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AAN > SEC Filings for AAN > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for AARON'S INC


7-Nov-2012

Quarterly Report


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 general economic conditions, our growth strategy, competition, trends in corporate spending, our franchise program, litigation, customer privacy, information security, customer demand, government regulation and the risks and uncertainties discussed under Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission, and in our 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, 2012 and 2011, 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, 2011.

Overview

Aaron's, Inc. ("Aaron's") is a leader in the sales and lease ownership and specialty retailing of residential furniture, consumer electronics, computers, home appliances and accessories. Our major operating divisions are the Aaron's Sales & Lease Ownership division, the HomeSmart division and the Woodhaven Furniture Industries division, which manufactures and supplies nearly one-half of the upholstered furniture and bedding leased and sold in our stores.

Aaron's has demonstrated strong revenue growth over the last three years. Total revenues have increased from $1.753 billion in 2009 to $2.022 billion in 2011, representing a compound annual growth rate of 7.4%. Total revenues from operations for the three months ended September 30, 2012 were $529.5 million, an increase of $44.8 million, or 9.2%, over the comparable period in 2011. Total revenues from operations for the nine months ended September 30, 2012 were $1.654 billion, an increase of $154.5 million, or 10.3%, over the comparable period in 2011.

The majority 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 $750,000 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 revenues per store, which we believe represents a higher per store 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 conditions 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 climate continues for an extensive period of time or there is another economic downturn, our customer base will not curtail spending on household merchandise.


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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 $63.3 million of revenues in 2011, up from $52.9 million in 2009, representing a compound annual growth rate of 9.4%. Total revenues from franchise royalties and fees for the three months ended September 30, 2012 were $16.0 million, an increase of $92,000, or 0.6%, over the comparable period in 2011. Total revenues from franchise royalties and fees for the nine months ended September 30, 2012 were $49.6 million, an increase of $2.2 million, or 4.7%, over the comparable period in 2011.

Same Store Revenues. We believe the changes in same store revenues are a key performance indicator. For the three months ended September 30, 2012, we calculated this amount by comparing revenues for the three months ended September 30, 2012 to revenues for the comparable period in 2011 for all stores open for the entire 15-month period ended September 30, 2012, excluding stores that received lease agreements from other acquired, closed, or merged stores. For the nine months ended September 30, 2012, we calculated this amount by comparing revenues for the nine months ended September 30, 2012 to revenues for the comparable period in 2011 for all stores open for the entire 24-month period ended September 30, 2012, 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 our 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 include all revenues derived from lease agreements at Company-operated stores, including agreements that result in our customers acquiring ownership at the end of the term. Retail sales represent sales of both new and returned lease merchandise from Company-operated stores. Non-retail sales mainly represent new merchandise sales to our Aaron's Sales & Lease Ownership division franchisees. Franchise royalties and fees represent fees from the sale of franchise rights and royalty payments from franchisees, as well as other related income from our franchised stores. Other revenues include, at times, income from gains on asset dispositions and other miscellaneous revenues.

Retail Cost of Sales. Retail cost of sales represents the original or depreciated cost of merchandise sold through our Company-operated stores.

Non-Retail Cost of Sales. Non-retail cost of sales primarily represents the cost of merchandise sold to our franchisees.

Operating Expenses. Operating expenses include personnel costs, selling costs, occupancy costs, delivery costs, and lease merchandise write-offs, among other expenses.

Lawsuit (Income)Expense. Lawsuit (income) expense consists of the net cost of paying legal judgments and settlement amounts; defense costs are included in operating expenses.

Retirement Charge. Retirement charge represents costs associated with the retirement of the Company's founder and Chairman of the Board.

Depreciation of Lease Merchandise. Depreciation of lease merchandise reflects the expense associated with depreciating merchandise held for lease and leased to customers by our Company-operated stores.

Critical Accounting Policies

Refer to the 2011 Annual Report on Form 10-K.


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Results of Operations

Three months ended September 30, 2012 compared with three months ended September 30, 2011

For the three months ended September 30, 2012 and 2011, the Company's Sales and Lease Ownership, Franchise and HomeSmart segments accounted for substantially all of the operations of the Company and, therefore, unless otherwise noted only the material changes are discussed within these three segments. The production of our Manufacturing segment, consisting of our Woodhaven Furniture Industries division, is leased or sold through our Company-operated and franchised stores, and consequently that segment's revenues and earnings before income taxes are eliminated through the elimination of intersegment revenues and intersegment profit.

