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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

 

March 31, 2005

 

1-13941

For Quarter Ended

 

Commission File No.

 

AARON RENTS, INC.

(Exact name of registrant as
specified in its charter)

 

Georgia

 

58-0687630

(State or other jurisdiction of
incorporation or organization)

 

(I. R. S. Employer
Identification No.)

 

 

 

309 E. Paces Ferry Road, N.E.
Atlanta, Georgia

 

30305-2377

(Address of principal executive offices)

 

(Zip Code)

 

(404) 231-0011

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former
fiscal year, if changed since last report)

 

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.

 

Yes ý

No o

 

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

 

Yes ý

No o

 

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

 

Title of Each Class

 

Shares Outstanding as of
May 6, 2005

Common Stock, $.50 Par Value

 

41,384,468

Class A Common Stock, $.50 Par Value

 

8,396,233

 

 



 

AARON RENTS, INC.

 

INDEX

 

PART I. FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements:

 

 

 

Consolidated Balance Sheets –March 31, 2005 (Unaudited) and December 31, 2004

 

 

 

Consolidated Statements of Earnings (Unaudited) - Three Months Ended March 31, 2005 and 2004

 

 

 

Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended March 31, 2005 and 2004

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

 

 

Independent Registered Public Accounting Firm Review Report

 

 

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

 

 

Signatures

 



 

PART I - - FINANCIAL INFORMATION
Item 1 - Financial Statements

 

AARON RENTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

 

 

 

(Unaudited)
March 31
2005

 

December 31,
2004

 

 

 

(In Thousands, Except Share Data)

 

ASSETS:

 

 

 

 

 

Cash

 

$

4,473

 

$

5,865

 

Accounts Receivable (net of allowances of $1,780 in 2005 and $1,963 in 2004)

 

36,774

 

32,736

 

Rental Merchandise

 

654,212

 

639,192

 

Less: Accumulated Depreciation

 

(216,496

)

(213,625

)

 

 

437,716

 

425,567

 

Property, Plant and Equipment, Net

 

114,725

 

111,118

 

Goodwill and Other Intangibles, Net

 

80,647

 

74,874

 

Prepaid Expenses and Other Assets

 

30,002

 

50,128

 

Total Assets

 

$

704,337

 

$

700,288

 

 

 

 

 

 

 

LIABILITIES & SHAREHOLDERS’ EQUITY:

 

 

 

 

 

Accounts Payable and Accrued Expenses

 

$

118,718

 

$

93,565

 

Dividends Payable

 

647

 

647

 

Deferred Income Taxes Payable

 

88,543

 

95,173

 

Customer Deposits and Advance Payments

 

18,225

 

19,070

 

Credit Facilities

 

84,901

 

116,655

 

Total Liabilities

 

311,034

 

325,110

 

 

 

 

 

 

 

Commitments & Contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Common Stock, Par Value $.50 Per Share; Authorized: 50,000,000 Shares; Shares Issued: 44,989,602 at March 31, 2005 and December 31, 2004

 

22,495

 

22,495

 

Class A Common Stock, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 12,063,856 at March 31, 2005 and December 31, 2004

 

6,032

 

6,032

 

Additional Paid-in Capital

 

91,105

 

91,032

 

Retained Earnings

 

311,852

 

294,077

 

Accumulated Other Comprehensive Loss

 

(338

)

(539

)

 

 

431,146

 

413,097

 

 

 

 

 

 

 

Less: Treasury Shares at Cost,

 

 

 

 

 

Common Stock, 3,613,659 Shares at March 31, 2005 and 3,625,230 Shares at December 31, 2004

 

(21,939

)

(22,015

)

Class A Common Stock, 3,667,623 Shares at March 31, 2005 and December 31, 2004

 

(15,904

)

(15,904

)

Total Shareholders’ Equity

 

393,303

 

375,178

 

 

 

 

 

 

 

Total Liabilities & Shareholders’ Equity

 

$

704,337

 

$

700,288

 

 

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

 



 

AARON RENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2005

 

2004

 

 

 

(In Thousands, Except Per Share Data)

 

 

 

 

 

 

 

REVENUES:

 

 

 

 

 

Rentals and Fees

 

$

209,145

 

$

172,372

 

Retail Sales

 

16,043

 

16,471

 

Non-Retail Sales

 

45,571

 

46,499

 

Franchise Royalties and Fees

 

7,191

 

5,916

 

Other

 

1,398

 

