ITEM 1. BUSINESS
General
Aaron’s, Inc. (“we”, “our”, “us”, “Aaron’s” or the “Company”) is a leading specialty retailer of consumer electronics, computers, residential and office furniture, household appliances and accessories. We engage in the lease ownership, lease and retail sale of a wide variety of products such as widescreen and LCD televisions, computers, living room, dining room and bedroom furniture, washers, dryers and refrigerators. We carry well-known brands such as JVC®, Mitsubishi®, Philips®, Panasonic®, Sony®, Dell®, Hewlett-Packard®, Simmons®, Frigidaire®, and Sharp®. Our major operating divisions are the Aaron’s Sales & Lease Ownership division and the MacTavish Furniture Industries division, which supplies the majority of the upholstered furniture and bedding leased and sold in our stores. Our strategic focus is on expanding our sales and lease ownership business through opening new company-operated stores, expanding our franchise program, and making selective acquisitions.
As of December 31, 2009, we had 1,679 sales and lease ownership stores, comprised of 1,082 company-operated stores in 31 states and Canada and 597 independently-owned franchised stores in 48 states and Canada. We have added 466 company-operated and 240 franchised sales and lease ownership stores since the beginning of 2005. Included in the sales and lease ownership store counts above are 11 company-operated and seven franchised RIMCO stores, our wheels, tires and accessories sales and lease ownership concept. We also have 15 office furniture stores in 8 states.
During the fourth quarter of 2008 the Company sold substantially all of the assets of its Aaron’s Corporate Furnishings division, which leased residential furniture, office furniture and related accessories through 47 company-operated stores in 16 states, to CORT Business Services Corporation (“CORT”). As a result of the sale, our financial statements have been prepared reflecting the Aaron’s Corporate Furnishings division as discontinued operations. All historical financial statements have been restated to conform to this presentation.
We have a history of revenue growth and profitability. Total revenues increased to $1.753 billion in 2009 from $1.032 billion in 2005, representing a 14.2% compound annual growth rate. Our total net earnings from continuing operations increased to $112.9 million in 2009 from $51.7 million in 2005 representing a 21.6% compound annual growth rate.
Our Chairman, R. Charles Loudermilk, Sr., established Aaron’s in 1955, and we were incorporated under the laws of Georgia in 1962. Our principal business address is 309 E. Paces Ferry Road, Atlanta, Georgia, 30305-2377, and our telephone number is (404) 231-0011.
We own or have rights to various trademarks and trade names used in our business.
Aaron’s Sales & Lease Ownership. Our sales and lease ownership division focuses on providing durable household goods to lower to middle income consumers who have limited or no access to traditional credit sources such as bank financing, installment credit or credit cards. Our sales and lease ownership program enables these customers to obtain quality-of-life enhancing merchandise that they might otherwise not be able to afford, without incurring additional debt or long-term obligations.
Our strategic focus is to expand our Aaron’s Sales & Lease Ownership division by opening company-operated stores, expanding our franchise program and making selective acquisitions. We franchise our sales and lease ownership stores in select markets where we have no immediate plans to enter. Our franchise program:
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provides additional revenues from franchise fees and royalties;
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allows us to grow more quickly;
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enables us to achieve economies of scale in purchasing, distribution, manufacturing and advertising for our sales and lease ownership stores; and
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increases exposure to our brand.
Aaron’s Office Furniture. Our office furniture division leases and sells new and lease return merchandise to individuals and businesses, with a focus on leasing office furniture to business customers. Business customers, who represent an increasing portion of lease customers, also enter into lease agreements for office furniture to meet seasonal, temporary or start-up needs.
MacTavish Furniture Industries. Aaron’s is the only major furniture lease company in the United States that manufactures its own furniture. We operate six furniture plants and five bedding facilities. By manufacturing our own specially designed residential furniture, we believe we enjoy an advantage over our competitors. Manufacturing enables us to control the quality, cost, delivery, styling, durability and quantity of our furniture products.
Industry Overview
The Rent-to-Own Industry
The rent-to-own industry offers customers an alternative to traditional methods of obtaining electronics, computers, home furnishings and appliances. In a typical rent-to-own transaction, the customer has the option to acquire merchandise over a fixed term, usually 12 to 24 months, normally by making weekly lease payments. The customer may cancel the agreement at any time by returning the merchandise to the store, with no further lease obligation. If the customer leases the item to the full term, he obtains ownership of the item, though he can choose to buy it at any time.
The rent-to-own concept is particularly popular with consumers who cannot pay the full purchase price for merchandise at once or who lack the credit to qualify under conventional financing programs. Rent-to-own is also popular with consumers who, despite good credit, do not wish to incur additional debt, have only a temporary need for the merchandise or want to try out a particular brand or model before buying it.
We believe that the decline in the number of furniture stores and the limited number of retailers that focus on credit installment sales to lower and middle income consumers has created a market opportunity for our unique sales and lease ownership concept. The traditional retail consumer durable goods market is much larger than the lease market, leaving substantial potential for growth for our sales and lease ownership division. We believe that the segment of the population targeted by our sales and lease ownership division comprises approximately 50% of all households in the United States and that the needs of these consumers are generally underserved.
Aaron’s Sales & Lease Ownership versus Traditional Rent-to-Own
We believe that our sales and lease ownership model is unique. By providing customers with the option either to lease merchandise with the opportunity to obtain ownership or to purchase merchandise outright, we blend elements of rent-to-own and traditional retailing. We believe our sales and lease ownership program is a more effective method of retailing our merchandise to lower to middle income consumers than a typical rent-to-own business or the more traditional method of credit installment sales.
Our sales and lease ownership model is distinctive from a typical rent-to-own business in that we encourage our customers to obtain ownership of their lease merchandise. Based on industry data, we believe that more of the initial renters of our merchandise (over 45%) obtain ownership versus rent-to-own businesses in general (approximately 25%). We believe our sales and lease ownership model offers the following unique characteristics versus traditional rent-to-own stores:
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Lower total cost-our agreement terms typically provide a lower cost of ownership to the customer.
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Wider merchandise selection-we generally offer a larger selection of higher-quality merchandise.
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Larger store layout-our stores are typically 9,000 square feet, nearly twice the size of typical rent-to-own stores.
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Fewer payments- our typical plan offers semi-monthly or monthly payments versus the industry standard of weekly payments. Our agreements also usually provide for a shorter term until the customer obtains ownership.
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Flexible payment methods-we offer our customers the opportunity to pay by cash, check, credit card or debit card, compared with the more common cash payment method at rent-to-own stores. We receive approximately 53% of our payment volume (in dollars) from customers by check, credit card or debit card.
We believe our sales and lease ownership model also has attractive features in common with traditional retailers. Among these features are store size, merchandise selection and the latest product offerings, such as “state-of-the-art” electronics and computers. As technology has advanced and home furnishings and appliances have evolved, we have strived to offer our customers the latest product developments at affordable prices.
Unlike transactions with most traditional retailers, where the customer is committed to purchase the merchandise, our sales and lease ownership transactions are not credit installment contracts, and the customer may elect to terminate the transaction after a short initial lease period. Our sales and lease ownership stores offer an up-front “cash and carry” purchase option on most merchandise at prices that are competitive with traditional retailers.
Operating Strategies
Our operating strategies are focused on differentiation from our competitors and improved efficiencies. We strive to:
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Differentiate our Aaron’s Sales & Lease Ownership concept - We believe that the success of our sales and lease ownership operation is attributable to our distinctive approach to the business that sets us apart from our rent-to-own and credit retail competitors. We have pioneered innovative approaches to meeting changing customer needs that differ from our competitors’, such as offering lease ownership agreements which result in a lower “all-in” price, larger and more attractive store showrooms, a wider selection of higher-quality merchandise and up-front cash and carry purchase options on select merchandise at prices that are competitive with traditional retailers. Most sales and lease ownership customers make their payments in person, and we use these frequent visits to strengthen customer relationships and make these customers feel welcome in our stores.
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Offer high levels of customer service and satisfaction - We foster good relationships with our customers to attract recurring business and encourage them to lease merchandise for the full agreement term by providing high levels of service and satisfaction. We demonstrate our commitment to superior customer service by providing customers quick delivery of leased merchandise, in many cases by same or next day delivery, and repair service at no charge to the customer. We have also established an employee training program called Aaron’s E-University, which is a 50-course curriculum designed to enhance the customer relations skills of both company-operated and franchised store managers.
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Promote our vendors and the Aaron’s® brand name - Our marketing initiatives reach the target Aaron’s customer in a variety of ways. We advertise our brand name “Dream Products” through our “Drive Dreams Home” sponsorship of NASCAR Championship Racing. Sponsorship of other sporting events, such as professional basketball and baseball, and various college sports, also targets this distinct market. Every month, we distribute mass mailings of promotional material outlining specific products. Our goal is to reach households within a specified radius of each store on a consistent basis every month. Currently, we mail over 28 million flyers each month to consumers in areas served by our stores. We also utilize local television and radio advertising in concentrated geographic markets and for special promotions throughout the year.
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Manage merchandise through our manufacturing and distribution capabilities - We believe that our manufacturing operations and network of 17 fulfillment centers at December 31, 2009 give us a strategic advantage over our competitors. Manufacturing enables us to control the quality, cost, delivery, styling, durability and quantity of a substantial portion of our furniture merchandise, and provides us a reliable source of furniture. Our distribution system allows us to deliver merchandise promptly to our stores in order to meet customer demand quickly and manage inventory levels more effectively.
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Utilize proprietary management information systems - We use proprietary computerized information systems to systematically pursue collections, to manage merchandise returns and to match inventory with demand. Each of our stores, including franchised sales and lease ownership stores, is linked by computer directly to our corporate headquarters, which enables us to monitor the performance of each store on a daily basis.
Growth Strategies
We seek to increase our revenues and profitability through the execution of our growth strategies, which are to:
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Open additional company-operated sales and lease ownership stores - We plan to open sales and lease ownership stores in existing and select new geographic markets. Additional stores help us to realize economies of scale in purchasing, marketing and distribution. We added a net of 45 company-operated stores in 2009.
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Increase our sales and lease ownership franchises - We believe that our franchise program allows us to grow more quickly and increase our brand exposure in new markets. In addition, the combination of company-operated and franchised stores creates a larger store base that enhances the economies of scale in purchasing, distribution, manufacturing and advertising for our sales and lease ownership stores. Franchise fees and royalties represent a growing source of company revenues.
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Increase revenues and net earnings from existing sales and lease ownership stores - We experienced same store revenue growth (revenues earned in stores open for the entirety of both periods) from our company-operated sales and lease ownership stores of 8.1% in 2009, 3.1% in 2008, and 3.8% in 2007. We calculate same store revenue growth by comparing revenues from comparable periods for all stores open during the entirety of those periods, excluding stores that received lease agreements from other acquired, closed or merged stores. We expect revenues and net earnings of our sales and lease ownership division to continue to grow as the large number of stores we have opened in the past few years increase their customer bases.
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Seek selective acquisitions in both new and existing sales and lease ownership markets - We will continue to explore acquisitions of other rent-to-own operations and select company franchised stores. In 2009, we acquired the lease agreements, merchandise and assets of 44 sales and lease ownership stores. Fifteen of these stores were subsequently merged with existing locations, resulting in 29 new stores from acquisitions. We will also seek to convert the stores of existing independent lease operators to Aaron’s Sales & Lease Ownership franchised stores.
Operations
Sales and Lease Ownership
We established our Aaron’s Sales & Lease Ownership operation in 1987. At December 31, 2009, we had 1,082 company-operated sales and lease ownership stores in 31 states and Canada.
We have developed a distinctive concept for our sales and lease ownership stores with specific merchandising, store layout, pricing and agreement terms for our target customer market. We believe that these features create a store and a sales and lease ownership concept significantly different from the operations of rent-to-own stores and corporate furnishings (rent-to-rent) businesses, and the operations of consumer electronics and home furnishings retailers who finance merchandise.
The typical Aaron’s Sales & Lease Ownership store layout is a combination showroom and warehouse of 8,000 to 10,000 square feet, with an average of approximately 9,000 total square feet. In selecting locations for new sales and lease ownership stores, we generally look for sites in well-maintained strip shopping centers with good access, which are strategically located in established working class neighborhoods and communities. We also build to suit or occupy stand-alone stores in certain markets. Many of our stores are placed near existing competitors’ stores. Each sales and lease ownership store usually maintains at least two trucks and crews for pickups and deliveries and generally offers same or next day delivery for addresses located within approximately ten miles of the store. We emphasize a broad selection of brand name electronics, computers and appliances, and offer customers a wide selection of furniture, including furniture manufactured by our MacTavish Furniture Industries division. Our sales and lease ownership stores also offer lawn tractors.
We believe that our sales and lease ownership stores offer lower merchandise prices than similar items offered by traditional rent-to-own operators, and substantially equivalent to the “all-in” contract price of similar items offered by retailers who finance merchandise. Approximately 89% of our sales and lease ownership agreements are monthly and approximately 11% are semi-monthly as compared to the industry standard of weekly agreements, and our agreements usually provide for a shorter term leading to customer ownership. Customers can have the item serviced free of charge or replaced at any time during the lease agreement. We re-lease or sell merchandise that customers return to us prior to the expiration of their agreements. We also offer, for select merchandise, an up-front cash and carry purchase option at prices that are competitive with traditional retailers.
During the latter part of 2004, we opened two experimental stores under the RIMCO name that lease automobile wheels, tires and rims to customers under sales and lease ownership agreements. Although the products offered are different, these stores are managed, monitored and operated similarly to our other sales and lease ownership stores. At December 31, 2009, we had 11 company-operated and seven franchised RIMCO stores open.
Sales and Lease Ownership Franchise Program
We began franchising Aaron’s Sales & Lease Ownership stores in select markets in 1992 and have continued to attract franchisees. Our franchised stores do not compete with company-operated stores, nor do we anticipate any such competition, as we mainly award franchises in markets where we have no operations and no current plans to enter. As of December 31, 2009, we had 597 franchised stores open and area development agreements with franchisees to open 269 stores in the future. We believe that our relations with our franchisees are generally good.
Franchisees are approved on the basis of the applicant’s business background and financial resources. We generally seek franchisees who will enter into area development agreements for several stores, although some franchisees currently operate a single store. Most franchisees are involved in the day-to-day operations of the stores.
We enter into franchise agreements with our franchisees to govern the opening and operation of franchised stores. Under our current standard agreement, we require the franchisee to pay a franchise fee from $15,000 to $50,000 per store depending upon market size. Agreements are for a term of ten years, with one ten-year renewal option, and franchisees are obligated to remit to us royalty payments of 5% or 6% of the franchisee’s weekly cash collections. The royalty payments increased from 5% to 6% for most franchise agreements entered into or renewed after December 31, 2002.
