Summary of AARON'S INC - Yahoo! Finance

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 Item 1A, "Risk Factors," in the Company's Annual Report on Form 10-K for the Year Ended December 31, 2008, 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 and nine months ended September 30, 2009, including the notes to those statements, appearing elsewhere in this report. We also suggest that management's discussion and analysis appearing in this report 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, 2008.
Overview
Aaron's, Inc. is a leading specialty retailer of consumer electronics, computers, office furniture, household appliances and accessories. Our major operating divisions are the Aaron's Sales & Lease Ownership Division and the MacTavish Furniture Industries Division, which manufactures and supplies nearly one-half of the furniture and related accessories leased and sold in our stores. Aaron's has demonstrated strong revenue growth over the last three years. Total revenues have increased from $1.228 billion in 2006 to $1.593 billion in 2008, representing a compound annual growth rate of 13.9%. Total revenues from continuing operations for the three months ended September 30, 2009, were $415.3 million, an increase of $27.2 million, or 7.0%, over the comparable period in 2008. Total revenues from continuing operations for the nine months ended September 30, 2009, were $1.307 billion, an increase of $118.8 million, or 10.0%, over the comparable period in 2008.
Most of our growth comes from the opening of new sales and lease ownership stores and increases in same store revenues from previously opened stores. We spend on average approximately $600,000 in the first year of operation of a new store, which includes purchases of lease merchandise, investments in leasehold improvements and financing first year start-up costs. Our new sales and lease ownership stores typically achieve revenues of approximately $1.1 million in their third year of operation. Our comparable stores open more than three years normally achieve approximately $1.4 million in unit revenues, which we believe represents a higher unit revenue volume than the typical rent-to-own store. Most of our stores are cash flow positive in the second year of operations following their opening.
We believe that the decline in the number of furniture stores, the limited number of retailers that focus on credit installment sales to lower and middle income consumers and increased consumer credit constraints during the current economic downturn have created a market opportunity for our unique sales and lease ownership concept. The traditional retail consumer durable goods market is much larger than the lease market, leaving substantial potential for growth for our sales and lease ownership division. We believe that the segment of the population targeted by our sales and lease ownership division comprises approximately 50% of all households in the United States and that the needs of these consumers are generally underserved. However, although we believe our business is 'recession-resistant', with those who are no longer able to access consumer credit becoming new customers of Aaron's, there can be no guarantee that if the current economic downturn deepens or continues for an extensive period of time that our customer base will not curtail spending on household merchandise.
We also use our franchise program to help us expand our sales and lease ownership concept more quickly and into more areas than we otherwise would by opening only Company-operated stores. Franchise royalties and other related fees represent a growing source of high margin revenue for us, accounting for approximately $45.0 million of revenues in 2008, up from $33.6 million in 2006, representing a compounded annual growth rate of 15.7%. Total revenues from franchise royalties and fees for the three months ended September 30, 2009, were $12.9 million, an increase of $1.8 million, or 15.8%, over the comparable period in 2008. Total revenues from franchise royalties and fees for the nine months ended September 30, 2009, were $38.9 million, an increase of $5.8 million, or 17.7%, over the comparable period in 2008.

