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, 2001
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 check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or 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 check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]
The aggregate market value of voting stock held by nonaffiliates of the
Registrant was approximately $19.1 million at March 18, 2002. The number of
common shares outstanding at March 18, 2002 was 5,925,735.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be mailed to
stockholders in connection with the Registrant's 2002 Annual Meeting of
Stockholders are incorporated by reference into Part III, Items 10-13.
RAINBOW RENTALS, INC.
INDEX
PART I
Item 1. Business 4
Item 2. Properties 11
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 21
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure 21
PART III
Item 10. Directors and Executive Officers of the Registrant 22
Item 11. Executive Compensation 22
Item 12. Security Ownership of Certain Beneficial Owners and Management 22
Item 13. Certain Relationships and Related Transactions 22
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 23
2
PART I
FORWARD-LOOKING STATEMENTS
When used in this Form 10-K, or, in future filings by Rainbow Rentals,
Inc. (the "Company") with the Securities and Exchange Commission, 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, the
words or phrases "will likely result", "are expected to", "will continue", "is
anticipated", "estimate", "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such statements are subject to certain
risks and uncertainties including, but not limited to, (i) the ability of the
Company to execute effectively its expansion program, (ii) the ability to
attract and retain quality store personnel and (iii) changes in the government's
regulation of the industry, that could cause actual results to differ materially
from historical earnings and those presently anticipated or projected. The
Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. The Company
wishes to advise readers that the factors listed above and other factors could
affect the Company's financial performance and could cause the Company's actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions, which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
RISK FACTORS
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 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 effect 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. Additionally,
a significant portion of the Company's revenues are derived from the rental of
computers and peripherals. 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. 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 effect on the Company's business, financial condition and results of
operations.
3
No federal legislation has been enacted regulating or otherwise governing
rental-purchase transactions. From time to time, legislation has been introduced
in Congress that would regulate rental-purchase transactions, including
legislation that would subject rental-purchase transactions to implied interest
rates, finance charge and fee limitations, as well as the Federal Truth in
Lending Act. Any federal legislation, if enacted, could have a material effect
on the Company's business, financial condition and results of operations.
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 effect 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. In general, 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 effect on the Company's business, financial
condition or results of operations.
ITEM 1. BUSINESS
GENERAL
Founded in 1986 with six stores, the Company, as of the date of this
report, operates 114 rental-purchase stores under the Rainbow Rentals trade name
in Connecticut, Massachusetts, Michigan, New York, North Carolina, Ohio,
Pennsylvania, Rhode Island, South Carolina, Tennessee and Virginia. The Company
has opened 90 of its 114 current locations, with the balance of the additional
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 24 months). Customers have
4
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 2001, Rainbow opened six new stores (four in existing markets and
two in new markets), consolidated two stores into existing locations and sold
one store. In 2002 through the date of this report, Rainbow opened two new
stores and consolidated one store into an existing location.
INDUSTRY OVERVIEW
The rental-purchase industry provides an alternative to traditional retail
installment sales, appealing to individuals with poor or limited credit
histories and to individuals with an aversion to debt. Rental-purchase programs
permit customers to have immediate possession of products without the assumption
of debt or large cash payment. 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. 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 24 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.
The Association of Progressive Rental Organizations (APRO), the industry's
trade association, estimated that the rental-purchase industry generated $5.3
billion in revenues and approximately 3.1 million customers were served in 2000
(the latest year for which statistics are available). APRO also estimates that
more than 68% of rental-purchase customers have annual household incomes between
$24,000 and $49,999. However, management believes that the majority of its
customers are wage earners with annual household income between $15,000 and
$35,000. The U.S. Census Bureau reported that in 2000 there were approximately
28 million households with annual income between $15,000 and $35,000 and
approximately 44 million households with annual income between $15,000 and
$49,999. During the mid to late 1990's, the rent-to-own industry experienced
significant consolidation. Initially, larger, multi-store chains acquired
smaller highly leveraged operators. Subsequent to that, the larger chains began
to consolidate themselves. In 2000, the larger rent-to-own operators began to
accelerate their growth primarily through new store openings. The number of
additional stores, however, only slightly increased as APRO estimates there were
approximately 7,500 stores in operation as of December 31, 1995 and 8,000 stores
at December 31, 2000. Management believes the industry's three largest public
companies currently operate approximately 4,300 stores or 54% of the total
rental-purchase stores in operation.
Management believes the rental-purchase industry remains under-penetrated
and highly fragmented, providing growth opportunities for companies that are
well capitalized and have access to both debt and equity capital. Management
believes that the number of large acquisition targets has declined, slowing the
recent trend of consolidations. As a result, more recently, industry growth has
predominantly occurred through new store openings. As large consolidators have
begun to concentrate on new store openings, management believes that in addition
to capitalizing on its established new store-opening program, there will be
greater opportunities for the Company to make acquisitions.
OPERATING STRATEGY
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 addition to generating store level operating income
of approximately 22%. Annual revenues per store, including core and non-core
stores, were $836,000 during 2001, which management believes is 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 a toll free customer service hotline is posted in every
store to encourage
5
customers to voice their concerns. The Company strives to make the
rental-process convenient by enabling customers to initiate transactions
over the phone or via the Internet, and once the order is approved, take
delivery of the merchandise without coming into the store. 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 (4,600 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 ten and five years, respectively (excluding managers from
newly opened and acquired stores). The Company's founding executive
officers have worked in the rental-purchase industry for an average of
over 20 years and 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 significant degree of autonomy and accountability,
allowing them to operate their stores much as owners of their own small
business. 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, meeting operational standards and achieving store profitability
benchmarks. Managers are eligible for bonuses equal to as much as 60% of
total compensation, based on store operating income. 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
this group consists of 14 former store managers who have been with the
Company for an average of 10 years. They generally live within their
geographic area to reduce travel time and expense and are tied directly to
their region's profitability through incentive based compensation that
makes up nearly 50% of their total compensation. 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 no
more than 10 stores.
6
GROWTH STRATEGY
The Company's growth strategy is to accelerate its new store-opening
program, increase comparable store revenue and profitability and continue to
make opportunistic and operationally sound acquisitions.
New Store Openings. Beginning with six stores in 1986, the Company has
opened 90 of its current 114 store locations and has developed a
consistent, replicable model for opening new stores. The Company believes
the rental-purchase market is significantly under-penetrated and provides
substantial new store expansion potential. The Company currently plans to
continue opening new stores in current and new markets within the Midwest,
Mid-Atlantic and New England states. The Company believes its model for
opening new stores results in more predictable growth and greater
operational control than is typically achieved through acquisitions.
Because the Company's growth strategy emphasizes internal growth primarily
through new store openings, management believes the current state of the
industry presents an opportunity for the Company to capitalize on its
demonstrated ability to open new stores.
Increase Comparable Store Revenue and Profitability. The Company
continually strives to increase revenue per store by enhancing individual
store operations and offering a new and different product selection. The
Company has demonstrated an ability to recognize increasing customer
demand for products and to provide such products. For example, the Company
recognized its customers' desire for computers and has developed an
effective strategy to meet this demand. Accordingly, the Company was the
first in the industry to offer computers and remains a leader in this
product category generating nearly 24% of its 2001 revenue from computer
rentals and sales. In addition, the Company is able to achieve increased
profitability by leveraging its stores' fixed costs over the higher
revenues generated by existing stores and by placing new stores in
existing markets.