1,235

 

 

 

279,348

 

242,493

 

COSTS AND EXPENSES:

 

 

 

 

 

Retail Cost of Sales

 

10,736

 

11,710

 

Non-Retail Cost of Sales

 

42,633

 

43,306

 

Operating Expenses

 

119,631

 

102,093

 

Depreciation of Rental Merchandise

 

75,130

 

63,470

 

Interest

 

1,600

 

1,208

 

 

 

249,730

 

221,787

 

 

 

 

 

 

 

EARNINGS BEFORE INCOME TAXES

 

29,618

 

20,706

 

 

 

 

 

 

 

INCOME TAXES

 

11,196

 

7,889

 

 

 

 

 

 

 

NET EARNINGS

 

$

18,422

 

$

12,817

 

 

 

 

 

 

 

COMMON STOCK AND CLASS A COMMON STOCK EARNINGS PER SHARE:

 

 

 

 

 

Basic

 

$

.37

 

$

.26

 

Assuming Dilution

 

.36

 

.26

 

 

 

 

 

 

 

CASH DIVIDENDS DECLARED PER SHARE:

 

 

 

 

 

Common Stock

 

$

.013

 

$

 

Class A Common Stock

 

.013

 

 

 

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

 



 

AARON RENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

 

 

(In Thousands)

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net Earnings

 

$

18,422

 

$

12,817

 

Depreciation and Amortization

 

81,805

 

69,919

 

Additions to Rental Merchandise

 

(140,294

)

(144,481

)

Book Value of Rental Merchandise Sold or Disposed

 

56,308

 

59,271

 

Change in Deferred Income Taxes

 

(1,702

)

4,447

 

Loss / (Gain) on Sale of Property, Plant, and Equipment

 

7

 

(234

)

Change in Income Tax Receivable, Included in Prepaid Expenses and Other Assets

 

15,095

 

 

Change in Accounts Payable and Accrued Expenses

 

25,220

 

6,764

 

Change in Accounts Receivable

 

(4,038

)

(2,287

)

Other Changes, Net

 

(501

)

4,905

 

Cash Provided by Operating Activities

 

50,322

 

11,121

 

 

 

 

 

 

 

INVESTING ACTIVITIES:

 

 

 

 

 

Additions to Property, Plant and Equipment

 

(10,551

)

(7,821

)

Contracts and Other Assets Acquired

 

(9,869

)

(4,192

)

Proceeds from Sale of Marketable Securities

 

9

 

 

Proceeds from Sale of Property, Plant, and Equipment

 

1,013

 

2,151

 

Cash Used by Investing Activities

 

(19,398

)

(9,862

)

 

 

 

 

 

 

FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from Credit Facilities

 

30,534

 

38,699

 

Repayments on Credit Facilities

 

(62,288

)

(41,827

)

Dividends Paid

 

(647

)

(655

)

Issuance of Stock Under Stock Option Plans

 

85

 

592

 

Cash Used by Financing Activities

 

(32,316

)

(3,191

)

 

 

 

 

 

 

Decrease in Cash

 

(1,392

)

(1,932

)

Cash at Beginning of Period

 

5,865

 

4,687

 

Cash at End of Period

 

$

4,473

 

$

2,755

 

 

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

 



 

AARON RENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2005
(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, 2005, and the consolidated statements of earnings and the consolidated statements of cash flows for the quarters ended March 31, 2005 and 2004, are unaudited.  The preparation of interim consolidated financial statements 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.

 

On July 12, 2004 the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend on both Common Stock and Class A Common Stock.  New shares were distributed on August 16, 2004 to shareholders of record as of the close of business on August 2, 2004.  All share and per share information has been restated for all periods presented to reflect this transaction.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted.  We suggest you read these financial statements 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, 2004.  The results of operations for the quarter ended March 31, 2005 are not necessarily indicative of operating results for the full year.

 

Certain reclassifications have been made to the prior periods to conform to the current period presentation.

 

Accounting Policies and Estimates
 

See Note A to the consolidated financial statements in the 2004 Annual Report on Form 10-K.

 

Cash

 

In the previous consolidated balance sheet and consolidated statement of cash flow presentations as of March 31, 2004, checks outstanding were classified as a reduction to cash.  Because the financial institutions with checks outstanding and those with deposits on hand did not and do not have legal rights of offset, we have reclassified checks outstanding in certain zero balance bank accounts to accounts payable at March 31, 2005 and for all consolidated balance sheets and consolidated statements of cash flows presented.  This reclassification has the effect of increasing both cash and accounts payable and accrued expenses by $2.7 million on the consolidated balance sheet as of March 31, 2004 and change in accounts payable and accrued expenses on the consolidated statement of cash flows for the quarter ended March 31, 2004.