We assist each franchisee in selecting the proper site for each store. Because of the importance of location to the Aaron’s Sales & Lease Ownership concept, one of our pre-opening directors visits the intended market and helps guide the franchisee through the selection process. Once a site is selected, we help in designing the floor plan, including the proper layout of the showroom and warehouse. In addition, we provide assistance in assuring that the design and decor of the showroom is consistent with our requirements. We also lease the exterior signage to the franchisee and assist with placing pre-opening advertising, ordering initial inventory and obtaining delivery vehicles.
We have an arrangement with several banks to provide financing to qualifying franchisees to assist with establishing and operating their stores. An inventory financing plan to provide franchisees with the capital to purchase inventory is the primary component of the financing program. For qualified established franchisees, we have arranged in some cases for these institutions to provide a revolving credit line to allow franchisees the flexibility to expand. We guarantee amounts outstanding under the franchisee financing programs.
All franchisees are required to complete a comprehensive training program and to operate their franchised sales and lease ownership stores in compliance with our policies, standards and specifications, including such matters as decor, lease agreement terms, hours of operation, pricing and merchandise. Franchisees in general are not required to purchase their lease merchandise from our fulfillment centers, although most do so in order to take advantage of company sponsored financing, bulk purchasing discounts and favorable delivery terms.
We conduct a financial audit of our franchised stores every six to 12 months and also conduct regular operational audits - generally visiting each franchised store almost as often as we visit our company-operated stores. In addition, our proprietary management information system links each franchised store to corporate headquarters.
Aaron’s Office Furniture
At December 31, 2009, the Aaron’s Office Furniture division included 15 office furniture stores in eight states. Our typical corporate furniture store layout consists of a combination showroom and warehouse comprising about 19,000 square feet. Office showrooms feature lines of desks, chairs, conference tables, credenzas, sofas and accessories. We believe that locating a warehouse next to each showroom permits store managers to exercise greater control over inventory, merchandise condition, and pickup and deliveries, resulting in more efficient and consistent service for the customer.
Items held for lease, whether new or lease return, are available for purchase and lease purchase at all corporate furniture stores. Each office furniture store generally offers next day delivery for addresses located within 50 miles of the store and maintains at least one truck and a crew for pickups and deliveries. We believe that our ability to obtain and deliver furniture and equipment to customers quickly and efficiently gives us an advantage over general furniture retailers who often require several weeks to affect delivery.
We generally sell lease return merchandise at stores at or above its book value - that is, cost less depreciation, plus selling expenses - at a price which is usually lower than the price for comparable new merchandise. Most merchandise held for sale in stores may also be acquired through a lease purchase option. Because new merchandise is sold at the same location as lease return merchandise, we have the opportunity to sell both new and lease return merchandise to customers who may have been attracted to the store by the advertising and price appeal of lease return merchandise. The ability to sell new and lease return merchandise at the same location allows for more efficient use of facilities and personnel and minimizes overhead.
Furniture Manufacturing
Our MacTavish Furniture Industries division has manufactured furniture for our stores since 1971. The division has six furniture manufacturing plants and five bedding manufacturing facilities totaling approximately 654,000 square feet in the aggregate, that supply the majority of our upholstered furniture and bedding. We currently have no plans to significantly expand our capacity.
Our MacTavish Furniture Industries division manufactures:
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upholstered living-room furniture, including contemporary sofas, sofa beds, chairs and modular sofa and ottoman collections in a variety of natural and synthetic fabrics; and
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bedding, including standard sizes of mattresses and box springs.
MacTavish has designed special features for the furniture it manufactures that we believe reduce production costs, enhance product durability, and improve the shipping process relative to furniture purchased from third parties. These features include:
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standardization of components;
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reduction of parts and features susceptible to wear or damage;
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more resilient foam;
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durable, soil-resistant fabrics and sturdy frames for longer life and higher residual value; and
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devices that allow sofas to stand on end for easier and more efficient transport.
MacTavish also manufactures replacement covers of all styles and fabrics of its upholstered furniture for use in reconditioning lease return furniture.
The principal raw materials we use in furniture manufacturing are fabric, foam, fiber, wire-innerspring assemblies, plywood and hardwood. All of these materials are purchased in the open market from unaffiliated sources. We are not dependent on any single supplier, and none of the raw materials we use are in short supply.
Discontinued Operations-Corporate Furnishings
On September 12, 2008, the company entered into an asset purchase agreement with CORT Business Services Corporation pursuant to which the company sold substantially all of the assets of its Aaron’s Corporate Furnishings division to CORT. The results of the Aaron’s Corporate Furnishings division are presented as discontinued operations in the accompanying consolidated financial statements.
Marketing and Advertising
In our sales and lease ownership operations, we rely heavily on national and local television advertising. We advertise nationally on television with a variety of commercials. All of our television commercials feature brand name furniture, electronics, appliances and computers. Aaron’s has national broadcast partnerships with ESPN/ABC, SPEED Channel, TNT, TBS and Univision.
We believe we have garnered significant value from our sports marketing initiatives. We advertise and sponsor motorsports at various levels and professional and collegiate sports, such as professional basketball and baseball, and SEC and ACC league college football and basketball, among others.
Our premier event partnership continues to be the Aaron’s Dream Weekend at Talladega Superspeedway consisting of the Aaron’s 499 NASCAR Sprint Cup Series Race and the Aaron’s 312 NASCAR Nationwide Series Race. Both races are broadcast live on television and are among the most watched NASCAR events.
We have expanded our sponsorship of Michael Waltrip Racing with David Reutimann driving the Aaron’s #00 Dream Machine fulltime in the Sprint Cup Series in 2010. We expect that Michael Waltrip will drive the #99 Aaron’s Dream Machine in the Nationwide Series at Talladega, while Trevor Bayne will drive nine additional Nationwide Series races in 2010.
All of our sports partnerships are integrated directly into advertising, promotional and marketing initiatives, which we strongly believe significantly boost the company’s brand awareness and customer loyalty.
Paces East Advertising, Aaron’s in-house advertising and promotions department, distributes over 28 million direct circulars each month which highlight featured merchandise and demonstrate the cost advantage to consumers of sales and lease ownership over typical rent-to-own transactions.
Store Operations
Management. Our Aaron’s Sales & Lease Ownership division has 12 regional vice presidents and Aaron’s Office Furniture has two vice presidents who are primarily responsible for monitoring individual store performance and inventory levels within their respective regions.
Stores are directly supervised by 112 sales and lease ownership regional managers, one RIMCO regional manager and two office furniture regional managers. At the individual store level, the store manager is primarily responsible for:
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customer and credit relations;
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deliveries and pickups;
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warehouse and inventory management; and
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certain marketing efforts.
Store managers are also responsible for inspecting lease return merchandise to determine whether it should be sold as is, leased again as is, repaired and sold, or reconditioned for additional lease. A significant portion of the store manager’s compensation is dependent upon store revenues and profits.
Executive management directs and coordinates:
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purchasing;
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financial planning and control;
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franchise operations;
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marketing and advertising;
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manufacturing;
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employee training;
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new store site selection and construction for company-operated stores;
Our internal audit department conducts periodic operational audits of every store, including audits of company-operated sales and lease ownership stores several times each year, and semi-annual audits of our stores and franchised sales and lease ownership stores. Our business philosophy has always emphasized safeguarding of company assets, strict cost containment and fiscal controls. Executive and store level management monitor expenses to contain costs. We pay all invoices from company headquarters in order to enhance fiscal accountability. We believe that careful attention to the safeguarding of lease merchandise, our most significant asset, as well as the expense side of our operations, has enabled us to maintain financial stability and profitability.
Management Information Systems. We use computer-based management information systems to facilitate cash collections, merchandise returns and inventory monitoring. Through the use of proprietary software developed in-house, each of our stores is linked by computer directly to corporate headquarters, which enables us to monitor the performance of each store on a daily basis. At the store level, the store manager is better able to track merchandise on the showroom floor and in the warehouse to minimize delivery times, assist with product purchasing, and match customer needs with available inventory.
Lease Agreement Approval, Renewal and Collection. One of the keys to the success of our sales and lease ownership operation is timely cash collections. Individual store managers track cash collections and customers are contacted within a few days of their lease payment due dates in order to encourage customers to keep their agreement current and in force, rather than having to return the merchandise for non-payment, and to renew their agreements for an additional period. Careful attention to cash collections is particularly important in sales and lease ownership operations, where the customer typically has the option to cancel the agreement at any time and each payment is considered a renewal of the agreement rather than a collection of a receivable.
We generally perform no formal credit check with respect to sales and lease ownership customers, other than to verify employment or other reliable sources of income and personal references supplied by the customer. All of our agreements for residential and office merchandise require payments in advance, and the merchandise normally is repossessed if a payment is significantly in arrears.
We do not extend credit to sales and lease ownership customers. Net company-wide merchandise shrinkage as a percentage of combined lease revenues was 2.9% in 2009 and 2008 and 2.8% in 2007. We believe that our collection and repossession policies comply with applicable legal requirements, and we discipline any employee that we discover deviating from such policies.
Customer Service. We believe that customer service is one of the most important elements in the success of our business. Customer satisfaction is critical because the customer typically has the option of returning the leased merchandise at any time. Our goal is to make our customers feel positive about Aaron’s and our products from the moment they enter our showrooms. Items are serviced at no charge to the customer, and quick, free delivery is available in many cases. In order to increase leasing at existing stores, we foster relationships with existing customers to attract recurring business, and many new agreements are attributable to repeat customers.
Because of the importance of customer service, we believe that a prerequisite for successful operations and growth is skilled, effective employees who value our customers and project a genuine desire to serve customers’ needs. Our Aaron’s Sales & Lease Ownership division has developed one of the largest training programs in the industry, called Aaron’s E-University. Aaron’s University is designed to provide a uniform customer service experience regardless of the store’s location, or whether it is company-operated or franchised. Standardizing operating procedures throughout our system is a primary focus of Aaron’s E-University. Aaron’s national trainers provide live training via e-learning through an ongoing 50-course curriculum for all sales and lease ownership associates from entry level to management.
In addition to the e-learning program, Aaron’s E-University has a management development program that offers facilities-based training for store management-caliber associates. Additionally, approximately once a month we distribute a DVD entitled “Inside Aaron’s®.” These DVDs are intended to communicate a wide variety of topics of interest to our store personnel regarding current company initiatives. Our policy of primarily promoting from within boosts employee retention and underscores our commitment to customer service and other business philosophies, allowing us to realize greater benefits from our employee training programs.
Purchasing and Distribution
Our product mix is determined by store managers in consultation with regional managers and regional vice presidents, based on an analysis of customer demands.
The following table shows the percentage of sales and lease ownership division revenues for the year ended December 31, 2009 attributable to different merchandise categories:
We purchase the majority of our merchandise directly from manufacturers, with the balance from local distributors. One of our largest suppliers is our own MacTavish Furniture Industries division, which supplies the majority of the upholstered furniture and bedding we lease or sell. We have no long-term agreements for the purchase of merchandise and believe that our relationships with suppliers are good.
Sales and lease ownership operations utilize fulfillment centers, which are on average approximately 94,000 square feet, to control merchandise. All company-operated sales and lease ownership stores receive merchandise directly from our 17 fulfillment centers, together totaling approximately 1,604,000 square feet. Most of our stores are within a 250-mile radius of a fulfillment center, facilitating timely shipment of products to the stores and fast delivery of orders to customers.
We realize freight savings from truckload discounts and more efficient distribution of merchandise by using fulfillment centers. We use our own tractor-trailers, local delivery trucks and various contract carriers to make weekly deliveries to individual stores.
Competition
Aaron’s business is highly competitive. Our largest competitor in the rent-to-own market is Rent-A-Center, Inc. According to industry sources and our estimates, Aaron’s and Rent-A-Center, Inc., which are the two largest industry participants, account for approximately 4,900 of the 8,500 rent-to-own stores in the United States and Canada. Our stores compete with other national and regional 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 lease rates and terms.
Seasonality
Aaron’s revenue mix is moderately seasonal, with the first quarter of each year generally resulting in higher revenues than any other quarter during the year, primarily due to realizing the full benefit of business that historically gradually increases in the fourth quarter as a result of the holiday season, as well as the receipt by our customers in the first quarter of federal income tax refunds. Generally, our customers will more frequently exercise the early purchase option on their existing lease agreements or purchase merchandise off the showroom floor during the first quarter of the year. We expect this trend to continue in future periods. Furthermore, we tend to experience slower growth in the number of agreements on lease in the third quarter of each fiscal when compared to the other quarters of the year. We also expect this trend to continue in future periods unless we significantly change our store base as a result of new store openings or opportunistic acquisitions and dispositions.
Government Regulation
Our operations are extensively regulated by and subject to the requirements of various federal and state laws and regulations. In general such laws regulate applications for leases, late fees, other finance rates, the form of disclosure statements, the substance and sequence of required disclosures, the content of advertising materials and certain collection procedures. Violations of certain provisions of these laws may result in penalties ranging from nominal amounts up to and including forfeiture of fees and other amounts due on leases. We do not believe that the various laws and regulations have had or will have a material adverse effect on our operations. However, we are unable to predict the nature or effect on our operations or earnings of unknown future legislation, regulations and judicial decisions or future interpretations of existing and future legislation or regulations relating to our operations, and there can be no assurance that future laws, decisions or interpretations will not have a material adverse effect on our operations and earnings.
A summary of certain of the state and federal laws under which we operate follows. This summary does not purport to be a complete summary of the laws referred to below or of all the laws regulating our operations.
Currently, 47 states and the District of Columbia specifically regulate rent-to-own transactions, including states in which we currently operate Aaron’s Sales & Lease Ownership stores. Most state lease purchase laws require rent-to-own companies to disclose to their customers the total number of payments, total amount and timing of all payments to acquire ownership of any item, any other charges that may be imposed, and miscellaneous other items. The more restrictive state lease purchase laws limit the total amount that a customer may be charged for an item, or regulate the amount of deemed “interest” that rent-to-own companies may charge on rent-to-own transactions, generally defining “interest” as lease fees paid in excess of the “retail” price of the goods. Our long-established policy in all states is to disclose the terms of our lease purchase transactions as a matter of good business ethics and customer service. We believe we are in material compliance with the various state lease purchase laws. At the present time, no federal law specifically regulates the rent-to-own industry. Federal legislation to regulate the industry has been proposed from time to time.