                                                                                                  Dollar Increase/            % Increase/
                                        Three Months Ended           Three Months Ended            (Decrease) to             (Decrease) to
(In Thousands)                          September 30, 2012           September 30, 2011            2012 from 2011            2012 from 2011
REVENUES:
Lease Revenues and Fees                $            414,490         $            370,350         $           44,140                     11.9 %
Retail Sales                                          7,912                        8,298                       (386 )                   (4.7 )
Non-Retail Sales                                     87,221                       86,100                      1,121                      1.3
Franchise Royalties and Fees                         15,981                       15,889                         92                      0.6
Other                                                 3,906                        4,094                       (188 )                   (4.6 )

                                                    529,510                      484,731                     44,779                      9.2

COSTS AND EXPENSES:
Retail Cost of Sales                                  4,696                        4,872                       (176 )                   (3.6 )
Non-Retail Cost of Sales                             79,681                       78,508                      1,173                      1.5
Operating Expenses                                  237,291                      218,319                     18,972                      8.7
Retirement Charge                                    10,394                           -                      10,394                    100.0
Depreciation of Lease Merchandise                   150,783                      136,727                     14,056                     10.3

                                                    482,845                      438,426                     44,419                     10.1

OPERATING PROFIT                                     46,665                       46,305                        360                      0.8
Interest Income                                         932                          464                        468                    100.9
Interest Expense                                     (1,553 )                     (1,677 )                     (124 )                   (7.4 )

EARNINGS BEFORE INCOME TAXES                         46,044                       45,092                        952                      2.1
INCOME TAXES                                         17,103                       17,047                         56                      0.3

NET EARNINGS                           $             28,941         $             28,045         $              896                      3.2 %

Revenues

The 9.2% increase in total revenues, to $529.5 million for the three months ended September 30, 2012, from $484.7 million for the comparable period in 2011, was due mainly to a $20.9 million, or 4.5%, increase in revenues from the Sales and Lease Ownership segment, an $8.4 million, or 146.0%, increase in revenues from the HomeSmart segment and a $92,000, or 0.6%, increase in revenues from the Franchise segment.

Sales and Lease Ownership segment revenues increased due to a 5.9% increase in lease revenues and fees and 1.3% increase in non-retail sales, partially offset by a 4.7% decrease in retail sales. Lease revenues and fees within the Sales and Lease Ownership segment increased due to a net addition of 58 Company-operated stores since September 30, 2011 and a 6.2% increase in same store revenues. Non-retail sales increased primarily due to the net addition of 25 franchised stores since September 30, 2011, and a 3.2% increase in same store revenues of existing franchised stores. Retail sales decreased primarily as a result of the Company discouraging the clearance sale of previously leased product in favor of refurbishing and re-leasing the merchandise.


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HomeSmart segment revenues increased by $8.4 million primarily due to the growth in the number of HomeSmart stores to 78, reflecting a net addition of 22 stores since September 30, 2011.

Franchise segment revenues increased primarily due to a $635,000 or 5.0%, increase in royalty income from franchisees, partially offset by decreases in franchise fees. Franchise royalty income increased primarily due to the growth in the number of franchised stores and a 3.2% increase in same store revenues of existing franchised stores. The total number of franchised sales and lease ownership stores at September 30, 2012 was 724, reflecting a net addition of 25 stores since September 30, 2011.

The $44.1 million increase in lease revenues and fees, the $1.1 million increase in non-retail sales and the $386,000 decrease in retail sales were primarily attributable to our Sales and Lease Ownership segment discussed above. The $92,000 increase in franchise royalties and fees was attributable to our Franchise segment also discussed above.

Included in other revenues for the three months ended September 30, 2012 and 2011 are gains of $2,000 and $1.7 million, respectively, on sales of Company-operated stores.

Cost and Expenses

Retail cost of sales decreased $176,000, or 3.6%, to $4.7 million for the three months ended September 30, 2012, from $4.9 million for the comparable period in 2011, and as a percentage of retail sales, increased to 59.4% from 58.7% due to a change in the mix of products.

Non-retail cost of sales increased 1.5% to $79.7 million for the three months ended September 30, 2012, from $78.5 million for the comparable period in 2011, and as a percentage of non-retail sales, increased to 91.4% from 91.2% due to a change in the mix of products.

Operating expenses for the three months ended September 30, 2012 increased $19.0 million, or 8.7%, to $237.3 million from $218.3 million for the comparable period in 2011 primarily as a result of increased operating expenses related to the growth of the sales and lease ownership business and increased legal fees and expenses associated with the Company's privacy and data security initiatives. As a percentage of total revenues, operating expenses were 44.8% for the three months ended September 30, 2012 and 45.0% for the comparable period in 2011.

