FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C.  20549

 

Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of l934

 

 

AARON RENTS, INC.

(Exact name of registrant as
specified in its charter)

 

 

Indicate by check mark whether registrant (l) has filed all reports required to be filed by Section 13 or  15 (d) of the Securities Exchange Act of l934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

AARON RENTS, INC.

 

INDEX

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets - March 31, 2003 (Unaudited) and December 31, 2002
	Consolidated Statements of Earnings (Unaudited) - Three Months Ended March 31, 2003 and 2002
	Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended March 31, 2003 and 2002
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosure of Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K
Signatures
Certification of Chief Executive Officer
Certification of Chief Financial Officer

 

 

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

 

AARON RENTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		(Unaudited) March 31, 2003			December 31, 2002
		(In Thousands, Except Share Data)
ASSETS
Cash		$	4,777		$	96
Accounts Receivable (net of allowances of $1,022 in 2003 and $347 in 2002)		26,811			26,973
Rental Merchandise		470,398			470,225
Less: Accumulated Depreciation		(151,528		)	(152,938		)
		318,870			317,287
Property, Plant and Equipment, Net		88,214			87,094
Goodwill, Net		27,885			25,985
Prepaid Expenses and Other Assets		25,196			26,213
Total Assets		$	491,753		$	483,648
LIABILITIES & SHAREHOLDERS’ EQUITY
Accounts Payable and Accrued Expenses		$	64,954		$	64,131
Dividends Payable					434
Deferred Income Taxes Payable		55,861			50,517
Customer Deposits and Advance Payments		15,265			14,756
Credit Facilities		65,931			73,265
Total Liabilities		202,011			203,103
Commitments & Contingencies
Shareholders’ Equity
Common Stock,  Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 19,995,987 at March 31, 2003 and  December 31, 2002		9,998			9,998
Class A Common Stock, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 5,361,761		2,681			2,681
Additional Paid-in Capital		87,503			87,502
Retained Earnings		232,676			223,928
Accumulated Other Comprehensive Loss		(1,422		)	(1,868		)
		331,436			322,241
Less: Treasury Shares at Cost,
Common Stock, 2,012,335 Shares at March 31, 2003 and 2,012,470 Shares at December 31, 2002		(25,790		)	(25,792		)
Class A Common Stock, 1,630,055 Shares at March 31, 2003 and December 31, 2002		(15,904		)	(15,904		)
Total Shareholders’ Equity		289,742			280,545
Total Liabilities & Shareholders’ Equity		$	491,753		$	483,648

 

The accompanying notes are an integral part of the Consolidated Financial Statements

 

1

 

AARON RENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

		Three Months Ended March 31,
		2003			2002
		(In Thousands, Except Per Share)
REVENUES:
Rentals and Fees		$	131,037		$	112,502
Retail Sales		23,038			17,015
Non-Retail Sales		31,557			22,463
Other		5,628			4,683
		191,260			156,663
COSTS AND EXPENSES:
Retail Cost of Sales		16,855			12,378
Non-Retail Cost of Sales		29,402			20,828
Operating Expenses		83,119			73,134
Depreciation of Rental Merchandise		46,389			39,700
Interest		1,588			1,166
		177,353			147,206
EARNINGS BEFORE TAXES		13,907			9,457
INCOME TAXES		5,159			3,536
NET EARNINGS		$	8,748		$	5,921
EARNINGS PER SHARE		$	.40		$	.30
EARNINGS PER SHARE ASSUMING DILUTION		.40			.29
CASH DIVIDENDS DECLARED PER SHARE
Common Stock		$	—		$	—
Class A Common Stock		—			—
WEIGHTED AVERAGE SHARES OUTSTANDING		21,685			19,912
WEIGHTED AVERAGE SHARES OUTSTANDING ASSUMING DILUTION		21,942			20,192

 

The accompanying notes are an integral part of the Consolidated Financial Statements

