UPBOUND GROUP, INC. - Annual Report: 2010 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

 

Commission File No. 0-25370

 

 

 

 

Rent-A-Center, Inc.

(Exact name of registrant as specified in its charter)

 

 

5501 Headquarters Drive

Plano, Texas 75024

(Address, including zip code of registrant’s
principal executive offices)

 

Registrant’s telephone number, including area code: 972-801-1100

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

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 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.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

Documents incorporated by reference:

 

Portions of the definitive proxy statement relating to the 2011 Annual Meeting of Stockholders of Rent-A-Center, Inc. are incorporated by reference into Part III of this report.

 

 

TABLE OF CONTENTS

 

 

 

Overview

 

Unless the context indicates otherwise, references to “we,” “us” and “our” refers to the consolidated business operations of Rent-A-Center, Inc., the parent, and all of its direct and indirect subsidiaries.

 

We are the largest operator in the United States rent-to-own industry with an approximate 35% market share based on store count. At December 31, 2010, we operated 3,008 company-owned stores nationwide and in Canada, Puerto Rico and Mexico, including 42 retail installment sales stores under the names “Get It Now” and “Home Choice,” and 18 rent-to-own stores located in Canada under the name “Rent-A-Centre.” Our subsidiary, ColorTyme, is a national franchisor of rent-to-own stores. At December 31, 2010, ColorTyme had 209 franchised rent-to-own stores in 32 states. These franchise stores represent an additional 2% market share based on store count.

 

As part of our current growth strategy, we are focused on seeking additional distribution channels for our products and services. We operate kiosk locations under the “RAC Acceptance” model which offers the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer. These kiosks are located within such retailer’s store locations. At December 31, 2010, we operated 384 RAC Acceptance locations.

 

In addition, we are expanding our operations in Canada and Mexico and seeking to identify other international markets in which we believe our products and services would be in demand. At December 31, 2010, we operated 18 stores in Canada and five stores in Mexico.

 

Our stores generally offer high quality durable products such as major consumer electronics, appliances, computers, and furniture and accessories under flexible rental purchase agreements that generally allow the customer to obtain ownership of the merchandise at the conclusion of an agreed-upon rental period. The rental purchase transaction is a flexible alternative for consumers to obtain use and enjoyment of brand name merchandise without incurring debt. Key features of the rental purchase transaction include:

 

• convenient payment options:

 

 

• no long-term obligations;

 

• right to terminate without penalty;

 

• no requirement of a credit history;

 

• delivery and set-up;

 

• product maintenance;

 

 

We offer well known brands such as Sony, Philips, LG, Hitachi, Toshiba and Mitsubishi home electronics, Whirlpool appliances, Toshiba, Sony, Hewlett-Packard, Dell, Acer and Compaq computers and Ashley, England, Standard, Albany and Klaussner furniture. We also offer high levels of customer service, including repair, pickup and delivery, generally at no additional charge. Our customers benefit from the ability to return merchandise at any time without further obligation and make payments that build toward ownership. We estimate that approximately 74% of our business is from repeat customers.

 

We were incorporated in Delaware in 1986. Our principal executive offices are located at 5501 Headquarters Drive, Plano, Texas 75024. Our telephone number is (972) 801-1100 and our company website is www.rentacenter.com. We do not intend for information contained on our website to be part of this Form 10-K.

We make available free of charge on or through our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”). Additionally, we provide electronic or paper copies of our filings free of charge upon request.

 

Industry Overview

 

According to the Association of Progressive Rental Organizations (“APRO”), the rent-to-own industry in the United States and Canada consists of approximately 8,600 stores and serves approximately 4.1 million households. We estimate that the two largest rent-to-own industry participants account for approximately 4,900 of the total number of stores, and the majority of the remainder of the industry consists of operations with fewer than 50 stores. The rent-to-own industry is highly fragmented and has experienced significant consolidation. We believe this consolidation trend in the industry will continue, presenting opportunities for us to continue to acquire additional stores or customer accounts on favorable terms.

 

The rent-to-own industry serves a highly diverse customer base. According to APRO, approximately 83% of rent-to-own customers have household incomes between $15,000 and $50,000 per year. The rent-to-own industry serves a wide variety of customers by allowing them to obtain merchandise that they might otherwise be unable to obtain due to insufficient cash resources or a lack of access to credit. We believe the number of consumers lacking access to credit is increasing. According to a report issued by the Fair Isaac Corporation on July 13, 2010, consumers in the “subprime” category (those with credit scores below 650) made up 35% of the United States population.

 

According to the latest available United States Federal Trade Commission study dated April 2000, 75% of rent-to-own customers were satisfied with their experience with rent-to-own transactions. The study noted that customers gave a wide variety of reasons for their satisfaction, including “the ability to obtain merchandise they otherwise could not; the low payments; the lack of a credit check; the convenience and flexibility of the transaction; the quality of the merchandise; the quality of the maintenance, delivery, and other services; the friendliness and flexibility of the store employees; and the lack of any problems or hassles.”

 

Locations

 

Since March 1993, the number of our locations has grown from 27 to 3,392 at December 31, 2010, primarily through acquisitions. During this period, we acquired over 3,300 stores, including approximately 400 of our franchised stores. These acquisitions occurred in approximately 280 separate transactions, including 11 transactions where we acquired in excess of 50 locations. In addition, we strategically opened or acquired stores near market areas served by existing stores (“cannibalized”) to enhance service levels, gain incremental sales and increase market penetration.

 

As part of our current growth strategy, we are focused on seeking additional distribution channels for our products and services and are expanding our presence in third-party retailers through our RAC Acceptance initiative, as well as opening new stores in Canada and Mexico.

 

The following table summarizes our locations allocated among rent-to-own stores, RAC Acceptance kiosk locations, Get It Now/Home Choice retail locations, Canada and Mexico as of December 31, 2010:

 

Future Growth.  We continue to believe there are attractive opportunities to expand our presence in the rent-to-own industry both nationally and internationally. We plan to continue opening new stores and kiosks in targeted markets and acquiring existing rent-to-own stores and store account portfolios. We will focus new market penetration in adjacent areas or regions that we believe are underserved by the rent-to-own industry. In addition, we intend to pursue our acquisition strategy of targeting under-performing and under-capitalized rent-to-own stores. Periodically, we critically evaluate the markets in which we operate and will close, sell or merge underperforming stores.

 

Competitive Strengths

 

We believe the following competitive strengths position us well for continued growth:

 

Geographic Footprint.  At December 31, 2010, we operated 3,008 stores nationwide and in Canada, Puerto Rico and Mexico, and 384 RAC Acceptance kiosk locations in 29 states and Puerto Rico. In addition, our subsidiary, ColorTyme, franchised 209 stores in 32 states. We believe the number and location of our stores combined with the strength of our brand provides us with a unique platform from which to market additional products and services to our customer demographic. The following table shows the geographic distribution of our stores:

 

 

 

 

Management Expertise.  Our senior management team averages over 20 years of rent-to-own or similar retail experience and has successfully grown our business, including the successful integration of approximately 3,300 stores acquired through approximately 280 acquisition transactions. In addition, our regional and district managers have long tenures with us, and we have a history of promoting management personnel from within. We believe this

extensive industry and integration experience will allow us to capitalize on ongoing consolidation opportunities created by the fragmented nature of the rent-to-own industry.

 

Financial Strength.  Historically, our operations have generated strong cash flow, averaging $269.1 million in operating cash flow per year since 2001. As a result, we have been able to invest in new business opportunities, including acquisitions, and people, processes and technology, while maintaining a strong balance sheet.

 

Strategy

 

We intend to capitalize on our competitive strengths and continue to build our position as a leading provider of products and services to cash and credit constrained consumers by focusing our strategic efforts on the following:

 

 

Enhancing the Operations, Revenue and Profitability of Our Store Locations

 

We continually seek to improve store performance through strategies intended to produce gains in operating efficiency, revenue and profitability. We believe we will achieve gains in revenues and operating margins in both existing and newly acquired stores by continuing to:

 

 

Seeking Additional Distribution Channels for Our Products and Services

 

We believe there are opportunities for us to obtain new customers through sources other than our existing rent-to-own stores. We are currently exploring the following alternatives:

 

 

There can be no assurance that we will be successful in our efforts to expand our distribution channels, or that such operations, should they be added, will prove to be profitable.

Leveraging our Financial Strength

 

We believe we can leverage our financial strength by investing significantly in people, processes and technology to increase revenue and reduce our cost infrastructure through our investments in the following:

 

 

We believe our financial strength allows us to pursue these and other initiatives while also making strategic use of our cash.

 

Strengthening Customer Relationships through Community Involvement

 

We seek to further strengthen relationships with our customers through community involvement both at the local store level and as a company through corporate donations and initiatives. We encourage the management of each of our stores to involve themselves with their respective local communities. In addition, we participate in various programs, including the following:

 

 

 

Rent-A-Center Store Operations

 

Store Design

 

Our stores average approximately 4,700 square feet and are located primarily in strip centers. Because we utilize “just in time” inventory strategies, receiving merchandise shipments in relatively small quantities directly from vendors, we are able to dedicate approximately 75% of the store space to showroom floor, and also eliminate warehousing costs. We continually evaluate store design in an effort to improve our customers’ in-store experience. Stores are remodeled approximately every five years.

 

Product Selection

 

Our stores generally offer merchandise from four basic product categories: major consumer electronics, appliances, computers and furniture and accessories. Although we seek to maintain sufficient inventory in our stores to offer customers a wide variety of models, styles and brands, we generally limit merchandise to prescribed levels to maintain strict inventory controls. We seek to provide a wide variety of high quality merchandise to our customers, and we emphasize high-end products from name-brand manufacturers. For the year ended December 31, 2010, consumer electronic products accounted for approximately 33% of our store rental revenue, furniture and accessories for 32%, appliances for 18% and computers for 17%. Customers may request either new merchandise or previously rented merchandise. Previously rented merchandise is generally offered at the same weekly or monthly rental rate as is offered for new merchandise, but with an opportunity to obtain ownership of the merchandise after fewer rental payments.

 

Major consumer electronic products offered by our stores include high definition televisions, home theatre systems, video game consoles and stereos from top name-brand manufacturers such as Sony, Philips, LG, Hitachi, Toshiba, Mitsubishi and Microsoft. We offer major appliances manufactured by Whirlpool, including refrigerators, washing machines, dryers, freezers and ranges. We offer desktop and laptop computers from Toshiba, Sony, Hewlett Packard, Dell, Acer and Compaq. We offer a variety of furniture products, including dining room, living room and bedroom furniture featuring a number of styles, materials and colors. We offer furniture made by Ashley, England, Standard, Albany and Klaussner and other top name-brand manufacturers. Accessories include lamps and tables and are typically rented as part of a package of items, such as a complete room of furniture. Showroom displays enable customers to visualize how the product will look in their homes and provide a showcase for accessories.