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Same Store Revenues. We believe the changes in same store revenues are a key performance indicator. For the three months ended September 30, 2009, we calculated this amount by comparing revenues for the three months ended September 30, 2009 to revenues for the comparable period in 2008 for all stores open for the entire 15-month period ended September 30, 2009, excluding stores that received lease agreements from other acquired, closed, or merged stores. For the nine months ended September 30, 2009, we calculated this amount by comparing revenues for the nine months ended September 30, 2009 to revenues for the comparable period in 2008 for all stores open for the entire 24-month period ended September 30, 2009, excluding stores that received lease agreements from other acquired, closed or merged stores. Key Components of Earnings
In this management's discussion and analysis section, we review the Company's consolidated results.
Revenues. We separate our total revenues into five components: lease revenues and fees, retail sales, non-retail sales, franchise royalties and fees, and other. Lease revenues and fees includes all revenues derived from lease agreements from our sales and lease ownership and office furniture stores, including agreements that result in our customers acquiring ownership at the end of the term. Retail sales represent sales of both new and lease return merchandise from our sales and lease ownership and office furniture stores. Non-retail sales mainly represent merchandise sales to our sales and lease ownership division franchisees. Franchise royalties and fees represent fees from the sale of franchise rights and royalty payments from franchisees, as well as other related income from our franchised stores. Other revenues include, at times, income from gains on sales of sales and lease ownership businesses and other miscellaneous revenues.
Cost of Sales. We separate our cost of sales into two components: retail and non-retail. Retail cost of sales represents the original or depreciated cost of merchandise sold through our Company-operated stores. Non-retail cost of sales primarily represents the cost of merchandise sold to our franchisees. Depreciation of Lease Merchandise. Depreciation of lease merchandise reflects the expense associated with depreciating merchandise leased to customers and held for lease by our Company-operated sales and lease ownership and office furniture stores.
Critical Accounting Policies
Revenue Recognition. Lease revenues are recognized in the month they are due on the accrual basis of accounting. For internal management reporting purposes, lease revenues from the sales and lease ownership division are recognized as revenue in the month the cash is collected. On a monthly basis, we record a deferral of revenue for lease payments received prior to the month due and an accrual for lease revenues due but not yet received, net of allowances. Our revenue recognition accounting policy matches the lease revenue with the corresponding costs, mainly depreciation, associated with the lease merchandise. As of September 30, 2009 and December 31, 2008, we had a revenue deferral representing cash collected in advance of being due or otherwise earned totaling $29.3 million and $32.2 million, respectively, and an accrued revenue receivable, net of allowance for doubtful accounts, based on historical collection rates of $5.0 million and $4.8 million, respectively. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt by the franchisee, and revenues from such sales to other customers are recognized at the time of shipment.
Lease Merchandise. Our sales and lease ownership division depreciates merchandise over the agreement period, generally 12 to 24 months when leased, and 36 months when not leased, to 0% salvage value. Our office furniture stores depreciate merchandise over the lease ownership agreement period, generally 12 to 24 months when leased, and 60 months when not leased, or when on a rent-to-rent agreement, to 0% salvage value. Sales and lease ownership merchandise is generally depreciated at a faster rate than our office furniture merchandise.
Our policies require weekly lease merchandise counts by store managers and write-offs for unsalable, damaged, or missing merchandise inventories. Full physical inventories are generally taken at our fulfillment and manufacturing facilities two to four times a year with appropriate provisions made for missing, damaged and unsalable merchandise. In addition, we monitor lease merchandise levels and mix by division, store and fulfillment center, as well as the average age of merchandise on hand. If unsalable lease merchandise cannot be returned to vendors, its carrying value is adjusted to net realizable value or written off. All lease merchandise is available for lease and sale. We record lease merchandise carrying value adjustments on the allowance method, which estimates the merchandise losses incurred but not yet identified by management as of the end of the accounting period.

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Leases and Closed Store Reserves. The majority of our Company-operated stores are operated from leased facilities under operating lease agreements. The majority of leases are for periods that do not exceed five years, although lease terms range in length up to 15 years. Leasehold improvements related to these leases are generally amortized over periods that do not exceed the lesser of the lease term or five years. While some of our leases do not require escalating payments, for the leases which do contain such provisions we record the related lease expense on a straight-line basis over the lease term. We do not generally obtain significant amounts of lease incentives or allowances from landlords. Any incentive or allowance amounts we receive are recognized ratably over the lease term.
From time to time, we close or consolidate stores. Our primary costs associated with closing or consolidating stores are the future lease payments and related commitments. We record an estimate of the future obligation related to closed or consolidated stores based upon the present value of the future lease payments and related commitments, net of estimated sublease income which we base upon historical experience. As of September 30, 2009 and December 31, 2008, our reserve for closed or consolidated stores was $2.6 million and $3.0 million, respectively. Due to changes in the market conditions, our estimates related to sublease income may change and as a result, our actual liability may be more or less than the liability recorded at September 30, 2009.
Insurance Programs. Aaron's maintains insurance contracts to fund workers compensation, vehicle liability, general liability and group health insurance claims. Using actuarial analysis and projections, we estimate the liabilities associated with open and incurred but not reported workers compensation, vehicle liability and general liability claims. This analysis is based upon an assessment of the likely outcome or historical experience, net of any stop loss or other supplementary coverage. We also calculate the projected outstanding plan liability for our group health insurance program. Our gross liability for workers compensation insurance claims, vehicle liability, general liability and group health insurance was estimated at $21.8 million and $19.7 million at September 30, 2009 and December 31, 2008, respectively. In addition, we have prefunding balances on deposit with the insurance carriers of $18.6 million and $20.0 million at September 30, 2009 and December 31, 2008, respectively. If we resolve insurance claims for amounts that are in excess of our current estimates and within policy stop loss limits, we will be required to pay additional amounts beyond those accrued at September 30, 2009. The assumptions and conditions described above reflect management's best assumptions and estimates, but these items involve inherent uncertainties as described above, which may or may not be controllable by management. As a result, the accounting for such items could result in different amounts if management used different assumptions or if different conditions occur in future periods.