Acquisitions. The third prong of the Company's growth strategy is to make
opportunistic acquisitions of rental agreements and store locations. The
Company utilizes its acquisition strategy to increase existing store
revenue and profitability by purchasing the accounts of a nearby
competitor and placing them in an existing Company location. Referred to
as "tuck-ins", this strategy allows the Company to leverage its
experienced management team, store operating systems and store fixed
costs. In addition, the Company will enter new markets or expand
underserved markets by acquiring competitor store locations. Ideally,
acquisitions will have a mixture of tuck-ins and new store locations.
Since 1998, the Company has acquired 31 stores of which 13 were
"tucked-in" to existing locations. Management believes it will continue to
have opportunities to augment its growth strategy through acquisitions.
See the Company's acquisition activity in the table on page 8.
STORES
As of December 31, 2001, Rainbow operated 113 stores in eleven states, as
set forth in the following table:
Location Number of Stores
-------- ----------------
Ohio 27
Pennsylvania 22
Massachusetts 12
Virginia 9
Tennessee 8
Connecticut 7
Michigan 7
New York 7
South Carolina 7
North Carolina 5
Rhode Island 2
7
The following table sets forth the number of stores opened, acquired and
consolidated or closed since the Company commenced operations in 1986. Several
stores have been enlarged or relocated.
Year Ended December 31,
----------------------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Stores open at beginning
of period 0 6 15 20 24 28 36 38 42 46 51 55 62 70 92 110
Stores opened 6 9 5 4 4 8 2 4 4 0 4 7 8 9 11 6
Stores acquired (1) (2) (3) 0 0 0 0 0 0 0 0 0 7 0 0 1 13 7 0
Stores
consolidated/closed/sold 0 0 0 0 0 0 0 0 0 2 0 0 1 0 0 3
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Stores open at end of
period 6 15 20 24 28 36 38 42 46 51 55 62 70 92 110 113
==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ====
(1) During 1995, the Company acquired 10 stores and consolidated three into
existing Company locations.
(2) During 1999, the Company acquired 19 stores and consolidated six into
existing Company locations.
(3) During 2000, the Company acquired 12 stores and consolidated five into
existing Company locations.
Rainbow's primary method of growth is through the opening of new store
locations. New store openings are dilutive to earnings generally for the first
nine to twelve months as they build a customer base and develop a recurring
revenue stream. Generally, new stores have a maturation period of approximately
three years. Rainbow opened two stores to date in 2002 and plans to open ten
additional stores during the remainder the year.
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.
The most critical step in the selection of a new store location is a site
inspection. Many factors are reviewed by the Company's Director of Real Estate
prior to choosing a new store location, including proximity to national discount
retailers or grocery stores, traffic patterns and proximity to other Rainbow
locations.
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, 2001, rental-purchase agreements for home electronics
accounted for approximately 29.2%; furniture accounted for 30.9%; appliances
accounted for 16.8%; and computers accounted for 23.1% of the Company's total
units on rent. Previously rented merchandise is marketed under the Company's
"Maximum Value Product" program that was introduced in 2001. This unique program
certifies that the merchandise has been cleaned and mechanically tested and
offers, at no charge, an extended repair warranty well beyond the current
rent-to-own term. In addition, weekly and monthly rates or ownership terms are
reduced from those of similar new products to ensure the value to the customer.
This program keeps the previously rented merchandise moving through the rental
system allowing the Company to maintain the proper mix of new merchandise on its
showroom floor.
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 managers from within. To ensure the
strength of its store level management team both in terms of experience and
availability, the Company, for the first time in its history, hired 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.
8
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 is run by the
Company's Vice President of Operations and consists of a six to twelve month
agenda involving formal class training as well as on-site store training. In
addition, the Company has designated one store as its "training store". All
manager trainees spend at least one week under the tutelage of the "training
store manager". Also, trainees are sent to various stores to receive a more
broad on-the-job training experience and to assist troubled stores. After an
associate becomes a store manager, the training continues. Manager meetings are
conducted twice per year at a central location 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 formed a network of committees, a majority of
whose members are store managers who assist senior management in areas of
pricing, product selection and computer operations. In addition, one committee,
comprised of top performing managers, serves as a sounding board for new
concepts and innovative operational and sales techniques.
MARKETING
The Company uses advertising mediums such as radio, television, billboards
and direct mail to introduce and reinforce the benefits of its rental-purchase
program to existing and potential customers and to make such customers aware of
new products and promotions. During the fourth quarter of 2001, the Company
hired an outside advertising agency to develop and produce substantially all of
the advertising with assistance from the Company's downsized in-house
advertising department. Management believes its advertising agency will benefit
the Company in both the short- and long-term due to its research tools,
creativity and knowledge of demographics. Prior to hiring the outside
advertising agency, substantially all of the Company's advertising was developed
and produced by its in-house advertising department. The Company advertises in
both English and Spanish. Most of the Company's advertisements encourage
customers to "shop by phone" or via the internet and feature the Company's
toll-free telephone number and web address. When the toll-free number is dialed,
the call is automatically routed to the Company store closest to the source of
the call. Each product displayed in the Company's direct mailing piece is
numbered for easy reference during telephone orders. Store managers and sales
associates are trained to explain the rental-purchase program clearly and to
obtain orders over the telephone. The Company initiates a majority of its
rental-purchase agreements over the telephone. Several direct marketing tools
are also employed to solicit the Company's existing customer base. The Company
has developed a preferred customer program, directed at current and past
customers. Under this program, special promotions, including significant
discounts and new product offerings, are periodically run for these customers to
encourage additional rentals.
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
9
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.
CUSTOMER SERVICE AND MANAGEMENT
In addition to the enjoyment of quality products, customers are afforded
many services provided by well-trained and professionally attired 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 service under
the rental-purchase agreement at no additional cost, including delivery and
installation, product training, maintenance to ensure the product continues to
perform, and pick-up service to return the merchandise if requested. By limiting
the add-on fees charged, the Company enables its customers to spend more of
their rental renewal payment on the merchandise. Rental income represented
approximately 94% of the Company's total revenue in 2001. In addition, customers
are able to upgrade products, reinstate a previously terminated agreement and
are given free service for a reasonable period 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. The day after a renewal payment is missed the account manager
contacts the customer by phone to ascertain if there is any problem with the
merchandise, to remind them of the Company's appreciation for their patronage
and to encourage the customer's continued use of the product by renewing the
agreement. If the initial telephone contact does not lead to renewal or return
of the merchandise, then the account manager will make personal visits to the
customer's home in an effort to renew the agreement or pick-up the merchandise.
In cases where the customer refuses to return the merchandise, the Company uses
various legal methods to recover the merchandise.
MANAGEMENT INFORMATION SYSTEMS
The Company utilizes a flexible, proprietary, Windows NT - based
management information system to support its rental activities, to assist in
compliance with applicable laws and regulations and to monitor its decentralized
store network. This proprietary system was the industry's first Windows-based
system and is constantly upgraded and modified by the Company to conform to
operational changes and the Company's philosophy of customer management. In
addition, the Company has a company-wide Intranet allowing for easy
communication and fast and effective transfer of data between corporate
headquarters and stores.