 

2

 

AARON RENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS
OF CASH FLOWS

(Unaudited)

 

		Three Months Ended March 31,
		2003			2002
		(In Thousands)
OPERATING ACTIVITIES
Net Earnings		$	8,748		$	5,921
Depreciation and Amortization		51,047			43,639
Deferred Income Taxes		5,344			4,662
Change in Accounts Payable and Accrued Expenses		1,127			6,699
Change in Accounts Receivable		162			3,771
Other Changes, Net		1,422			4,673
Cash Provided by Operating Activities		67,850			69,365
INVESTING ACTIVITIES
Additions to Property, Plant and Equipment		(7,861		)	(5,784		)
Book Value of Property Retired or Sold		2,083			2,558
Additions to Rental Equipment		(94,294		)	(75,527		)
Book Value of Rental Equipment Sold		47,145			34,636
Contracts and Other Assets Acquired		(2,474		)	(422		)
Cash Used by Investing Activities		(55,401		)	(44,539		)
FINANCING ACTIVITIES
Proceeds from Credit Facilities		27,522			16,171
Repayments on Credit Facilities		(34,856		)	(39,272		)
Dividends Paid		(434		)	(399		)
Acquisition of Treasury Stock					(1,667		)
Issuance of Stock Under Stock Option Plans					340
Cash Used by Financing Activities		(7,768		)	(24,827		)
Increase (Decrease) in Cash		4,681			(1		)
Cash at Beginning of Period		96			93
Cash at End of Period		$	4,777		$	92

 

The accompanying notes are an integral part of the Consolidated Financial Statements

 

3

 

AARON RENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note A - Basis of Presentation

 

The consolidated financial statements include the accounts of Aaron Rents, Inc. (the “Company”) and its wholly-owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated.

 

The Consolidated Balance Sheet as of March 31, 2003, and the Consolidated Statements of Earnings and Cash Flows for the quarter ended March 31, 2003 and 2002, are unaudited.  The preparation of interim consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amount of revenues and expenses during the period.  Actual results could differ from those estimates.  In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations and cash flows at March 31, 2003 and for all periods presented have been made.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2002.  The results of operations for the quarter ended March 31, 2003 are not necessarily indicative of the operating results for the full year.

 

Critical Accounting Policies and Estimates

 

See Note A to the consolidated financial statements in the 2002 Annual Report on Form 10-K.

 

Rental Merchandise

 

See Note A to the consolidated financial statements in the 2002 Annual Report on Form 10-K.  Rental merchandise adjustments for the first quarter were $2,587,000 in 2003 and $2,250,000 in 2002.  These charges are recorded as a component of operating expenses.

 

Note B – Credit Facilities

 

See Note E to the consolidated financial statements in the Company’s Annual Report on Form 10-K.  There were no significant changes in the nature of the Company’s borrowings under credit facilities during the three months ended March 31, 2003.  In addition, the Company was in compliance with all restrictive covenants contained in such credit facilities.

 

Note C – Comprehensive Income

 

Comprehensive income is comprised of the net earnings of the Company and the change in the fair value of interest rate swap agreements, net of income taxes.  Comprehensive income for the three month periods ended March 31, 2003 and 2002 was $9,194,000 and $6,359,000,  respectively.

 

4

 

AARON RENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note D – Segment Information

 

		Three Months Ended March 31,
(In Thousands)		2003			2002
Revenues from external customers:
Sales & Lease Ownership		$	157,971		$	121,140
Rent-to-Rent		28,982			32,745
Franchise		4,635			3,962
Other		1,123			1,205
Manufacturing		17,409			15,490
Elimination of Intersegment Revenues		(17,445		)	(15,485		)
Cash to Accrual Adjustments		(1,415		)	(2,394		)
Total Revenues from External Customers		$	191,260		$	156,663
Earnings before income taxes:
Sales & Lease Ownership		$	12,063		$	7,676
Rent-to-Rent		2,178			3,040
Franchise		3,341			2,457
Other		(563		)	(1,793		)
Manufacturing		351			624
Earnings Before Income Taxes for Reportable Segments		17,370			12,004
Elimination of Intersegment Profit		(1,375		)	(652		)
Cash to Accrual Adjustments		(2,088		)	(1,895		)
Total Earnings Before Income Taxes		$	13,907		$	9,457

