 174,200
======= ======= =======
40
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ---------------------
WEIGHTED
AVERAGE WEIGHTED NUMBER OF WEIGHTED
REMAINING AVERAGE OPTIONS AVERAGE
NUMBER CONTRACTUAL EXERCISE CURRENTLY EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------ ----------------------------------- ---------------------
$5.03 - $ 5.25 86,500 7.5 $ 5.17 41,668 $ 5.15
$5.35 - $ 6.00 90,000 9.3 5.78 6,667 6.00
$6.30 - $ 7.11 94,459 8.7 6.83 20,168 6.98
$7.42 - $ 7.88 37,375 7.6 7.68 19,792 7.78
$8.88 - $ 9.25 30,000 6.1 9.00 30,000 9.00
$9.75 - $10.00 234,700 4.4 10.00 234,700 10.00
$11.63 10,000 6.5 11.63 7,500 11.63
------- -------
583,034 6.6 $ 7.95 360,495 $ 9.02
======= === ======= ======= ========
(13) 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 years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
---------- ---------- ----------
Numerator:
Net income available to common shareholders $ 879 $ 1,641 $ 1,174
Denominator:
Basic weighted average shares 5,929,435 5,928,006 5,925,735
Effect of dilutive stock options 11,163 12,600 15,264
---------- ---------- ----------
Diluted weighted average shares 5,940,598 5,940,606 5,940,999
========== ========== ==========
Basic earnings per share $ 0.15 $ 0.28 $ 0.20
========== ========== ==========
Diluted earnings per share $ 0.15 $ 0.28 $ 0.20
========== ========== ==========
41
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Stock options of 401,538, 368,225 and 334,050 shares in 2003, 2002 and
2001, respectively, were not included in computed diluted earnings per share
because their effects were anti-dilutive.
(14) COMMITMENTS AND CONTINGENCIES
The Company is subject to claims and lawsuits in the ordinary course of
its normal operations. Outstanding matters of which the Company has knowledge
are covered by insurance, or in the opinion of management, would not have a
material adverse affect on the financial position, results of operations or cash
flows of the Company.
(15) SUBSEQUENT EVENT
On February 4, 2004, Rent-A-Center, Inc. and the Company entered into a
definitive agreement pursuant to which Rent-A-Center will acquire the Company
for $16.00 in cash per share of Rainbow Rentals, Inc. common stock. The
agreement also provides that each holder of non-qualified stock options of
Rainbow Rentals, Inc. will receive an amount equal to the difference between
$16.00 per share and the exercise price of the option. The acquisition, which is
expected to be completed in the second quarter of 2004, is conditioned upon
customary closing conditions for a transaction of this nature, including the
receipt of requisite regulatory approval, approval of the Company's
shareholders and approval by the Company's primary lender. Management believes
that the Company's primary lender will approve the acquisition.
(16) GUARANTEES AND PRODUCT WARRANTIES
The Company has applied the provisions of FASB Interpretation No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others, to its agreements that contain
guarantees or indemnification clauses. These disclosure requirements expand
those required by FASB Statement No. 5, Accounting for Contingencies, by
requiring a guarantor to disclose certain types of guarantees, even if the
likelihood of requiring the guarantor's performance is remote.
The Company provides standby letters of credit through its financial
institution to certain vendors and insurance providers. If the Company is not
able to make payment, the vendors and insurance providers may draw on our
financial institution. At December 31, 2003, the maximum future payment
obligations relative to these guarantees totaled $2.9 million, and no associated
liability was recorded.
The Company provides free service on merchandise to its customers,
generally for 90 days beyond a product's rental term, which the Company records
an estimated liability for potential service calls. Estimated service calls are
based on historical factors, such as number of service calls, replacement parts
and labor costs. The Company has not experienced significant service calls for
products beyond its rental term.