 

Certain transactions previously reflected as a reduction of book value of rental merchandise sold or disposed in the accompanying consolidated statements of cash flows for the quarter ended March 31, 2004 are reflected as an addition to rental merchandise for the quarter ended March 31, 2005.  These transactions have been reclassified in the accompanying consolidated statements of cash flows to conform with the current period presentation, resulting in increases in both additions to rental merchandise and book value of rental merchandise sold or disposed of $3.1 million for the quarter ended March 31, 2004.

 



 

Rental Merchandise
 

See Note A to the consolidated financial statements in the 2004 Annual Report on Form 10-K.  Rental merchandise adjustments for the three-month periods ended March 31 were $3.1 million in 2005 and $3.7 million in 2004.  These charges are recorded as a component of operating expenses.  Effective September 30, 2004 we began recording rental merchandise adjustments on the allowance method, which estimates merchandise losses incurred but not yet identified by management as of the end of the accounting period.  We expect periodic rental merchandise adjustments under this new method to be materially consistent with the prior year’s adjustments under the direct write-off method, pursuant to which merchandise losses were only recognized after they were specifically identified.

 

Goodwill and Other Intangibles
 

During the first quarter of 2005, the Company recorded $5.7 million in goodwill and $.6 million in customer relationship intangibles in connection with a series of acquisitions of sales and lease ownership businesses.  Customer relationship intangibles are amortized on a straight-line basis over their estimated useful lives of 2 years.  Amortization expense approximated $486,000 and $351,000 for the three-month periods ended March 31, 2005 and 2004, respectively.  The aggregate purchase price for these asset acquisitions totaled approximately $9.2 million, and the principal tangible assets acquired consisted of rental merchandise and certain fixtures and equipment.  These purchase price allocations are tentative and preliminary and we anticipate finalizing them prior to December 31, 2005.  The results of operations of the acquired businesses are included in the Company’s results of operations from the dates of acquisition and are not significant.

 

Stock Compensation

 

The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations in accounting for its employee stock options and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (SFAS 123).  The Company grants stock options for a fixed number of shares to employees primarily with an exercise price equal to the fair value of the shares at the date of grant and, accordingly, recognizes no compensation expense for these stock option grants.  The Company has granted stock options for a fixed number of shares to certain key executives with an exercise price below the fair value of the shares at the date of grant.  Compensation expense for these grants is recognized over the three-year vesting period of the options for the difference between the exercise price and the fair value of a share of Common Stock on the date of grant times the number of options granted

 

For purposes of pro forma disclosures under SFAS No. 123 as amended by SFAS No. 148, the estimated fair value of the options is amortized to expense over the options’ vesting period.  The following table illustrates the effect on net earnings and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period:

 

 

 

Three Months Ended
March 31,

 

(In Thousands, Except Share Data)

 

2005

 

2004

 

Net Earnings before effect of Key Executive grants

 

$

18,554

 

$

12,817

 

Expense effect of Key Executive grants recognized

 

(132

)

 

Net Earnings as Reported

 

$

18,422

 

$

12,817

 

Stock-based Employee Compensation Cost, Net of Tax - Pro Forma

 

(496

)

(408

)

Pro Forma Net Earnings

 

$

17,926

 

$

12,409

 

Basic Earnings Per Share - As Reported

 

$

.37

 

$

.26

 

Basic Earnings Per Share - Pro Forma

 

$

.36

 

$

.25

 

Diluted Earnings Per Share - As Reported

 

$

.36

 

$

.26

 

Diluted Earnings Per share - Pro Forma

 

$

.36

 

$

.25

 

 



 

For periods beginning after December 31, 2005, the Company anticipates accounting for all employee stock options under the fair-value method.  See Note E.

 

Note B – Credit Facilities

 

See Note D to the consolidated financial statements in the 2004 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, 2005 or to its capital leases with related parties.  The Company was in compliance with all restrictive covenants contained in its credit facilities.