 

Revenues in the "Other" category are primarily from leasing space to unrelated, third parties in our corporate headquarters building and revenues from several minor unrelated activities.  The pretax losses in the "Other" category are the net result of the profit and losses from leasing a portion of the corporate headquarters and several minor unrelated activities, and the portion of corporate overhead not allocated to the reportable segments for management purposes.

 

Earnings before income taxes for each reportable segment are generally determined in accordance with generally accepted accounting principles with the following adjustments:

 

•                  A predetermined amount of approximately 2.3% in 2003 and 2.2% in 2002 of each reportable segments’ revenues is charged to the reportable segments as an allocation of corporate overhead.

•                  Non-recurring or unusual adjustments related to store closures and rent payments related to closed stores are not recorded on the reportable segments' financial statements, but rather maintained and controlled by corporate headquarters.

•                  The capitalization and amortization of manufacturing variances is recorded on the consolidated financial statements as part of other adjustments and allocations and is not allocated to the segment which holds the related rental merchandise.

•                  Interest on borrowings is estimated at the beginning of each year.  Interest is then allocated to operating segments on the basis of relative total assets.

•                  Sales and lease ownership revenues are reported on the cash basis for management reporting purposes.

 

5

 

AARON RENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note E – Stock Compensation

 

The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations, which measure compensation cost using the intrinsic value method of accounting for stock options.  Accordingly, the Company does not recognize compensation cost based upon the fair value method of accounting as provided for under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”).  If the Company had elected to recognize compensation cost based on the fair value of the options granted beginning in fiscal year 1996, as prescribed by SFAS No. 123, net income would have been reduced to the pro forma amounts indicated in the table below:

 

		Three Months Ended March 31,
(In Thousands, Except Per Share)		2003			2002
Net Earnings - as reported		$	8,748		$	5,921
Stock-based employee compensation cost, net of tax - pro forma		(292		)	(271		)
Net Earnings - pro forma		$	8,456		$	5,650
Basic Earnings per share - as reported		$	.40		$	.30
Basic Earnings per share - pro forma		.39			.28
Diluted Earnings per share - as reported		$	.40		$	.29
Diluted Earnings per share - pro forma		.39			.28

 

Note F – Adoption of New Accounting Principles

 

In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146) which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (EITF 94-3). SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred as opposed to the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes fair value as the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS 146 as of January 1, 2003.  Such adoption had no impact on the Company’s financial statements.

 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure (SFAS No. 148). SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and Accounting Principles Board Opinion No. 28, Interim Financial Reporting, to require disclosure in the summary of significant accounting policies of  the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. SFAS No. 148’s amendment of the transition and annual disclosure requirements of SFAS No. 123 are effective for fiscal years ending after December 15, 2002. The additional disclosures required under SFAS No. 148 have been included in Note E.

 

6

 

AARON RENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In November 2002, the FASB issued Interpretation Number 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires an entity to disclose in its interim and annual financial statements information with respect to its obligations under certain guarantees that it has issued. It also requires an entity to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are effective for interim and annual periods ending after December 15, 2002. These disclosures are presented in Note G of the 2002 Annual Report on Form 10-K, and there has been no significant change in the amount or nature of such guarantees. The initial recognition and measurement requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The Company adopted the financial statement recognition provisions of FIN 45 as of January 1, 2003. Such adoption did not have an impact on the Company’s financial position or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. FIN 46 is not expected to have any effect on the Company’s financial statements.