 

Rental Purchase Agreements

 

Our customers generally enter into weekly, semi-monthly or monthly rental purchase agreements, which renew automatically upon receipt of each payment. We retain title to the merchandise during the term of the rental purchase agreement. Ownership of the merchandise generally transfers to the customer if the customer has continuously renewed the rental purchase agreement for a period of seven to 30 months, depending upon the product type, or exercises a specified early purchase option. We do not conduct a formal credit investigation of each customer. We do require a potential customer to provide store management with sufficient personal information to allow us to verify their residence and sources of income. References listed by the customer are also contacted to verify the information contained in the customer’s rental purchase order form. Rental payments are generally made in the store or by telephone. We accept cash and credit or debit cards. Approximately 83% of our agreements are on a weekly term. Depending on state regulatory requirements, we may charge for the reinstatement of terminated accounts or collect a delinquent account fee, and collect loss/damage waiver fees from customers desiring product protection in case of theft or certain natural disasters. These fees are standard in the industry and may be subject to government-specified limits. Please read the section entitled “— Government Regulation.”

Product Turnover

 

On average, a minimum rental term of 18 months is generally required to obtain ownership of new merchandise. Approximately 25% of our initial rental purchase agreements are taken to the full term of the agreement. The average total life for each product is approximately 20 months, which includes the initial rental period, all re-rental periods and idle time in our system. To cover the relatively high operating expenses generated by greater product turnover, rental purchase agreements require higher aggregate payments than are generally charged under other types of purchase plans, such as installment purchase or credit plans.

 

Customer Service

 

We generally offer same day or 24-hour delivery and installation of our merchandise at no additional cost to the customer. We provide any required service or repair without additional charge, except for damage in excess of normal wear and tear. Repair services are provided through our national network of 24 service centers, the cost of which may be reimbursed by the vendor if the item is still under factory warranty. If the product cannot be repaired at the customer’s residence, we provide a temporary replacement while the product is being repaired. Generally, the customer is fully liable for damage, loss or destruction of the merchandise, unless the customer purchases an optional loss/damage waiver covering the particular loss. Most of the products we offer are covered by a manufacturer’s warranty for varying periods which, subject to the terms of the warranty, is transferred to the customer in the event that the customer obtains ownership.

 

Collections

 

Store managers use our management information system to track collections on a daily basis. Our goal is to have no more than 5.99% of our rental agreements past due one day or more each Saturday evening. For fiscal years 2010, 2009, and 2008, the average week ending past due percentages were 6.90%, 6.50% and 6.38%, respectively. If a customer fails to make a rental payment when due, store personnel will attempt to contact the customer to obtain payment and reinstate the agreement, or will terminate the account and arrange to regain possession of the merchandise. We attempt to recover the rental items as soon as possible following termination or default of a rental purchase agreement, generally by the seventh day. Collection efforts are enhanced by the personal and job-related references required of customers, the personal nature of the relationships between store employees and customers and the fact that, following a period in which a customer is temporarily unable to make payments on a piece of rental merchandise and must return the merchandise, that customer generally may re-rent a piece of merchandise of similar type and age on the terms the customer enjoyed prior to that period.

 

If the customer does not return the merchandise or make payment, the remaining book value of the rental merchandise associated with delinquent accounts is generally charged off on or before the ninetieth day following the time the account became past due. Charge offs in our rental stores due to customer stolen merchandise, expressed as a percentage of rental store revenues, were approximately 2.3% in 2010 and 2009 and 2.5% in 2008.

 

Management

 

We organize our network of stores and kiosks geographically with multiple levels of management. At the individual store level, each store manager is responsible for customer and account relations, delivery and collection of merchandise, inventory management, staffing, training store personnel and certain marketing efforts. Two times each week, store management is required to count the store’s inventory on hand and compare the count to our accounting records, with the district manager performing a similar count at least quarterly. In addition, our individual store managers track their daily store performance for revenue collected as compared to the projected performance of their store. Each store manager reports to a district manager within close proximity who typically oversees six to eight stores. Typically, a district manager focuses on developing the personnel in his or her district and ensuring all stores meet our quality, cleanliness and service standards. In addition, a district manager routinely audits numerous areas of the stores’ operations. A significant portion of a district manager’s and store manager’s compensation is dependent upon store revenues and profits.

 

At December 31, 2010, we had 484 district managers who, in turn, reported to 73 regional directors. Regional directors monitor the results of their entire region, with an emphasis on developing and supervising the district

managers in their region. Similar to the district managers, regional directors are responsible for ascertaining whether stores are following the operational guidelines. The regional directors report to nine division vice presidents located at our corporate headquarters in Plano, Texas. The regional directors receive a significant amount of their compensation based on the revenue and profitability of the stores under their management.

 

Our executive management team, including our division vice presidents, oversees field operations, with an overall strategic focus. The executive management team directs and coordinates advertising, purchasing, financial planning and controls, employee training, personnel matters, acquisitions and new store initiatives. The centralization and coordination of such operational matters allows our store managers to focus on individual store performance. A significant portion of our executive management compensation is determined by the revenue and profits generated by us.

 

Management Information Systems

 

Through a licensing agreement with High Touch, Inc., we utilize an integrated management information and control system. Each store is equipped with a computer system utilizing point of sale software developed by High Touch. This system tracks individual components of revenue, each item in idle and rented inventory, total items on rent, delinquent accounts, items in service and other account information. We electronically gather each day’s activity report, which provides our executive management with access to all operating and financial information concerning any of our stores, markets or regions and generates management reports on a daily, weekly, month-to-date and year-to-date basis for each store and for every rental purchase transaction. The system enables us to track all of our merchandise and rental purchase agreements, which often include more than one unit of merchandise. In addition, our bank reconciliation system performs a daily sweep of available funds from our stores’ depository accounts into our central operating account based on a formula that enables us to meet store operating needs while effectively utilizing excess cash. Our system also includes extensive management software, report-generating capabilities and a virtual private network. The virtual private network allows us to communicate with our stores more effectively and efficiently. Utilizing the management information system, our executive management, division vice presidents, regional directors, district managers and store managers closely monitor the productivity of stores under their supervision according to our prescribed guidelines. We are currently investing in the development of new point of sale systems and processes to further enhance our management information system.

 

The integration of our management information system, developed by High Touch, with our accounting system, developed by Lawson Software, Inc., facilitates the production of our internal financial statements. These financial statements are distributed monthly to all stores, markets, regions and our executive management team for their review.

 

Purchasing and Distribution

 

We utilize a centralized inventory management system that includes automated merchandise replenishment. Our automated replenishment system uses perpetual inventory records to analyze individual store requirements, as well as other pertinent information such as delivery and return forecasts, blanket orders, predetermined inventory levels, and vendor performance, to generate recommended merchandise order information. These recommended orders are reviewed by the store manager and delivered electronically to our vendors. The stores also have online access to determine whether other stores in their market may have merchandise available. All merchandise is shipped by vendors directly to each store, where it is held for rent. We do not utilize any distribution centers in the United States. These systems and procedures allow us to retain tight control over our inventory, improve the diversity and assortment of merchandise in our stores, and assist us in having the right products available at the right time. In addition, these systems require less involvement by our store employees resulting in more time available for customer service and sales activities.

 

We purchase our rental merchandise from a variety of manufacturers and distributors. In 2010, approximately 14.9% and 12.1%, respectively, of merchandise purchases were attributable to Whirlpool and Ashley. No other brand accounted for more than 10% of merchandise purchased during this period. We do not generally enter into written contracts with our suppliers that obligate us to meet certain minimum purchasing levels. Although we expect to continue relationships with our existing suppliers, we believe there are numerous sources of products

available, and we do not believe the success of our operations is dependent on any one or more of our present suppliers.

 

Marketing

 

We promote our products and services through television and radio commercials, print advertisements, Internet sites, direct response and store signage, all of which are designed to increase our name recognition among our customers and potential customers. Our advertisements emphasize such features as product and name-brand selection, prompt delivery, price match, service at no extra cost, lifetime reinstatement and the absence of initial deposits, credit investigations or long-term obligations. In addition, we promote the “RAC Worry-Free Guarantee^®” to further highlight these aspects of the rent-to-own transaction. We believe that as the Rent-A-Center name gains familiarity and national recognition through our advertising efforts, we will continue to educate our customers and potential customers about the rent-to-own alternative to merchandise purchases as well as solidify our reputation as a leading provider of high quality branded merchandise and services.

 

Advertising expense as a percentage of store revenue remained approximately at 2.9% for the years ended December 31, 2010, 2009 and 2008. As we obtain new stores in our existing market areas, the advertising expenses of each store in the market can generally be reduced by listing all stores in the same market-wide advertisement.

 

Competition

 

The rent-to-own industry is highly competitive. According to industry sources and our estimates, the two largest industry participants account for approximately 4,900 of the 8,600 rent-to-own stores in the United States and Canada. We are the largest operator in the rent-to-own industry with 3,008 stores, 384 kiosk locations and 209 franchised locations as of December 31, 2010. Our stores compete with other national, regional and local rent-to-own businesses, as well as with rental stores that do not offer their customers a purchase option. With respect to customers desiring to purchase merchandise for cash or on credit, we also compete with retail stores. Competition is based primarily on store location, product selection and availability, customer service and rental rates and terms.

 

Seasonality

 

Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales than any other quarter during a fiscal year, primarily related to federal income tax refunds. Generally, our customers will more frequently exercise the early purchase option on their existing rental purchase agreements or purchase pre-leased merchandise off the showroom floor during the first quarter of each fiscal year. We expect this trend to continue in future periods. Furthermore, we tend to experience slower growth in the number of rental purchase agreements in the third quarter of each fiscal year when compared to other quarters throughout the year. As a result, we would expect revenues for the third quarter of each fiscal year to remain relatively flat with the prior quarter. We expect this trend to continue in future periods unless we add significantly to our store base during the third quarter of future fiscal years as a result of new store openings or opportunistic acquisitions.