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Results of Operations
Three months ended September 30, 2009 compared with three months ended
September 30, 2008
The Aaron's Corporate Furnishings division was disposed of on November 6, 2008
and is reflected as a discontinued operation for all periods presented. The
following table shows key selected financial data for the three month periods
ended September 30, 2009 and 2008, and the changes in dollars and as a
percentage to 2009 from 2008:

                                                                                                 Dollar Increase/         % Increase/
                                             Three Months Ended        Three Months Ended         (Decrease) to          (Decrease) to
(In Thousands)                               September 30, 2009        September 30, 2008         2009 from 2008        2009 from 2008
REVENUES:
Lease Revenues and Fees                     $            320,603      $            291,103      $           29,500                 10.1 %
Retail Sales                                               8,846                    10,230                  (1,384 )              (13.5 )
Non-Retail Sales                                          69,501                    70,691                  (1,190 )               (1.7 )
Franchise Royalties and Fees                              12,881                    11,127                   1,754                 15.8
Other                                                      3,428                     4,869                  (1,441 )              (29.6 )

                                                         415,259                   388,020                  27,239                  7.0

COSTS AND EXPENSES:
Retail Cost of Sales                                       5,283                     6,266                    (983 )              (15.7 )
Non-Retail Cost of Sales                                  63,503                    64,752                  (1,249 )               (1.9 )
Operating Expenses                                       193,440                   175,339                  18,101                 10.3
Depreciation of Lease Merchandise                        117,024                   106,962                  10,062                  9.4
Interest                                                   1,010                     2,243                  (1,233 )              (55.0 )

                                                         380,260                   355,562                  24,698                  6.9

EARNINGS FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES                                       34,999                    32,458                   2,541                  7.8

INCOME TAXES                                              10,344                    12,621                  (2,277 )              (18.0 )

NET EARNINGS FROM CONTINUING OPERATIONS                   24,655                    19,837                   4,818                 24.3
NET (LOSS) EARNINGS FROM DISCONTINUED
OPERATIONS                                                   (19 )                   1,241                  (1,260 )             (101.5 )

NET EARNINGS                                $             24,636      $             21,078      $            3,558                 16.9 %

Revenues. The 7.0% increase in total revenues, to $415.3 million for the three months ended September 30, 2009, from $388.0 million in the comparable period in 2008, was due mainly to a $29.5 million, or 10.1%, increase in lease revenues and fees, plus a $1.8 million, or 15.8%, increase in franchise royalties and fees. The $29.5 million increase in lease revenues and fees was attributable to our sales and lease ownership division, which had a 6.3% increase in same store revenues during the third quarter of 2009.
The 13.5% decrease in revenues from retail sales, to $8.8 million for the three months ended September 30, 2009 from $10.2 million in the comparable period in 2008, was due to decreased demand.
The 1.7% decrease in non-retail sales (which mainly represents merchandise sold to our franchisees), to $69.5 million for the three months of September 30, 2009, from $70.7 million for the comparable period in 2008, was mainly due to lower costs of electronic products shipped to our franchised stores, although overall unit shipments of all items increased 8% in the third quarter of 2009 over the comparable period in 2008.
The total number of franchised sales and lease ownership stores at September 30, 2009, was 569, reflecting a net addition of 59 stores since September 30, 2008. The 15.8% increase in franchise royalties and fees, to $12.9 million for the three months ended September 30, 2009, from $11.1 million for the comparable period in 2008, primarily reflects an increase in royalty income from franchisees, increasing 13.7% to $10.4 million for the three months ended September 30, 2009, compared to $9.1 million for the three months ended September 30, 2008. The increase in royalty income is due primarily to the growth in the number of franchised stores and same store growth in the revenues in their existing stores.