 

In January 2003, the Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor (EITF 02-16). EITF 02-16 addresses accounting and reporting issues related to how a reseller should account for cash consideration received from vendors. Generally, cash consideration received from vendors is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, under certain circumstances this presumption may be overcome and recognition as revenue or as a reduction of other costs in the income statement may be appropriate. The Company does receive cash consideration from vendors subject to the provisions of EITF 02-16. EITF 02-16 is effective for fiscal periods beginning after December 15, 2002. The Company adopted EITF 02-16 as of January 1, 2003.  Such adoption did not have a material effect on the Company’s financial statements since substantially all cooperative advertising consideration received from vendors represents a reimbursement of specific identifiable and incremental costs incurred in selling the vendors’ products.  Separately, the Company receives certain volume rebates which are unrelated to cooperative advertising.  While not significant to the Company’s financial position or results of operations, such consideration has always been accounted for as a component of inventory cost.

 

7

 

AARON RENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note G – Commitments

 

The Company has guaranteed the borrowings of certain independent franchisees under a franchise loan program with a bank. 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 franchisee’s debt obligations, which would be due in full within 90 days of the event of default. At March 31, 2003, the portion which we might be obligated to repay in the event our franchisees defaulted was approximately $64.1 million. However, due to franchisee borrowing limits, we believe any losses associated with any defaults would be mitigated through recovery of rental merchandise as well as the associated rental agreements and other assets. Since its inception, the Company has had no losses associated with the franchisee loan and guaranty program.

 

We have no long-term commitments to purchase merchandise. See Note G to the consolidated financial statements in the 2002 Annual Report on Form 10K for further information.

 

The following table shows the Company’s approximate contractual obligations and commitments to make future payments as of March 31, 2003:

 

(In Thousands)		Total			Period Less Than 1 Year			Period 1-3 Years			Period 4-5 Years			Period Over 5 Years
Credit facilities, including capital leases		$	65,931		$	268		$	10,813		$	21,020		$	33,830
Operating leases		107,530			33,326			47,678			19,426			7,100
Total contractual cash obligations		$	173,461		$	33,594		$	58,491		$	40,446		$	40,930

 

The Company has certain commercial commitments related to franchisee borrowing guarantees and residual values under operating leases. The Company believes the likelihood of any significant amounts being funded in connection with these commitments to be remote. The following table shows the Company’s approximate commercial commitments as of March 31, 2003:

 

(In Thousands)		Total Amounts Committed			Period Less Than 1 Year			Period 1-3 Years			Period 4-5 Years			Period Over 5 Years
Guaranteed borrowings of franchisees		$	64,100		$	64,100		$	—		$	—		$	—
Residual value guarantee under operating leases		20,900			—			—			20,900			—
Total commercial commitments		$	85,000		$	64,100		$	—		$	20,900		$	—

 

8

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Special Note Regarding Forward-Looking Information: Except for historical information contained herein, the matters set forth in this Form 10-Q are forward-looking statements.  Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements, including risks and uncertainties associated with our growth strategy, competition, trends in corporate spending, our franchise program, government regulation and the other risks and uncertainties discussed under the caption “Certain Factors Affecting Forward-Looking Statements” in Part I, Item 1—"Business” in the Company’s Annual Report on Form 10-K for the Year Ended December 31, 2002 filed with the Securities and Exchange Commission and in the Company’s other public filings.

 

The following discussion should be read in conjunction with the consolidated financial statements as of and for the three months ended March 31, 2003, including the notes to those statements, appearing elsewhere in this report.  We also suggest that this management’s discussion and analysis be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2002.