 

RAC Acceptance Kiosk Operations

 

Through our RAC Acceptance program, we provide an onsite rent-to-own option at a third-party retailer’s location. In the event a retail purchase credit application is declined, the customer can be directed to an in-store RAC Acceptance representative who introduces them to the rental purchase transaction. Because the rental purchase transaction does not include the incurrence of debt, no credit check is needed and applicants who meet the basic criteria are generally approved. We believe our RAC Acceptance program is beneficial for both the retail dealers and the consumer. The retail dealers capture more sales because we buy the inventory item directly from them and future rental payments are generally made at the retail dealer. We believe consumers also benefit from our RAC Acceptance program because they are able to obtain the products they want and need without the necessity of credit. As of December 31, 2010, we operated 384 kiosk locations inside approximately 50 furniture and electronics retailers located in 29 states and Puerto Rico. We expect to add approximately 300 kiosk locations during 2011.

Retail Store Operations

 

As of December 31, 2010, we operated 42 stores utilizing a retail model which generates installment credit sales through a retail sale transaction. Twenty-four of these stores operate under the name “Get It Now” and 18 stores under the name “Home Choice.” Our retail stores are located in Illinois, Minnesota and Wisconsin.

 

ColorTyme Operations

 

ColorTyme is our nationwide franchisor of rent-to-own stores. At December 31, 2010, ColorTyme franchised 209 stores in 32 states. These rent-to-own stores primarily offer high quality durable products such as home electronics, appliances, computers and furniture and accessories. During 2010, 13 new franchise locations were added, nine were sold (all of which we purchased) and five stores closed.

 

All of the ColorTyme franchised stores use ColorTyme’s trade names, service marks, trademarks and logos. All stores operate under distinctive operating procedures and standards. ColorTyme’s primary source of revenue is the sale of rental merchandise to its franchisees who, in turn, offer the merchandise to the general public for rent or purchase under a rent-to-own program. As franchisor, ColorTyme receives royalties of 2.0% to 5.0% of the franchisees’ monthly gross revenue and, generally, an initial fee up to $20,000 per new location for existing franchisees and up to $25,000 per location for new franchisees.

 

The ColorTyme franchise agreement generally requires the franchised stores to utilize specific computer hardware and software for the purpose of recording rentals, sales and other record keeping and central functions. ColorTyme retains the right to retrieve data and information from the franchised stores’ computer systems. The franchise agreement also limits the ability of the franchisees to compete with other franchisees and provides us a right of first refusal to purchase the franchise location of a ColorTyme franchisee that wishes to exit the business.

 

The franchise agreement also requires the franchised stores to exclusively offer for rent or sale only those brands, types and models of products that ColorTyme has approved. The franchised stores are required to maintain an adequate mix of inventory that consists of approved products for rent as dictated by ColorTyme policy manuals. ColorTyme negotiates purchase arrangements with various suppliers it has approved. ColorTyme’s largest suppliers are Ashley and Whirlpool, which accounted for approximately 18.5% and 12.7% of merchandise purchased by ColorTyme in 2010, respectively.

 

ColorTyme franchisees may also offer financial services, such as short term secured and unsecured loans, in addition to traditional rent-to-own products. In addition, some of ColorTyme’s franchised stores offer custom rims and tires for sale or rental under the trade names “RimTyme” or “ColorTyme Custom Wheels.” As of December 31, 2010, 42 ColorTyme stores operated by 15 separate franchisees offered financial services. Seventeen ColorTyme stores operated by six separate franchisees offered tires and rims exclusively.

 

Our subsidiary, ColorTyme Finance, Inc., is a party to an agreement with Citibank, N.A., who provides up to $25.0 million in aggregate financing to qualifying franchisees of ColorTyme. Under the Citibank agreement, upon an event of default by the franchisee under agreements governing this financing and upon the occurrence of certain other events, Citibank can assign the loans and the collateral securing such loans to ColorTyme Finance, with ColorTyme Finance paying or causing to be paid the outstanding debt to Citibank and then succeeding to the rights of Citibank under the debt agreements, including the right to foreclose on the collateral. Rent-A-Center and ColorTyme Finance guarantee the obligations of the franchise borrowers under the Citibank facility. An additional $20.0 million of financing is provided by Texas Capital Bank, National Association (“Texas Capital Bank”) under an agreement similar to the Citibank financing, which is guaranteed by Rent-A-Center East, Inc., a subsidiary of Rent-A-Center. The maximum guarantee obligations under these agreements, excluding the effects of any amounts that could be recovered under collateralization provisions, is $45.0 million, of which $17.9 million was outstanding as of December 31, 2010.

 

ColorTyme has established national advertising funds for the franchised stores, whereby ColorTyme has the right to collect up to 3% of the monthly gross revenue from each franchisee as contributions to the fund. Currently, ColorTyme has set the monthly franchisee contribution at $250 per store per month. ColorTyme directs the advertising programs of the fund, generally consisting of advertising in print, television and radio. ColorTyme also has the right to require franchisees to expend 3% of their monthly gross revenue on local advertising.

ColorTyme licenses the use of its trademarks and service marks to its franchisees under the franchise agreement. ColorTyme owns various trademarks and service marks, including ColorTyme^®, RimTyme^®, and Your Hometown ColorTyme^®, that are used in connection with its operations and have been registered with the United States Patent and Trademark office. The duration of these marks is unlimited, subject to periodic renewal and continued use.

 

Some of ColorTyme’s franchisees may be in locations where they directly compete with our company-owned stores, which could negatively impact the business, financial condition and operating results of our company-owned stores.

 

Financial Services Operations

 

On October 25, 2010, we announced that, in connection with an analysis of our available growth initiatives, we were exploring strategic alternatives with respect to our financial services business, including the possible sale or divestiture of such business. As of February 18, 2011, we had ceased making new loans, sold a majority of our customer accounts, and had less than $5.0 million in remaining loan balance.

 

Trademarks

 

We own various trademarks and service marks, including Rent-A-Center^®, that are used in connection with our operations and have been registered with the United States Patent and Trademark Office. The duration of our trademarks is unlimited, subject to periodic renewal and continued use. In addition, we have obtained trademark registrations in Canada and Mexico. We believe we hold the necessary rights for protection of the trademarks and service marks essential to our business. The products held for rent in our stores also bear trademarks and service marks held by their respective manufacturers.

 

Employees

 

As of February 18, 2011, we had approximately 18,300 employees, of whom 660 are assigned to our headquarters and the remainder of whom are directly involved in the management and operation of our stores and service centers. The employees of the ColorTyme franchisees are not employed by us. While we have experienced limited union activity in the past, none of our employees are covered by a collective bargaining agreement. We believe relationships with our employees are generally good.

 

Government Regulation

 

State Regulation

 

Currently, 46 states, the District of Columbia and Puerto Rico have legislation that recognize and regulate rental purchase transactions as separate and distinct from credit sales. We believe this existing legislation is generally favorable to us, as it defines and clarifies the various disclosures, procedures and transaction structures related to the rent-to-own business with which we must comply. With some variations in individual states, most related state legislation requires the lessor to make prescribed disclosures to customers about the rental purchase agreement and transaction, and provides time periods during which customers may reinstate agreements despite having failed to make a timely payment. Some state rental purchase laws prescribe grace periods for non-payment, prohibit or limit certain types of collection or other practices, and limit certain fees that may be charged. Ten states limit the total rental payments that can be charged to amounts ranging from 2.0 times to 2.4 times the disclosed cash price or the retail value of the rental product.

 

Although Minnesota has a rental purchase statute, the rental purchase transaction is also treated as a credit sale subject to consumer lending restrictions pursuant to judicial decision. Therefore, we offer our customers in Minnesota an opportunity to purchase our merchandise through an installment sale transaction in our Home Choice stores. We operate ten Home Choice stores in Minnesota.

 

North Carolina has no rental purchase legislation. However, the retail installment sales statute in North Carolina expressly provides that lease transactions which provide for more than a nominal purchase price

at the end of the agreed rental period are not credit sales under the statute. We operate 129 rent-to-own stores and 19 RAC Acceptance locations in North Carolina.

 

Courts in Wisconsin and New Jersey, which do not have rental purchase statutes, have rendered decisions which classify rental purchase transactions as credit sales subject to consumer lending restrictions. Accordingly, in Wisconsin, we offer our customers an opportunity to purchase our merchandise through an installment sale transaction in our Get It Now stores. In New Jersey, we have modified our typical rental purchase agreements to provide disclosures, grace periods, and pricing that we believe conform with the retail installment sales act. We operate 24 Get It Now stores in Wisconsin and 44 Rent-A-Center stores in New Jersey.

 

Federal Legislation

 

To date, no comprehensive federal legislation has been enacted regulating or otherwise impacting the rental purchase transaction. The Dodd-Frank Wall Street Reform and Consumer Protection Act does not regulate leases with terms of 90 days or less. The rent-to-own transaction is for a term of week to week, or at most, month to month. Established federal law deems the term of a lease to be its minimum term regardless of extensions or renewals, if any. We do, however, comply with the Federal Trade Commission recommendations for disclosure in rental purchase transactions.

 

From time to time, we have supported legislation introduced in Congress that would regulate the rental purchase transaction. While both beneficial and adverse legislation may be introduced in Congress in the future, any adverse federal legislation, if enacted, could have a material and adverse effect on us.

 

There can be no assurance as to whether new or revised rental purchase laws will be enacted or whether, if enacted, the laws would not have a material and adverse effect on us.

 

 

You should carefully consider the risks described below before making an investment decision. We believe these are all the material risks currently facing our business. Our business, financial condition or results of operations could be materially adversely affected by these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. You should also refer to the other information included in this report, including our consolidated financial statements and related notes.

 

Future revenue growth depends on our ability to identify and execute new growth strategies.

 

We have a mature store base. As a result, our same store sales have increased more slowly than in historical periods, or in some cases, decreased. Our future growth will require that we successfully increase revenue in our rent-to-own stores, as well as seek to identify additional distribution channels for our products and services. If we are unable to identify and successfully implement these strategic growth initiatives, our earnings may grow more slowly or even decrease.

 

Rent-to-own transactions are regulated by law in most states. Any adverse change in these laws or the passage of adverse new laws could expose us to litigation or require us to alter our business practices.

 

As is the case with most businesses, we are subject to various governmental regulations, including in our case, regulations specifically regarding rent-to-own transactions. Currently, 46 states, the District of Columbia and Puerto Rico have passed laws that regulate rental purchase transactions as separate and distinct from credit sales. One additional state has a retail installment sales statute that excludes leases, including rent-to-own transactions, from its coverage if the lease provides for more than a nominal purchase price at the end of the rental period. The specific rental purchase laws generally require certain contractual and advertising disclosures. They also provide varying levels of substantive consumer protection, such as requiring a grace period for late fees and contract reinstatement rights in the event the rental purchase agreement is terminated. The rental purchase laws of ten states limit the total amount that may be charged over the life of a rental purchase agreement and the laws of four states limit the cash prices for which we may offer merchandise. Most states also regulate rental purchase transactions, as well as other consumer transactions, under various consumer protection statutes. The rental purchase statutes and

other consumer protection statutes provide various consumer remedies, including monetary penalties, for violations. In our history, we have been the subject of litigation alleging that we have violated some of these statutory provisions.