 

Note C – Comprehensive Income

 

Comprehensive income is comprised of the net earnings of the Company, the change in the fair value of interest rate swap agreements, net of income taxes, and the changes in unrealized gains or losses on available-for-sale securities, net of income taxes, as summarized below:

 

 

 

Three Months Ended
March 31,

 

(In Thousands)

 

2005

 

2004

 

Net Earnings

 

$

18,422

 

$

12,817

 

Other comprehensive income:

 

 

 

 

 

Derivative instruments, net of taxes

 

120

 

121

 

Unrealized gain on marketable securities, net of taxes

 

82

 

2,196

 

Total other comprehensive income

 

202

 

2,317

 

Comprehensive Income

 

$

18,624

 

$

15,134

 

 



 

Note D – Segment Information

 

 

 

Three Months Ended
March 31,

 

(In Thousands)

 

2005

 

2004

 

 

 

 

 

 

 

Revenues From External Customers:

 

 

 

 

 

Sales & Lease Ownership

 

$

240,618

 

$

209,403

 

Rent-to-Rent

 

30,185

 

27,591

 

Franchise

 

7,270

 

5,928

 

Other

 

1,199

 

1,123

 

Manufacturing

 

25,949

 

19,084

 

Elimination of Intersegment Revenues

 

(25,963

)

(19,175

)

Cash to Accrual Adjustments

 

90

 

(1,461

)

Total Revenues from External Customers

 

$

279,348

 

$

242,493

 

 

 

 

 

 

 

Earnings Before Income Taxes:

 

 

 

 

 

Sales & Lease Ownership

 

$

21,213

 

$

17,300

 

Rent-to-Rent

 

3,642

 

2,668

 

Franchise

 

5,404

 

4,271

 

Other

 

(623

)

(2,038

)

Manufacturing

 

587

 

932

 

Earnings Before Income Taxes for Reportable Segments

 

30,223

 

23,133

 

Elimination of Intersegment (Profit)

 

(530

)

(1,007

)

Cash to Accrual and Other Adjustments

 

(75

)

(1,420

)

Total Earnings Before Income Taxes

 

$

29,618

 

$

20,706

 

 

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 pre-tax items in the “Other” category are the net result of the profits 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 accounting principles generally accepted in the United States with the following adjustments:

 

                  A predetermined amount of approximately 2.3% of each reportable segment’s revenues is charged to the reportable segment as an allocation of corporate overhead.

                  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 and distribution 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 rental merchandise.

                  Advertising expense in our 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 Cash to Accrual and Other Adjustments.

                  Sales and lease ownership rental 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 Cash to Accrual and Other Adjustments.

 



 

                  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 a cash basis for management reporting purposes.

 

Note E – Adoption of New Accounting Principles

 

In November 2004 the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs - An Amendment of ARB No. 43, Chapter 4 (SFAS 151).  SFAS 151 amends Accounting Research Bulletin No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges.  In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  SFAS 151 is effective for the Company beginning January 1, 2006, though early application is permitted.  Management is currently assessing the impact of SFAS 151, but does not expect the impact to be material.

 

In December 2004 the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-based Payment (SFAS 123R).  SFAS 123R amends SFAS 123 to require adoption of the fair-value method of accounting for employee stock options.  In April 2005, the SEC extended the adoption date of SFAS 123R to January 1, 2006 for calendar-year companies.  The transition guidance in SFAS 123R specifies that compensation expense for options granted prior to the effective date be recognized over the remaining vesting period of those options, and that compensation expense for options granted subsequent to the effective date be recognized over the vesting period of those options.  We anticipate recognizing compensation expense of approximately $2.6 million and $1.0 million for the years ended December 31, 2006 and 2007, respectively, in connection with stock option grants made prior to December 31, 2004.

 

Note F – Commitments

 

The Company leases warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2019.  We also lease certain properties under capital leases with certain related parties that are more fully described in Note D to the consolidated financial statements in the 2004 Annual Report on Form 10-K.  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.

 

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, the Company 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, 2005, the portion that the Company might be obligated to repay in the event franchisees defaulted was approximately $105.4 million.  However, due to franchisee borrowing limits, management believes 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.

 

The Company has no long-term commitments to purchase merchandise.  See Note F to the consolidated financial statements in the 2004 Annual Report on Form 10-K for further information.

 



 

Report of Independent Registered Public Accounting Firm

 

We have reviewed the consolidated balance sheet of Aaron Rents, Inc. and Subsidiaries as of March 31, 2005, and the related consolidated statements of income for the three-month periods ended March 31, 2005 and 2004, and the consolidated statements of cash flows for the three-month periods ended March 31, 2005 and 2004.  These interim financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Aaron Rents, Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated March 7, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

 

 

/s/ Ernst & Young LLP

 

 

Atlanta, Georgia

May 5, 2005

 



 

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, 2004 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, 2005, 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, 2004.