The current economic downturn has renewed legislative attention in the United States, at both the state and federal levels, on consumer debt transactions in general, which may result in an increase in legislative regulatory efforts directed at the rent-to-own industry. We cannot predict whether any such legislation will be enacted and what the impact of such legislation would be on us. Although we are unable to predict the results of any regulatory initiatives, we do not believe that existing and currently proposed regulations will have a material adverse impact on our sales and lease ownership or other operations.
We have introduced a form of consumer lease as an alternative to our typical lease purchase agreement in a number of states. The consumer lease differs from a lease purchase agreement in that it has an initial lease term in excess of four months. Generally, state laws that govern the rent-to-own industry only apply to lease agreements with an initial term of four months or less. The consumer lease is governed by federal and state laws and regulations other than the state lease purchase laws. The federal regulations applicable to the consumer lease require certain disclosures similar to the rent-to-own regulations, but are generally less restrictive as to pricing and other charges. We believe we are in material compliance with all laws applicable to our consumer leasing program.
Our sales and lease ownership franchise program is subject to Federal Trade Commission (“FTC”) regulation and various state laws regulating the offer and sale of franchises. Several state laws also regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise offering circular containing prescribed information. A number of states in which we might consider franchising also regulate the sale of franchises and require registration of the franchise offering circular with state authorities. We believe we are in material compliance with all applicable franchise laws in those states in which we do business and with similar laws in Canada.
Employees
At December 31, 2009, Aaron’s had approximately 10,000 employees. None of our employees are covered by a collective bargaining agreement, and we believe that our relations with our employees are good.
Information on Segments and Geographic Areas
We currently only operate in the United States and Canada. Information on our three reportable segments-sales and lease ownership, franchise and manufacturing-is set forth in Note K to our Consolidated Financial Statements. See Item 8 of Part II.
Available Information
We make available free of charge on or through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). Our Internet address is www.aaronsinc.com.
ITEM 1A.
ITEM 1A. RISK FACTORS
Aaron’s business is subject to certain risks and uncertainties, some of which are set forth below.
Our growth strategy depends considerably on opening new company-operated stores. Our ability to expand our store base is influenced by factors beyond our control, which may impair our growth strategy and impede our revenue growth.
Opening new company-operated stores is an important part of our growth strategy. Our ability to continue opening new stores is affected by, among other things:
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the substantial outlay of financial resources required to open new stores and initially operate them, and the availability of capital sources to finance new openings and initial operation;
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difficulties associated with hiring, training and retaining additional skilled personnel, including store managers;
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our ability to identify suitable new store sites and to negotiate acceptable leases for these sites;
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competition in existing and new markets;
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consumer demand, tastes and spending patterns in new markets that differ from those in our existing markets; and
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challenges in adapting our distribution and other operational and management systems to an expanded network of stores.
If we cannot address these challenges successfully, we may not be able to expand our business or increase our revenues at the rates we currently contemplate.
If we cannot manage the costs of opening new stores, our profitability may suffer.
Opening large numbers of new stores requires significant start-up expenses, and new stores are generally not profitable until their second year of operation. Consequently, opening many stores over a short period can materially decrease our net earnings for a time. This effect is sometimes called “new store drag.” During 2009, we estimate that start-up expenses for new stores reduced our net earnings by approximately $11 million, or $.20 per diluted share. We cannot be certain that we will be able to fully recover these significant costs in the future.
We may not be able to attract qualified franchisees, which may slow the growth of our business.
Our growth strategy depends significantly upon our franchisees developing new franchised sales and lease ownership stores. We generally seek franchisees who meet our stringent business background and financial criteria, and who are willing to enter into area development agreements for several stores. A number of factors, however, could inhibit our ability to find qualified franchisees, including general economic downturns or legislative or litigation developments that make the rent-to-own industry less attractive to potential franchisees. These developments could also adversely affect our franchisees’ ability to obtain adequate capital to develop and operate new stores on time, or at all. Our inability to find qualified franchisees could slow our growth.
Qualified franchisees who conform to our standards and requirements are also important to the overall success of our business. Our franchisees, however, are independent contractors and not employees, and consequently we cannot and do not control them to the same extent as our company-operated stores. Our franchisees may fail in key areas, which could in turn slow our growth, reduce our franchise revenues or damage our image and reputation.
If we are unable to integrate acquired businesses successfully and realize anticipated economic, operational and other benefits in a timely manner, our profitability may decrease.
We frequently acquire other sales and lease ownership businesses. We acquired the lease agreements, merchandise and assets of 44 stores through acquisitions in 2009. If we are unable to integrate businesses we acquire successfully, we may incur substantial cost and delays in increasing our customer base. In addition, the failure to integrate acquisitions successfully may divert management’s attention from Aaron’s existing business. Integration of an acquired business may be more difficult when we acquire a business in an unfamiliar market, or a business with a different management philosophy or operating style.
Our competitors could impede our ability to attract new customers, or cause current customers to cease doing business with us.
The industries in which we compete are highly competitive. In the sales and lease ownership market, our competitors include national, regional and local operators of rent-to-own stores and credit retailers. Our competitors in the sales and lease ownership and traditional retail markets may have significantly greater financial and operating resources, and greater name recognition in certain markets, than we have. Greater financial resources may allow our competitors to grow faster than us, including through acquisitions. This in turn may enable them to enter new markets before we can, which may decrease our opportunities in those markets. Greater name recognition, or better public perception of a competitor’s reputation, may help them divert market share away from us, even in our established markets.
In addition, new competitors may emerge. Current and potential competitors may establish financial or strategic relationships among themselves or with third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share.
If our independent franchisees fail to meet their debt service payments or other obligations under outstanding loans guaranteed by us as part of a franchise loan program, amounts that the lenders participating in the program could require us to pay to satisfy these obligations could have a material adverse effect on our business and financial condition.
We have guaranteed the borrowings of certain franchisees under a franchise loan program with several banks with a maximum commitment amount of $175.0 million, and we also guarantee franchisee borrowings under certain other debt facilities. In the event these franchisees are unable to meet their debt service payments or otherwise experience an event of default, we would be unconditionally liable for a portion of the outstanding balance of the franchisees’ debt obligations, which at December 31, 2009 was $128.8 million. Of this amount, approximately $120.2 million represents franchisee borrowings outstanding under the franchise loan program and approximately $8.6 million represents franchisee borrowings that we guarantee under other debt facilities. Although we have had no significant losses associated with the franchisee loan and guaranty program since its inception, and we believe that any losses associated with any defaults would be mitigated through recovery of lease merchandise and other assets, we cannot guarantee that there will be no significant losses in the future or that we will be able to adequately mitigate any such losses. If we fail to adequately mitigate any such future losses, our business and financial condition could be materially adversely impacted.
Any loss of the services of our key executives, or our inability to attract and retain qualified managers, could have a material adverse impact on our operations.
We believe that we have benefited substantially from our current executive leadership and that the loss of their services at any time in the near future could adversely affect our business and operations. We also depend on the continued services of the rest of our management team. The loss of these individuals without adequate replacement could also adversely affect our business. Although we have employment agreements with some of our key executives, they are generally terminable on short notice and we do not carry key man life insurance on any of our officers.
Additionally, we need a growing number of qualified managers to operate our stores successfully. The inability to attract and retain qualified individuals, or a significant increase in the costs to do so, would materially adversely affect our operations.
You should not rely solely on our same store revenues as an indication of our future results of operations because they fluctuate significantly.
Our historical same store revenue growth figures have fluctuated significantly from year to year. For example, we experienced same store revenue growth of 8.1% in 2009 and 3.1% in 2008. We calculate same store revenue growth by comparing revenues for comparable periods for all stores open during the entirety of those periods. Even though we achieved significant same store revenue growth in the past and consider it a key indicator of historical performance, we may not be able to increase same store revenues in the future. A number of factors have historically affected, and will continue to affect, our same store revenues, including:
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changes in competition;
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general economic conditions;
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new product introductions;
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consumer trends;
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changes in our merchandise mix;
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the opening of new stores;
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the impact of our new stores on our existing stores, including potential decreases in existing stores’ revenues as a result of opening new stores;
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timing of promotional events; and
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our ability to execute our business strategy effectively.
Changes in our quarterly and annual same store revenues could cause the price of our common stock to fluctuate significantly.
Our operations are regulated by and subject to the requirements of various federal and state laws and regulations. These laws and regulations, as the same may be amended or supplemented or interpreted by the courts from time to time, could expose us to significant compliance costs or burdens or force us to change our business practices in a manner that may be materially adverse to our operations, prospects or financial condition.
Currently 47 states and the District of Columbia specifically regulate rent-to-own transactions, including states in which we currently operate Aaron’s Sales & Lease Ownership stores. At the present time, no federal law specifically regulates the rent-to-own industry, although federal legislation to regulate the industry has been proposed from time to time. Any adverse changes in existing laws, or the passage of new adverse legislation by states or the federal government could materially increase both our costs of complying with laws and the risk that we could be sued or be subject to government sanctions if we are not in compliance. In addition, new burdensome legislation might force us to change our business model and might reduce the economic potential of our sales and lease ownership operations.
Most of the states that regulate rent-to-own transactions have enacted disclosure laws which require rent-to-own companies to disclose to their customers the total number of payments, total amount and timing of all payments to acquire ownership of any item, any other charges that may be imposed by them and miscellaneous other items. The more restrictive state lease purchase laws limit the total amount that a customer may be charged for an item, or regulate the amount of deemed “interest” that rent-to-own companies may charge on rent-to-own transactions, generally defining “interest” as lease fees paid in excess of the “retail” price of the goods.
The current economic downturn has renewed legislative attention in the United States, at both the state and federal levels, on consumer debt transactions in general, which may result in an increase in legislative regulatory efforts directed at the rent-to-own industry. We cannot guarantee that the federal government or states will not enact additional or different legislation that would be disadvantageous or otherwise materially adverse to us.
In addition to the risk of lawsuits related to the laws that regulate rent-to-own and consumer lease transactions, we could be subject to lawsuits alleging violations of federal and state laws and regulations and consumer tort law, including fraud and consumer protection laws, because of the consumer-oriented nature of the rent-to-own industry. A large judgment could adversely affect our financial condition and results of operations. Moreover, an adverse outcome from a lawsuit, even one against one of our competitors, could result in changes in the way we and others in the industry do business, possibly leading to significant costs or decreased revenues or profitability.
Continuation or deepening of the current economic recession could result in decreased revenues or increased costs.
The United States’ and other economies are currently experiencing severe distress, accompanied by disruptions and contraction in the credit markets and broad unemployment. Although we believe the economic downturn has resulted in increased business in our sales and lease ownership stores, as consumers increasingly find it difficult to purchase home furnishings, electronics and appliances from traditional retailers on store installment credit, it is possible that if the recession continues for a significant period of time, or deepens, consumers may curtail spending on all or some of the types of merchandise we offer, in which event our revenues may suffer.
In addition, unemployment may result in increased defaults on lease payments, resulting in increased merchandise return costs and merchandise losses.
Disruptions in the credit and capital markets may negatively affect the Company’s access to capital.
We have historically relied partially on the credit and capital markets to fund its growth, including through bank loan arrangements and periodic public stock offering and private placements of debt securities. Beginning in the second half of 2008, the global credit and capital markets experienced severe disruptions, resulting in increased costs of capital, and unavailability of some forms of capital. Although the credit and capital markets have improved somewhat, they have not recovered to their pre-crisis strength. While we believe our sources of capital will be adequate to fund our operations for the next 24 months, if credit and capital market disruptions continue for an extended period, or deteriorate further, we may not be able to obtain capital at favorable costs, and may not be able to obtain some forms of capital at all.
We are subject to laws that regulate franchisor-franchisee relationships. Our ability to develop new franchised stores and enforce our rights against franchisees may be adversely affected by these laws, which could impair our growth strategy and cause our franchise revenues to decline.
As a franchisor, we are subject to regulation by the Federal Trade Commission, state laws and certain Canadian provincial laws regulating the offer and sale of franchises. Because we plan to expand our business in part by selling more franchises, our failure to obtain or maintain approvals to sell franchises could significantly impair our growth strategy. In addition, our failure to comply with franchise regulations could cause us to lose franchise fees and ongoing royalty revenues. Moreover, state laws that regulate substantive aspects of our relationships with franchisees may limit our ability to terminate or otherwise resolve conflicts with our franchisees.
We are subject to legal proceedings from time to time which seek material damages.
From time to time, we are subject to legal proceedings, including class actions, that seek material damages. Although we do not presently believe that any of the legal proceedings to which we are currently a party will ultimately have a material adverse impact upon us, we cannot assure you that we will not incur material damages in a lawsuit or other proceeding in the future. Significant final judgments, settlement amounts, amounts needed to post a bond pending an appeal or defense costs could materially and adversely affect our liquidity and capital resources.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We lease space for most of our store and warehouse operations under operating leases expiring at various times through 2028. Most of the leases contain renewal options for additional periods ranging from one to 15 years at rental rates generally adjusted on the basis of the consumer price index or other factors.
The following table sets forth certain information regarding our furniture manufacturing plants, bedding facilities, and fulfillment centers:
Our executive and administrative offices occupy approximately 36,000 square feet in an 11-story, 87,000 square-foot office building that we own in Atlanta, Georgia. We lease most of the remaining space to third parties under leases with remaining terms averaging three years. We lease a two-story building with over 50,000 square feet in Kennesaw, Georgia and a one-story building with over 46,000 square feet in Marietta, Georgia for additional administrative functions. We believe that all of our facilities are well maintained and adequate for their current and reasonably foreseeable uses.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are party to various legal proceedings arising in the ordinary course of business. Although the Company does not presently believe that any of the legal proceedings to which it is currently a party will ultimately have a material adverse impact upon its business, financial position or results of operations, it is currently a party to the proceeding described below:
In Kunstmann et al v. Aaron Rents, Inc. pending in the United States District Court, Northern District of Alabama (the “court”), plaintiffs have alleged that the Company improperly classified store general managers as exempt from the overtime provisions of the Fair Labor Standards Act. Plaintiffs seek to recover unpaid overtime compensation and other damages for all similarly situated general managers nationwide for the period January 25, 2007 to present. After initially denying plaintiffs’ class certification motion in April 2009, the court ruled to conditionally certify a plaintiff class in early 2010. The potential class is an estimated 2,600 individuals. Those individuals who affirmatively opt to join the class may be required to travel at their own expense to Alabama for discovery purposes and/or trial. The court’s class certification ruling is procedural only and does not address the merits of the plaintiffs’ claims.