 

Although there is currently no comprehensive federal legislation regulating rental purchase transactions, adverse federal legislation may be enacted in the future. From time to time, both favorable and adverse legislation seeking to regulate our business has been introduced in Congress. In addition, various legislatures in the states where we currently do business may adopt new legislation or amend existing legislation that could require us to alter our business practices.

 

We may be subject to legal proceedings from time to time which seek material damages. The costs we incur in defending ourselves or associated with settling any of these proceedings, as well as a material final judgment or decree against us, could materially adversely affect our financial condition by requiring the payment of the settlement amount, a judgment or the posting of a bond.

 

In our history, we have defended class action lawsuits alleging various regulatory violations and have paid material amounts to settle such claims. Significant settlement amounts or final judgments could materially and adversely affect our liquidity. The failure to pay any material judgment would be a default under our senior credit facilities and the indenture governing our outstanding senior unsecured notes.

 

Our debt agreements impose restrictions on us which may limit or prohibit us from engaging in certain transactions. If a default were to occur, our lenders could accelerate the amounts of debt outstanding, and holders of our secured indebtedness could force us to sell our assets to satisfy all or a part of what is owed.

 

Covenants under our senior credit facilities and the indenture governing our outstanding senior unsecured notes restrict our ability to pay dividends and engage in various operational matters. In addition, covenants under our senior credit facilities require us to maintain specified financial ratios. Our ability to meet these financial ratios may be affected by events beyond our control. These restrictions could limit our ability to obtain future financing, make needed capital expenditures or other investments, repurchase our outstanding debt or equity, pay dividends, withstand a future downturn in our business or in the economy, dispose of operations, engage in mergers, acquire additional stores or otherwise conduct necessary corporate activities. Various transactions that we may view as important opportunities, such as specified acquisitions, are also subject to the consent of lenders under the senior credit facilities, which may be withheld or granted subject to conditions specified at the time that may affect the attractiveness or viability of the transaction.

 

If a default were to occur, the lenders under our senior credit facilities could accelerate the amounts outstanding under the credit facilities. In addition, the lenders under these agreements could terminate their commitments to lend to us. If the lenders under these agreements accelerate the repayment of borrowings, we may not have sufficient liquid assets at that time to repay the amounts then outstanding under our indebtedness or be able to find additional alternative financing. Even if we could obtain additional alternative financing, the terms of the financing may not be favorable or acceptable to us.

 

The existing indebtedness under our senior credit facilities is secured by substantially all of our assets. Should a default or acceleration of this indebtedness occur, the holders of this indebtedness could sell the assets to satisfy all or a part of what is owed.

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

 

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2010, $401.1 million was outstanding under our senior credit facilities.

 

Under the indenture governing our outstanding senior unsecured notes, in the event of a change in control, we may be required to offer to purchase all of our outstanding senior unsecured notes at 101% of their original

aggregate principal amount, plus accrued interest to the date of repurchase. A change in control also would result in an event of default under our senior credit facilities, which would allow our lenders to accelerate indebtedness owed to them.

 

If a specified change in control occurs and the lenders under our debt instruments accelerate these obligations, we may not have sufficient liquid assets to repay amounts outstanding under these agreements.

 

Rent-A-Center’s organizational documents and our debt instruments contain provisions that may prevent or deter another group from paying a premium over the market price to Rent-A-Center’s stockholders to acquire its stock.

 

Rent-A-Center’s organizational documents contain provisions that classify its Board of Directors, authorize its Board of Directors to issue blank check preferred stock and establish advance notice requirements on its stockholders for director nominations and actions to be taken at meetings of the stockholders. In addition, as a Delaware corporation, Rent-A-Center is subject to Section 203 of the Delaware General Corporation Law relating to business combinations. Our senior credit facilities and the indenture governing our senior unsecured notes each contain various change of control provisions which, in the event of a change of control, would cause a default under those provisions. These provisions and arrangements could delay, deter or prevent a merger, consolidation, tender offer or other business combination or change of control involving us that could include a premium over the market price of Rent-A-Center’s common stock that some or a majority of Rent-A-Center’s stockholders might consider to be in their best interests.

 

Rent-A-Center is a holding company and is dependent on the operations and funds of its subsidiaries.

 

Rent-A-Center is a holding company, with no revenue generating operations and no assets other than its ownership interests in its direct and indirect subsidiaries. Accordingly, Rent-A-Center is dependent on the cash flow generated by its direct and indirect operating subsidiaries and must rely on dividends or other intercompany transfers from its operating subsidiaries to generate the funds necessary to meet its obligations, including the obligations under the senior credit facilities. The ability of Rent-A-Center’s subsidiaries to pay dividends or make other payments to it is subject to applicable state laws. Should one or more of Rent-A-Center’s subsidiaries be unable to pay dividends or make distributions, its ability to meet its ongoing obligations could be materially and adversely impacted.

 

Our stock price is volatile, and you may not be able to recover your investment if our stock price declines.

 

The price of our common stock has been volatile and can be expected to be significantly affected by factors such as:

 

 

In addition, the stock market as a whole has experienced extreme price and volume fluctuations that have affected the market price of many specialty retailers in ways that may have been unrelated to these companies’ operating performance.

 

Failure to achieve and maintain effective internal controls could have a material adverse effect on our business and stock price.

 

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our brand and operating results could be harmed. All internal control systems, no matter

how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

While we continue to evaluate and improve our internal controls, we cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.

 

If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could cause investors to lose confidence in our reported financial information, which could have a material adverse effect on our stock price.

 

Our continued expansion into international markets presents unique challenges which may subject us to risks associated with the legislative, judicial, accounting, regulatory, political, cultural and economic factors specific to the countries or regions in which we currently operate or may operate in the future, which could adversely affect our financial performance.

 

We entered the Canadian market in 2004 and operate 18 stores in Canada as of December 31, 2010. We opened our first store in Mexico in October 2010, and now operate five stores in Mexico as of December 31, 2010. As these operations grow, they may require greater management and financial resources. International operations require the integration of personnel with varying cultural and business backgrounds and an understanding of the relevant differences in the cultural, legal and regulatory environments. In addition, these operations are subject to the potential risks of changing economic and financial conditions in each of its markets, legal and regulatory requirements in local jurisdictions, tariffs and trade barriers, difficulties in staffing and managing local operations, failure to understand the local culture and market, difficulties in protecting intellectual property, the burden of complying with foreign laws, including tax laws and financial accounting standards, and adverse local economic, political and social conditions in certain countries.

 

In addition, we are subject to exchange rate risks in the ordinary course of our business as a result of our operations in Canada and Mexico and are, therefore, exposed to risks associated with the fluctuations of foreign currencies, in particular U.S. dollars, Canadian dollars and Mexican pesos. Such foreign currency exchange rates and fluctuations may have an impact on our future costs or on future cash flows from our international operations, and could adversely affect our financial performance.

 

Our operations are dependent on effective management information systems. Failure of these systems could negatively impact our ability to manage store operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

We utilize integrated management information and control systems. The efficient operation of our business is dependent on these systems to effectively manage our financial and operational data. The failure of our information systems to perform as designed, loss of data or any interruption of our information systems for a significant period of time could disrupt our business. If the information systems sustain repeated failures, we may not be able to manage our store operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

We are currently investing in the development of new point of sale systems and processes to further enhance our management information system. Such enhancements to or replacement of our management information system could have a significant impact on our ability to conduct our core business operations and increase our risk of loss resulting from disruptions of normal operating processes and procedures that may occur during the implementation of new information systems. We can make no assurances that the costs of investments in our information systems will not exceed estimates, that the systems will be implemented without material disruption, or that the systems will be as beneficial as predicted. If any of these events occur, our results of operations could be harmed.

If we fail to protect the integrity and security of customer and co-worker information, we could be exposed to litigation or regulatory enforcement and our business could be adversely impacted.

 

The increasing costs associated with information security, such as increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud, could adversely impact our business. We also routinely possess sensitive customer and co-worker information and, while we have taken reasonable and appropriate steps to protect that information, if our security procedures and controls were compromised, it could harm our business, reputation, operating results and financial condition and may increase the costs we incur to protect against such information security breaches.

 

 

None.

 

 

We lease space for substantially all of our stores and service center locations, as well as regional offices, under operating leases expiring at various times through 2019. Most of our store leases are five year leases and contain renewal options for additional periods ranging from three to five years at rental rates adjusted according to agreed-upon formulas. Store sizes range from approximately 1,200 to 24,000 square feet, and average approximately 4,700 square feet. Approximately 75% of each store’s space is generally used for showroom space and 25% for offices and storage space.

 

We believe suitable store space generally is available for lease and we would be able to relocate any of our stores without significant difficulty should we be unable to renew a particular lease. We also expect additional space is readily available at competitive rates to open new stores.

 

We own the land and building at 5501 Headquarters Drive, Plano, Texas, in which our corporate headquarters are located. The land and improvements are pledged as collateral under our senior credit facilities.

 

 

From time to time, we, along with our subsidiaries, are party to various legal proceedings arising in the ordinary course of business. In our history, we have defended class action lawsuits alleging various regulatory violations and have paid material amounts to settle such claims. We accrue for litigation loss contingencies that are both probable and reasonably estimable. Legal fees and expenses associated with the defense of all of our litigation are expensed as such fees and expenses are incurred. As of December 31, 2010, we had no accrual relating to probable losses for our outstanding litigation.

 

We continue to monitor our litigation exposure, and will review the adequacy of our legal reserves on a quarterly basis in accordance with applicable accounting rules. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies Involving Critical Estimates, Uncertainties or Assessments in Our Financial Statements” regarding our process for evaluating our litigation reserves.

 

 

None.

 

 

Our common stock has been listed on the Nasdaq Global Select Market^® and its predecessors under the symbol “RCII” since January 25, 1995, the date we commenced our initial public offering. The following table sets forth, for the periods indicated, the high and low closing sales price per share of our common stock as reported, and the quarterly cash dividend declared per share on our common stock.

 

 

 

As of February 18, 2011, there were approximately 67 record holders of our common stock.