 

Results of Operations

 

Three months ended March 31, 2003 versus three months ended March 31, 2002

 

Revenues

Total revenues for the first quarter of 2003 increased $34.6 million to $191.3 million compared to $156.7 million in the comparable period in 2002, a 22.1% increase. The increase was due mainly to an $18.5 million, or 16.5%, increase in rentals and fees revenues, plus a $9.1 million, or 40.5%, increase in non-retail sales. Our rentals and fees revenues include all revenues derived from rental agreements from our sales and lease ownership and rent-to-rent stores, including agreements that result in our customers acquiring ownership at the end of the term of the rental agreements. The increase in rentals and fees revenues was attributable to a $21.3 million increase from our sales and lease ownership division, which had an average increase of 14.1% in same store revenues for the first quarter of 2003 and added 32 Company-operated stores since the end of the first quarter 2002 along with $1.6 million in rentals and fees from Sight & Sound stores acquired in August 2002. The growth in our sales and lease ownership division was offset by a $2.8 million decrease in rental revenues in our rent-to-rent division. The decrease in rent-to-rent division revenues is primarily the result of a decline of same store revenues as well as a net reduction of four stores since the end of the first quarter of 2002.

 

Revenues from retail sales increased $6.0 million to $23 million in the first quarter of 2003 from $17 million in the comparable period in 2002 due to an increase of $7.1 million in the sales and lease ownership division offset by a decrease of $1.1 million in our rent-to-rent division. Retail sales represent sales of both new and rental return merchandise. Non-retail sales, which primarily represent merchandise sold to our franchisees, increased 40.5% to $31.6 million in the first quarter of 2003 from $22.5 million in the comparable period in 2002. The increase in non-retail sales reflects the growth of our franchise operations.

 

Other revenues, which include franchise fee and royalty income and other miscellaneous revenues, for the quarter ended  March 31, 2003 increased $945,000 to $5.6 million compared with $4.7 million in 2002, a 20.2% increase. This increase was attributable to franchise fee and royalty income increasing $728,000, or 18.6%, to $4.6 million compared with $3.9 million in the first quarter of 2002, reflecting the net addition of 29 franchised stores since the end of the first quarter  2002 and improved operating revenues at older franchised stores.

 

With respect to our major operating units, revenues for our sales and lease ownership division increased $36.8 million to $158 million in the first quarter of 2003 compared with $121.1 million for the comparable period in 2002, a 30.4% increase. This increase was attributable to same store revenue growth and the store additions described above. Rent-to-rent division revenues for the three months ended March 31, 2003 decreased 11.5% to $29 million from $32.7 million for the comparable period in 2002, due primarily to the same store revenue decline and store closings of under-performing

 

9

 

stores as previously described.

 

Cost of Sales

Cost of sales from retail sales increased $4.5 million, or 36.2%, to $16.9 million in the first quarter of 2003 compared to $12.4 million for the comparable period in 2002, and as a percentage of sales, increased to 73.2% from 72.7%. The increase in retail cost of sales as a percentage of sales was primarily due to lower margins on retail sales from our newly acquired Sight & Sound stores partially offset by increased margins in Company-operated sales and lease ownership and rent-to rent-stores. Cost of sales from non-retail sales increased $8.6 million to $29.4 million in the first quarter of 2003 from $20.8 million in the first quarter of 2002, and as a percentage of sales, increased to 93.2% from 92.7%. The decreased margins on non-retail sales were primarily the result of slightly lower margins on certain products sold to franchisees.

 

Expenses

Operating expenses in the first quarter of 2003 increased $10 million to $83.1 million from $73.1 million for the comparable period in 2002, a 13.7% increase. As a percentage of total revenues, operating expenses were 43.5% for the three months ended March 31, 2003 and 46.7% for the comparable period in 2002. Operating expenses decreased in 2003 as a percentage of total revenues primarily due to the maturing of new Company-operated sales and lease ownership stores added over the past several years, and a 14.1% increase in same store revenue growth.