The Company believes it has meritorious defenses to the proceeding described above, and intends to vigorously defend itself against it. However, this proceeding is still developing, and due to inherent uncertainty in litigation and similar adversarial proceedings, there can be no guarantee that the Company will ultimately be successful in this proceeding, or in others to which it is currently a party. Substantial losses from legal proceedings could have a material adverse impact upon the Company’s business, financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information, Holders and Dividends
The Company’s Common Stock and Class A Common Stock are listed on the New York Stock Exchange under the symbols “AAN” and “AAN.A”, respectively.
The number of shareholders of record of the Company’s Common Stock and Class A Common Stock at February 24, 2010 was 249 and 111, respectively. The closing prices for the Common Stock and Class A Common Stock at February 24, 2010 were $29.80 and $24.30 respectively.
The following table shows the range of high and low closing prices per share for the Common Stock and Class A Common Stock and the quarterly cash dividends declared per share for the periods indicated.
Subject to our ongoing ability to generate sufficient income, any future capital needs and other contingencies, we expect to continue our policy of paying dividends. Our articles of incorporation provide that no cash dividends may be paid on our Class A Common Stock unless equal or higher dividends are paid on the Common Stock. Under our revolving credit agreement, we may pay cash dividends in any year only if the dividends do not exceed 50% of our consolidated net earnings for the prior fiscal year plus the excess, if any, of the cash dividend limitation applicable to the prior year over the dividend actually paid in the prior year.
Issuer Purchases of Equity Securities
The Company made no repurchases of its Common Stock or Class A Common Stock during 2009. As of December 31, 2009 3,920,413 common shares remained available for repurchase under the purchase authority approved by the Company’s Board of Directors and publicly announced from time-to-time.
Information concerning the Company’s equity compensation plans is set forth in Item 12 of Part III of this Annual Report on Form 10-K.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data of Aaron’s, Inc. which have been derived from the Consolidated Financial Statements of the Company for each of the five years in the period ended December 31, 2009. Amounts have been restated to reflect the Aaron’s Corporate Furnishings division as discontinued operations. See Note N to our Consolidated Financial Statements in Item 8 of Part II for a discussion of the sale of our Aaron’s Corporate Furnishings division. This historical information may not be indicative of the Company’s future performance. The information set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the notes thereto.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Aaron’s, Inc. is a leading specialty retailer of consumer electronics, computers, residential and office furniture, household appliances and accessories. Our major operating divisions are the Aaron’s Sales & Lease Ownership Division and the MacTavish Furniture Industries Division, which manufactures and supplies the majority of the upholstered furniture and bedding leased and sold in our stores.
Aaron’s has demonstrated strong revenue growth over the last three years. Total revenues have increased from $1.395 billion in 2007 to $1.753 billion in 2009, representing a compound annual growth rate of 12.1%. Total revenues for the year ended December 31, 2009 were $1.753 billion, an increase of $160.2 million, or 10.1%, over the prior year.
Most of our growth comes from the opening of new sales and lease ownership stores and increases in same store revenues from previously opened stores. We added a net of 45 company-operated sales and lease ownership stores in 2009. We spend on average approximately $600,000 to $700,000 in the first year of operation of a new store, which includes purchases of lease merchandise, investments in leasehold improvements and financing first year start-up costs. Our new sales and lease ownership stores typically achieve revenues of approximately $1.1 million in their third year of operation. Our comparable stores open more than three years normally achieve approximately $1.4 million in unit revenues, which we believe represents a higher unit revenue volume than the typical rent-to-own store. Most of our stores are cash flow positive in the second year of operations following their opening.
We also use our franchise program to help us expand our sales and lease ownership concept more quickly and into more areas than we otherwise would by opening only company-operated stores. Our franchisees added a net of 93 stores in 2009. We purchased 19 franchised stores during 2009. Franchise royalties and other related fees represent a growing source of high margin revenue for us, accounting for approximately $52.9 million of revenues in 2009, up from $38.8 million in 2007, representing a compounded annual growth rate of 16.8%.
Same Store Revenues. We believe the changes in same store revenues are a key performance indicator. The change in same store revenues is calculated by comparing revenues for the year to revenues for the prior year for all stores open for the entire 24-month period, excluding stores that received lease agreements from other acquired, closed or merged stores.
Key Components of Income
In this management’s discussion and analysis section, we review the Company’s consolidated results including the five components of our revenues (lease revenues and fees, retail sales, non-retail sales, franchise royalties and fees, and other revenues), costs of sales and expenses (of which depreciation of lease merchandise is a significant part).
Revenues. We separate our total revenues into five components: lease revenues and fees, retail sales, non-retail sales, franchise royalties and fees, and other revenues. Lease revenues and fees include all revenues derived from lease agreements from our stores, including agreements that result in our customers acquiring ownership at the end of the term. Retail sales represent sales of both new and lease return merchandise from our stores. Non-retail sales mainly represent new merchandise sales to our sales and lease ownership division franchisees. Franchise royalties and fees represent fees from the sale of franchise rights and royalty payments from franchisees, as well as other related income from our franchised stores. Other revenues include, at times, income from gains on asset dispositions and other miscellaneous revenues.
Cost of Sales. We separate our cost of sales into two components: retail and non-retail. Retail cost of sales represents the original or depreciated cost of merchandise sold through our company-operated stores. Non-retail cost of sales primarily represents the cost of merchandise sold to our franchisees.
Operating Expenses. Operating expenses include personnel costs, selling costs, occupancy costs, and delivery, among other expenses.
Depreciation of Lease Merchandise. Depreciation of lease merchandise reflects the expense associated with depreciating merchandise held for lease and leased to customers by our stores.
Critical Accounting Policies
Revenue Recognition. Lease revenues are recognized in the month they are due on the accrual basis of accounting. For internal management reporting purposes, lease revenues from the sales and lease ownership division are recognized as revenue in the month the cash is collected. On a monthly basis, we record an accrual for lease revenues due but not yet received, net of allowances, and a deferral of revenue for lease payments received prior to the month due. Our revenue recognition accounting policy matches the lease revenue with the corresponding costs, mainly depreciation, associated with the lease merchandise. At December 31, 2009 and 2008, we had a revenue deferral representing cash collected in advance of being due or otherwise earned totaling $37.4 million and $32.2 million, respectively, and an accrued revenue receivable, net of allowance for doubtful accounts, based on historical collection rates of $5.3 million and $4.8 million, respectively. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt of the merchandise by the franchisee and revenues from such sales to other customers are recognized at the time of shipment.
Lease Merchandise. Our sales and lease ownership division depreciates merchandise over the agreement period, generally 12 to 24 months when leased, and 36 months when not leased, to 0% salvage value. Our office furniture stores depreciate merchandise over the lease ownership agreement period, generally 12 to 24 months when leased, and 60 months when not leased or when on a rent-to-rent agreement, to 0% salvage value. Sales and lease ownership merchandise is generally depreciated at a faster rate than our office furniture merchandise. Our policies require weekly lease merchandise counts by store managers and write-offs for unsalable, damaged, or missing merchandise inventories. Full physical inventories are generally taken at our fulfillment and manufacturing facilities two to four times a year with appropriate provisions made for missing, damaged and unsalable merchandise. In addition, we monitor lease merchandise levels and mix by division, store and fulfillment center, as well as the average age of merchandise on hand. If unsalable lease merchandise cannot be returned to vendors, its carrying value is adjusted to net realizable value or written off. All lease merchandise is available for lease and sale.
We record lease merchandise carrying value adjustments on the allowance method, which estimates the merchandise losses incurred but not yet identified by management as of the end of the accounting period. Lease merchandise adjustments totaled $38.3 million, $34.5 million, and $29.0 million for the years ended December 31, 2009, 2008, and 2007, respectively.
Leases and Closed Store Reserves. The majority of our company-operated stores are operated from leased facilities under operating lease agreements. The majority of these leases are for periods that do not exceed five years. Leasehold improvements related to these leases are generally amortized over periods that do not exceed the lesser of the lease term or five years. While a majority of our leases do not require escalating payments, for the leases which do contain such provisions we record the related lease expense on a straight-line basis over the lease term. Finally, we do not generally obtain significant amounts of lease incentives or allowances from landlords. The total amount of incentives and allowances received in 2009, 2008, and 2007 totaled $1.1 million, $946,000, and $1.4 million, respectively. Such amounts are recognized ratably over the lease term.
From time to time, we close or consolidate stores. Our primary cost associated with closing or consolidating stores is the future lease payments and related commitments. We record an estimate of the future obligation related to closed or consolidated stores based upon the present value of the future lease payments and related commitments, net of estimated sublease income which we base upon historical experience. For the years ended December 31, 2009 and 2008, our reserve for closed or consolidated stores was $2.3 million and $3.0 million, respectively. If our estimates related to sublease income are not correct, our actual liability may be more or less than the liability recorded at December 31, 2009.
Insurance Programs. Aaron’s maintains insurance contracts to fund workers compensation, vehicle liability, general liability and group health insurance claims. Using actuarial analysis and projections, we estimate the liabilities associated with open and incurred but not reported workers compensation, vehicle liability and general liability claims. This analysis is based upon an assessment of the likely outcome or historical experience, net of any stop loss or other supplementary coverage. We also calculate the projected outstanding plan liability for our group health insurance program. Our gross liability for workers compensation insurance claims, vehicle liability, general liability and group health insurance was $22.5 million and $19.7 million at December 31, 2009 and 2008, respectively. In addition, we have prefunding balances on deposit with the insurance carriers of $19.8 million and $20.0 million at December 31, 2009 and 2008, respectively.
If we resolve insurance claims for amounts that are in excess of our current estimates and within policy stop loss limits, we will be required to pay additional amounts beyond those accrued at December 31, 2009. The assumptions and conditions described above reflect management’s best assumptions and estimates, but these items involve inherent uncertainties as described above, which may or may not be controllable by management. As a result, the accounting for such items could result in different amounts if management used different assumptions or if different conditions occur in future periods.
Income Taxes. The calculation of our income tax expense requires significant judgment and the use of estimates. We periodically assess tax positions based on current tax developments, including enacted statutory, judicial and regulatory guidance. In analyzing our overall tax position, consideration is given to the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, income tax balances are adjusted appropriately through the income tax provision. Reserves for income tax uncertainties are maintained at levels we believe are adequate to absorb probable payments. Actual amounts paid, if any, could differ significantly from these estimates.
We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets when we expect the amount of tax benefit to be realized is less than the carrying value of the deferred tax asset.
Results of Operations
Year Ended December 31, 2009 Versus Year Ended December 31, 2008
The Aaron’s Corporate Furnishings division is reflected as a discontinued operation for all periods presented. The following table shows key selected financial data for the years ended December 31, 2009 and 2008, and the changes in dollars and as a percentage to 2009 from 2008.
Revenues
The 10.1% increase in total revenues, to $1.753 billion in 2009 from $1.593 billion in 2008, was due mainly to a $132.0 million, or 11.2%, increase in lease revenues and fees revenues, plus an $18.7 million increase in non-retail sales. The $132.0 million increase in lease revenues and fees revenues was attributable to our sales and lease ownership division, which had a 8.1% increase in same store revenues during the 24 month period ended December 31, 2009 and added a net 68 company-operated stores since the beginning of 2008.
The 6.0% increase in non-retail sales (which mainly represents merchandise sold to our franchisees), to $328.0 million in 2009 from $309.3 million in 2008, was due to the growth of our franchise operations and our distribution network. The total number of franchised sales and lease ownership stores at December 31, 2009 was 597, reflecting a net addition of 113 stores since the beginning of 2008.
The 17.6% increase in franchise royalties and fees, to $52.9 million in 2009 from $45.0 million in 2008, primarily reflects an increase in royalty income from franchisees, increasing 15.9% to $42.3 million in 2009 compared to $36.5 million in 2008. The increase is due primarily to the growth in the number of franchised stores and same store growth in the revenues of existing stores.
Other revenues increased 8.5% to $17.7 million in 2009 from $16.4 million in 2008. Included in other revenues in 2009 is a $7.8 million gain from the sales of the assets of 39 stores. Included in other revenues in 2008 is an $8.5 million gain on the sales of the assets of 41 stores.
Cost of Sales
Cost of sales from retail sales decreased 2.5% to $25.7 million in 2009 compared to $26.4 million in 2008, with retail cost of sales as a percentage of retail sales decreasing to 59.3% and from 61.1% in 2008 as a result of improved pricing and lower product cost.
Cost of sales from non-retail sales increased 5.8%, to $299.7 million in 2009 from $283.4 million in 2008, and as a percentage of non-retail sales, was consistent at 91.4% in 2009 and 91.6% in 2008.
Expenses
Operating expenses in 2009 increased $66.1 million to $771.6 million from $705.6 million in 2008, a 9.4% increase. As a percentage of total revenues, operating expenses were 44.0% for the year ended December 31, 2009, and 44.3% for the comparable period in 2008. Operating expenses decreased as a percentage of total revenues for the year mainly due to increased revenues which primarily resulted from the maturing of new Company-operated sales and lease ownership stores, less new store start-up expenses, and the 8.1% increase in same store revenues previously mentioned. Additionally, the decrease as a percentage of total revenues was related to a reduction in expenses in certain areas.
Depreciation of lease merchandise increased $45.1 million to $475.0 million in 2009 from $429.9 million during the comparable period in 2008, a 10.5% increase. As a percentage of total lease revenues and fees, depreciation of lease merchandise decreased to 36.2% from 36.5% a year ago, primarily due to product mix and lower product cost from favorable purchasing trends.
Interest expense decreased to $4.3 million in 2009 compared with $7.8 million in 2008, a 45.0% decrease. The decrease in interest expense was due to lower debt levels during 2009.
Income tax expense increased $9.8 million to $63.6 million in 2009, compared with $53.8 million in 2008, representing an 18.1% increase. Aaron’s effective tax rate decreased to 36.0% in 2009 from 38.6% in 2008 primarily related to the favorable impact of a $2.3 million reversal of previously recorded liabilities for uncertain tax positions due to statue of limitations expiration.
Net Earnings from Continuing Operations
Net earnings from continuing operations increased $27.1 million to $112.9 million in 2009 compared with $85.8 million in 2008, representing a 31.6% increase. As a percentage of total revenues, net earnings from continuing operations were 6.4% and 5.4% in 2009 and 2008, respectively. The increase in net earnings from continuing operations was primarily the result of the maturing of new company-operated sales and lease ownership stores added over the past several years, contributing to an 8.1% increase in same store revenues, and a 17.6% increase in franchise royalties and fees.