 

Future decisions to pay cash dividends on our common stock continue to be at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, contractual restrictions, financial condition, future prospects and any other factors our Board of Directors may deem relevant. While cash dividend payments are subject to certain restrictions in our debt agreements, these restrictions do not currently prohibit the payment of cash dividends. Please see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Senior Credit Facilities” and “— 65/8% Senior Notes” on page 32 of this report for further discussion of such restrictions.

 

Under our common stock repurchase program, we are authorized to repurchase up to $800.0 million in aggregate purchase price of our common stock. As of December 31, 2010, we had repurchased a total of 23,470,345 shares of Rent-A-Center common stock for an aggregate purchase price of $551.2 million under our common stock repurchase program. For the year ended December 31, 2010, we repurchased 3,585,495 shares of our common stock for an aggregate purchase price of $84.6 million. In the fourth quarter of 2010, we effected the following repurchases of our common stock:

 

Stock Performance Graph

 

The following chart represents a comparison of the five year total return of our common stock to the NASDAQ Market Index and a peer group index selected by us. Due to the discontinuation of our financial services business, we revised our peer group index in 2010 to include companies offering similar products and services as ours, such as rent-to-own and general merchandise retailers that market to our targeted customer demographic. The 2010 peer group index consists of Aaron’s, Inc., Family Dollar Stores, Inc., 99¢ Only Stores, Dollar Tree Stores, Inc., and Dollar General Corp. In 2009, the peer group index consisted of Aaron’s, Inc., Family Dollar Stores, Inc., 99¢ Only Stores, Dollar Tree Stores, Inc., Dollar Financial Corp., Advance America, Cash Advance Centers, Inc., EZCORP, Inc., and Cash America International, Inc. The graph assumes $100 was invested on December 31, 2005 and dividends, if any, were reinvested for all years ending December 31.

 

 

The selected financial data presented below for the five years ended December 31, 2010 have been derived from our consolidated financial statements as audited by Grant Thornton LLP, an independent registered public accounting firm. The historical financial data are qualified in their entirety by, and should be read in conjunction with, the consolidated financial statements and the notes thereto, the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included in this report.

 

 

 

 

 

Overview

 

We are the largest operator in the United States rent-to-own industry with an approximate 35% market share based on store count. At December 31, 2010, we operated 3,008 company-owned stores nationwide and in Canada, Puerto Rico and Mexico, including 42 retail installment sales stores under the names “Get It Now” and “Home Choice,” and 18 rent-to-own stores located in Canada under the name “Rent-A-Centre.” Our subsidiary, ColorTyme, is a national franchisor of rent-to-own stores. At December 31, 2010, ColorTyme had 209 franchised rent-to-own stores in 32 states. These franchise stores represent an additional 2% market share based on store count.

 

As part of our current growth strategy, we are focused on seeking additional distribution channels for our products and services. We operate kiosk locations under the “RAC Acceptance” model which offers the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer. These kiosks are located within such retailer’s store locations. At December 31, 2010, we operated 384 RAC Acceptance locations, which included 158 kiosk locations as a result of the acquisition of The Rental Store, Inc.

 

In addition, we are expanding our operations in Canada and Mexico and seeking to identify other international markets in which we believe our products and services would be in demand. At December 31, 2010, we operated 18 stores in Canada and five stores in Mexico.

 

Our stores generally offer high quality durable products such as major consumer electronics, appliances, computers, and furniture and accessories under flexible rental purchase agreements that generally allow the customer to obtain ownership of the merchandise at the conclusion of an agreed-upon rental period. The rental purchase transaction is a flexible alternative for consumers to obtain use and enjoyment of brand name merchandise without incurring debt. Key features of the rental purchase transaction include:

 

• convenient payment options:

 

 

• no long-term obligations;

 

• right to terminate without penalty;

 

• no requirement of a credit history;

 

• delivery and set-up;

 

• product maintenance;

 

 

Rental payments are made generally on a weekly basis and, together with applicable fees, constitute our primary revenue source.

 

Our expenses primarily relate to merchandise costs and the operations of our stores, including salaries and benefits for our employees, occupancy expense for our leased real estate, advertising expenses, lost, damaged, or stolen merchandise, fixed asset depreciation, and corporate and other expenses.

 

Historically, we pursued an aggressive growth strategy in which we sought to acquire underperforming rent-to-own stores to which we could apply our operating model as well as open new stores. As a result, the acquired stores have generally experienced more significant revenue growth during the initial periods following their acquisition than in subsequent periods. Total financing requirements of a typical new store approximate $625,000, with roughly 65% of that amount relating to the purchase of rental merchandise inventory. A newly opened rent-to-own store is typically profitable on a monthly basis in the ninth to twelfth month after its initial opening. Historically, a typical store has achieved cumulative break-even profitability in 18 to 24 months after its initial

opening and has achieved results consistent with other stores that have been operating within the system for greater than two years by the end of its third year of operation. As a result, our quarterly earnings are impacted by how many new stores we opened during a particular quarter and the quarters preceding it. Because of significant growth since our formation, our historical results of operations and period to period comparisons of such results and other financial data, including the rate of earnings growth, may not be meaningful or indicative of future results.

 

In addition, we strategically open or acquire stores near market areas served by existing stores (“cannibalize”) to enhance service levels, gain incremental sales and increase market penetration. This planned cannibalization may negatively impact our same store revenue and cause us to grow at a slower rate. There can be no assurance we will open any new rent-to-own stores in the future, or as to the number, location or profitability thereof.

 

The following discussion focuses on our results of operations, and issues related to our liquidity and capital resources. You should read this discussion in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.

 

Forward-Looking Statements

 

The statements, other than statements of historical facts, included in this report are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “would,” “expect,” “intend,” “could,” “estimate,” “should,” “anticipate” or “believe.” We believe the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that these expectations will occur. Our actual future performance could differ materially from such statements. Factors that could cause or contribute to these differences include, but are not limited to:

 

 

 

Additional important factors that could cause our actual results to differ materially from our expectations are discussed under the section “Risk Factors” and elsewhere in this report. You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. Except as required by law, we are not obligated to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.

 

Critical Accounting Policies Involving Critical Estimates, Uncertainties or Assessments in Our Financial Statements

 

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent losses and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. In applying accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. We believe the following are areas where the degree of judgment and complexity in determining amounts recorded in our consolidated financial statements make the accounting policies critical.

 

Self-Insurance Liabilities.  We have self-insured retentions with respect to losses under our workers’ compensation, general liability and vehicle liability insurance policies. We establish reserves for our liabilities associated with these losses by obtaining forecasts for the ultimate expected losses and estimating amounts needed to pay losses within our self-insured retentions.

 

We continually institute procedures to manage our loss exposure and increases in health care costs associated with our insurance claims through our risk management function, including a transitional duty program for injured workers, ongoing safety and accident prevention training, and various other programs designed to minimize losses and improve our loss experience in our store locations. We make assumptions on our liabilities within our self-insured retentions using actuarial loss forecasts, company specific development factors, general industry loss development factors, and third party claim administrator loss estimates which are based on known facts surrounding individual claims. These assumptions incorporate expected increases in health care costs. Periodically, we reevaluate our estimate of liability within our self-insured retentions. At that time, we evaluate the adequacy of our accruals by comparing amounts accrued on our balance sheet for anticipated losses to our updated actuarial loss forecasts and third party claim administrator loss estimates, and make adjustments to our accruals as needed.

 

As of December 31, 2010, the amount accrued for losses within our self-insured retentions with respect to workers’ compensation, general liability and vehicle liability insurance was $130.3 million, as compared to $128.8 million at December 31, 2009. If any of the factors that contribute to the overall cost of insurance claims were to change, the actual amount incurred for our self-insurance liabilities would be directly affected. While we believe our loss prevention programs will reduce our total cost for self-insurance claims, our actual cost could be greater than the amounts currently accrued.

 

Litigation Reserves.  We are the subject of litigation in the ordinary course of our business. Historically, our litigation has involved lawsuits alleging various regulatory violations. In preparing our financial statements at a given point in time, we accrue for loss contingencies that are both probable and reasonably estimable.

 

Each quarter, we make estimates of our probable losses, if reasonably estimable, and record such amounts in our consolidated financial statements. These amounts represent our best estimate, or may be the minimum range of probable loss when no single best estimate is determinable. We, together with our counsel, monitor developments related to these legal matters and, when appropriate, adjustments are made to reflect current facts and circumstances. Legal fees and expenses associated with the defense of all of our litigation are expensed as such fees and expenses are incurred. As of December 31, 2010 and 2009, we had no accrual relating to probable losses for our outstanding litigation.

Income Taxes.  Our annual tax rate is affected by many factors, including the mix of our earnings, legislation and acquisitions, and is based on our income, statutory tax rates and tax planning opportunities available to us in the jurisdictions in which we operate. Tax laws are complex and subject to differing interpretations between the taxpayer and the taxing authorities. Significant judgment is required in determining our tax expense, evaluating our tax positions and evaluating uncertainties. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon the ultimate settlement with the relevant tax authority. We review our tax positions quarterly and adjust the balance as new information becomes available.

 

If we make changes to our accruals in accordance with the policies described above, our earnings would be impacted. Increases to our accruals would reduce earnings and, similarly, reductions to our accruals would increase our earnings. A pre-tax change of $1.1 million in our estimates would result in a corresponding $0.01 change in our earnings per common share.

 

Based on an assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe our consolidated financial statements fairly present in all material respects the financial condition, results of operations and cash flows of our company as of, and for, the periods presented in this report. However, we do not suggest that other general risk factors, such as those discussed elsewhere in this report as well as changes in our growth objectives or performance of new or acquired stores, could not adversely impact our consolidated financial position, results of operations and cash flows in future periods.

 

Significant Accounting Policies

 

Our significant accounting policies are summarized below and in Note A to our consolidated financial statements included elsewhere in this report.

 

Revenue.  Merchandise is rented to customers pursuant to rental purchase agreements which provide for weekly, semi-monthly or monthly rental terms with non-refundable rental payments. Generally, the customer has the right to acquire title either through a purchase option or through payment of all required rentals. Rental revenue and fees are recognized over the rental term and merchandise sales revenue is recognized when the customer exercises the purchase option and pays the cash price due. Cash received prior to the period in which it should be recognized is deferred and recognized according to the rental term. Revenue is accrued for uncollected amounts due based on historical collection experience. However, the total amount of the rental purchase agreement is not accrued because the customer can terminate the rental agreement at any time and we cannot enforce collection for non-payment of future rents.

 

Revenue from the sale of merchandise in our retail installment stores is recognized when the installment note is signed, the customer has taken possession of the merchandise and collectability is reasonably assured.