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Other revenues decreased 29.6% to $3.4 million for the three months ended September 30, 2009, from $4.9 million for the comparable period in 2008. Included in other revenues for the three months ended September 30, 2009 and 2008, respectively, is a $193,000 and a $2.6 million gain on sales of Company-operated stores.
Cost of Sales. Retail cost of sales decreased 15.7% to $5.3 million for the three months ended September 30, 2009, compared to $6.3 million for the comparable period in 2008, and as a percentage of retail sales, decreased to 59.7% from 61.3% in 2008 as a result of improved pricing and lower product cost. Non-retail cost of sales decreased 1.9%, to $63.5 million for the three months ended September 30, 2009, from $64.8 million for the comparable period in 2008, and as a percentage of non-retail sales, decreased slightly to 91.4% from 91.6% as a result of higher cost of certain products without improved pricing. Expenses. Operating expenses for the three months ended September 30, 2009, increased $18.1 million to $193.4 million from $175.3 million for the comparable period in 2008, a 10.3% increase. As a percentage of total revenues, operating expenses were 46.6% for the three months ended September 30, 2009, and 45.2% for the comparable period in 2008. Operating expenses increased as a percentage of total revenues for the three months ended September 30, 2009 mainly due to the addition of 59 company-operated sales and lease ownership stores since September 30, 2008 and increased advertising expenses. Additionally, in the third quarter of 2009 the Company recorded a $2.2 million pre-tax charge to operating expenses relating to the write-down of certain lease merchandise and the impairment of long-lived assets associated with its Aaron's Office Furniture stores.
Depreciation of lease merchandise increased $10.0 million to $117.0 million for the three months ended September 30, 2009, from $107.0 million during the comparable period in 2008, a 9.4% increase. As a percentage of total lease revenues and fees, depreciation of lease merchandise was 36.5% and 36.7%, for the three months ended September 30, 2009, and 2008, respectively. Interest expense decreased to $1.0 million for the three months ended September 30, 2009, compared with $2.2 million for the comparable period in 2008, a 55.0% decrease. The decrease in interest expense was due to lower debt levels during the third quarter of 2009.
Income tax expense decreased $2.3 million to $10.3 million for the three months ended September 30, 2009, compared with $12.6 million for the comparable period in 2008, representing a 18.0% decrease. Aaron's effective tax rate was 29.6% in 2009 and 38.9% in 2008. The decrease was due to the favorable impact of a $2.3 million reversal of previously recorded liabilities for uncertain tax positions.
Net Earnings from Continuing Operations. Net earnings increased $4.8 million to $24.7 million for the three months ended September 30, 2009, compared with $19.8 million for the comparable period in 2008, representing a 24.3% increase. As a percentage of total revenues, net earnings from continuing operations were 5.9% for the three months ended September 30, 2009, and 5.1% for the three months ended September 30, 2008. The increase in net earnings was primarily the result of the maturing of new Company-operated sales and lease ownership stores added over the past several years, contributing to a 6.3% increase in same store revenues, and a 15.8% increase in franchise royalties and fees. Additionally, other income for the three months ended September 30, 2009 and 2008, respectively, included a $193,000 and $2.6 million gain on the sales of Company-operated stores.
Discontinued Operations. Net earnings or losses from discontinued operations (which represents earnings or losses from the Aaron's Corporate Furnishings division that was sold on November 6, 2008), net of tax, were a $19,000 loss for the three months ended September 30, 2009, compared to earnings of $1.2 million for the comparable period in 2008.