The system provides store managers with all of the relevant store-level
financial and operating data as well as individual profiles on each store's
customers to assist in the marketing effort. Senior management has immediate
access to data on a daily basis that provides them with the ability to analyze
performance indicators on both a store, regional and corporate level. Critical
data, such as outstanding agreements, idle inventory, revenue, delinquencies,
cash receipts and deposits are available the following day. In addition,
regional managers have remote access to this data each morning by utilizing the
Company's Intranet. On a daily, weekly and monthly basis, reports are generated
that provide information about products, margins, collection performance and
other operating and financial indicators to enable senior management, regional
managers and store managers to monitor the productivity of stores. In addition,
on a monthly basis, store results are compared to each other and ranked on
critical operating statistics and financial benchmarks. These reports create a
healthy competitive environment among store managers and are the basis for
annual awards given out at the Company's annual award ceremony. Similar reports
are generated for customer management personnel as well as regional managers.
The Company's system maintains all standard agreements, and all agreements
are printed off the system on an as-needed basis at each store. In addition,
where there is a change in state laws, the Company can make timely modifications
on its systems to the standard agreements in the various states.
10
COMPETITION
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. Competition is based primarily
on product selection and availability, customer service and rental rates and
terms. The Company's three largest competitors, Rent-A-Center, Inc., Rent-Way,
Inc., and Aaron Rents, Inc., have significantly greater financial and operating
resources and name recognition than Rainbow. In response to the acceleration of
new store openings by the industry's three largest chains, many of which were in
the Company's existing markets, management implemented a competitor new store
action plan. Once an impending opening is identified, the existing Rainbow store
is given additional advertising, special pricing and promotional allowances as
well as an influx of new merchandise to compete with many of its competitors'
grand opening programs. In addition, store staffing levels are strengthened and
sales techniques are reviewed to assure the highest customer service possible.
PERSONNEL
As of March 18, 2002, the Company had approximately 820 associates,
including 598 full-time associates. Approximately 40 associates are located at
the Company's corporate headquarters in Canfield, Ohio. None of the Company's
associates is represented by a labor union. Management believes its relations
with its associates are good.
GOVERNMENT REGULATION
There are currently 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 effect on the Company.
No federal legislation has been enacted regulating or otherwise governing
rental-purchase transactions. 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. In addition, the Company provides its customers
with a toll-free number to telephone corporate headquarters to report any
irregularities in service or misconduct by its associates.
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.
ITEM 2. PROPERTIES
The Company leases all of its stores under operating leases that expire at
various times through 2012. 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 2,500 to 7,500
square feet, and average approximately 4,600 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 three of its executive
officers (see "Related Party Transactions"). The corporate office consists of
approximately 10,000 square feet and is leased through January 31, 2006. In
2001, the rental amount was $121,000. 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.
11
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 effect on the Company's liquidity, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
12
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 18, 2002, there were 5,925,735
shares outstanding held by approximately 350 stockholders of record, not
including the number of persons or entities holding stock in nominee or street
name through various brokerage firms.
The following table shows the quarterly high and low trade prices of the
common shares for the years ended 2001 and 2000.
2001 2000
----------------- -----------------
High Low High Low
------ ------ ------- ------
Quarter ended March 31 $ 7.50 $ 4.94 $ 11.00 $ 7.63
Quarter ended June 30 7.23 4.94 11.63 8.63
Quarter ended September 30 8.82 4.69 14.00 5.25
Quarter ended December 31 8.27 6.50 8.00 5.06
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 New Credit Facility. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
13
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, 2001, 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,
----------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share amounts)
Statement of Income Data:
Revenues
Rental revenue $ 88,770 $ 86,099 $ 75,932 $ 59,932 $ 52,153
Fees 2,697 2,849 2,639 1,959 1,588
Merchandise sales 3,088 2,947 2,287 1,588 1,587
----------- ---------- ---------- ---------- ----------
Total revenues 94,555 91,895 80,858 63,479 55,328
Operating expenses
Merchandise costs 33,310 30,775 26,758 21,765 19,145
Store expenses
Salaries and related 22,713 21,774 18,374 13,943 11,809
Occupancy 8,458 7,478 6,027 4,671 4,068
Advertising 5,928 4,446 3,662 3,500 3,283
Other expenses 12,741 11,807 10,310 7,686 6,127
----------- ---------- ---------- ---------- ----------
Total store expenses 49,840 45,505 38,373 29,800 25,287
----------- ---------- ---------- ---------- ----------
Total merchandise costs and
store expenses 83,150 76,280 65,131 51,565 44,432
General and administrative expenses 7,568 6,795 5,585 4,607 4,096
Amortization of goodwill and
noncompete agreements 689 608 456 33 --
----------- ---------- ---------- ---------- ----------
Total operating expenses 91,407 83,683 71,172 56,205 48,528
----------- ---------- ---------- ---------- ----------
Operating income 3,148 8,212 9,686 7,274 6,800
Interest expense 689 933 697 918 1,822
Other expense, net 485 380 361 76 329
----------- ---------- ---------- ---------- ----------
Income before income taxes 1,974 6,899 8,628 6,280 4,649
Income taxes 800 2,794 3,580 2,662 1,968
----------- ---------- ---------- ---------- ----------
Net income $ 1,174 $ 4,105 $ 5,048 $ 3,618 $ 2,681
=========== ========== ========== ========== ==========
Basic and diluted earnings per
common share $ 0.20 $ 0.69 $ 0.85 $ 0.73 $ 0.59
=========== ========== ========== ========== ==========
Weighted average common
shares outstanding:
Basic 5,925,735 5,925,735 5,925,735 4,970,256 4,509,406
Diluted 5,940,999 5,930,157 5,930,887 4,970,256 4,509,406
Operating Data:
Stores open at end of period 113 110 92 70 62
Comparable store revenue growth(1) (4.3%) 1.7% 4.4% 3.8% 9.9%
(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.
14
Year Ended December 31,
----------------------------------------------------------
2001 2000 1999 1998 1997
------- ------- ------- ------- -------
(Dollars in thousands)
Balance Sheet Data:
Rental-purchase merchandise, net $39,330 $36,545 $33,042 $25,246 $23,411
Total assets 60,121 58,429 50,324 33,068 31,293
Total long-term debt 9,440 12,340 10,522 190(3) 23,203(2)
Total liabilities 22,956 22,438 18,438 6,230(3) 28,240(2)
Shareholders' equity 37,165 35,991 31,886 26,838(3) 3,053(2)
(2) Includes the effect of the redemption of shares from a prior
shareholder-officer.
(3) Includes the effect of the Company's initial public offering and
subsequent elimination of debt.
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, 2001 and 2000 and results of
operations for the years ended December 31, 2001, 2000 and 1999. This discussion
should be read in conjunction with the Company's financial statements and notes
thereto included herein.
GENERAL
At December 31, 2001, the Company operated 113 rental-purchase stores in
11 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 24 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.
CRITICAL ACCOUNTING POLICIES
The Company's critical accounting policies include the following:
- Rental-purchase merchandise, including depreciation and
impairment;
- Revenue recognition;
- Accounting for income taxes; and
- Valuation of long-lived and intangible assets and goodwill
Rental-purchase merchandise, including depreciation and impairment.