 

Depreciation of rental merchandise increased $6.7 million to $46.4 million in the first quarter of 2003 from $39.7 million during the comparable period in 2002, a 16.8% increase. As a percentage of total rentals and fees, depreciation of rental merchandise increased slightly to 35.4% from 35.3% from quarter to quarter. The increase as a percentage of rentals and fees reflects a greater percentage of our rentals and fees revenues coming from our sales and lease ownership division, which depreciates its rental merchandise at a faster rate than our rent-to-rent division.

 

Interest expense increased $422,000 to $1.6 million for the quarter ended March 31, 2003 compared with $1.2 million in 2002, a 36.2% increase. As a percentage of total revenues, interest expense increased to 0.8% in the first quarter of 2003 from 0.7% in the comparable period in 2002. The increase in interest expense as a percentage of total revenues was primarily due to higher interest rates in the first three months of 2003. The higher interest rates relate to the Company's August 2002 private debt placement.

 

Income tax expense increased $1.6 million to $5.2 million in the first quarter of 2003 compared with $3.5 million in 2002, representing a 45.9% increase due to the higher pre-tax earnings. Aaron Rents’ effective tax rate was 37.1% in the first quarter of 2003 compared with 37.4% in the comparable period of 2002, primarily due to lower non-deductible expenses.

 

Net Earnings

As a result, net earnings increased $2.8 million to $8.7 million for the first quarter of 2003 compared with $5.9 million for the same period last year, representing a 47.7% increase. As a percentage of total revenues, net earnings were 4.6% in 2003 and 3.8% in 2002. The increase in net earnings was primarily due to the maturing of new Company-operated sales and lease ownership stores added over the past several years and a 14.1% increase in same store revenue growth.

 

Balance Sheet

 

Cash. The Company’s cash balance increased $4.7 million to $4.8 million at March 31, 2003 compared with $96,000 at December 31, 2002.  The increase in cash is the result of the Company using excess cash in the prior year to pay down its revolving credit line. During the first quarter of 2003 the Company paid down its revolving credit line by $7.3 million to a zero balance.  The remaining credit facilities are fixed rate obligations with set payment dates.  As a result of the change in the structure of the Company’s credit facilities, the Company had excess cash at March 31, 2003.

 

10

 

Deferred Income Taxes. The increase of $5.3 million in deferred income taxes from December 31, 2002 to March 31, 2003 is primarily the result of March 2002 tax law changes, effective September 2001, that allow accelerated depreciation of rental merchandise for tax purposes.

 

Bank Debt. The reduction in bank debt of $7.3 million from December 31, 2002 to March 31, 2003 is the result of the Company paying down its revolving debt to a zero balance in the first quarter of 2003.

 

Liquidity and Capital Resources

 

General

 

Cash flows from operations for the quarters ended  March 31, 2003 and 2002 were $67.8 and $ 69.4 million, respectively. Our cash flows include profits on the sale of rental return merchandise. Our primary capital requirements consist of buying rental merchandise for both Company-operated sales and lease ownership and rent-to-rent stores. As Aaron Rents continues to grow, the need for additional rental merchandise will continue to be our major capital requirement. These capital requirements historically have been financed through:

 

•                  bank credit

•                  cash flow from operations

•                  trade credit with vendors

•                  proceeds from the sale of rental return merchandise

•                  private debt

•                  stock offerings

 

At March 31, 2003, no amounts were outstanding under the Company's revolving credit agreement. The Company’s long-term debt decreased by approximately $7.3 million in the first quarter of 2003. The decline in borrowings is primarily attributable to cash generated from operating activities of $67.8 million. Information regarding our obligations to make future payments under our credit facility appears in Note G to the consolidated financial statements. We use interest rate swap agreements as part of our overall long-term financing program. Aaron Rents also has $50 million in aggregate principal amount of 6.88% senior unsecured notes due August 2009 currently outstanding, principal repayments for which are first required in 2004.