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Nine months ended September 30, 2009 compared with nine months ended September 30, 2008
The Aaron's Corporate Furnishings division was disposed of on November 6, 2008 and is reflected as a discontinued operation for all periods presented. The following table shows key selected financial data for the nine month periods ended September 30, 2009 and 2008, and the changes in dollars and as a percentage to 2009 from 2008:

                                                                                             Dollar Increase/         % Increase/
                                            Nine Months Ended        Nine Months Ended         (Decrease) to         (Decrease) to
(In Thousands)                             September 30, 2009       September 30, 2008        2009 from 2008        2009 from 2008
REVENUES:
Lease Revenues and Fees                    $           989,216      $           885,554      $         103,662                 11.7 %
Retail Sales                                            34,211                   32,363                  1,848                  5.7
Non-Retail Sales                                       230,302                  222,180                  8,122                  3.7
Franchise Royalties and Fees                            38,908                   33,060                  5,848                 17.7
Other                                                   13,882                   14,557                   (675 )               (4.6 )

                                                     1,306,519                1,187,714                118,805                 10.0

COSTS AND EXPENSES:
Retail Cost of Sales                                    20,502                   19,839                    663                  3.3
Non-Retail Cost of Sales                               210,311                  203,222                  7,089                  3.5
Operating Expenses                                     575,528                  529,001                 46,527                  8.8
Depreciation of Lease Merchandise                      360,143                  323,600                 36,543                 11.3
Interest                                                 3,450                    6,593                 (3,143 )              (47.7 )

                                                     1,169,934                1,082,255                 87,679                  8.1

EARNINGS FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES                                    136,585                  105,459                 31,126                 29.5

INCOME TAXES                                            48,744                   40,698                  8,046                 19.8

NET EARNINGS FROM CONTINUING OPERATIONS                 87,841                   64,761                 23,080                 35.6
NET (LOSS) EARNINGS FROM DISCONTINUED
OPERATIONS                                                (304 )                  4,349                 (4,653 )             (107.0 )

NET EARNINGS                               $            87,537      $            69,110      $          18,427                 26.7 %

Revenues. The 10.0% increase in total revenues, to $1.307 billion for the nine months ended September 30, 2009, from $1.188 billion in the comparable period in 2008, was due mainly to a $103.7 million, or 11.7%, increase in lease revenues and fees, plus an $8.1 million, or 3.7%, increase in non-retail sales. The $103.7 million increase in lease revenues and fees was attributable to our sales and lease ownership division, which had a 4.5% increase in same store revenues during the 24-month period ended September 30, 2009.
The 5.7% increase in revenues from retail sales, to $34.2 million for the nine months ended September 30, 2009, from $32.4 million in the comparable period in 2008, was due to increased demand in our sales and lease ownership stores during the first part of 2009 and the addition of 59 company-operated sales and lease ownership stores since September 30, 2008.
The 3.7% increase in non-retail sales (which mainly represents merchandise sold to our franchisees), to $230.3 million for the nine months of September 30, 2009, from $222.2 million for the comparable period in 2008, was due to the growth of our franchise operations. The total number of franchised sales and lease ownership stores at September 30, 2009, was 569, reflecting a net addition of 59 stores since September 30, 2008.
The 17.7% increase in franchise royalties and fees, to $38.9 million for the nine months ended September 30, 2009, from $33.1 million for the comparable period in 2008, primarily reflects an increase in royalty income from franchisees, increasing 15.7% to $31.3 million for the nine months ended September 30, 2009, compared to $27.0 million for the nine months ended September 30, 2008. The increase in royalty income is due primarily to the growth in the number of franchised stores and same store growth in the revenues in their existing stores.

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Other revenues decreased 4.6% to $13.9 million for the nine months ended September 30, 2009, from $14.6 million for the comparable period in 2008. Included in other revenues for the nine months ended September 30, 2009 and 2008, is a $6.3 million and an $8.4 million gain, respectively, on sales of Company-operated stores. . . .