42
RAINBOW RENTALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(17) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table represents certain unaudited financial information
for the periods indicated:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
Year ended December 31, 2003
Revenue $ 25,745 $ 25,775 $ 25,437 $ 25,716
Merchandise costs and store expenses 22,812 22,612 22,701 23,373
Other operating expenses 2,070 2,443 2,183 2,229
-------- -------- -------- --------
Operating income 863 720 553 114
Interest and other expenses 200 211 194 192
-------- -------- -------- --------
Operating income (loss) 663 509 359 (78)
Income tax expense (benefit) 262 201 142 (31)
-------- -------- -------- --------
Net income (loss) $ 401 $ 308 $ 217 $ (47)
======== ======== ======== ========
Basic and diluted earnings (loss) per share $ 0.07 $ 0.05 $ 0.04 $ (0.01)
======== ======== ======== ========
Year ended December 31, 2002
Revenue $ 24,965 $ 24,835 $ 24,344 $ 25,123
Merchandise costs and store expenses 22,075 21,571 21,578 22,305
Other operating expenses 1,757 2,160 2,007 1,957
-------- -------- -------- --------
Operating income (loss) 1,133 1,104 759 861
Interest and other expenses 242 224 191 203
-------- -------- -------- --------
Income from continuing operations,
before income taxes 891 880 568 658
Income taxes 360 355 209 260
-------- -------- -------- --------
Income from continuing operations 531 525 359 398
Loss on discontinued operations, net of tax (2) (49) (25) (96)
-------- -------- -------- --------
Net income $ 529 $ 476 $ 334 $ 302
======== ======== ======== ========
Basic and diluted earnings per share $ 0.09 $ 0.08 $ 0.06 $ 0.05
======== ======== ======== ========
Basic and diluted loss per share
from discontinued operations $ - $ (0.01) $ - $ (0.02)
======== ======== ======== ========
43
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.
RAINBOW RENTALS, INC.
By: /s/ WAYLAND J. RUSSELL
--------------------------------
Wayland J. Russell
Chairman and Chief Executive Officer
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 March 5, 2004.
SIGNATURES TITLE
/s/ WAYLAND J. RUSSELL Chairman, Chief Executive Officer and Director
- --------------------------
Wayland J. Russell
/s/ S. ROBERT HARRIS Chief Operating Officer
- --------------------------
S. Robert Harris
/s/ MICHAEL J. VIVEIROS President and Director
- --------------------------
Michael J. Viveiros
/s/ MICHAEL A. PECCHIA Chief Financial Officer
- --------------------------
Michael A. Pecchia
/s/ BRIAN L. BURTON Director
- --------------------------
Brian L. Burton
/s/ ROBERT A. GLICK Director
- --------------------------
Robert A. Glick
/s/ IVAN J. WINFIELD Director
- --------------------------
Ivan J. Winfield
44
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- -------- -----------------------
2.1* Agreement and Plan of Merger, dated February 4, 2004, by and among Registrant,
Rent-A-Center, Inc., and Eagle Acquisition Sub, Inc.
3.1 (1) Amended and Restated Articles of Incorporation
3.2 (1) Amended and Restated Code of Regulations
4.1 (2) Security Agreement dated as of January 11, 2002 between the Company and National City
Bank, as agent
4.2 (2) Credit Agreement dated as of January 11, 2002 by and among the Company and The
Guarantors Party Thereto and National City Bank, as agent and The Other Banks Party
Thereto
10.1 (1) 1998 Stock Option Plan
10.2 (1) Lease by and between the Company and Rainbow Properties, Ltd. dated January 1, 1996
for the Company's principal executive offices
10.3* Lease termination agreement by and between Rainbow Properties, Ltd. and the Company
dated February 19, 2004.
10.4 (3) Severance Agreement and Mutual Release, dated May 1, 2003, between Registrant and
Lawrence S. Hendricks
10.5 (3) Letter of Employment, dated May 6, 2003, between Registrant and S. Robert Harris
10.6* Letter, dated February 4, 2004, to Wayland J. Russell
10.7* Letter, dated February 4, 2004, to Michael J. Viveiros
10.8* Letter, dated February 4, 2004, to Michael A. Pecchia
10.9* Change-in-Control Agreement, dated February 4, 2004, between Registrant and S. Robert
Harris
14* Code of Ethics for Executive Officers and All Senior Financial Officers
23* Consent of Independent Public Accountants
31.1* CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2* CFO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32* CEO and CFO certification pursuant to Section 906 of the Sarbanes-Oxley act of 2002
(1) Incorporated by reference to an exhibit included in the Company's
Registration Statement on Form S-1 (file no. 333-48769).
(2) Incorporated by reference to an exhibit included in the Company's 2001
Annual Report on Form 10-K.
(3) Incorporated by reference to an exhibit included in the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003.
* Filed Herewith
45