Rental-purchase merchandise is stated at historical cost, net of accumulated
depreciation. The Company depreciates inventory 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 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.
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 with nonrefundable rental payments. Rental revenue is recognized over the
lease term. Deferred revenue is recognized based on 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 a
purchase option. Amounts received from such sales, as well as sales of new and
used merchandise available for rent in the stores, are included in merchandise
sales.
15
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 and goodwill. The Company
assesses the impairment of identifiable intangible assets, long-lived assets and
related goodwill 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,
long-lived assets and related goodwill 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. Identifiable intangible assets and
goodwill totaled $929,000 and $9.1 million, respectively, at December 31, 2001.
On January 1, 2002, Statement of Financial Accounting Standards (SFAS) No.
142, Goodwill and Other Intangible Assets became effective. As a result,
goodwill totaling $9.1 million will no longer be amortized, but rather will be
assessed annually for impairment, with any such impairment recognized as a
reduction to earnings in the period identified. Management is currently
assessing the impact that adopting SFAS No. 142 will have on the Company's
financial position, results of operations and cash flows.
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 options and upon the sale of new 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 as incurred.
16
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 the Company's semi-annual
manager meetings, committee meetings and training, as well as legal and
professional fees, charitable contributions and state taxes not based on income,
are included.
Amortization. Amortization includes the amortization of goodwill and
non-compete agreements related to acquisitions. See "New Accounting
Pronouncements" contained within this document regarding amortization of
intangibles effective in 2002.
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.
NEW STORE OPENINGS
The Company's primary method of growth is through the opening of new store
locations. New store openings are dilutive to earnings for the first nine to
twelve months as they build a customer base and develop a recurring revenue
stream. Generally, new stores have a maturation period of approximately three
years. The timing of new store openings and the number of stores in various
stages of the three year maturation process will have an effect on quarterly and
annual comparisons.
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,
-------------------------------------
2001 2000 1999
----- ----- -----
Statement of Income Data:
Revenues
Rental revenue 93.9% 93.7% 93.9%
Fees 2.8 3.1 3.3
Merchandise sales 3.3 3.2 2.8
----- ----- -----
Total revenues 100.0 100.0 100.0
Operating expenses
Merchandise costs 35.2 33.5 33.1
Store expenses
Salaries and related 24.0 23.7 22.7
Occupancy 8.9 8.1 7.5
Advertising 6.3 4.8 4.5
Other expenses 13.5 12.9 12.7
----- ----- -----
Total store expenses 52.7 49.5 47.4
----- ----- -----
Total merchandise costs and store expenses 87.9 83.0 80.5
General and administrative expenses 8.0 7.4 6.9
Amortization of goodwill and noncompete agreements 0.7 0.7 0.6
----- ----- -----
Total operating expenses 96.6 91.1 88.0
----- ----- -----
Operating income 3.4 8.9 12.0
Interest expense 0.7 1.0 0.9
Other expense, net 0.5 0.4 0.4
----- ----- -----
Income before income taxes 2.2 7.5 10.7
Income taxes 0.9 3.0 4.5
----- ----- -----
Net income 1.3% 4.5% 6.2%
===== ===== =====
17
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND
2000
Total revenues increased $2.7 million, or 2.9%, to $94.6 million for the
year ended December 31, 2001 compared to $91.9 million for the year ended
December 31, 2000. Revenue from stores opened and acquired in 2000 totaled $10.1
million for the year ended December 31, 2001, an increase of $6.0 million
compared to the same prior year period due to the inclusion of a full twelve
months' results in 2001. In addition, revenue from stores opened in 2001
accounted for $710,000 of the increase. This increase was partially offset by a
$3.7 million, or 4.3%, decline in revenue from comparable stores (stores in
operation on January 1, 2000), which totaled $83.6 million and $87.3 million,
respectively, for the years ended December 31, 2001 and 2000. The decline in
comparable store revenue was primarily due to a decrease in average customers
per store since the beginning of 2000 coupled with a decrease in the average
rate charged per rental agreement during the last half of 2001 as the Company
lowered prices on both new and pre-rented merchandise to regain its customer
base. Management believes the decline in customers per store was due to
increased competition and other market factors. As a result of lowering prices,
the Company's customer base increased 8.4% during the last four months of 2001
and the Company's inventories of older, pre-rented merchandise decreased
significantly by the end of 2001.
Merchandise costs increased $2.5 million, or 8.2%, to $33.3 million for
the year ended December 31, 2001 compared to $30.8 million for the year ended
December 31, 2000. The increase was primarily due to the merchandise costs of
the stores opened and acquired in 2000 and 2001. To a lesser extent, a higher
average cost per unit on rent in 2001 compared to 2000 contributed to the
increase. Merchandise costs totaled 35.2% of revenues for the year ended
December 31, 2001 compared to 33.5% of revenues for the year ended December 31,
2000. The increase in merchandise costs as a percentage of revenue was primarily
the result of lowering prices on new and pre-rented merchandise. As previously
mentioned, the Company lowered rental rates on new and pre-rented merchandise
during mid-2001 in an effort to increase its customer base.
Store expenses increased $4.3 million, or 9.5%, to $49.8 million for the
year ended December 31, 2001 compared to $45.5 million for the year ended
December 31, 2000. Salaries and related expenses increased $939,000 and was
mainly attributable to stores opened and acquired in 2001 and 2000 in addition
to a change in certain associate benefit programs that resulted in an increased
expense of $466,000. These increases were partially offset by a decrease in
salaries and related expenses of comparable stores associated with reduced
staffing at certain stores as a result of the decline in the number of customers
per store. Increases in occupancy and other expenses totaling $980,000 and
$934,000, respectively, were attributable to stores opened and acquired during
2000 and 2001. In addition, advertising expense increased $1.5 million due to
increased spending levels in an effort to rebuild Rainbow's customer base and to
costs related to new stores. Store expenses totaled 52.7% of revenues for the
year ended December 31, 2001 compared to 49.5% of revenues for the year ended
December 31, 2000. The increase in store expenses as a percentage of revenue was
primarily attributable to the reasons mentioned above.
General and administrative expenses increased $773,000 comparing the years
ended December 31, 2001 and 2000. This increase was primarily due to expanding
the Company's regional management team, adding key support personnel and
increased consulting fees in an effort to facilitate the Company's anticipated
growth.
Interest expense in 2001 decreased $244,000 from the prior year due to
lower average outstanding debt and lower interest rates.
Income taxes decreased $2.0 million and was attributable to a decline in
income before income taxes. For the years ended December 31, 2001 and 2000, the
Company's effective income tax rate was 40.5%.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND
1999
For the year ended December 31, 2000, total revenues increased to $91.9
million from $80.9 million, an increase of 13.6% over the prior year. Revenue
from the 18 stores opened and acquired in 2000 accounted for 36.6% of the total
increase in revenue, or $4.0 million. The increase in revenue from the nine
stores opened in 1999, which accounted for 35.1% of the increase, or $3.9
million, was due to the ramp-up of the stores' customer base as well as the
inclusion of a full year's results in 2000. The inclusion of a full year's
results from the 13 stores acquired in 1999 accounted for 17.6% of the increase,
or $1.9 million. Revenue from comparable stores (stores in operation on January
1, 1999) increased 1.7% and accounted for 10.7% of the increase, or $1.2
million. An increase in revenue earned per customer was offset by a decline in
the number of customers per store.