 

Aaron Rents’ revolving credit agreement, senior unsecured notes, the construction and lease facility, and the franchisee loan program discussed below, contain financial covenants which, among other things, forbid us from exceeding certain debt to equity levels and require us to maintain minimum fixed charge coverage ratios. If we fail to comply with these covenants, then we will be in default under these commitments, and all amounts would become due immediately. Aaron Rents was complying with all these covenants at March 31, 2003.

 

As of March 31, 2003, Aaron Rents was authorized by its Board of Directors to purchase up to an additional 1,186,890 common shares.

 

Subsequent to the quarter ended March 31, 2003, Aaron Rents increased the authorized number of shares of Common Stock by 25 million shares for a total of 50 million shares.  The purpose of increasing the number of shares of authorized Common Stock is to give the Company greater flexibility in connection with its capital structure, possible future financing requirements, employee compensation and other corporate matters.

 

Aaron Rents has paid dividends for 16 consecutive years. A $.02 per share dividend on Common Stock and Class A Common Stock was paid in January 2002 and July 2002, for a total fiscal year cash outlay of $798,000 and in January 2003 a $434,000 dividend was paid. Subject to sufficient operating profits, to any future capital needs and to other contingencies, we currently expect to continue our policy of paying dividends.

 

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We believe that our existing credit facilities, our expected cash flows from operations, proceeds from the sale of rental return merchandise, and vendor credit will be sufficient to fund our capital and liquidity needs for at least the next 24 months.

 

Commitments

 

Construction and Lease Facility. On October 31, 2001, we renewed our $25 million construction and lease facility. From 1996 to 1999, we arranged for a bank holding company to purchase or construct properties identified by us pursuant to this facility, and we subsequently leased these properties from the bank holding company under operating lease agreements. The total amount advanced and outstanding under this facility at March 31, 2003 was approximately $24.7 million. Since the resulting leases are accounted for as operating leases, we do not record any debt obligation on our balance sheet. This construction and lease facility expires in 2006. Lease payments fluctuate based upon current interest rates and are generally based upon LIBOR plus 1.35%. The lease facility contains residual value guarantee and default guarantee provisions. Although we believe the likelihood of funding to be remote, the maximum guarantee obligation under the residual value and default guarantee provisions upon termination are approximately $20.9 million and $24.7 million, respectively, at March 31, 2003.

 

Leases. Aaron Rents leases warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2015. 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 which do not represent bargain purchase options. We also lease transportation and computer equipment under operating leases expiring during the next three 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 March 31, 2003 including leases under our construction and lease facility described above are as follows: $33.3 million in 2003; $27.9 million in 2004; $19.8 million in 2005; $12.6 million in 2006; $6.8 million in 2007; and $7.1 million thereafter.

 

The Company has 13 capital leases, 12 of which are with limited liability companies (LLCs) whose owners include Aaron Rents’ executive officers and majority shareholder. Eleven of these related party leases relate to properties purchased from Aaron Rents in December 2002 by one of the LLCs for a total purchase price of approximately $5 million. The LLC is leasing back these properties to Aaron Rents for 15-year terms at an aggregate annual rental of approximately $635,000. The twelfth related party capital lease relates to a property sold by Aaron Rents to a second LLC for $6.3 million in April 2002 and leased back to Aaron Rents for a 15-year term at an annual rental of approximately $617,000. See Note E to the Consolidated Financial Statements in the 2002 Annual Report on Form 10-K.

 

Franchise Guaranty. See Note G to the Consolidated Financial Statements contained in Part I, Item I of the Quarterly Report on Form 10-Q.

 

Market Risk

 

Aaron Rents manages its exposure to changes in short-term interest rates, particularly to reduce the impact on our variable payment construction and lease facility and floating-rate borrowings, by entering into interest rate swap agreements. These swap agreements involve the receipt of amounts by us when floating rates exceed the fixed rates and the payment of amounts by us to the counterparties when fixed rates exceed the floating rates in the agreements over their term. We accrue the differential we may pay or receive as interest rates change, and recognize it as an adjustment to the floating rate interest expense related to our debt. The counterparties to these contracts are high credit quality commercial banks, which we believe minimizes the risk of counterparty default to a large extent.