Discontinued Operations
Loss from discontinued operations (which represents the loss from the former Aaron’s Corporate Furnishings division), net of tax, was $277,000 in 2009, compared to net earnings of $4.4 million in 2008. Included in the 2008 results is a $1.2 million pre-tax gain on the sale of substantially all of the assets of the Aaron’s Corporate Furnishings division to CORT Business Services Corporation in the fourth quarter of 2008.
Year Ended December 31, 2008 Versus Year Ended December 31, 2007
The Aaron’s Corporate Furnishings division is reflected as a discontinued operation for all periods presented. The following table shows key selected financial data for the years ended December 31, 2008 and 2007, and the changes in dollars and as a percentage to 2008 from 2007.
Revenues
The 14.2% increase in total revenues, to $1.593 billion in 2008 from $1.395 billion in 2007, was due mainly to a $132.9 million, or 12.7%, increase in lease revenues and fees, plus a $47.7 million increase in non-retail sales. The $132.9 million increase in lease revenues and fees was attributable to our sales and lease ownership division, which had a 3.1% increase in same store revenues during the 24 month period ended December 31, 2008 and added 192 company-operated stores since the beginning of 2007.
The 24.9% increase in revenues from retail sales, to $43.2 million in 2008 from $34.6 million in 2007, was due to increased demand in our sales and lease ownership division.
The 18.3% increase in non-retail sales (which mainly represents merchandise sold to our franchisees), to $309.3 million in 2008 from $261.6 million in 2007, was due to the growth of our franchise operations and our distribution network. The total number of franchised sales and lease ownership stores at December 31, 2008 was 504, reflecting a net addition of 63 stores since the beginning of 2007.
The 16.0% increase in franchise royalties and fees, to $45.0 million in 2008 from $38.8 million in 2007, primarily reflects an increase in royalty income from franchisees, increasing 22.4% to $36.5 million in 2008 compared to $29.8 million in 2007. The increase is due primarily to the growth in the number of franchised stores and same store growth in the revenues in their existing stores.
The 15.5% increase in other revenues, to $16.4 million in 2008 from $14.2 million in 2007, is primarily due to an increase in the gain on store sales in 2008. Included in other revenues in 2008 is an $8.5 million gain from the sales of the assets of 41 stores. Included in other revenues in 2007 are a $2.7 million gain on the sales of the assets of 11 stores and a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters.
Cost of Sales
Cost of sales from retail sales increased 24.4% to $26.4 million in 2008 compared to $21.2 million in 2007, with retail cost of sales as a percentage of retail sales remaining stable at 61.1% and 61.3%, respectively, for the comparable periods.
Cost of sales from non-retail sales increased 18.2%, to $283.4 million in 2008 from $239.8 million in 2007, and as a percentage of non-retail sales, was consistent at 91.6% in 2008 and 91.7% in 2007.
Expenses
Operating expenses in 2008 increased $88.5 million to $705.6 million from $617.1 million in 2007, a 14.3% increase.
As a percentage of total revenues, operating expenses were 44.3% for the year ended December 31, 2008 and 44.2% for the comparable period in 2007. Operating expenses increased slightly as a percentage of total revenues in 2008 mainly due to the addition of 192 company-operated stores since the beginning of 2007.
Depreciation of lease merchandise increased $38.4 million to $429.9 million in 2008 from $391.5 million during the comparable period in 2007, a 9.8% increase. As a percentage of total lease revenues and fees, depreciation of lease merchandise decreased to 36.5% from 37.4% a year ago, primarily due to product mix and lower product cost from favorable purchasing trends.
Interest expense increased to $7.8 million in 2008 compared with $7.6 million in 2007, a 3.0% increase. The increase in interest expense was primarily due to higher debt levels on average throughout 2008.
Income tax expense increased $9.5 million to $53.8 million in 2008 compared with $44.3 million in 2007, representing a 21.4% increase. Aaron’s effective tax rate was 38.6% in 2008 compared with 37.6% in 2007 due to higher state income taxes.
Net Earnings from Continuing Operations
Net earnings from continuing operations increased $12.3 million to $85.8 million in 2008 compared with $73.4 million in 2007, representing a 16.8% increase. As a percentage of total revenues, net earnings from continuing operations were 5.4% and 5.3% in 2008 and 2007, respectively. The increase in net earnings from continuing operations was primarily the result of the maturing of new company-operated sales and lease ownership stores added over the past several years, contributing to a 3.1% increase in same store revenues, and a 16.0% increase in franchise royalties and fees. Additionally, included in other revenues in 2008 is an $8.5 million gain on the sales of company-operated stores. Included in other revenues in 2007 are a $2.7 million gain on the sales of company-operated stores and a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters.
Discontinued Operations
Earnings from discontinued operations (which represents earnings from the former Aaron’s Corporate Furnishings division), net of tax, were $4.4 million in 2008, compared to $6.9 million in 2007. Included in the 2008 results is a $1.2 million pre-tax gain on the sale of substantially all of the assets of the Aaron’s Corporate Furnishings division in the fourth quarter of 2008. Operating results in the fourth quarter of 2008 declined significantly from announcement of the transaction until the sale was consummated on November 6, 2008.
Balance Sheet
Cash and Cash Equivalents. The Company’s cash balance increased to $109.7 million at December 31, 2009 from $7.4 million at December 31, 2008. The increase in our cash balance is due to cash flow generated from operations, less cash used by investing and financing activities of $102.6 million. For additional information, refer to the “Liquidity and Capital Resources” section below.
Lease Merchandise. The increase of $1.3 million in lease merchandise, net of accumulated depreciation, to $682.4 million at December 31, 2009 from $681.1 million at December 31, 2008, is primarily the result of continued revenue growth of new and existing company-operated stores, partially offset by lower product costs.
Property, Plant and Equipment. The increase of $3.2 million in property, plant and equipment, net of accumulated depreciation, to $227.6 million at December 31, 2009 from $224.4 million at December 31, 2008, is primarily the result of a series of acquisitions of sales and lease ownership businesses since December 31, 2008. In 2009, the Company recorded an impairment charge of $3.0 million on certain properties and land parcels and an impairment charge of $1.3 million related to certain leasehold improvements in the Aaron’s Office Furniture stores. The Company also recorded an $838,000 impairment loss on certain leasehold assets in 2008.
Goodwill. The $8.4 million increase in goodwill, to $194.4 million on December 31, 2009 from $186.0 million on December 31, 2008, is the result of a series of acquisitions of sales and lease ownership businesses. During 2009, the Company acquired a total of 44 stores. The aggregate purchase price for these asset acquisitions totaled $25.2 million, with the principal tangible assets acquired consisting of lease merchandise and certain fixtures and equipment.
Other Intangibles, Net. The $2.3 million decrease in other intangibles, to $5.2 million on December 31, 2009 from $7.5 million on December 31, 2008, is the result of amortization of certain finite-life intangible assets, net of acquisitions of sales and lease ownership businesses mentioned above.
Prepaid Expenses and Other Assets. Prepaid expenses and other assets decreased $31.3 million to $36.1 million at December 31, 2009 from $67.4 million at December 31, 2008, primarily as a result of a decrease in prepaid income taxes.
Accounts Payable and Accrued Expenses. The increase of $3.4 million in accounts payable and accrued expenses, to $177.3 million at December 31, 2009 from $173.9 million at December 31, 2008, is primarily the result of fluctuations in the timing of payments.
Deferred Income Taxes Payable. The increase of $15.0 million in deferred income taxes payable to $163.7 million at December 31, 2009 from $148.6 million at December 31, 2008 is primarily the result of bonus lease merchandise depreciation deductions for tax purposes included in the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009.
Credit Facilities and Senior Notes. The $59.8 million decrease in the amounts we owe under our credit facilities to $55.0 million on December 31, 2009 from $114.8 million on December 31, 2008, reflects net payments under our revolving credit facility during 2009. Additionally, we made $22.0 million in scheduled repayments on our senior unsecured notes in 2009.
Liquidity and Capital Resources
General
Cash flows from continuing operations for the year ended December 31, 2009 and 2008 were $193.7 million and $79.3 million, respectively. Purchases of sales and lease ownership stores had a positive impact on operating cash flows in each period presented. The positive impact on operating cash flows from purchasing stores occurs as the result of lease merchandise, other assets and intangibles acquired in these purchases being treated as an investing cash outflow. As such, the operating cash flows attributable to the newly purchased stores usually have an initial positive effect on operating cash flows that may not be indicative of the extent of their contributions in future periods. The amount of lease merchandise purchased in acquisitions and shown under investing activities was $9.5 million in 2009, $28.5 million in 2008 and $20.4 million in 2007. Sales of sales and lease ownership stores are an additional source of investing cash flows in each period presented. Proceeds from such sales were $32.0 million in 2009, $22.7 million in 2008 and $6.9 million in 2007. The amount of lease merchandise sold in these sales and shown under investing activities was $16.3 million in 2009, $11.7 million in 2008 and $3.5 million in 2007. In addition, in 2008 the proceeds from the sale of the Aaron’s Corporate Furnishings division shown under investing activities were $76.4 million.
Our cash flows include profits on the sale of lease return merchandise. Our primary capital requirements consist of buying lease merchandise for sales and lease ownership stores. As Aaron’s continues to grow, the need for additional lease merchandise will continue to be our major capital requirement. Other capital requirements include purchases of property, plant and equipment and expenditures for acquisitions. These capital requirements historically have been financed through:
At December 31, 2009, there was no balance under our revolving credit agreement. The credit facilities balance decreased by $35.0 million in 2009 as a result of net payments made on our credit facility during the period. On May 23, 2008, we entered into a new revolving credit agreement which replaced the previous revolving credit agreement. The new revolving credit facility expires May 23, 2013 and the terms are consistent with the previous agreement. The total available credit on our revolving credit agreement is $140.0 million.
We have $36.0 million currently outstanding in aggregate principal amount of 5.03% senior unsecured notes due July 2012, principal repayments of which were made in 2008 and 2009, and are due in equal $12.0 million annual installments until maturity.
Our revolving credit agreement and senior unsecured notes, and our franchisee loan program discussed below, contain certain financial covenants. These covenants include requirements that we maintain ratios of: (1) EBITDA plus lease expense to fixed charges of no less than 2:1; (2) total debt to EBITDA of no greater than 3:1; and (3) total debt to total capitalization of no greater than 0.6:1. “EBITDA” in each case, means consolidated net income before interest and tax expense, depreciation (other than lease merchandise depreciation) and amortization expense, and other non-cash charges. The Company is also required to maintain a minimum amount of shareholders’ equity. See the full text of the covenants themselves in our credit and guarantee agreements, which we have filed as exhibits to our Securities and Exchange Commission reports, for the details of these covenants and other terms. If we fail to comply with these covenants, we will be in default under these agreements, and all amounts would become due immediately. We were in compliance with all of these covenants at December 31, 2009 and believe that we will continue to be in compliance in the future.
We purchase our common shares in the market from time to time as authorized by our board of directors. We did not repurchase shares during 2009 and have authority remaining to purchase 3,920,413 shares.
We have a consistent history of paying dividends, having paid dividends for 22 consecutive years. A $.016 per share dividend on Common Stock and Class A Common Stock was paid in January 2008, April 2008, July 2008, and October 2008 for a total cash outlay of $3.4 million in 2008. Our board of directors increased the dividend 6.3% for the fourth quarter of 2008 on November 5, 2008 to $.017 per share from the previous quarterly dividend of $.016 per share. A $.017 per share dividend on Common Stock and Class A Common Stock was paid in January 2009, April 2009, July 2009, and October 2009 for a total cash outlay of $3.7 million in 2009. Our board of directors increased the dividend 5.9% for the fourth quarter of 2009 to $.018 per share from the previous quarterly dividend of $.017 per share. Subject to sufficient operating profits, any future capital needs and other contingencies, we currently expect to continue our policy of paying dividends.
If we achieve our expected level of growth in our operations, we anticipate we will supplement our expected cash flows from operations, existing credit facilities, vendor credit and proceeds from the sale of lease return merchandise by expanding our existing credit facilities, by securing additional debt financing, or by seeking other sources of capital to ensure we will be able to fund our capital and liquidity needs for at least the next 24 months. We believe we can secure these additional sources of capital in the ordinary course of business at terms which are acceptable to us. However, if the credit and capital markets experience disruptions like those that began in the second half of 2008, we may not be able to obtain access to capital at as favorable costs as we have historically been able to, and some forms of capital may not be available at all.
Commitments
Income Taxes. During 2009, we made $15.3 million in income tax payments. During 2010, we anticipate that we will make cash payments for income taxes approximating $120 million.
The Economic Stimulus Act of 2008 provided for accelerated depreciation by allowing a bonus first-year depreciation deduction of 50% of the adjusted basis of qualified property placed in service during 2008. Accordingly, our cash flow benefited in 2008 from having a lower cash tax obligation which, in turn, provided additional cash flow from operations. We estimated that our 2008 operating cash flow increased by approximately $62.0 million as a result of the Economic Stimulus Act of 2008, with the associated deferral generally expected to begin to reverse over a three year period beginning in 2009. However, in February 2009 the American Recovery and Reinvestment Act of 2009 was signed into law which extended the bonus depreciation provision of the Economic Stimulus Act of 2008 by continuing the bonus first-year depreciation deduction of 50% of the adjusted basis of qualified property placed in service during 2009. We estimate the cash tax benefit of the American Recovery and Reinvestment Act of 2009 to be approximately $63.0 million, of which approximately $49.0 million offset the 2008 deferral that reverses in 2009, and the remaining $14.0 million increased our 2009 operating cash flow. We estimate that at December 31, 2009 the remaining tax deferral associated with the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 is approximately $76.0 million of which approximately 78% will reverse in 2010 and the remainder will reverse between 2011 and 2012.
Leases. We lease warehouse and retail store space for most of our operations under operating leases expiring at various times through 2028. Most of the leases contain renewal options for additional periods ranging from one to 15 years or provide for options to purchase the related property at predetermined purchase prices that do not represent bargain purchase options. We also lease transportation and computer equipment under operating leases expiring during the next five years. We expect that most leases will be renewed or replaced by other leases in the normal course of business. Approximate future minimum rental payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as of December 31, 2009, are shown in the below table under “Contractual Obligations and Commitments.”