18
For the year ended December 31, 2000, merchandise costs increased to $30.8
million from $26.8 million, an increase of 15.0% over the prior year primarily
due to merchandise costs associated with stores opened and acquired in 2000. As
a percentage of total revenues, merchandise costs increased to 33.5% from 33.1%.
The slight decrease in gross margins was mainly from the cost of inventory
accessory items in 2000.
For the year ended December 31, 2000, total store expenses increased to
$45.5 million from $38.4 million, an increase of 18.5% over the prior year. The
increase in total store expenses was primarily due to expenses associated with
the 18 stores opened and acquired in 2000. This increase accounted for 52.0% of
the total increase in store expenses, or $3.7 million. An increase in store
expenses from the nine stores opened in 1999 and the inclusion of a full year's
results from the 13 stores acquired in 1999 accounted for 43.7% of the increase,
or $3.1 million. As a percentage of total revenues, total store expenses
increased to 49.5% from 47.4% mainly due to the number and timing of new store
openings and acquisitions in 2000 and 1999. Total store expenses of comparable
stores, however, decreased as a percentage of revenue to 45.5% from 45.8%
primarily from the growth and profitability of stores opened in 1998. Salaries
and related expenses increased as a percentage of revenue to 23.7% from 22.7%.
In addition to the increase from the timing of new store openings and
acquisitions in 2000 and 1999, salaries and related expenses of comparable
stores increased as a percentage of revenue to 22.3% from 21.9% due to increased
turnover and related staffing shortages during the summer and fall months.
Increases in part-time hours, over-time pay, and training costs, as well as an
increase in the pay rates of key store personnel due to a tight labor market,
resulted in higher payroll and related expenses in comparable stores. The
addition of a Human Resource Director during 2000 improved turnover and staffing
in stores during the fourth quarter. The increases in occupancy, advertising and
other expenses, as well as the increase of these items as a percentage of
revenue, was due to the stores added in 2000 and 1999.
For the year ended December 31, 2000, general and administrative expenses
increased to $6.8 million from $5.6 million, an increase of 21.6% over the prior
year and as a percentage of total revenue increased to 7.4% from 6.9%. The
increase was primarily due to the expansion of the Company's regional management
team, the addition of several key support personnel, and increased training
costs all of which were necessitated by the Company's current and anticipated
growth. In addition, travel costs associated with relocating managers and
staffing stores increased due to higher turnover of store personnel.
For the year ended December 31, 2000, operating income decreased to $8.2
million from $9.7 million, a decrease of 15.2% from the prior year and, as a
percentage of total revenues, decreased to 8.9% from 12.0% due to the factors
discussed above.
For the year ended December 31, 2000, interest expense increased to
$933,000 from $697,000 in the comparable 1999 year due to higher average
outstanding debt and interest rates.
For the year ended December 31, 2000, the Company's effective tax rate
decreased to 40.5% from 41.5% for the prior year due to lower effective state
tax rates.
For the year ended December 31, 2000, net income decreased to $4.1 million
from $5.0 million, a decrease of 18.6% from the prior year, and as a percentage
of total revenues decreased to 4.5% from 6.2% due to the factors discussed
above.
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, borrowings and the issuance of capital stock.
For the years ended December 31, 2001 and 2000, purchases of rental
merchandise (excluding acquired inventory) amounted to $36.2 million and $33.0
million, respectively. The increase primarily reflects inventory purchased for
new store openings.
For the year ended December 31, 2001, cash provided by operations totaled
$5.4 million compared to $5.2 million for the year ended December 31, 2000. Cash
used in investing activities decreased $4.0 million and totaled $2.0 million and
$6.0 million, respectively, for the year ended December 31, 2001 and 2000. The
decrease was
19
primarily due to fewer new store openings and acquisitions during 2001 as
compared to 2000. Due to significant repayments on the Company's debt, cash used
in financing activities totaled $3.0 million for the year ended December 31,
2001 compared to financing activities providing $1.8 million for the year ended
December 31, 2000.
On January 11, 2002, the Company refinanced its Credit Facility with a
$25.0 million revolving loan agreement (the "New Credit Facility") that matures
in January 2005. A borrowing base measured against rental purchase merchandise
limits borrowings under the New Credit Facility. Excess availability as of
February 28, 2002 was $1.9 million. 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 restrict 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. In the
event of default, the outstanding loan balance will be subject to the "Base Rate
Option", as defined in the loan agreement, plus an additional 2% (which is equal
to prime plus 3%) in addition to becoming currently due. Interest charged
portions of the outstanding principal balance is at LIBOR plus 3% and the
remaining outstanding balance is at prime plus 1%. The weighed average interest
rate charged on the outstanding balance at February 28, 2002 was 4.85%.
The Company opened two new stores to date in 2002 and plans to open
approximately ten more stores during the remainder of 2002. The Company believes
it will continue to have the opportunity to increase the number of its stores
and rental-purchase agreements through selective acquisitions. Potential
acquisitions may vary in size and the Company may consider larger acquisitions
that could be material to the Company. To provide any additional funds necessary
for the continued pursuit of its growth strategies, the Company may use cash
flow from operations, borrow additional amounts under its New 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 on terms acceptable to the Company or its current
lender.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations initiated after June 30, 2001 as well as
all purchase method business combinations completed after June 30, 2001. SFAS
No. 141 also specifies criteria for intangible assets acquired and reported
apart from goodwill, noting that any purchase price allocable to an assembled
workforce may not be accounted for separately. SFAS No. 142 will require that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of SFAS No. 142. SFAS No. 142 will also require that
intangible assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144. The Company adopted the provisions
of SFAS No. 141 as of July 1, 2001 and SFAS No. 142 effective January 1, 2002
and had unamortized goodwill totaling $9.1 million all of which will be subject
to the provisions of SFAS Nos. 141 and 142. Amortization expense related to
goodwill was $525,000 and $486,000 for the years ended December 31, 2001 and
2000, respectively. Management is currently assessing the impact that adopting
SFAS No. 142 will have on the Company's financial position, results of
operations and cash flows.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
fiscal years beginning after June 14, 2002. The Company has reviewed the
provisions of SFAS No. 143, and believes that upon adoption, it will not have a
material impact on its financial position, results of operations or cash flows.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 provides a single
accounting model for long-lived assets to be disposed of. Although retaining
many of the fundamental recognition and measurement provisions of SFAS No. 121,
SFAS No. 144 significantly changes the criteria that would have to be met to
classify an asset as held-for-sale. This distinction is important because assets
held-for-sale are stated at the lower of their fair values or carrying amounts
and depreciation is no longer recognized. The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001. The Company believes the adoption
20
of SFAS No. 144 will not have a material impact on its financial position,
results of operations or cash flows.
SEASONALITY
Management believes that the Company's operating results may be 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, 2001, 2000 and 1999, the cost of
rental-purchase merchandise, 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 does not have significant exposure to changing interest rates,
other than the Company's variable-rate on its New Credit Facility. The Company
does not undertake any specific actions to cover its exposure to interest rate
risk and the Company is not party to any interest rate risk management
transactions.