 

Overview

 

Aaron Rents, Inc. is a leading U.S. company engaged in the combined businesses of the rental, lease ownership and specialty retailing of consumer electronics, residential and office furniture, household appliances and accessories.  Our major operating divisions are the Aaron’s Sales & Lease Ownership Division, the Aaron Rents’ Rent-to-Rent Division, and the MacTavish Furniture Industries Division, which manufactures and supplies nearly one-half of the furniture and related accessories rented and sold in our stores.  Our sales and lease ownership division accounted for 89% of our total revenues in the first quarter of 2005 compared with 88% in the comparable period in 2004.

 

In this management’s discussion and analysis section we review the results of our sales and lease ownership and rent-to-rent divisions, as well as the four components of our revenues: rentals and fees, retail sales, non-retail sales and other revenues.  Rentals and fees includes 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. Retail sales represents sales of both new and rental return merchandise.  Non-retail sales mainly represents merchandise sales to our franchisees from our sales and lease ownership division.  Franchise Royalties and Fees represents fees from sale of franchise rights and royalty payments from franchisees as well as other related income from our franchise stores.   Other represents other miscellaneous revenues ancillary to our core operations.

 

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 mainly represents the cost of merchandise sold to our franchisees.

 



 

Results of Operations

 

Three months ended March 31, 2005 versus three months ended March 31, 2004

 

The following table shows key selected financial data for the quarters ended March 31, 2005 and 2004, and the changes in dollars and as a percentage to 2005 from 2004:

 

(In Thousands)

 

Three Months
Ended March 31,
2005

 

Three Months
Ended March 31,
2004

 

Dollar Increase/
(Decrease) to
2005 from 2004

 

% Increase/
(Decrease) to
2005 from
2004

 

REVENUES:

 

 

 

 

 

 

 

 

 

Rentals and Fees

 

$

209,145

 

$

172,372

 

$

36,773

 

21.3

%

Retail Sales

 

16,043

 

16,471

 

(428

)

(2.6

)

Non-Retail Sales

 

45,571

 

46,499

 

(928

)

(2.0

)

Franchise Royalties and Fees

 

7,191

 

5,916

 

1,275

 

21.6

 

Other

 

1,398

 

1,235

 

163

 

13.2

 

 

 

279,348

 

242,493

 

36,855

 

15.2

 

COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

 

Retail Cost of Sales

 

10,736

 

11,710

 

(974

)

(8.3

)

Non-Retail Cost of Sales

 

42,633

 

43,306

 

(673

)

(1.6

)

Operating Expenses

 

119,631

 

102,093

 

17,538

 

17.2

 

Depreciation of Rental Merchandise

 

75,130

 

63,470

 

11,660

 

18.4

 

Interest

 

1,600

 

1,208

 

392

 

32.5

 

 

 

249,730

 

221,787

 

27,943

 

12.6

 

EARNINGS BEFORE INCOME TAXES

 

29,618

 

20,706

 

8,912

 

43.0

 

INCOME TAXES

 

11,196

 

7,889

 

3,307

 

41.9

 

NET EARNINGS

 

$

18,422

 

$

12,817

 

$

5,605

 

43.7

%

 

Revenues

 

The 15.2% increase in total revenues in the first quarter of 2005 over the same period in 2004 is primarily attributable to continued growth in our sales and lease ownership division in which revenues increased 15.9%, offset slightly by a lesser increase in revenues of 9.7% in our rent-to-rent division.  Total revenues for our sales and lease ownership division increased $34.2 million to $248.7 million in the first quarter of 2005 compared to $214.5 million in the first quarter of 2004, a 15.9% increase.  This increase was attributable to an 8.3% increase in same store revenues and the net addition of 128 Company-operated stores since the end of the first quarter of 2004.

 

Revenues from retail sales fell 2.6% due to a $1.6 million decrease in our sales and lease ownership division, which reflects a decreased focus on retail sales in certain stores and the impact of the introduction of an alternative shorter-term lease, which we believe replaced many retail sales.  The decrease in the sales and lease ownership divisions retail sales was partially offset by a $1.2 million increase in retail sales in the rent-to-rent division which was primarily the result of improving economic conditions.