We have 20 capital leases, 19 of which are with a limited liability company (“LLC”) whose managers and owners are 11 Aaron’s executive officers and its controlling shareholder, with no individual, including the controlling shareholder, owning more than 13.33% of the LLC. Nine of these related party leases relate to properties purchased from Aaron’s in October and November of 2004 by the LLC for a total purchase price of $6.8 million. The LLC is leasing back these properties to Aaron’s for a 15-year term, with a five-year renewal at Aaron’s option, at an aggregate annual lease amount of $716,000. Another ten of these related party leases relate to properties purchased from Aaron’s in December 2002 by the LLC for a total purchase price of approximately $5.0 million. The LLC is leasing back these properties to Aaron’s for a 15-year term at an aggregate annual lease of $556,000. We do not currently plan to enter into any similar related party lease transactions in the future.
We finance a portion of our store expansion through sale-leaseback transactions. The properties are generally sold at net book value and the resulting leases qualify and are accounted for as operating leases. We do not have any retained or contingent interests in the stores nor do we provide any guarantees, other than a corporate level guarantee of lease payments, in connection with the sale-leasebacks. The operating leases that resulted from these transactions are included in the table below.
Franchise Loan Guaranty. We have guaranteed the borrowings of certain independent franchisees under a franchise loan program with several banks and we also guarantee franchisee borrowings under certain other debt facilities. At December 31, 2009, the portion that the Company might be obligated to repay in the event franchisees defaulted was $128.8 million. Of this amount, approximately $120.2 million represents franchise borrowings outstanding under the franchisee loan program and approximately $8.6 million represents franchisee borrowings that we guarantee under other debt facilities. However, due to franchisee borrowing limits, we believe any losses associated with any defaults would be mitigated through recovery of lease merchandise and other assets. Since its inception in 1994, we have had no significant losses associated with the franchise loan and guaranty program. The Company believes the likelihood of any significant amounts being funded in connection with these commitments to be remote. The Company receives guarantee fees based on such franchisees’ outstanding debt obligations, which it recognizes as the guarantee obligation is satisfied.
We have no long-term commitments to purchase merchandise. See Note F to the Consolidated Financial Statements for further information. The following table shows our approximate contractual obligations, including interest, and commitments to make future payments as of December 31, 2009:
The following table shows the Company’s approximate commercial commitments as of December 31, 2009:
Purchase obligations are primarily related to certain advertising and marketing programs. Purchase orders or contracts for the purchase of lease merchandise and other goods and services are not included in the tables above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. We do not have significant agreements for the purchase of lease merchandise or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months.
Deferred income tax liabilities as of December 31, 2009 were approximately $163.7 million. This amount is not included in the total contractual obligations table because we believe this presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax basis of assets and liabilities and their respective book basis, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs.
Recent Accounting Pronouncements
We are not aware of any recent accounting pronouncements that will materially impact the Company’s Consolidated Financial Statements in future periods.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2009, we had $36.0 million of senior unsecured notes outstanding at a fixed rate of 5.03%. We had no balance outstanding under our revolving credit agreement indexed to the LIBOR (“London Interbank Offer Rate”) or the prime rate, which exposes us to the risk of increased interest costs if interest rates rise. Based on our overall interest rate exposure at December 31, 2009, a hypothetical 1.0% increase or decrease in interest rates would not be material.
We do not use any market risk sensitive instruments to hedge commodity, foreign currency, or other risks, and hold no market risk sensitive instruments for trading or speculative purposes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
The Board of Directors and Shareholders of Aaron’s, Inc.
We have audited the accompanying consolidated balance sheets of Aaron’s, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aaron’s, Inc. and subsidiaries at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Aaron’s, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 26, 2010
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Shareholders of Aaron’s, Inc.
We have audited Aaron’s, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Aaron’s, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Aaron’s, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Aaron’s, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our report dated February 26, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 26, 2010
Management Report on Internal Control Over Financial Reporting
Management of Aaron’s, Inc.(the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, the risk.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on its assessment, management believes that, as of December 31, 2009, the Company’s internal control over financial reporting was effective based on those criteria.
The Company’s internal control over financial reporting as of December 31, 2009 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report dated February 26, 2010, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009.
AARON’S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the Consolidated Financial Statements.
AARON’S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
The accompanying notes are an integral part of the Consolidated Financial Statements.
AARON’S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of the Consolidated Financial Statements.
AARON’S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the Consolidated Financial Statements.
Note A: Summary of Significant Accounting Policies
As of December 31, 2009 and 2008, and for the Years Ended December 31, 2009, 2008 and 2007.
Basis of Presentation - The consolidated financial statements include the accounts of Aaron’s, Inc. and its wholly owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated. The preparation of the Company’s consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates. Generally, actual experience has been consistent with management’s prior estimates and assumptions. Management does not believe these estimates or assumptions will change significantly in the future absent unsurfaced or unforeseen events.
Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, “Generally Accepted Accounting Principles - Overall” (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”). The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. References previously made to FASB guidance throughout this document have been updated for the Codification.
During the fourth quarter of 2008, the Company sold substantially all of the assets of its Aaron’s Corporate Furnishings division. As a result of the sale, the Company’s financial statements have been prepared reflecting the Aaron’s Corporate Furnishings division as discontinued operations. All historical financial statements have been restated to conform to this presentation. See Note N for a discussion of the sale of the Aaron’s Corporate Furnishings division.
Certain reclassifications have been made to the prior periods to conform to the current period presentation. In all periods presented, Aaron’s Office Furniture was reclassified from the Sales and Lease Ownership Segment to the Other Segment. Refer to Note K for the segment disclosure.
The Company evaluated subsequent events through February 26, 2010 which represents the date the financial statements were issued.
Line of Business - The Company is engaged in the business of leasing and selling residential and office furniture, consumer electronics, appliances, computers, and other merchandise throughout the U.S. and Canada. The Company manufactures furniture principally for its stores.
Lease Merchandise - The Company’s lease merchandise consists primarily of residential and office furniture, consumer electronics, appliances, computers, and other merchandise and is recorded at cost, which includes overhead from production facilities, shipping costs and warehousing costs. The sales and lease ownership division depreciates merchandise over the lease agreement period, generally 12 to 24 months when on rent and 36 months when not on lease, to a 0% salvage value. The office furniture stores depreciate merchandise over the lease ownership agreement period, generally 12 to 24 months when leased, and 60 months when not leased, or when on a rent-to-rent agreement, to 0% salvage value. The Company’s policies require weekly lease merchandise counts by store managers, which include write-offs for unsalable, damaged, or missing merchandise inventories. Full physical inventories are generally taken at the fulfillment and manufacturing facilities two to four times a year, and appropriate provisions are made for missing, damaged and unsalable merchandise. In addition, the Company monitors lease merchandise levels and mix by division, store, and fulfillment center, as well as the average age of merchandise on hand. If unsalable lease merchandise cannot be returned to vendors, it is adjusted to its net realizable value or written off.
All lease merchandise is available for lease or sale. On a monthly basis, all damaged, lost or unsalable merchandise identified is written off. The Company records lease merchandise adjustments on the allowance method. Lease merchandise write-offs totaled $38.3 million, $34.5 million and $29.0 million during the years ended December 31, 2009, 2008 and 2007, respectively, and are included in operating expenses in the accompanying consolidated statements of earnings.
Cash and Cash Equivalents - The Company classifies as cash highly liquid investments with maturity dates of less than three months when purchased.
Accounts Receivable - The Company maintains an allowance for doubtful accounts. The reserve for returns is calculated based on the historical collection experience associated with lease receivables. The Company’s policy is to write off lease receivables that are 60 days or more past due.
The following is a summary of the Company’s allowance for doubtful accounts as of December 31:
Property, Plant and Equipment - The Company records property, plant and equipment at cost. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the respective assets, which are from eight to 40 years for buildings and improvements and from one to five years for other depreciable property and equipment. Gains and losses related to dispositions and retirements are recognized as incurred. Maintenance and repairs are also expensed as incurred; renewals and betterments are capitalized. Depreciation expense, included in operating expenses in the accompanying consolidated statements of earnings, for property, plant and equipment was $40.7 million, $38.4 million and $34.8 million during the years ended December 31, 2009, 2008 and 2007, respectively.
Goodwill and Other Intangibles - Goodwill represents the excess of the purchase price paid over the fair value of the net tangible and identifiable intangible assets acquired in connection with business acquisitions. The Company has elected to perform its annual impairment evaluation as of September 30. Based on the evaluation, there was no impairment as of September 30, 2009. More frequent evaluations are completed if indicators of impairment become evident. Other intangibles represent the value of customer relationships acquired in connection with business acquisitions, acquired franchise development rights and non-compete agreements, recorded at fair value as determined by the Company. As of December 31, 2009 and 2008, net intangibles other than goodwill were $5.2 million and $7.5 million, respectively. The customer relationship intangible is amortized on a straight-line basis over a two-year useful life. Acquired franchise development rights are amortized over the unexpired life of the franchisee’s ten year area development agreement. The non-compete intangible is amortized on a straight-line basis over a three year useful life. Amortization expense on intangibles, included in operating expenses in the accompanying consolidated statements of earnings, was $3.8 million, $3.0 million and $2.5 million during the years ended December 31, 2009, 2008 and 2007, respectively.
The following is a summary of the Company’s goodwill in its sales and lease ownership segment at December 31:
Impairment - The Company assesses its long-lived assets other than goodwill for impairment whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. When it is determined that the carrying value of the assets are not recoverable, the Company compares the carrying value of the assets to their fair value as estimated using discounted expected future cash flows, market values or replacement values for similar assets. The amount by which the carrying value exceeds the fair value of the asset is recognized as an impairment loss. The Company performed an impairment analysis on the Aaron’s Office Furniture long-lived assets in the third quarter of 2009 due to continuing negative performance. As a result, the Company also recorded an impairment charge of $1.3 million within operating expenses related primarily to the impairment of leasehold improvements in the Aaron’s Office Furniture stores. In addition, the Company recorded an $865,000 write-down to certain office furniture lease merchandise in 2009 within operating expenses. The impairment charge and inventory write-down are included in the other segment.
The Company also recorded an impairment charge of $3.0 million within operating expenses in 2009 which relates primarily to the impairment of various land outparcels and buildings included in our sales and lease ownership segment that the Company decided not to utilize for future expansion. In 2008, the Company recorded an impairment charge of $838,000 within operating expenses which related primarily to the impairment of leasehold improvements in several of our RIMCO stores included in our sales and lease ownership segment.
Fair Value of Financial Instruments - The fair values of the Company’s cash and cash equivalents, accounts receivable, and accounts payable approximate their carrying amounts due to their short-term nature.
Deferred Income Taxes - Deferred income taxes represent primarily temporary differences between the amounts of assets and liabilities for financial and tax reporting purposes. Such temporary differences arise principally from the use of accelerated depreciation methods on lease merchandise for tax purposes.
Revenue Recognition - Lease revenues are recognized as revenue in the month they are due. Lease payments received prior to the month due are recorded as deferred lease revenue. Until all payments are received under sales and lease ownership agreements, the Company maintains ownership of the lease merchandise. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt of the merchandise by the franchisee, and revenues from such sales to other customers are recognized at the time of shipment, at which time title and risk of ownership are transferred to the customer. Refer to Note I for discussion of recognition of other franchise-related revenues. The Company presents sales net of sales taxes.
Cost of Sales - Included in cost of sales is the net book value of merchandise sold, primarily using specific identification. It is not practicable to allocate operating expenses between selling and lease operations.
Shipping and Handling Costs - The Company classifies shipping and handling costs as operating expenses in the accompanying consolidated statements of earnings, and these costs totaled $55.0 million in 2009, $55.1 million in 2008 and $48.1 million in 2007.
Advertising - The Company expenses advertising costs as incurred. Advertising costs are recorded as expenses the first time an advertisement appears. Such costs aggregated to $31.0 million in 2009, $28.5 million in 2008 and $29.4 million in 2007. These advertising expenses are shown net of cooperative advertising considerations received from vendors, substantially all of which represents reimbursement of specific, identifiable and incremental costs incurred in selling those vendors’ products. The amount of cooperative advertising consideration netted against advertising expense was $23.4 million in 2009, $24.7 million in 2008 and $20.1 million in 2007. The prepaid advertising asset was $2.6 million and $1.5 million at December 31, 2009 and 2008, respectively.
Stock-Based Compensation - The Company has stock-based employee compensation plans, which are more fully described in Note H below. The Company estimates the fair value for the options granted on the grant date using a Black-Scholes option-pricing model and accounts for stock-based compensation under the fair value recognition provisions codified in FASB ASC Topic 718, “Compensation - Stock Compensation” (“ASC 718”).
Insurance Reserves - Estimated insurance reserves are accrued primarily for group health and workers compensation benefits provided to the Company’s employees. Estimates for these insurance reserves are made based on actual reported but unpaid claims and actuarial analyses of the projected claims run off for both reported and incurred but not reported claims.
Comprehensive Income - For the years ended December 31, 2009, 2008 and 2007, comprehensive income totaled $113.9 million, $88.8 million and $80.2 million, respectively.
Foreign Currency Translation - Assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the current rate of exchange on the last day of the reporting period. Revenues and expenses are generally translated at a daily exchange rate and equity transactions are translated using the actual rate on the day of the transaction.
New Accounting Pronouncements - The pronouncements that the Company adopted in 2009 did not have a material impact on the consolidated financial statements.
Note B: Earnings Per Share
Earnings per share is computed by dividing net earnings by the weighted average number of shares of Common Stock and Class A Common Stock outstanding during the year, which were approximately 54,092,000 shares in 2009, 53,409,000 shares in 2008, and 54,163,000 shares in 2007. The computation of earnings per share assuming dilution includes the dilutive effect of stock options and awards. Such stock options and awards had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 442,000 in 2009, 683,000 in 2008, and 809,000 in 2007.
The Company has issued restricted stock awards under its stock incentive plan whereby shares vest upon satisfaction of certain performance conditions. As of December 31, 2009, only a portion of the performance conditions had been met, and therefore only a portion of these shares have been included in the computation of diluted earnings per share. The effect of restricted stock increased weighted average shares outstanding by 100,000 in 2009, 97,000 in 2008 and 110,000 in 2007.
Note C: Property, Plant and Equipment
Following is a summary of the Company’s property, plant, and equipment at December 31:
Amortization expense on assets recorded under capital leases is included in operating expenses.
Note D: Credit Facilities
Following is a summary of the Company’s credit facilities at December 31:
Bank Debt - The Company has a revolving credit agreement with several banks providing for unsecured borrowings up to $140.0 million. Amounts borrowed bear interest at the lower of the lender’s prime rate or LIBOR plus 87.5 basis points. The pricing under a working capital line is based upon overnight bank borrowing rates. At December 31, 2009, there was a zero balance under our revolving credit agreement. At December 31, 2008, $35.0 million (bearing interest at 1.37%) was outstanding under the revolving credit agreement. The Company pays a .20% commitment fee on unused balances. The weighted average interest rate on borrowings under the revolving credit agreement was 1.23% in 2009, 3.66% in 2008 and 5.99% in 2007. The revolving credit agreement expires May 23, 2013.