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 14 of this Form 10-K for the
information required by Item 8.
ITEM 9. CHANGES IN DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Shareholders, and is
incorporated herein by reference. The only executive officer that is not a
director is Michael A. Pecchia, Chief Financial Officer and Secretary, whose age
was 41 at March 18, 2002. Mr. Pecchia has served as Treasurer and Secretary of
the Company since 1991, as well as Chief Financial Officer since February 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Shareholders, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Shareholders, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Shareholders, and is
incorporated herein by reference.
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements:
Independent Auditors' Report 24
Balance Sheets as of December 31, 2001 and 2000 25
Statements of Income for the Years Ended
December 31, 2001, 2000 and 1999 26
Statements of Shareholders' Equity for the Years Ended
December 31, 2001, 2000 and 1999 27
Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 28
Notes to Financial Statements 29
(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 financial statements and notes
thereto.
(a) (3) Exhibits
See the Index to Exhibits included on page 39.
(b) Reports on Form 8-K:
None.
23
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Rainbow Rentals, Inc.:
We have audited the accompanying balance sheets of Rainbow Rentals, Inc.
as of December 31, 2001 and 2000, and the related statements of income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits 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 financial statements referred to above present fairly,
in all material respects, the financial position of Rainbow Rentals, Inc. as of
December 31, 2001 and 2000, and the results of its operations and cash flows for
each of the years in the three-year period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States of
America.
KPMG LLP
Cleveland, Ohio
February 27, 2002
24
RAINBOW RENTALS, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31,
-----------------------
2001 2000
-------- --------
ASSETS
Current assets
Cash and cash equivalents $ 1,839 $ 1,426
Rental-purchase merchandise, net 39,330 36,545
Income tax receivable -- 778
Prepaid expenses and other current assets 2,047 1,709
-------- --------
Total current assets 43,216 40,458
Property and equipment, net 5,273 5,259
Deferred income taxes 1,546 1,460
Goodwill, net 9,098 9,887
Other assets, net 988 1,365
-------- --------
Total assets $ 60,121 $ 58,429
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Deferred revenue $ 1,263 $ 782
Accounts payable 3,827 2,410
Accrued income taxes 306 --
Accrued compensation and related costs 2,082 1,525
Other liabilities and accrued expenses 2,062 1,703
Deferred income taxes 3,976 3,678
-------- --------
Total current liabilities 13,516 10,098
Long-term debt 9,440 12,340
-------- --------
Total liabilities 22,956 22,438
Commitments and contingencies
Shareholders' equity
Serial preferred stock, no par value; 2,000,000 shares authorized
none issued -- --
Common stock, no par value; 10,000,000 shares authorized,
6,392,610 issued and 5,925,735 outstanding 11,039 11,039
Retained earnings 28,033 26,859
Treasury stock, 466,875 common shares at cost (1,907) (1,907)
-------- --------
Total shareholders' equity 37,165 35,991
-------- --------
Total liabilities and shareholders' equity $ 60,121 $ 58,429
======== ========
See accompanying notes to financial statements.
25
RAINBOW RENTALS, INC.
STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
YEARS ENDED DECEMBER 31,
------------------------------------------
2001 2000 1999
---------- ---------- ----------
Revenues
Rental revenue $ 88,770 $ 86,099 $ 75,932
Fees 2,697 2,849 2,639
Merchandise sales 3,088 2,947 2,287
---------- ---------- ----------
Total revenues 94,555 91,895 80,858
Operating expenses
Merchandise costs 33,310 30,775 26,758
Store expenses
Salaries and related 22,713 21,774 18,374
Occupancy 8,458 7,478 6,027
Advertising 5,928 4,446 3,662
Other expenses 12,741 11,807 10,310
---------- ---------- ----------
Total store expenses 49,840 45,505 38,373
---------- ---------- ----------
Total merchandise costs and store expenses 83,150 76,280 65,131
General and administrative expenses 7,568 6,795 5,585
Amortization of goodwill and noncompete agreements 689 608 456
---------- ---------- ----------
Total operating expenses 91,407 83,683 71,172
---------- ---------- ----------
Operating income 3,148 8,212 9,686
Interest expense 689 933 697
Other expense, net 485 380 361
---------- ---------- ----------
Income before income taxes 1,974 6,899 8,628
Income taxes 800 2,794 3,580
---------- ---------- ----------
Net income $ 1,174 $ 4,105 $ 5,048
========== ========== ==========
EARNINGS PER COMMON SHARE:
Basic and diluted earnings per share $ 0.20 $ 0.69 $ 0.85
========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 5,925,735 5,925,735 5,925,735
========== ========== ==========
Diluted 5,940,999 5,930,157 5,930,887
========== ========== ==========
See accompanying notes to financial statements.
26
RAINBOW RENTALS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
COMMON STOCK TOTAL
------------------------- RETAINED TREASURY SHAREHOLDERS'
SHARES COST EARNINGS STOCK EQUITY
--------- ------- -------- -------- -------------
Balance at December 31, 1998 5,925,735 $11,039 $17,706 $(1,907) $26,838
Net income -- -- 5,048 -- 5,048
--------- ------- ------- ------- -------
Balance at December 31, 1999 5,925,735 11,039 22,754 (1,907) 31,886
Net income -- -- 4,105 -- 4,105
--------- ------- ------- ------- -------
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
========= ======= ======= ======= =======
See accompanying notes to financial statements.
27
RAINBOW RENTALS, INC.
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
YEARS ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
-------- -------- --------
Cash flows from operating activities
Net income $ 1,174 $ 4,105 $ 5,048
Reconciliation of net income to net cash provided
by operating activities
Depreciation of property and equipment and
amortization of intangibles 2,990 2,689 2,446
Depreciation of rental-purchase merchandise 26,904 24,557 21,821
Loss on write-down of rental purchase merchandise 46 110 --
Write-off of goodwill from sale of store 260 -- --
Deferred income taxes 212 857 506
(Gain) loss on disposal of property and equipment 10 (129) (207)
Gain on sale of store assets (110) -- --
Purchases of rental-purchase merchandise (36,169) (32,971) (31,244)
Rental-purchase merchandise disposed, net 6,414 6,121 5,251
(Increase) decrease in
Income tax receivable 778 (778) --
Prepaid expenses and other current assets (354) (286) (717)
Increase (decrease) in
Accounts payable 1,514 441 212
Accrued income taxes 306 (432) 142
Accrued compensation and related costs 557 (97) 193
Other liabilities and accrued expenses 840 975 344
-------- -------- --------
Net cash provided by operating activities 5,372 5,162 3,795
-------- -------- --------
Cash flows from investing activities
Purchase of property and equipment, net (2,113) (2,433) (2,323)
Proceeds from sale of property and equipment 77 160 360
Proceeds from sale of store assets 272 -- --
Acquisitions (245) (3,721) (11,687)
-------- -------- --------
Net cash used in investing activities (2,009) (5,994) (13,650)
-------- -------- --------
Cash flows from financing activities
Proceeds from long-term debt 27,070 32,147 38,420
Current installments and repayments of long-term debt (29,970) (30,205) (28,022)
Loan fees paid (50) -- (37)
Principal payments under capital lease obligations -- (124) (66)
-------- -------- --------
Net cash provided by (used in) financing activities (2,950) 1,818 10,295
-------- -------- --------
Net increase in cash 413 986 440
Cash at beginning of period 1,426 440 --
-------- -------- --------
Cash at end of period $ 1,839 $ 1,426 $ 440
======== ======== ========
Supplemental cash flow information
Net cash paid (received) during the period for
Interest $ 694 $ 917 $ 560
Income taxes (348) 3,055 3,031
See accompanying notes to financial statements.