 

The revenue from our financial services is recognized depending on the type of transaction. Fees collected on loans are recognized ratably over the term of the loan. For money orders, wire transfers, check cashing and other customer service type transactions, fee revenue is recognized at the time the service is performed.

 

Franchise Revenue.  Revenue from the sale of rental merchandise is recognized upon shipment of the merchandise to the franchisee. Franchise fee revenue is recognized upon completion of substantially all services and satisfaction of all material conditions required under the terms of the franchise agreement.

 

Depreciation of Rental Merchandise.  Depreciation of rental merchandise is included in the cost of rentals and fees on our statement of earnings. Generally, we depreciate our rental merchandise using the income forecasting method. Under the income forecasting method, merchandise held for rent is not depreciated and merchandise on rent is depreciated in the proportion of rents received to total rents provided in the rental contract, which is an activity-based method similar to the units of production method. We depreciate merchandise held for rent (except for computers) that is at least 270 days old and held for rent for at least 180 consecutive days using the straight-line method for a period generally not to exceed 20 months.

On computers that are 24 months old or older and which have become idle, depreciation is recognized using the straight-line method for a period of at least six months, generally not to exceed an aggregate depreciation period of 30 months.

 

Cost of Merchandise Sold.  Cost of merchandise sold represents the net book value of rental merchandise at time of sale.

 

Salaries and Other Expenses.  Salaries and other expenses include all salaries and wages paid to store level employees, together with district managers’ salaries, payroll taxes and benefits, and travel, as well as all store level general and administrative expenses and selling, advertising, insurance, occupancy, delivery, fixed asset depreciation and other operating expenses.

 

General and Administrative Expenses.  General and administrative expenses include all corporate overhead expenses related to our headquarters such as salaries, payroll taxes and benefits, occupancy, administrative and other operating expenses.

 

Stock-Based Compensation Expense.  We recognize share-based payment awards to our employees and directors at the estimated fair value on the grant date. Determining the fair value of any share-based awards requires information about several variables including, but not limited to, expected stock volatility over the terms of the awards, expected dividend yields and the predicted employee exercise behavior. We base expected life on historical exercise and post-vesting employment-termination experience, and expected volatility on historical realized volatility trends. In addition, all stock-based compensation expense is recorded net of an estimated forfeiture rate. The forfeiture rate is based upon historical activity and is analyzed at least quarterly as actual forfeitures occur. Stock options granted during the twelve months ended December 31, 2010 were valued using the binomial method pricing model with the following assumptions for employee options: expected volatility of 34.95% to 56.30%, a risk-free interest rate of 0.26% to 2.16%, a dividend yield of 0.80%, and an expected life of 5.48 years. During the twelve months ended December 31, 2010, we recognized $4.1 million in pre-tax compensation expense related to stock options and restricted stock units granted.

Results of Operations

 

The following table sets forth, for the periods indicated, historical Consolidated Statements of Earnings data as a percentage of total store and franchise revenues.

 

 

2010 Overview

 

Highlights of our operating results for the year ended December 31, 2010 include:

 

 

Comparison of the Years ended December 31, 2010 and 2009

 

Store Revenue.  Total store revenue decreased by $22.9 million, or 0.8%, to $2,696.2 million in 2010 from $2,719.1 million in 2009. This decrease in total store revenue was primarily the result of the November 2009 divestiture of our subsidiary engaged in the prepaid telecommunications and energy business, which contributed approximately $50.5 million in merchandise sales in 2009, offset by an increase in installment sales and other revenue.

Same store revenues represent those revenues earned in 2,627 stores that were operated by us for each of the entire twelve month periods ended December 31, 2010 and 2009. Same store revenues decreased by $9.6 million, or 0.4%, to $2,262.0 million in 2010 as compared to $2,271.6 million in 2009. This decrease in same store revenues was primarily attributable to a lower average revenue per agreement in 2010 as compared to 2009.

 

Franchise Revenue.  Total franchise revenue increased by $2.6 million, or 7.9%, to $35.4 million in 2010 as compared to $32.8 million in 2009. This increase was primarily attributable to an increase in the number of products sold to franchisees in 2010 as compared to 2009.

 

Cost of Rentals and Fees.  Cost of rentals and fees consists of depreciation of rental merchandise and the costs associated with our membership programs. Cost of rentals and fees for 2010 decreased by $10.7 million, or 2.0%, to $519.3 million as compared to $530.0 million in 2009. This decrease in cost of rentals and fees was primarily the result of a lower average cost per unit in 2010 as compared to 2009. Cost of rentals and fees expressed as a percentage of store rentals and fees revenue decreased slightly to 22.2% in 2010 as compared to 22.6% in 2009.

 

Cost of Merchandise Sold.  Cost of merchandise sold decreased by $24.3 million, or 12.9%, to $164.1 million in 2010 from $188.4 million in 2009. The gross margin percent of merchandise sales decreased to 25.5% in 2010 from 28.0% in 2009. These decreases were primarily the result of the November 2009 divestiture of our subsidiary engaged in the prepaid telecommunications and energy business.

 

Salaries and Other Expenses.  Salaries and other expenses decreased by $12.7 million, or 0.8%, to $1,543.4 million in 2010 as compared to $1,556.1 million in 2009. This decrease was attributable to a decrease in store level expenses due to our cost control initiatives, primarily in the management of labor expense. Charge offs in our rental stores due to customer stolen merchandise, expressed as a percentage of rental store revenues, remained unchanged at approximately 2.3% in 2010 and 2009. Salaries and other expenses expressed as a percentage of total store revenue remained unchanged at 57.2% in 2010 and 2009.

 

Franchise Cost of Merchandise Sold.  Franchise cost of merchandise sold increased by $2.4 million, or 9.0%, to $29.2 million in 2010 as compared to $26.8 million in 2009. This increase was primarily attributable to an increase in the number of products sold to franchisees in 2010 as compared to 2009.

 

General and Administrative Expenses.  General and administrative expenses decreased by $11.3 million, or 8.2%, to $126.3 million in 2010 as compared to $137.6 million in 2009. This decrease was primarily the result of the November 2009 divestiture of our subsidiary engaged in the prepaid telecommunications and energy business. General and administrative expenses expressed as a percentage of total revenue decreased to 4.6% in 2010 from 5.0% in 2009.

 

Amortization and Write-Down of Intangibles.  Amortization of intangibles increased by $411,000, or 14.5%, to $3.3 million in 2010 from $2.8 million in 2009. This increase was due to the write-down of goodwill associated with stores sold or closed in 2010 as compared to 2009.

 

Operating Profit.  Operating profit increased by $7.5 million, or 2.5%, to $303.8 million in 2010 as compared to $296.3 million in 2009. This increase was primarily attributable to a reduction in expenses, offset by an $18.9 million impairment charge related to the discontinuation of our financial services business in 2010 as compared to 2009. Operating profit as a percentage of total revenue increased to 11.1% in 2010 from 10.8% for 2009.

 

Interest Expense.  Interest expense remained unchanged at $26.8 million in 2010 and 2009. Interest expense was not impacted by the increase in our weighted average interest rate to 4.62% in 2010 from 3.37% in 2009 due to a decrease in our outstanding debt in 2010 as compared to 2009.

 

Income Tax Expense.  Income tax expense increased slightly by $600,000, or 0.6%, to $103.1 million in 2010 as compared to $102.5 million in 2009.

 

Net Earnings.  Net earnings increased by $3.7 million, or 2.3%, to $171.6 million in 2010 as compared to $167.9 million in 2009. This increase was primarily attributable to an increase in operating profit, offset by the $3.1 million financing expense related to the write-off of unamortized financing costs in 2010 as compared to 2009.

Comparison of the Years ended December 31, 2009 and 2008

 

Store Revenue.  Total store revenue decreased by $126.9 million, or 4.5%, to $2,719.1 million in 2009 from $2,846.0 million in 2008. This decrease in total store revenue was primarily the result of a 3.5% reduction in same store sales, predominantly attributable to a decrease in the number of units per customer, together with the impact of the 2007 restructuring plan.

 

Same store revenues represent those revenues earned in 2,277 stores that were operated by us for each of the entire twelve month periods ended December 31, 2009 and 2008. Same store revenues decreased by $71.3 million, or 3.5%, to $1,985.3 million in 2009 as compared to $2,056.6 million in 2008. This decrease in same store revenues was primarily attributable to a decrease in the number of units per customer in 2009 as compared to 2008.

 

Franchise Revenue.  Total franchise revenue decreased by $5.4 million, or 14.1%, to $32.8 million in 2009 as compared to $38.2 million in 2008. This decrease was primarily attributable to a decrease in the number of products sold to franchisees in 2009 as compared to 2008 due to fewer franchise stores in 2009.

 

Cost of Rentals and Fees.  Cost of rentals and fees consists of depreciation of rental merchandise and the costs associated with our membership programs. Cost of rentals and fees for 2009 decreased by $42.9 million, or 7.5%, to $530.0 million as compared to $572.9 million in 2008. This decrease in cost of rentals and fees is primarily attributable to a decrease in the number of units on rent in 2009 as compared to 2008. Cost of rentals and fees expressed as a percentage of store rentals and fees revenue decreased to 22.6% in 2009 as compared to 22.9% in 2008.

 

Cost of Merchandise Sold.  Cost of merchandise sold decreased by $6.2 million, or 3.2%, to $188.4 million in 2009 from $194.6 million in 2008. The gross margin percent of merchandise sales increased to 28.0% in 2009 from 24.2% in 2008. This percentage increase was primarily attributable to a higher margin on early purchase option transactions during the 2009 period.

 

Salaries and Other Expenses.  Salaries and other expenses decreased by $95.7 million, or 5.8%, to $1,556.1 million in 2009 as compared to $1,651.8 million in 2008. This decrease was primarily attributable to a decrease in store level expenses due to our cost control initiatives such as improvements in management of labor expense, delivery costs and inventory losses. Charge offs in our rental stores due to customer stolen merchandise, expressed as a percentage of rental store revenues, were approximately 2.3% in 2009 as compared to 2.5% in 2008. Salaries and other expenses expressed as a percentage of total store revenue decreased to 57.2% in 2009 from 58.0% in 2008.

 

Franchise Cost of Merchandise Sold.  Franchise cost of merchandise sold decreased by $4.9 million, or 15.4%, to $26.8 million in 2009 as compared to $31.7 million in 2008. This decrease was primarily attributable to a decrease in the number of products sold to franchisees in 2009 as compared to 2008 due to fewer franchise stores in 2009.