The revolving credit agreement contains financial covenants which, among other things, forbid the Company from exceeding certain debt to equity levels and require the maintenance of minimum fixed charge coverage ratios. If the Company fails to comply with these covenants, the Company will be in default under these agreements, and all amounts could become due immediately. At December 31, 2009, $166.9 million of retained earnings was available for dividend payments and stock repurchases under the debt restrictions, and the Company was in compliance with all covenants.
Senior Unsecured Notes - On August 14, 2002, the Company sold $50.0 million in aggregate principal amount of senior unsecured notes in a private placement to a consortium of insurance companies. The unsecured notes bore interest at a rate of 6.88% per year. Quarterly interest only payments at an annual rate of 6.88% were due for the first two years followed by annual $10,000,000 principal repayments plus interest for the five years thereafter. The notes were paid in full by the Company upon their maturity on August 13, 2009.
On July 27, 2005, the Company sold $60.0 million in aggregate principal amount of senior unsecured notes in a private placement to a consortium of insurance companies. The notes bear interest at a rate of 5.03% per year and mature on July 27, 2012. Interest only payments were due quarterly for the first two years, followed by annual $12 million principal repayments plus interest for the five years thereafter. The related note purchase agreement contains financial maintenance covenants, negative covenants regarding the Company’s other indebtedness, its guarantees and investments and other customary covenants substantially similar to the covenants in the Company’s, revolving credit facility. At December 31, 2009 there was $36.0 million outstanding under the July 2005 senior unsecured notes.
At December 31, 2009, the fair value of fixed rate long-term debt approximated its carrying value. The fair value of debt is estimated using valuation techniques that consider risk-free borrowing rates and credit risk.
Capital Leases with Related Parties - In October and November 2004, the Company sold eleven properties, including leasehold improvements, to a limited liability company (“LLC”) controlled by a group of Company executives, including the Company’s Chairman and controlling shareholder. The LLC obtained borrowings collateralized by the land and buildings totaling $6.8 million. The Company occupies the land and buildings collateralizing the borrowings under a 15-year term lease, with a five-year renewal at the Company’s option, at an aggregate annual rental of $716,000. The transaction has been accounted for as a financing in the accompanying consolidated financial statements. The rate of interest implicit in the leases is approximately 9.7%. Accordingly, the land and buildings, associated depreciation expense and lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction.
In December 2002, the Company sold ten properties, including leasehold improvements, to the LLC. The LLC obtained borrowings collateralized by the land and buildings totaling $5.0 million. The Company occupies the land and buildings collateralizing the borrowings under a 15-year term lease at an aggregate annual rental of approximately $556,000. The transaction has been accounted for as a financing in the accompanying consolidated financial statements. The rate of interest implicit in the leases is approximately 11.1%. Accordingly, the land and buildings, associated depreciation expense and lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction.
Sale-leasebacks - The Company finances a portion of store expansion through sale-leaseback transactions. The properties are generally sold at net book value and the resulting leases qualify and are accounted for as operating leases. The Company does not have any retained or contingent interests in the stores nor does the Company provide any guarantees, other than a corporate level guarantee of lease payments, in connection with the sale-leasebacks.
Other Debt - Other debt at December 31, 2009 and 2008 includes $3.3 million of industrial development corporation revenue bonds. The weighted average borrowing rate on these bonds in 2009 was 0.66%. No principal payments are due on the bonds until maturity in 2015.
Future maturities under the Company’s long-term debt and capital lease obligations are as follows:
Note E: Income Taxes
Following is a summary of the Company’s income tax expense for the years ended December 31:
The Company generated a net operating loss (“NOL”) of approximately $39.2 million in 2008 as a result of favorable deductions related to bonus depreciation and fully utilized this NOL in 2009.
Significant components of the Company’s deferred income tax liabilities and assets at December 31 are as follows:
The Company’s effective tax rate differs from the statutory U.S. Federal income tax rate for the years ended December 31 as follows:
The Company files a federal consolidated income tax return in the United States and the separate legal entities file in various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to federal, state and local tax examinations by tax authorities for years before 2006. The decrease in the effective rate in 2009 was due to the favorable impact of a $2.3 million reversal of previously recorded liabilities for uncertain tax positions.
The following table summarizes the activity related to the Company’s uncertain tax positions:
As of December 31, 2009 and 2008, the amount of uncertain tax benefits that, if recognized, would affect the effective tax rate is $1.1 million and $3.3 million, respectively, including interest and penalties. During the years ended December 31, 2009 and 2008, the Company recognized interest and penalties of $276,000 and $435,000, respectively. The Company had $349,000 and $877,000 of accrued interest and penalties at December 31, 2009 and 2008, respectively. The Company recognizes potential interest and penalties related to uncertain tax benefits as a component of income tax expense.
Note F: Commitments and Contingencies
The Company leases warehouse and retail store space for most of its operations under operating leases expiring at various times through 2028. The Company also leases certain properties under capital leases that are more fully described in Note D. Most of the leases contain renewal options for additional periods ranging from one to 15 years or provide for options to purchase the related property at predetermined purchase prices that do not represent bargain purchase options. In addition, certain properties occupied under operating leases contain normal purchase options. Leasehold improvements related to these leases are generally amortized over periods that do not exceed the lesser of the lease term or five years. While a majority of leases do not require escalating payments, for the leases which do contain such provisions the Company records the related lease expense on a straight-line basis over the lease term. The Company also leases transportation and computer equipment under operating leases expiring during the next five years. Management expects that most leases will be renewed or replaced by other leases in the normal course of business.
Future minimum lease payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as of December 31, 2009, are as follows:
The Company has guaranteed certain debt obligations of some of the franchisees amounting to $128.8 million and $95.6 million at December 31, 2009 and 2008, respectively. Of this amount, approximately $120.2 million represents franchise borrowings outstanding under the franchise loan program and approximately $8.6 million represents franchise borrowings under other debt facilities at December 31, 2009. The Company receives guarantee fees based on such franchisees’ outstanding debt obligations, which it recognizes as the guarantee obligation is satisfied. The Company has recourse rights to the assets securing the debt obligations. As a result, the Company has never incurred any, nor does management expect to incur any, significant losses under these guarantees.
Rental expense was $88.1 million in 2009, $81.8 million in 2008, and $70.8 million in 2007.
At December 31, 2009, the Company had non-cancelable commitments primarily related to certain advertising and marketing programs of $23.0 million. Payments under these commitments are scheduled to be $11.4 million in 2010, $11.4 million in 2011, and $200,000 in 2012.
The Company maintains a 401(k) savings plan for all its full-time employees with at least one year of service and who meet certain eligibility requirements. The plan allows employees to contribute up to 10% of their annual compensation with 50% matching by the Company on the first 4% of compensation. The Company’s expense related to the plan was $844,000 in 2009, $775,000 in 2008, and $806,000 in 2007.
The Company is a party to various claims and legal proceedings arising in the ordinary course of business. Management regularly assesses the Company’s insurance deductibles, analyzes litigation information with the Company’s attorneys and evaluates its loss experience. The Company also enters into various contracts in the normal course of business that may subject it to risk of financial loss if counterparties fail to perform their contractual obligations.
The Company does not currently believe its exposure to loss under any claim is probable, nor can management estimate a range of amounts of loss that is reasonably possible. Notwithstanding the foregoing, the Company is currently a party to the following proceeding:
In Kunstmann et al v. Aaron Rents, Inc. pending in the United States District Court, Northern District of Alabama (the “court”), plaintiffs have alleged that the Company improperly classified store general managers as exempt from the overtime provisions of the Fair Labor Standards Act. Plaintiffs seek to recover unpaid overtime compensation and other damages for all similarly situated general managers nationwide for the period January 25, 2007 to present. After initially denying plaintiffs’ class certification motion in April 2009, the court ruled to conditionally certify a plaintiff class in early 2010. The potential class is an estimated 2,600 individuals. Those individuals who affirmatively opt to join the class may be required to travel at their own expense to Alabama for discovery purposes and/or trial. The court’s class certification ruling is procedural only and does not address the merits of the plaintiffs’ claims.
The Company believes it has meritorious defenses to the proceeding described above, and intends to vigorously defend itself against it. However, this proceeding is still developing, and due to inherent uncertainty in litigation and similar adversarial proceedings, there can be no guarantee that the Company will ultimately be successful in this proceeding, or in others to which it is currently a party. Substantial losses from this proceeding could have a material adverse impact upon the Company’s business, financial position or results of operations. In addition, the Company’s requirement to record or disclose potential losses under generally accepted accounting principles could change in the near term depending upon changes in facts and circumstances. The Company believes it has recorded an adequate reserve for contingencies at December 31, 2009 and 2008.
Note G: Shareholders’ Equity
The Company held 6,265,331 shares in its treasury and was authorized to purchase an additional 3,920,413 shares at December 31, 2009. The Company’s articles of incorporation provide that no cash dividends may be paid on the Class A Common Stock unless equal or higher dividends are paid on the Common Stock. The Company did not repurchase any shares of its capital stock on the open market in 2009.
If the number of the Class A Common Stock (voting) falls below 10% of the total number of outstanding shares of the Company, the Common Stock (non-voting) automatically converts into Class A Common Stock (voting). The Common Stock may convert to Class A Common Stock in certain other limited situations whereby a national securities exchange rule might cause the Board of Directors to issue a resolution requiring such conversion. The Company has 1,000,000 shares of preferred stock authorized. The shares are issuable in series with terms for each series fixed by the Board and such issuance is subject to approval by the Board of Directors. No preferred shares have been issued.
Note H: Stock Options and Restricted Stock
The Company’s outstanding stock options are exercisable for the Company’s Common Stock (non-voting). The Company estimates the fair value for the options on the grant date using a Black-Scholes option-pricing model. The expected volatility is based on the historical volatility of the Company’s Common Stock over the most recent period generally commensurate with the expected estimated life of each respective grant. The expected lives of options are based on the Company’s historical option exercise experience. Forfeiture assumptions are based on the Company’s historical forfeiture experience. The Company believes that the historical experience method is the best estimate of future exercise and forfeiture patterns currently available. The risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options. The expected dividend yields are based on the approved annual dividend rate in effect and current market price of the underlying Common Stock at the time of grant. No assumption for a future dividend rate increase has been included unless there is an approved plan to increase the dividend in the near term. Shares are issued from the Company’s treasury shares upon share option exercises.
The results of operations for the year ended December 31, 2009, 2008 and 2007 include $2.4 million, $1.4 million and $1.9 million, respectively, in compensation expense related to unvested grants. At December 31, 2009, there was $4.6 million of total unrecognized compensation expense related to non-vested stock options which is expected to be recognized over a period of 3.8 years. Excess tax benefits of $3.9 million and $1.8 million are included in cash provided by financing activities for the year ended December 31, 2009 and 2008, respectively. The Company recognizes compensation cost for awards with graded vesting on a straight-line basis over the requisite service period for each separately vesting portion of the award.
Under the Company’s stock option plans, options granted to date become exercisable after a period of two to five years and unexercised options lapse ten years after the date of the grant. Options are subject to forfeiture upon termination of service.
The Company did not grant any stock options in 2009. The Company granted 1,016,000 and 337,500 stock options during 2008 and 2007, respectively. The weighted average fair value of options granted was $8.62 in 2008 and $10.79 in 2007. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2008 and 2007, respectively: risk-free interest rate 3.47% and 5.11%; a dividend yield of .25% and .24%; a volatility factor of the expected market price of the Company’s Common Stock of .38 and .39; weighted average assumptions of forfeiture rate 11.77% and 6.82%; and weighted average expected life of the option five and eight years. The aggregate intrinsic value of options exercised was $13.1 million, $6.4 million and $2.9 million in 2009, 2008 and 2007, respectively. The total fair value of options vested was $1.0 million and $6.6 million in 2008 and 2007, respectively.
Income tax benefits resulting from stock option exercises credited to additional paid-in capital totaled $4.8 million, $3.2 million, and $1.5 million, in 2009, 2008 and 2007, respectively.
The following table summarizes information about stock options outstanding at December 31, 2009:
The table below summarizes option activity for the periods indicated in the Company’s stock option plans:
The weighted average fair value of unvested options was $9.12 as of December 31, 2009 and 2008. The weighted average fair value of options that vested during 2009, 2008 and 2007 was $8.03, $6.54 and $6.57, respectively.
Shares of restricted stock may be granted to employees and directors and typically vest over approximately three years. Restricted stock grants may be subject to one or more objective employment, performance or other forfeiture conditions as established at the time of grant. Any shares of restricted stock that are forfeited will again become available for issuance. Compensation cost for restricted stock is equal to the fair market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Total compensation expense related to restricted stock was $1.3 million, $1.5 million and $1.7 million in 2009, 2008 and 2007, respectively.
The following table summarizes information about restricted stock activity:
Note I: Franchising of Aaron’s Sales and Lease Ownership Stores
The Company franchises Aaron’s Sales & Lease Ownership stores. As of December 31, 2009 and 2008, 866 and 786 franchises had been granted, respectively. Franchisees typically pay a non-refundable initial franchise fee from $15,000 to $50,000 depending upon market size and an ongoing royalty of either 5% or 6% of gross revenues. Franchise fees and area development fees are generated from the sale of rights to develop, own and operate Aaron’s Sales & Lease Ownership stores. These fees are recognized as income when substantially all of the Company’s obligations per location are satisfied, generally at the date of the store opening. Franchise fees and area development fees received before the substantial completion of the Company’s obligations are deferred. Substantially all of the amounts reported as non-retail sales and non-retail cost of sales in the accompanying consolidated statements of earnings relate to the sale of lease merchandise to franchisees.
Franchise agreement fee revenue was $3.8 million, $3.2 million and $3.4 million and royalty revenue was $42.3 million, $36.5 million and $29.8 million for the years ended December 31, 2009, 2008 and 2007, respectively. Deferred franchise and area development agreement fees, included in customer deposits and advance payments in the accompanying consolidated balance sheets, were $5.3 and $5.7 million at December 31, 2009 and 2008, respectively.