 

Non-retail sales decreased 2.0% during the first quarter of 2005 compared the same period in 2004.  Non-retail sales are low margin sales to franchisees of rental merchandise from the Company’s fulfillment centers, and vary from quarter to quarter based upon product demand and availability.

 

The 21.3% increase in rentals and fees revenues is attributable to a $35.3 million increase from our sales and lease ownership division related to the growth in same store revenues and the increase in the number of stores described above.

 



 

The 21.6% increase in franchise royalties and fees primarily reflects an increase in royalty income from franchisees, increasing $1.3 million to $5.5 million in the first quarter of 2005 compared to $4.2 million in the first quarter of 2004, with increased franchise and financing fee revenues comprising the majority of the remainder.  This franchisee-related revenue growth reflects the net addition of 49 franchised stores since the end of the first quarter 2004 and improving operating revenues driven by increased merchandise leasing volume at maturing franchised stores.  Our franchisees had revenues of $108.3 million during the first quarter of 2005, a 30.0% increase over the first quarter of 2004 revenues of $83.3 million.  Revenues of franchisees, however, are not revenues of Aaron Rents, Inc.

 

Cost of Sales

 

The 8.3% decrease in retail cost of sales is primarily the result of the decrease in retail sales in our sales and lease ownership division described above, with retail cost of sales as a percentage of retail sales decreasing to 66.9% from 71.1%, due primarily to higher margins on certain retail sales in our sales and lease ownership division.

 

Cost of sales from non-retail sales decreased 1.6%, following the decrease in non-retail sales described above, with margin on non-retail sales remaining comparable between the first quarters of 2005 and 2004.

 

Expenses

 

The 17.2% increase in operating expenses is a result of the growth of our sales and lease ownership division described above.  As a percentage of total revenues, operating expenses increased to 42.8% for the first quarter of 2005 compared to 42.1% for the first quarter of 2004.  The slight increase in operating expenses as a percentage of total revenues in 2005 is primarily the result of an unusual decrease in the non-retail sales category, which as discussed above can vary from quarter to quarter based on product demand and availability.

 

The 18.4% increase in depreciation of rental merchandise was the result of the growth of our sales and lease ownership division described above.  Depreciation of rental merchandise as a percentage of rentals and fees revenue decreased to 35.9% for the first quarter of 2005 from 36.8% for the first quarter of 2004, resulting primarily from increased rentals in the rent-to-rent division, which depreciates its rental merchandise over a longer life than the sales and lease ownership division.

 

The 32.5% increase in interest expense is primarily a result of higher debt levels in the first quarter of 2005 compared to the first quarter of 2004.

 

The 41.9% increase in income tax expense is driven primarily by the increase in net earnings described below, offset slightly by a reduction in the effective tax rate relating to state income taxes in 2005.

 

Net Earnings

 

The 43.7% increase in net earnings to $18.4 million in the first quarter of 2005 from $12.8 million in the first quarter of 2004 is primarily due to the maturation of new Company-operated sales and lease ownership stores added over the past several years contributing to a 8.3% increase in same store revenues, and a 21.5% increase in franchise fees, royalty income, and other related franchise income.  As a percentage of total revenues, net earnings increased to 6.6% for the first quarter of 2005 from 5.3% for the first quarter of 2004.

 



 

Balance Sheet

 

Cash. The Company’s cash balance decreased to $4.5 million at March 31, 2005 from $5.9 million at December 31, 2004.  This decrease between periods is the result of an increase in the funds transfers between banks without right of offset as of March 31, 2005.

 

Rental Merchandise.  The $12.1 million increase in rental merchandise, net of accumulated depreciation, to $437.7 million on March 31, 2005 from $425.6 million on December 31, 2004, is primarily the result of a net increase of 30 Company-operated Sales and Lease Ownership stores and one fulfillment center since December 31, 2004.

 

Goodwill and Other Intangibles.  The $5.7 million increase in goodwill and other intangibles, to $80.6 million on March 31, 2005 from $74.9 million on December 31, 2004, is the result of a series of acquisitions of sales and lease ownership businesses, net of amortization of certain finite-life intangible assets.  The aggregate purchase price for these asset acquisitions totaled approximately $9.2 million, and the principal tangible assets acquired consisted of rental merchandise and certain fixtures and equipment.

 

Prepaid Expenses and Other Assets.  The $20.1 million decrease in prepaid expenses and other assets, to $30.0 million on March 31, 2005 from $50.1 million on December 31, 2004, is primarily the result of collection during the quarter of $15.1 million in income tax refunds that were receivable at December 31, 2004.