 

General and Administrative Expenses.  General and administrative expenses increased by $12.0 million, or 9.5%, to $137.6 million in 2009 as compared to $125.6 million in 2008. General and administrative expenses expressed as a percentage of total revenue increased to 5.0% in 2009 from 4.4% in 2008. These increases are primarily attributable to additional personnel and related expansion at our corporate office to support our strategic initiatives.

 

Amortization and Write-Down of Intangibles.  Amortization of intangibles decreased by $13.8 million, or 82.9%, to $2.8 million in 2009 from $16.6 million in 2008. This decrease was due to intangible assets associated with the acquisition of Rent-Way that were fully amortized in 2009 as compared to 2008.

 

Operating Profit.  Operating profit increased by $21.9 million, or 8.0%, to $296.3 million in 2009 as compared to $274.4 million in 2008. Operating profit as a percentage of total revenue increased to 10.8% in 2009 from 9.5% for 2008. This increase was primarily attributable to a reduction in expenses and an improvement in gross margins offset by lower revenue in the 2009 period as compared to 2008.

 

Interest Expense.  Interest expense decreased by $39.4 million, or 59.6%, to $26.8 million in 2009 as compared to $66.2 million in 2008. This decrease was attributable to a decrease in our outstanding indebtedness in

2009 as compared to 2008, as well as a decrease in our weighted average interest rate to 3.37% in 2009 as compared to 6.21% in 2008 due to a decrease in the Eurodollar rate in 2009 as compared to 2008.

 

Income Tax Expense.  Income tax expense increased by $20.8 million, or 25.4%, to $102.5 million in 2009 as compared to $81.7 million in 2008. This increase is attributable to an increase in earnings before taxes for 2009 as compared to 2008 and an increase in our overall effective tax rate to 37.9% for 2009 as compared to 36.9% for 2008. The 2009 increase in our overall effective tax rate is primarily attributable to an increase in our state effective tax rate as well as certain state tax benefits realized in 2008 related to audit settlements that did not recur in 2009.

 

Net Earnings.  Net earnings increased by $28.3 million, or 20.2%, to $167.9 million in 2009 as compared to $139.6 million in 2008. This increase was primarily attributable to an increase in operating profit and a decrease in interest expense, offset by an increase in income tax expense in 2009 as compared to 2008.

 

Quarterly Results

 

The following table contains certain unaudited historical financial information for the quarters indicated.

 

 

 

Liquidity and Capital Resources

 

Overview.  For the year ended December 31, 2010, we generated $216.5 million in operating cash flow. In addition to funding operating expenses, we used $93.0 million in cash for capital expenditures, $74.4 million for acquisitions, $84.6 million for common stock repurchases, and paid cash dividends of $7.8 million. We ended the year with $70.7 million in cash and cash equivalents.

 

Analysis of Cash Flow.  Cash provided by operating activities decreased by $113.6 million to $216.5 million in 2010 from $330.1 million in 2009. This decrease is primarily attributable to the use of cash to purchase rental merchandise and the payment of federal estimated income taxes, offset by several noncash items. Rental merchandise purchases increased approximately $118.6 million as we benefited from increased customer demand and the full implementation of our centralized inventory management system which automates the replenishment of merchandise based on individual store requirements. Prepaid expenses and other assets increased approximately $114.2 million due to the payment of federal estimated income taxes of approximately $110.0 million during the first three quarters of 2010 and prior to the enactment of the Small Business Jobs Act of 2010 (the “2010 Jobs Act”) and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Relief Act”). This amount is recorded as a receivable in prepaid expenses and other assets. We expect this amount to be refunded to us during 2011, of which $65.0 million has been received as of February 18, 2011.

 

Cash used in investing activities increased by $94.3 million to $167.2 million in 2010 from $72.9 million in 2009. This increase is primarily attributable to an increase in acquisitions and capital expenditures in 2010 as compared to 2009.

 

Cash used in financing activities decreased by $163.8 million to $81.3 million in 2010 from $245.1 million in 2009. This decrease is primarily related to the changes in outstanding debt, offset by the repurchase of common stock in 2010 as compared to 2009.

 

Liquidity Requirements.  Our primary liquidity requirements are for rental merchandise purchases, implementation of our growth strategies, debt service, capital expenditures, and litigation expenses, including settlements or judgments. Our primary sources of liquidity have been cash provided by operations and borrowings. In the future, to provide any additional funds necessary for the continued pursuit of our operating and growth strategies, we may incur from time to time additional short-term or long-term bank indebtedness and may issue, in public or private transactions, equity and debt securities. The availability and attractiveness of any outside sources of financing will depend on a number of factors, some of which relate to our financial condition and performance, and some of which are beyond our control, such as prevailing interest rates and general financing and economic conditions. The global financial markets continue to experience volatility and adverse conditions and such conditions in the capital markets may affect our ability to access additional sources of financing. There can be no assurance that additional financing will be available, or if available, that it will be on terms we find acceptable.

We believe the cash flow generated from operations, together with amounts available under our senior credit facilities, will be sufficient to fund our liquidity requirements as discussed above during the next twelve months. Our revolving credit facilities, including our $20.0 million line of credit at Intrust Bank, provide us with revolving loans in an aggregate principal amount not exceeding $395.0 million, of which $247.6 million was available at February 18, 2011. At February 18, 2011, we had $96.2 million in cash. To the extent we have available cash that is not necessary to fund the items listed above, we may repurchase additional shares of our common stock, declare and pay dividends on our common stock, or make additional payments to service our existing debt. While our operating cash flow has been strong and we expect this strength to continue, our liquidity could be negatively impacted if we do not remain as profitable as we expect.

 

A change in control would result in an event of default under our senior credit facilities, which would allow our lenders to accelerate the indebtedness owed to them. In addition, if a change in control occurs, we may be required to offer to repurchase all of our outstanding senior unsecured notes at 101% of their principal amount, plus accrued interest to the date of repurchase. Our senior credit facilities restrict our ability to repurchase the senior unsecured notes, including in the event of a change in control. In the event a change in control occurs, we cannot be sure we would have enough funds to immediately pay our accelerated senior credit facility and senior note obligations or that we would be able to obtain financing to do so on favorable terms, if at all.

 

Litigation.  In our history, we have defended class action lawsuits alleging various regulatory violations and have paid material amounts to settle such claims. Significant settlement amounts or final judgments could materially and adversely affect our liquidity. Please refer to “Legal Proceedings” elsewhere in this report.

 

Deferred Taxes.  On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “2009 Recovery Act”) which extended the bonus depreciation provision of the 2008 Stimulus Act by continuing the bonus first-year depreciation deduction of 50% of the adjusted basis of qualified property placed in service during 2009. On September 27, 2010, President Obama signed into law the 2010 Jobs Act, which again extended the bonus depreciation provision of the 2009 Recovery Act by continuing the bonus first-year depreciation deduction of 50% of the adjusted basis of qualified property place in service during 2010. On December 17, 2010, President Obama signed into law the 2010 Tax Relief Act, which enacted 100% bonus depreciation on assets purchased after September 8, 2010 and before January 1, 2012.

 

Accordingly, our cash flow again benefited in 2010 from having a lower cash tax obligation which, in turn, provided additional cash flow from operations. We estimate that our 2010 operating cash flow increased by approximately $135.0 million as a result of the 2010 Jobs Act and the 2010 Tax Relief Act, less $77.0 million associated with the 2009 and 2008 deferral for a total increase of $58.0 million. We estimate that the remaining tax deferral associated with the 2008 Stimulus Act, the 2009 Recovery Act, the 2010 Jobs Act and the 2010 Tax Relief Act approximates $163.0 million at December 31, 2010, of which approximately 73%, or $119.0 million, will reverse in 2011 and the remainder will reverse between 2012 and 2013. We anticipate the $119.0 million reversal in 2011 will be offset by the expected benefit to operating cash flow of the 2010 Tax Relief Act.

 

Merchandise Inventory.  A reconciliation of merchandise inventory, which includes purchases, follows:

 

 

 

 

Capital Expenditures.  We make capital expenditures in order to maintain our existing operations as well as for new capital assets in new and acquired stores. We spent $93.0 million, $68.8 million and $61.9 million on capital expenditures in the years 2010, 2009 and 2008, respectively, and expect to spend approximately $75.0 million in 2011. The increase in capital expenditures for 2010 primarily related to our investment in the development of new point of sale systems and processes designed to further enhance our management information system.

 

Acquisitions and New Store Openings.  During 2010, we used approximately $74.4 million in cash acquiring stores and accounts in 15 separate transactions. Of this amount, $71.0 million, net of cash acquired, was funded in connection with the acquisition of The Rental Store, Inc.

 

The table below summarizes the rent-to-own store activity (excluding RAC Acceptance) for the years ended December 31, 2010, 2009 and 2008.

 

 

In addition, during 2010 we added 318 RAC Acceptance kiosk locations, including 158 kiosk locations through the acquisition of The Rental Store, Inc. As of December 31, 2010, we operated 384 RAC acceptance locations.

 

The profitability of our stores tends to grow at a slower rate approximately five years from entering our system. As a result of the increasing maturity of our store base, in order for us to show improvements in our profitability, it is important for us to open stores in new locations as well as increase revenue in our existing stores. We intend to accomplish such revenue growth by acquiring customer accounts on favorable terms, and seeking additional distribution channels for our products and services. We cannot assure you that we will be able to acquire customer accounts on favorable terms, or at all, or that we will be able to maintain the revenue from any such acquired customer accounts at the rates we expect, or at all. We also cannot assure you that we will be successful in identifying additional distribution channels for our products and services, or that such operations will be as profitable as we expect, or at all.

 

Senior Credit Facilities.  Our senior credit agreement, as amended, provides for a $1,024 million senior credit facility consisting of a $165 million term loan with the loans being referred to by us as the “tranche A term loans,” a $484 million term loan with the loans being referred to by us as the “tranche B term loans,” and a $375 million revolving credit facility. The tranche A term loans are divided into two equal sub-tranches of $82.5 million each, referred to by us as the “existing tranche A term loans” and the “extended tranche A term loans.” The existing tranche A term loans mature on June 30, 2011, and the extended tranche A term loans mature on September 30, 2013. The tranche B term loans are divided into two sub-tranches of approximately $184 million and $300 million, referred to by us as the “existing tranche B term loans” and the “extended tranche B term loans,” respectively. The existing tranche B term loans mature on June 30, 2012, and the extended tranche B term loans mature on March 31, 2015.

The table below shows the scheduled maturity dates of our senior term loans outstanding at December 31, 2010.

 

 

The full amount of the revolving credit facility may be used for the issuance of letters of credit, of which $137.4 million had been utilized as of February 18, 2011. As of February 18, 2011, $227.6 million was available under our revolving facility. The revolving credit facility expires September 30, 2013.