Franchised Aaron’s Sales & Lease Ownership store activity is summarized as follows:
Company-operated Aaron’s Sales & Lease Ownership store activity is summarized as follows:
In 2009, the Company acquired the lease contracts, merchandise and other related assets of 45 stores, including 19 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 29 stores. In 2008, the Company acquired the lease contracts, merchandise and other related assets of 95 stores, including 66 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 68 stores. In 2007, the Company acquired the lease contracts, merchandise and other related assets of 77 stores, including 39 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 51 stores.
Note J: Acquisitions and Dispositions
During 2009, the Company acquired the lease contracts, merchandise and other related assets of a net of 29 sales and lease ownership stores for an aggregate purchase price of $25.2 million. Consideration transferred consisted primarily of cash. Fair value of acquired tangible assets included $9.5 million for lease merchandise, $712,000 for fixed assets and $28,000 for other assets. The excess cost over the fair value of the assets and liabilities acquired in 2009, representing goodwill, was $12.0 million. The fair value of acquired separately identifiable intangible assets included $1.1 million for customer lists, $695,000 for non-compete intangibles and $477,000 for acquired franchise development rights. The estimated amortization of these customer lists and acquired franchise development rights in future years approximates $1.2 million, $724,000, $174,000, $58,000 and $51,000 for 2010, 2011, 2012, 2013 and 2014, respectively. The purchase price allocations for certain acquisitions during the fourth quarter of 2009 are preliminary pending finalization of the Company’s assessment of the fair values of tangible assets acquired.
During 2008, the Company acquired the lease contracts, merchandise and related assets of a net of 68 sales and lease ownership stores for an aggregate purchase price of $79.8 million. Consideration transferred consisted primarily of cash. Fair value of acquired tangible assets included $28.5 million for lease merchandise, $2.1 million for fixed assets, and $66,000 for other assets. The excess cost over the fair value of the assets and liabilities acquired in 2008, representing goodwill, was $44.1 million. The fair value of acquired separately identifiable intangible assets included $4.3 million for customer lists and $1.9 million for acquired franchise development rights.
During 2007, the Company acquired the lease contracts, merchandise, and other related assets of a net of 39 sales and lease ownership stores for an aggregate purchase price of $57.3 million. Fair value of acquired tangible assets included $20.4 million for lease merchandise, $2.2 million for fixed assets, and $241,000 for other assets. Fair value of liabilities assumed approximated $499,000. The excess cost over the fair value of the assets and liabilities acquired in 2007, representing goodwill, was $31.3 million. The fair value of acquired separately identifiable intangible assets included $2.7 million for customer lists and $1.1 million for acquired franchise development rights.
Acquisitions have been accounted for as purchases, and the results of operations of the acquired businesses are included in the Company’s results of operations from their dates of acquisition. The effect of these acquisitions on the 2009, 2008 and 2007 consolidated financial statements was not significant.
The Company sold 37, 27 and 11 of its sales and lease ownership locations to franchisees in 2009, 2008 and 2007, respectively. The effect of these sales on the consolidated financial statements was not significant.
Note K: Segments
Description of Products and Services of Reportable Segments
Aaron’s, Inc. has three reportable segments: sales and lease ownership, franchise and manufacturing. During 2008, the Company sold its corporate furnishings division. The sales and lease ownership division offers electronics, residential furniture, appliances and computers to consumers primarily on a monthly payment basis with no credit requirements. The Company’s franchise operation sells and supports franchisees of its sales and lease ownership concept. The manufacturing division manufactures upholstered furniture and bedding predominantly for use by Company-operated and franchised stores. The Company has elected to aggregate certain operating segments.
Earnings before income taxes for each reportable segment are generally determined in accordance with accounting principles generally accepted in the United States with the following adjustments:
•
Sales and lease ownership revenues are reported on the cash basis for management reporting purposes.
•
Accruals related to store closures are not recorded on the reportable segments’ financial statements, but are rather maintained and controlled by corporate headquarters.
•
The capitalization and amortization of manufacturing variances are recorded on the consolidated financial statements as part of Cash to Accrual and Other Adjustments and are not allocated to the segment that holds the related lease merchandise.
•
Advertising expense in the sales and lease ownership division is estimated at the beginning of each year and then allocated to the division ratably over time for management reporting purposes. For financial reporting purposes, advertising expense is recognized when the related advertising activities occur. The difference between these two methods is reflected as part of the Cash to Accrual and Other Adjustments line below.
•
Sales and lease ownership lease merchandise write-offs are recorded using the direct write-off method for management reporting purposes and using the allowance method for financial reporting purposes. The difference between these two methods is reflected as part of the Cash to Accrual and Other Adjustments line below.
•
Interest on borrowings is estimated at the beginning of each year. Interest is then allocated to operating segments based on relative total assets.
Revenues in the “Other” category are primarily revenues of the Aaron’s Office Furniture division, from leasing space to unrelated third parties in the corporate headquarters building and revenues from several minor unrelated activities. The pre-tax losses in the “Other” category are the net result of the activity mentioned above, net of the portion of corporate overhead not allocated to the reportable segments for management purposes, and a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters in the first quarter of 2007.
Measurement of Segment Profit or Loss and Segment Assets
The Company evaluates performance and allocates resources based on revenue growth and pre-tax profit or loss from operations. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies except that the sales and lease ownership division revenues and certain other items are presented on a cash basis. Intersegment sales are completed at internally negotiated amounts. Since the intersegment profit and loss affect inventory valuation, depreciation and cost of goods sold are adjusted when intersegment profit is eliminated in consolidation.
Factors Used by Management to Identify the Reportable Segments
The Company’s reportable segments are based on the operations of the Company that the chief operating decision maker regularly reviews to analyze performance and allocate resources among business units of the Company.
As discussed in Note N, the Company sold substantially all of the assets of the Aaron’s Corporate Furnishings division during the fourth quarter of 2008. For financial reporting purposes, this division has been classified as a discontinued operation and is not included in our segment information as shown below.
In all segment disclosure periods presented, the Aaron’s Office Furniture division was reclassified from the Sales and Lease Ownership Segment to the Other Segment.
Information on segments and a reconciliation to earnings before income taxes from continuing operations are as follows:
Note L - Related Party Transactions
The Company leases certain properties under capital leases with certain related parties that are more fully described in Note D above.
In 2009, the Company sponsored the son of its Chief Operating Officer as a driver for the Robert Richardson Racing team in the NASCAR Nationwide Series at a cost of $1.6 million. The Company also paid $22,000 for team decals, apparel and driver travel to corporate promotional events. The sponsorship agreement expired at the end of 2009 and was not renewed. Motor sports promotions and sponsorships are an integral part of the Company’s marketing programs.
In the second quarter of 2009, the Company entered into an agreement with R. Charles Loudermilk, Sr., Chairman of the Board of Directors of the Company, to exchange 500,000 of Mr. Loudermilk, Sr.’s shares of the Company’s voting Class A Common Stock for 416,335 shares of its non-voting Common Stock having approximately the same fair market value, based on a 30 trading day average.
Note M: Quarterly Financial Information (Unaudited)
*
Gross profit is the sum of lease revenues and fees, retail sales, and non-retail sales less retail cost of sales, non-retail cost of sales, depreciation of lease merchandise and write-offs of lease merchandise.
Note N: Discontinued Operations
On September 12, 2008, the Company entered into an agreement with CORT Business Services Corporation to sell substantially all of the assets of its Aaron’s Corporate Furnishings division and to transfer certain of the Aaron’s Corporate Furnishings division’s liabilities to CORT. The Aaron’s Corporate Furnishings division, which operated at 47 stores, primarily engaged in the business of leasing and selling residential and office furniture, electronics, appliances, housewares and accessories. The Company consummated the sale of the Aaron’s Corporate Furnishings division in the fourth quarter of 2008.
The consideration for the assets consisted of $72 million in cash plus payments for certain accounts receivable of the Aaron’s Corporate Furnishings division, subject to certain adjustments, including for differences in the amount of the Aaron’s Corporate Furnishings division’s inventory at closing and in the monthly rent potential of the division’s merchandise on lease at closing as compared to certain benchmark ranges set forth in the purchase agreement. The assets transferred include all of the Aaron’s Corporate Furnishings division’s lease contracts with customers and certain other contracts, certain inventory and accounts receivable and store leases or subleases for 27 locations. CORT assumed performance obligations under transferred lease and certain other contracts and customer deposits. The Company retained other liabilities of the Aaron’s Corporate Furnishings division, including its accounts payable and accrued expenses. Included in the 2008 results is a $1.2 million pre-tax gain on the sale of the Aaron’s Corporate Furnishings division in the fourth quarter of 2008.
Summarized operating results for the Aaron’s Corporate Furnishings division for the years ended December 31 are as follows:
Note O: Deferred Compensation Plan
Effective July 1, 2009, the Company adopted the Aaron’s, Inc. Deferred Compensation Plan (the “Plan”) an unfunded, nonqualified deferred compensation plan for a select group of management, highly compensated employees and non-employee directors. On a pre-tax basis, eligible employees can defer receipt of up to 75% of their base compensation and up to 100% of their incentive pay compensation, and eligible non-employee directors can defer receipt of up to 100% of both their cash and stock director fees, whether payable in cash or Company stock. In addition, the Company may elect to make restoration matching contributions on behalf of eligible employees to make up for certain limitations on the amount of matching contributions an employee can receive under the Company’s tax-qualified 401(k) plan.
Compensation deferred under the Plan is credited to each participant’s deferral account and a deferred compensation liability is recorded in accounts payable and accrued expenses in our consolidated balance sheets. The deferred compensation plan liability was approximately $713,000 as of December 31, 2009. Liabilities under the Plan are recorded at amounts due to participants, based on the fair value of participants’ selected investments. The obligations are unsecured general obligations of the Company and the participants have no right, interest or claim in the assets of the Company, except as unsecured general creditors. The Company has established a Rabbi Trust to fund obligations under the Plan with Company-owned life insurance (“COLI”) contracts. The cash surrender value of these policies totaled $772,000 as of December 31, 2009 and is included in prepaid expenses and other assets in the consolidated balance sheets.
Deferred compensation expense charged to operations for the Company’s matching contributions totaled $130,000 in 2009. No benefits have been paid as of December 31, 2009.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
An evaluation of Aaron’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, was carried out by management, with the participation of the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as of the end of the period covered by this Annual Report on Form 10-K.
No system of controls, no matter how well-designed and operated, can provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that the system of controls has operated effectively in all cases. Our disclosure controls and procedures, however, are designed to provide reasonable assurance that the objectives of disclosure controls and procedures are met.
Based on management’s evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2009 to provide reasonable assurance that the objectives of disclosure controls and procedures are met.
Internal Control Over Financial Reporting
There were no changes in Aaron’s internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, during the Company’s fourth fiscal quarter of 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Reports of Management and Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Management has assessed, and the Company’s independent registered public accounting firm, Ernst & Young LLP, has audited, the Company’s internal control over financial reporting as of December 31, 2009. The unqualified reports of management and Ernst & Young LLP thereon are included in Item 8 of this Annual Report on Form 10-K and are incorporated by reference herein.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE
The information contained in the Company’s definitive Proxy Statement, which the Company will file with the Securities and Exchange Commission no later than 120 days after December 31, 2009, with respect to: the identity, background and Section 16 filings of directors and executive officers of the Company; the Audit Committee of the Board of Directors and the Committee’s “audit committee financial expert”; the Company’s procedures by which security holders may recommend nominees to the Board of Directors; and the Company’s code of ethics applicable to its chief executive, financial, and accounting officers is incorporated herein by reference to this item.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the Company’s definitive Proxy Statement, which the Company will file with the Securities and Exchange Commission no later than 120 days after December 31, 2009, with respect to director and executive compensation, the Compensation Committee of the Board of Directors and the Compensation Committee Report, is incorporated herein by reference in response to this item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information contained in the Company’s definitive Proxy Statement, which the Company will file with the Securities and Exchange Commission no later than 120 days after December 31, 2009, with respect to the ownership of common stock by certain beneficial owners and management, and with respect to the Company’s compensation plans under which our equity securities are authorized for issuance, is incorporated herein by reference to this item.
For purposes of determining the aggregate market value of the Company’s voting and non-voting common stock held by non-affiliates, shares held by all directors and executive officers of the Company have been excluded. The exclusion of such shares is not intended to, and shall not, constitute a determination as to which persons or entities may be “affiliates” of the Company as defined by the Securities and Exchange Commission.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information contained in the Company’s definitive Proxy Statement, which the Company will file with the Securities and Exchange Commission no later than 120 days after December 31, 2009, with respect to related party transactions and director independence, is incorporated herein by reference in response to this item.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information contained under the heading “Audit Matters” in the Company’s definitive Proxy Statement, which the Company will file with the Securities and Exchange Commission no later than 120 days after December 31, 2009, is incorporated herein by reference in response to this item.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a) 1. FINANCIAL STATEMENTS
The following financial statements and notes thereto of Aaron’s, Inc. and Subsidiaries, and the related Reports of Independent Registered Public Accounting Firm are set forth in Item 8 and Item 9A.
2. FINANCIAL STATEMENT SCHEDULES
All schedules for which provision is made in the applicable accounting regulations of the SEC have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto.
3. EXHIBITS
*
Management contract or compensatory plan or arrangement
(b) EXHIBITS
The exhibits listed in Item 15(a)(3) are included elsewhere in this Report.
(c) FINANCIAL STATEMENTS AND SCHEDULES
The financial statements listed in Item 15(a)(1) are included in Item 8 in this Report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 26th day of February 2010.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 26th day of February 2010.
SIGNATURE
TITLE
/s/ R. CHARLES LOUDERMILK, SR.
R. Charles Loudermilk, Sr.
Chairman of the Board of Directors
/s/ ROBERT C. LOUDERMILK, JR.
Robert C. Loudermilk, Jr.
Chief Executive Officer
(Principal Executive Officer), President and Director
/s/ GILBERT L. DANIELSON
Gilbert L. Danielson
Executive Vice President, Chief Financial Officer and Director
(Principal Financial Officer)
/s/ ROBERT P. SINCLAIR, JR.
Robert P. Sinclair, Jr.
Vice President, Corporate Controller
(Principal Accounting Officer)
/s/ WILLIAM K. BUTLER, JR.
William K. Butler, Jr.
Chief Operating Officer and Director
/s/ RONALD W. ALLEN
Ronald W. Allen
Director
/s/ LEO BENATAR
Leo Benatar
Director
/s/ EARL DOLIVE
Earl Dolive
Director
/s/ DAVID L. KOLB
David L. Kolb
Director
/s/ JOHN C. PORTMAN
John C. Portman
Director
/s/ RAY M. ROBINSON
Ray M. Robinson
Director
/s/ JOHN SCHUERHOLZ
John Schuerholz
Director