 

Credit Facilities. The $31.8 million decrease in the amounts we owe under our credit facilities to $84.9 million at March 31, 2005 from $116.7 million at last fiscal year end reflects net payments of our revolving credit facility during the first three months of 2005 with cash generated from operations and receipt of a federal income tax refund.

 

Liquidity and Capital Resources

 

General

 

Cash flows from operations for the three months ended March 31, 2005 and 2004 were $50.3 million and $11.1 million, respectively.  The increase in cash flows from operations is primarily attributable to receipt of a $15.0 million income tax refund and increased net earnings despite increased non-cash expense for depreciation and amortization.  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:

 

                  cash flow from operations

                  bank credit

                  trade credit with vendors

                  proceeds from the sale of rental return merchandise

                  private debt

                  stock offerings

 

At March 31, 2005, $13.9 million was outstanding under the Company’s revolving credit agreement.  The Company’s credit facilities balance decreased by approximately $31.8 million in the first three months of 2005.  The decrease reflects net payments of our revolving credit facility during the first three months of 2005 with cash generated from operations and receipt of a federal income tax refund.  We renegotiated our revolving credit agreement on May 28, 2004, extending the life of the agreement until May 28, 2007 and increasing the total available credit to $87.0 million.  From time to time we use interest rate swap agreements as part of our overall long-term financing program. We also have $50.0 million in aggregate principal amount of 6.88% senior unsecured notes due August 2009 currently outstanding, for which annual principal repayments of $10 million are first required in the third quarter of 2005.

 



 

Aaron Rents’ revolving credit agreement and senior unsecured notes, and the construction and lease facility and 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, we will be in default under these commitments, and all amounts would become due immediately. We were in compliance with all these covenants at March 31, 2005 and anticipate remaining in compliance for the foreseeable future.

 

As of March 31, 2005 Aaron Rents was authorized by its Board of Directors to purchase up to an additional 2,670,502 common shares.

 

We have a consistent history of paying dividends, having paid dividends for 18 consecutive years.  A $.013 per share dividend on Common Stock and Class A Common Stock was paid in January 2004 and July 2004.  In addition, in July 2004 our Board of Directors declared a 3-for-2 stock split, effected in the form of a 50% stock dividend, which was distributed to shareholders in August 2004.  In August 2004 the Board of Directors announced an increase in the frequency of the $.013 per share cash dividends on both Common Stock and Class A Common Stock from semi-annual to quarterly basis.  The payment for the third quarter of 2004 was distributed in October 2004 for a total fiscal year cash outlay of $2,042,000.  The payment of the fourth quarter of 2004 was paid in January 2005 for a total cash outlay of $647,000 in 2005.  Our Board of Directors announced the dividend for the first quarter of 2005 on February 23, 2005.  Subject to sufficient operating profits, to any future capital needs, and to other contingencies, we currently expect to continue our policy of paying dividends.

 

If we achieve our expected level of growth in our operations, we will supplement our expected cash flows from operations, existing credit facilities, vendor credit, and proceeds from the sale of rental return merchandise by expanding our existing credit facilities, by securing additional 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 liquidity in the ordinary course of business.

 

Commitments

 

Construction and Lease Facility. We maintain a $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, 2005 was approximately $24.8 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 110 basis points.  The lease facility contains residual value guarantee and default guarantee provisions that would require us to make payments to the lessor if the underlying properties are worth less at termination of the facility than specified values in the agreement. 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 $21.1 million and $24.8 million, respectively, at March 31, 2005.

 

Income Taxes.  Within the next twelve months, we anticipate that we will make cash payments for 2005 income taxes approximating $59.0 million.

 

Leases. Aaron Rents leases warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2019.  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 March 31, 2005, including leases under our construction and lease facility described above, are shown below.

 



 

The Company at times obtains ownership of store locations when it constructs free standing properties or when it acquires competitor’s locations.  For over 30 years Aaron Rents has from time to time sold and leased back properties it has owned.  The Company presently owns more than 40 various properties at a net book value in excess of $25 million which we plan to sell and leaseback in future periods.