 

Borrowings under our amended senior credit facility accrue interest at varying rates equal to, at our election, either (y) the prime rate plus (i) up to 0.75% in the case of existing tranche A term loans, (ii) 1.5% to 2.0% in the case of revolving loans or extended tranche A term loans, (iii) .75% in the case of existing tranche B term loans, and (iv) 2.0% in the case of extended tranche B term loans; or (z) the Eurodollar rate plus (i) .75% to 1.75% in the case of existing tranche A term loans, (ii) 2.5% to 3.0% in the case of revolving loans or extended tranche A term loans, (iii) 1.75% in the case of existing tranche B term loans, and (iv) 3.0% in the case of extended tranche B term loans. Interest periods range from seven days (for borrowings under the revolving credit facility only) to one, two, three or six months, at our election. The weighted average Eurodollar rate on our outstanding debt was 0.31% at February 18, 2011. The margins on the Eurodollar rate and on the prime rate for revolving loans, existing tranche A term loans, and extended tranche A term loans may fluctuate dependent upon an increase or decrease in our consolidated leverage ratio as defined by a pricing grid included in the amended credit agreement. We have not entered into any interest rate protection agreements with respect to term loans under our senior credit facilities. A commitment fee equal to 0.5% to 0.625% of the average daily amount of the available revolving commitment is payable quarterly.

 

Our senior credit facilities are secured by a security interest in substantially all of our tangible and intangible assets, including intellectual property. Our senior credit facilities are also secured by a pledge of the capital stock of our wholly-owned U.S. subsidiaries (other than certain specified subsidiaries).

 

Our senior credit facilities contain, without limitation, covenants that generally limit our ability to:

 

 

Our senior credit facilities require us to comply with several financial covenants. The table below shows the required and actual ratios under our credit facilities calculated as of December 31, 2010:

 

These financial covenants, as well as the related components of their computation, are defined in the amended and restated credit agreement governing our senior credit facility, which is included as an exhibit to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010. In accordance with the credit agreement, the maximum consolidated leverage ratio was calculated by dividing the consolidated funded debt outstanding at December 31, 2010 ($656.7 million) by consolidated EBITDA for the twelve month period ended December 31, 2010 ($389.4 million). For purposes of the covenant calculation, (i) “consolidated funded debt” is defined as outstanding indebtedness less cash in excess of $25.0 million, and (ii) “consolidated EBITDA” is generally defined as consolidated net income (a) plus the sum of income taxes, interest expense, depreciation and amortization expense, extraordinary non-cash expenses or losses, and other non-cash charges, and (b) minus the sum of interest income, extraordinary income or gains, other non-cash income, and cash payments with respect to extraordinary non-cash expenses or losses recorded in prior fiscal quarters. Consolidated EBITDA is a non-GAAP financial measure that is presented not as a measure of operating results, but rather as a measure used to determine covenant compliance under our senior credit facilities.

 

The minimum fixed charge coverage ratio was calculated pursuant to the credit agreement by dividing consolidated EBITDA for the twelve month period ended December 31, 2010, as adjusted for certain capital expenditures ($485.7 million), by consolidated fixed charges for the twelve month period ended December 31, 2010 ($263.0 million). For purposes of the covenant calculation, “consolidated fixed charges” is defined as the sum of interest expense, lease expense, and mandatory debt repayments.

 

Events of default under our senior credit facilities include customary events, such as a cross-acceleration provision in the event that we default on other debt. In addition, an event of default under the senior credit facility would occur if a change of control occurs. This is defined to include the case where a third party becomes the beneficial owner of 35% or more of our voting stock or certain changes in Rent-A-Center’s Board of Directors occurs. An event of default would also occur if one or more judgments were entered against us of $30.0 million or more and such judgments were not satisfied or bonded pending appeal within 30 days after entry.

 

We utilize our revolving credit facility for the issuance of letters of credit, as well as to manage normal fluctuations in operational cash flow caused by the timing of cash receipts. In that regard, we may from time to time draw funds under the revolving credit facility for general corporate purposes. The funds drawn on individual occasions have varied in amounts of up to $98.0 million, with total amounts outstanding ranging from $2.0 million up to $108.0 million. The amounts drawn are generally outstanding for a short period of time and are generally paid down as cash is received from our operating activities.

 

65/8% Senior Notes.  On November 2, 2010, we issued $300.0 million in senior unsecured notes due November 2020, bearing interest at 65/8%, pursuant to an indenture dated November 2, 2010, among Rent-A-Center, Inc., its subsidiary guarantors and The Bank of New York Mellon Trust Company, as trustee. The proceeds of this offering were used to repay outstanding term debt under our senior credit facility and to repurchase shares of our common stock.

 

The 2010 indenture contains covenants that limit our ability to:

 

 

Events of default under the 2010 indenture include customary events, such as a cross-acceleration provision in the event that we default in the payment of other debt due at maturity or upon acceleration for default in an amount exceeding $50.0 million, as well as in the event a judgment is entered against us in excess of $50.0 million that is not discharged, bonded or insured.

 

The 65/8% notes may be redeemed on or after November 15, 2015, at our option, in whole or in part, at a premium declining from 103.313%. The 65/8% notes may be redeemed on or after November 15, 2018, at our option,

in whole or in part, at par. The 65/8% notes also require that upon the occurrence of a change of control (as defined in the 2010 indenture), the holders of the notes have the right to require us to repurchase the notes at a price equal to 101% of the original aggregate principal amount, together with accrued and unpaid interest, if any, to the date of repurchase. This would trigger an event of default under our senior credit facilities. We are not required to maintain any financial ratios under the 2010 indenture.

 

Store Leases.  We lease space for substantially all of our stores and service center locations, as well as regional offices, under operating leases expiring at various times through 2019. Most of our store leases are five year leases and contain renewal options for additional periods ranging from three to five years at rental rates adjusted according to agreed-upon formulas.

 

ColorTyme Guarantees.  Our subsidiary, ColorTyme Finance, Inc., is a party to an agreement with Citibank, N.A., who provides up to $25.0 million in aggregate financing to qualifying franchisees of ColorTyme. Under the Citibank agreement, upon an event of default by the franchisee under agreements governing this financing and upon the occurrence of certain other events, Citibank can assign the loans and the collateral securing such loans to ColorTyme Finance, with ColorTyme Finance paying or causing to be paid the outstanding debt to Citibank and then succeeding to the rights of Citibank under the debt agreements, including the right to foreclose on the collateral. Rent-A-Center and ColorTyme Finance guarantee the obligations of the franchise borrowers under the Citibank facility. An additional $20.0 million of financing is provided by Texas Capital Bank under an agreement similar to the Citibank financing, which is guaranteed by Rent-A-Center East, Inc., a subsidiary of Rent-A-Center. The maximum guarantee obligations under these agreements, excluding the effects of any amounts that could be recovered under collateralization provisions, is $45.0 million, of which $17.9 million was outstanding as of December 31, 2010.

 

Contractual Cash Commitments.  The table below summarizes debt, lease and other minimum cash obligations outstanding as of December 31, 2010:

 

 

 

 

Repurchases of Outstanding Securities.  Our Board of Directors has authorized a common stock repurchase program, permitting us to purchase, from time to time, in the open market and privately negotiated transactions, up to an aggregate of $800.0 million of Rent-A-Center common stock. As of December 31, 2010, we had purchased a total of 23,470,345 shares of Rent-A-Center common stock for an aggregate purchase price of $551.2 million under this common stock repurchase program. We repurchased 1,403,993 shares for $38.7 million in the fourth quarter of 2010. Through the twelve months ended December 31, 2010, we have repurchased a total of 3,585,495 shares for approximately $84.6 million in cash.

 

Economic Conditions.  Although our performance has not suffered in previous economic downturns, we cannot assure you that demand for our products, particularly in higher price ranges, will not significantly decrease in the event of a prolonged recession. Fluctuations in our targeted customers’ monthly disposable income or high levels of unemployment could adversely impact our results of operations.

Seasonality.  Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales than any other quarter during a fiscal year, primarily related to federal income tax refunds. Generally, our customers will more frequently exercise their early purchase option on their existing rental purchase agreements or purchase pre-leased merchandise off the showroom floor during the first quarter of each fiscal year. We expect this trend to continue in future periods. Furthermore, we tend to experience slower growth in the number of rental purchase agreements in the third quarter of each fiscal year when compared to other quarters throughout the year. As a result, we would expect revenues for the third quarter of each fiscal year to remain relatively flat with the prior quarter. We expect this trend to continue in future periods unless we add significantly to our store base during the third quarter of future fiscal years as a result of new store openings or opportunistic acquisitions.

 

Effect of New Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”), which changes various aspects of accounting for and disclosures of interests in variable interest entities. ASU 2009-17 is effective for interim and annual periods beginning after November 15, 2009. The adoption of ASU 2009-17 had no effect on our consolidated statement of earnings, financial condition, statement of cash flows or earnings per share.

 

From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of any other recently issued standards that are not yet effective are either not applicable to us at this time or will not have a material impact on our consolidated financial statements upon adoption.

 

 

Interest Rate Sensitivity

 

As of December 31, 2010, we had $300.0 million in senior notes outstanding at a fixed interest rate of 65/8%, $383.3 million in term loans and approximately $17.8 million outstanding on our Intrust line of credit at interest rates indexed to the Eurodollar rate. The fair value of the 65/8% senior notes, based on the closing price at December 31, 2010, was $299.8 million. Carrying value approximates fair value for all other indebtedness.

 

Market Risk

 

Market risk is the potential change in an instrument’s value caused by fluctuations in interest rates. Our primary market risk exposure is fluctuations in interest rates. Monitoring and managing this risk is a continual process carried out by our senior management. We manage our market risk based on an ongoing assessment of trends in interest rates and economic developments, giving consideration to possible effects on both total return and reported earnings. As a result of such assessment, we may enter into swap contracts or other interest rate protection agreements from time to time to mitigate this risk.

 

Interest Rate Risk

 

We hold senior credit facilities with variable interest rates indexed to prime or Eurodollar rates that exposes us to the risk of increased interest costs if interest rates rise. As of December 31, 2010, we have not entered into any interest rate swap agreements. The credit markets have experienced adverse conditions, including wide fluctuations in rates. Such volatility in the credit markets could increase the costs associated with our existing long-term debt. Based on our overall interest rate exposure at December 31, 2010, a hypothetical 1.0% increase or decrease in interest rates would have the effect of causing a $3.9 million additional pre-tax charge or credit to our statement of earnings.

 

INDEX TO FINANCIAL STATEMENTS