28
RAINBOW RENTALS, INC.
NOTES TO 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,
2001, Rainbow operated 113 stores in 11 states: Connecticut, 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.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash and
money market funds with maturities of three months or less from 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 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 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.
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. Leasehold improvements are amortized over the shorter
of the term of the applicable leases or useful life of the assets.
GOODWILL: Goodwill is the excess acquisition cost over the estimated fair
value of net assets acquired. Goodwill is stated at cost less accumulated
amortization. Amortization is computed using the straight-line method over
periods ranging from 18 to 20 years. Goodwill is measured for impairment using
the estimated undiscounted cash flow method and is written down, if necessary.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, Goodwill and Other Intangible Assets, which is effective January 1,
2002. Upon the adoption of SFAS No. 142, goodwill totaling $9,098 will no longer
be amortized, but rather will be assessed annually for impairment, with any such
impairment recognized as a reduction to earnings in the period identified.
Amortization expense for the year ended December 31, 2001 totaled $525.
Management is currently assessing the impact that adopting SFAS No. 142 will
have on the Company's financial position, results of operations and cash flows.
OTHER ASSETS: Other assets consist primarily of noncompete agreements and
a consulting agreement that arose in connection with the share repurchase from a
former officer of the Company. These costs are amortized over their respective
agreement lives.
29
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
RENTAL REVENUE: Merchandise is rented to customers pursuant to
rental-purchase agreements, which generally provide for weekly or monthly rental
terms with nonrefundable rental payments. Rental revenue is recognized over the
lease term. Deferred revenue is recognized based on 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 a
purchase option. Amounts received from such sales, 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 in Note 11 to the financial statements.
ADVERTISING COSTS: Costs incurred for producing and communicating
advertising are charged to expense as incurred.
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.
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, and future results could
differ.
RECLASSIFICATIONS: Certain reclassifications have been made to prior year
financial data in order to conform to the 2001 presentation.
(2) ACQUISITIONS
The Company has 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 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 ("goodwill") is being amortized on a straight-line basis over periods
ranging from 18 to 20 years. Assets acquired, other than goodwill, consisted
primarily of rental-purchase merchandise, property and equipment and non-compete
agreements.
30
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Acquisition activity for the years ended December 31, 2001, 2000 and 1999
is as follows:
2001 2000 1999
------- ------- -------
Goodwill $ 93 $ 2,093 $ 7,581
Rental-purchase merchandise 127 1,589 3,624
Other 25 39 482
------- ------- -------
Purchase price $ 245 $ 3,721 $11,687
======= ======= =======
(3) RENTAL-PURCHASE MERCHANDISE
Following is a summary of rental-purchase merchandise at December 31, 2001
and 2000:
2001 2000
------- -------
On rent
Original cost $57,428 $51,674
Less accumulated depreciation 25,483 23,416
------- -------
31,945 28,258
Held for rent
Original cost 10,827 12,125
Less accumulated depreciation 3,442 3,838
------- -------
7,385 8,287
------- -------
Total rental purchase merchandise, net $39,330 $36,545
======= =======
(4) PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following at December 31, 2001 and
2000:
2001 2000
------- -------
Vehicles $ 653 $ 456
Leasehold improvements 7,394 6,919
Computer equipment 1,488 1,234
Office equipment 2,902 2,633
------- -------
12,437 11,242
Less accumulated depreciation 7,164 5,983
------- -------
$ 5,273 $ 5,259
======= =======
(5) LONG-TERM DEBT
At December 31, 2001, the Company had a revolving loan agreement (the
"Credit Facility") with a lending institution; the maximum revolving loan amount
under this agreement was $11,000, of which $9,440 was outstanding. Interest
charged on the outstanding balance of the Credit Facility was 7.75% (prime plus
3%) at December 31, 2001, which was the result of the Company failing to comply
with two of the four debt covenants in the loan agreement, but was superceded by
a new loan agreement (see below). Prior to failing to comply with the debt
covenants, interest charged on a substantial portion of the outstanding balance
was approximately 4.5%, which
31
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
was based on the Interbank Offering Rate (IBOR) plus an additional margin
ranging from 1.875% to 2.25%. The Credit Facility was scheduled to mature on
March 1, 2002.
The Company entered into a revolving financing agreement (the "New Credit
Facility") with a syndicate of three financial institutions on January 11, 2002.
The agreement allows the Company to borrow up to $25,000 of which the Company
can request to have interest charged on portions of the outstanding principal at
the London Interbank Offering Rate (LIBOR) plus 3%. Under the New Credit
Facility, interest charged on the remaining outstanding balance will be at the
prime rate plus 1%. In addition, the Company must pay a commitment fee equal to
0.50% per annum on the unused portion of the loan commitment. Borrowings under
the New Credit Facility mature three years after the date of the loan. In
January 2002, the Company borrowed $11,249 under the New Credit Facility to
refinance the old Credit Facility. The LIBOR portion of the borrowing totaled
$9,000 with a rate of 4.74% and the remaining outstanding loan balance (prime
portion) was at a rate of 5.75%.
The amount of outstanding borrowings under the New Credit Facility is
primarily limited to 32% of the Company's rental purchase merchandise, which
serves as the security for the debt. As of February 28, 2002, excess
availability totaled $1.9 million. The New 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 Company must meet requirements
regarding monthly, quarterly and annual financial reporting. The New Credit
Facility contains non-financial covenants that restrict 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.
(6) RELATED PARTY TRANSACTIONS
The building that serves as Rainbow's corporate headquarters is leased
from a partnership, owned by the Company's three majority shareholders. The
Company entered into a 10-year building lease agreement, expiring January 2006,
at a rental rate that approximates market rates. Total rent paid to the
partnership in 2001, 2000 and 1999 was approximately $121, $120 and $113,
respectively. The future minimum lease payments under this lease are included in
the total lease obligations disclosed in Note 8.
(7) INCOME TAXES
The provision for income taxes for the years ended December 31, 2001, 2000
and 1999 consists of the following components:
2001 2000 1999
------ ------ ------
Current
Federal $ 467 $1,563 $2,567
State and local 121 374 507
------ ------ ------
588 1,937 3,074
Deferred
Federal 205 783 367
State and local 7 74 139
------ ------ ------
212 857 506
------ ------ ------
Total income tax expense $ 800 $2,794 $3,580
====== ====== ======
32
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
A reconciliation between income tax expense reported and income tax
expense computed by applying the federal statutory rate is as follows:
2001 2000 1999
------ ------ ------
Income before income taxes $1,974 $6,899 $8,628
Federal statutory tax rate 34% 34% 34%
------ ------ ------
671 2,346 2,934
State and local income taxes, net of
federal income tax benefit 84 296 426
Meals and entertainment and officers'
life insurance premiums 19 33 32
Other 26 119 188
------ ------ ------
$ 800 $2,794 $3,580
====== ====== ======
The tax effects of principal temporary differences and the resulting
deferred tax assets and liabilities at December 31, 2001 and 2000 are as
follows:
2001 2000
------- -------
Deferred tax assets
Property and equipment $ 1,258 $ 1,009
Intangibles 288 281
Minimum tax credits -- 170
Employee benefit programs 260 62
Other 25 53
------- -------
Total deferred tax assets 1,831 1,575
Deferred tax liabilities
Rental purchase merchandise (4,261) (3,793)
------- -------
Net deferred tax liability $(2,430) $(2,218)
======= =======
For the years ended December 31, 2001 and 2000, deferred tax assets of
$285 and $115, respectively, were classified as current and were netted with the
deferred tax liability. No valuation allowance was necessary for the years ended
December 31, 2001 and 2000.