 

At March 31, 2003, we had swap agreements with total notional principal amounts of $60 million which effectively fixed the interest rates on obligations in the notional amount of $28 million of debt under our variable payment construction and lease facility and other debt at an average rate of 7.23%, as follows: $20 million at an average rate of 6.22% until

 

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May 2003; $20 million at an average rate of 7.84% until November 2003; and an additional $20 million at an average rate of 7.64% until June 2005. In 2002, we reassigned approximately $24 million of notional amount of swaps to the variable payment obligations under our construction and lease facility described above. Since August 2002, fixed rate swap agreements in the notional amount of $32 million were not being utilized as a hedge of variable obligations, and accordingly, changes in the valuation of such swap agreements are recorded directly to earnings. The fair value of interest rate swap agreements was a liability of approximately $3.3 million at March 31, 2002. A 1% adverse change in interest rates on variable rate obligations would not have a material adverse impact on the future earnings and cash flows of the Company.

 

We do not use any market risk sensitive instruments to hedge commodity, foreign currency, or risks other than interest rate risk, and hold no market risk sensitive instruments of any kind for trading or speculative purposes.

 

New Accounting Pronouncements.

 

See Note F to the Consolidated Financial Statements contained in Part I, Item I of the Quarterly Report on Form 10-Q.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

 

Substantially all of the information called for by this item is provided under Item 2 in the Company’s Form 10-K for the year ended December 31, 2002, and Part I, Item 2 of this Quarterly Report above.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Within the 90 day period prior to the filing date of this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a - 14( c ) and 15d – 14( c ) under the Securities Exchange Act of 1934.  Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of the date of that evaluation.  There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date that Company management conducted its last evaluation of internal controls.

 

PART II – OTHER INFORMATION

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:

 

	(a) The following exhibits are furnished herewith:
		10(u)  Amendment Number Two to the Revolving Credit Agreement among Aaron Rents, Inc. as borrower, Aaron Rents, Inc. Puerto Rico as co-borrower and SunTrust Bank as Administrative Agent dated April 30, 2003.
		10(v) Amendment Number Two to the Loan Facility Agreement and Guaranty by and among Aaron Rents, Inc. and SunTrust Bank and each of the Participants Party Hereto dated April 30, 2003.
		10(w) Amendment Number one to the Servicing Agreement by and between Aaron Rents, Inc. (“Sponsor”), and SunTrust  Bank (the “Servicer”) dated April 30, 2003.
		99(a) Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to   Section 906 of the Sarbanes-Oxley Act of 2002.

 

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		99(b) Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.
	(b) No reports on Form 8-K were filed by the Registrant during the three months ended March 31, 2003.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date - May 13, 2003		AARON RENTS, INC.
		(Registrant)
		By	/s/ Gilbert L. Danielson
			Gilbert L. Danielson
			Executive Vice President
			Chief Financial Officer
Date - May 13, 2003			/s/ Robert P. Sinclair, Jr.
			Robert P. Sinclair, Jr.
			Vice President
			Corporate Controller

 

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CERTIFICATIONS

 

	I, R. Charles Loudermilk, Sr., certify that:
1.	I have reviewed this quarterly report on Form 10-Q of Aaron Rents, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and:
6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 13, 2003	/s/ R. Charles Loudermilk, Sr.
	R. Charles Loudermilk, Sr.
	Chairman of the Board, Chief Executive Officer

 

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CERTIFICATIONS

 

	I, Gilbert L. Danielson, certify that:
1.	I have reviewed this quarterly report on Form 10-Q of Aaron Rents, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and:
6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

	/s/ Gilbert L. Danielson
	Gilbert L. Danielson
	Executive Vice President, Chief Financial Officer
Date: May 13, 2003

 

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