 

We have 24 capital leases, 23 of which are with a limited liability company (“LLC”) whose managers and owners are fourteen Aaron Rents’ officers, including 10 of our executive officers, and its controlling shareholder, with no individual, including the controlling shareholder, owning more than 11% of the LLC.  Eleven of these related party leases relate to properties purchased from Aaron Rents in October and November 2004 by this LLC for a total purchase price of approximately $6.8 million.  This LLC is leasing back these properties to Aaron Rents for a 15-year term, with a five-year renewal at the Company’s option, at an aggregate annual rental of approximately $883,000.  Another eleven of these related party leases relate to properties purchased from Aaron Rents in December 2002 by the same LLC for a total purchase price of approximately $5.0 million.  This LLC is leasing back these properties to Aaron Rents for a 15-year term at an aggregate annual rental of approximately $702,000. 

 

The last related party capital lease relates to a property sold by Aaron Rents to a second LLC owned solely by the Company’s chairman, chief executive officer and controlling shareholder and by its president and chief operating officer, for $6.3 million in April 2002 and leased back to Aaron Rents for a 15-year term at an annual rental of approximately $681,000.

 

The Company does not currently plan to enter into any similar related party transactions in the future.  See Note D to the Consolidated Financial Statements in the 2004 Annual Report on Form 10-K.

 

Franchise and Residual Value Guaranty.  We have guaranteed the borrowings of certain independent franchisees under a franchise loan program with several banks.  However, due to franchisee borrowing limits, we believe any losses associated with any defaults would be mitigated through recovery of rental merchandise and other assets.  Since its inception, we have had no losses associated with the franchisee loan and guaranty program.  The Company believes the likelihood of any significant amounts being funded in connection with these commitments to be remote.

 

Contractual Obligations and Commitments.  The following table shows the Company’s approximate contractual obligations and commitments to make future payments as of March 31, 2005:

 

 

(In Thousands)

 

Total

 

Period Less
Than 1 Year

 

Period 2-3
Years

 

Period 4-5
Years

 

Period Over
5 Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Facilities, Excluding Capital Leases

 

$

67,250

 

$

10,004

 

$

33,926

 

$

20,012

 

$

3,308

 

Capital Leases

 

17,651

 

600

 

1,461

 

1,953

 

13,637

 

Operating Leases

 

155,046

 

40,374

 

60,713

 

31,152

 

22,807

 

Total Contractual Cash Obligations

 

$

239,947

 

$

50,978

 

$

96,100

 

$

53,117

 

$

39,752

 

 

The following table shows the Company’s approximate commercial commitments as of March 31, 2005:

 

(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

 

$

105,443

 

$

105,443

 

$

 

$

 

$

 

Residual Value Guarantee Under Operating Leases

 

21,149

 

 

 

21,149

 

 

 

 

 

Total Commercial Commitments

 

$

126,592

 

$

105,443

 

$

21,149

 

$

 

$

 

 

Market Risk

 

We manage our 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 to a large extent the risk of counterparty default.

 



 

At March 31, 2005, we had swap agreements with total notional principal amounts of $20.0 million that effectively fixed the interest rates on obligations in the notional amount of $20.0 million of debt under our variable payment construction and lease facility at an average rate of 7.5% until June 2005.  The fair value of interest rate swap agreements was a liability of approximately $0.2 million at March 31, 2005. A 1.0% 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 for trading or speculative purposes.

 

New Accounting Pronouncements

 

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

 



 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

 

The information called for by this item is provided under Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, and Part I, Item 2 of this Quarterly Report above.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures.

 

An evaluation of the Company’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 Quarterly Report on Form 10-Q.

 

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 the date of the evaluation 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 Rents’ internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, during the Company’s first quarter of 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 



 

PART II – OTHER INFORMATION

 

ITEM 6. EXHIBITS:

 

The following exhibits are furnished herewith:

 

15 Letter Re: Unaudited Interim Financial Information.

 

31(a) Certification of Chief Executive Officer, pursuant to Rules 13a-14(a)/15d-14(a).

 

31(b) Certification of Chief Financial Officer, pursuant to Rules 13a-14(a)/15d-14(a).

 

32(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.

 

32(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.

 



 

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.

 

 

AARON RENTS, INC.

 

 

(Registrant)

 

 

 

Date – May 10, 2005

By:

/s/ Gilbert L. Danielson

 

 

 

Gilbert L. Danielson

 

 

Executive Vice President,

 

 

Chief Financial Officer

 

 

 

 

 

 

Date – May 10, 2005

 

/s/ Robert P. Sinclair, Jr.

 

 

 

Robert P. Sinclair, Jr.

 

 

Vice President,

 

 

Corporate Controller