33
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(8) LEASES
The Company operates its retail stores and offices under noncancelable
operating leases with terms extending to 2012 and 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 $8,133, $7,402 and $5,866 for the years ended
December 31, 2001, 2000 and 1999, respectively. Future minimum lease payments
under noncancelable operating leases (with initial or remaining lease terms in
excess of one year) as of December 31, 2001 are as follows:
Year ending December 31,
------------------------
2002 $ 7,839
2003 6,645
2004 4,681
2005 2,708
2006 1,148
Thereafter 772
--------
Total minimum lease payments $ 23,793
========
(9) 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 2001, 2000 and 1999, the Company contributed $32,
$31 and $26, respectively.
(10) OTHER ASSETS
Following is a summary of other assets:
2001 2000
------ ------
Non-compete and consulting agreements $2,383 $2,853
Loan fees and other 159 113
------ ------
2,542 2,966
Less accumulated amortization 1,554 1,601
------ ------
$ 988 $1,365
====== ======
Amortization expense related to other assets totaled $448 and $447,
respectively, for the years ended December 31, 2001 and 2000.
(11) STOCK OPTION PLAN
Rainbow sponsors a stock option and incentive plan for the benefit of the
employees of the Company. A total of 600,000 shares of common stock have been
reserved under the plan, and 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.
34
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Following is activity under the plan during the years ended December 31,
2001, 2000 and 1999:
2001 2000 1999
--------------------------- ---------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ----------- ----------- ----------- ----------- -----------
Outstanding, beginning of year 359,800 $ 9.79 317,200 $ 9.96 297,600 $ 10.00
Granted 121,000 5.24 57,500 8.84 30,500 9.59
Exercised -- -- -- -- -- --
Forfeited (55,000) 9.21 (14,900) 9.64 (10,900) 10.00
---------- ----------- -----------
Outstanding, end of year 425,800 $ 8.58 359,800 $ 9.79 317,200 $ 9.96
========== =========== =========== =========== =========== ===========
Exercisable at end of year 256,602 183,942 71,675
========== =========== ===========
Available for grant at end of year 174,200 240,200 282,800
========== =========== ===========
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED NUMBER OF WEIGHTED
REMAINING AVERAGE OPTIONS AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE CURRENTLY EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
--------------- ----------- ------------ -------- ----------- --------
$5.03 - $5.25 103,500 9.1 $ 5.17 -- $ --
$6.00 10,000 9.4 6.00 -- --
$7.69 - $7.88 22,500 8.3 7.79 5,625 7.79
$8.88 - $9.25 30,000 8.1 9.00 13,335 9.06
$9.75 - $10.00 249,800 6.5 9.99 235,142 9.99
$11.63 10,000 8.5 11.63 2,500 11.63
-------- --------
425,800 7.4 $ 8.58 256,602 $ 9.91
======== ======== ======== ======== ========
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 2001,
2000 and 1999 was $3.15, $4.77 and $4.46 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 2001,
2000 and 1999:
2001 2000 1999
------- ------- --------
Risk-free interest rate 4.25% 6.50% 6.30%
Expected life of options 7 years 7 years 7 years
Expected stock price volatility 55% 40% 30%
Dividend yield 0% 0% 0%
35
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Had compensation cost for stock options been measured using SFAS No. 123,
the pro forma amounts for the years ended December 31, 2001, 2000 and 1999 are
indicated below.
2001 2000 1999
--------- --------- ---------
Net income
As reported $ 1,174 $ 4,105 $ 5,048
Pro forma 923 3,842 4,828
Basic and diluted earnings per common share
As reported 0.20 0.69 0.85
Pro forma 0.16 0.65 0.81
(12) 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, 2001, 2000 and 1999:
2001 2000 1999
---------- ---------- ----------
Numerator:
Net income available to common shareholders $ 1,174 $ 4,105 $ 5,048
Denominator:
Basic weighted average shares 5,925,735 5,925,735 5,925,735
Effect of dilutive stock options 15,264 4,422 5,152
---------- ---------- ----------
Diluted weighted average shares 5,940,999 5,930,157 5,930,887
========== ========== ==========
Basic earnings per share $ 0.20 $ 0.69 $ 0.85
========== ========== ==========
Diluted earnings per share $ 0.20 $ 0.69 $ 0.85
========== ========== ==========
(13) 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 effect on the financial position, results of operations or cash
flows of the Company.
36
RAINBOW RENTALS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(14) 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, 2001
Revenue $24,290 $23,589 $22,654 $ 24,022
Merchandise cost and store expenses 21,058 20,297 19,687 22,108
Other operating expenses 2,030 2,139 2,090 1,998
------- ------- ------- --------
Operating income (loss) 1,202 1,153 877 (84)
Interest and other expenses 311 450 215 198
Income taxes (benefit) 360 285 268 (113)
------- ------- ------- --------
Net income (loss) $ 531 $ 418 $ 394 $ (169)
======= ======= ======= ========
Basic and diluted earnings (loss) per share $ 0.09 $ 0.07 $ 0.07 $ (0.03)
======= ======= ======= ========
Year ended December 31, 2000
Revenue $22,462 $22,386 $23,527 $ 23,520
Merchandise cost and store expenses 18,167 17,929 20,124 20,060
Other operating expenses 1,750 1,847 2,046 1,760
------- ------- ------- --------
Operating income 2,545 2,610 1,357 1,700
Interest and other expenses 271 317 371 354
Income taxes 932 938 407 517
------- ------- ------- --------
Net income $ 1,342 $ 1,355 $ 579 $ 829
======= ======= ======= ========
Basic and diluted earnings per share $ 0.23 $ 0.23 $ 0.09 $ 0.14
======= ======= ======= ========
37
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 29, 2002.
SIGNATURES TITLE
- ---------- -----
/s/ WAYLAND J. RUSSELL Chairman, Chief Executive Officer and Director
- ----------------------------
Wayland J. Russell
/s/ LAWRENCE S. HENDRICKS Chief Operating Officer and Director
- ----------------------------
Lawrence S. Hendricks
/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
38
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- ---------------------------
3.1(1) Amended and Restated Articles of Incorporation
3.2(1) Amended and Restated By-Laws and Code of Regulations
4.1 Security Agreement dated as of January 11, 2002 between
the Company and National City Bank, as agent
4.2 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
13 Annual Report to Shareholders for the year ended
December 31, 2001
23 Consent of Independent Public Accountants
(1) Previously filed, as of June 5, 1998, pursuant to the Company's
Registration Statement on Form S-1.
39