Retirement charge for the three months ended September 30, 2012 was $10.4 million, representing costs associated with the retirement of the Company's founder and Chairman of the Board.

Depreciation of lease merchandise increased $14.1 million to $150.8 million for the three months ended September 30, 2012 from $136.7 million during the comparable period in 2011, a 10.3% increase. As a percentage of total lease revenues and fees, depreciation of lease merchandise decreased slightly to 36.4% for the three months ended September 30, 2012 from 36.9% for the three months ended September 30, 2011.

Operating Profit

Interest income increased to $932,000 for the three months ended September 30, 2012, compared with $464,000 for the comparable period in 2011, a 100.9% increase. The increase in interest income is due to higher average investment balances during the three months ended September 30, 2012, resulting in higher returns.

Interest expense decreased to $1.6 million for the three months ended September 30, 2012, compared with $1.7 million for the comparable period in 2011, a 7.4% decrease. The decrease in interest expense was due to lower average debt levels during the third quarter of 2012 as a result of the repayment at maturity of the remaining $12 million principal outstanding under the Company's July 2005 senior unsecured notes.


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Income Taxes. Income tax expense increased $56,000 to $17.1 million for the three months ended September 30, 2012, compared to $17.0 million for the comparable period in 2011, representing a 0.3% increase. The effective tax rate was 37.1% and 37.8% for the three months ended September 30, 2012 and 2011, respectively. The decrease in the effective tax rate to 37.1% in the three months ended September 30, 2012, from 37.8% in the comparable period in 2011, was due to changes in permanent items, principally the anticipated availability of the Section 199 domestic manufacturing deduction in 2012. The deduction was not available in 2011 due to the net operating loss caused by 100% bonus depreciation.

Net Earnings. Net earnings increased $896,000 to $28.9 million for the three months ended September 30, 2012, compared with $28.0 million for the comparable period in 2011, representing a 3.2% increase. As a percentage of total revenues, net earnings were 5.5% and 5.8% for the three month periods ended September 30, 2012 and 2011, respectively. The increased net earnings resulted primarily from the maturing of new Company-operated and franchised sales and lease ownership stores added over the past several years, contributing to a 6.5% increase in same store revenues. Additionally, the three months ended September 30, 2012 included $10.4 million in retirement charges associated with the retirement of the Company's founder and Chairman of the Board.

Nine months ended September 30, 2012 compared with nine months ended September 30, 2011

For the nine months ended September 30, 2012 and 2011, the Company's Sales and Lease Ownership, Franchise and HomeSmart segments accounted for substantially all of the operations of the Company and, therefore, unless otherwise noted only the material changes are discussed within these three segments. The production of our Manufacturing segment, consisting of our Woodhaven Furniture Industries division, is leased or sold through our Company-operated and franchised stores, and consequently that segment's revenues and earnings before income taxes are eliminated through the elimination of intersegment revenues and intersegment profit.

                                                                                              Dollar Increase/           % Increase/
                                       Nine Months Ended           Nine Months Ended            (Decrease) to           (Decrease) to
(In Thousands)                         September 30, 2012          September 30, 2011          2012 from 2011          2012 from 2011
REVENUES:
Lease Revenues and Fees               $          1,264,564        $          1,139,681        $         124,883                   11.0 %
Retail Sales                                        30,119                      30,491                     (372 )                 (1.2 )
Non-Retail Sales                                   299,160                     271,154                   28,006                   10.3
Franchise Royalties and Fees                        49,628                      47,408                    2,220                    4.7
Other                                               10,654                      10,892                     (238 )                 (2.2 )

                                                 1,654,125                   1,499,626                  154,499                   10.3

COSTS AND EXPENSES:
Retail Cost of Sales                                17,120                      18,157                   (1,037 )                 (5.7 )
Non-Retail Cost of Sales                           273,143                     246,718                   26,425                   10.7
Operating Expenses                                 709,774                     646,119                   63,655                    9.9
Lawsuit (Income) Expense                           (35,500 )                    36,500                  (72,000 )               (197.3 )
Retirement Charge                                   10,394                          -                    10,394                  100.0
Depreciation of Lease Merchandise                  457,350                     415,405                   41,945                   10.1

                                                 1,432,281                   1,362,899                   69,382                    5.1

OPERATING PROFIT                                   221,844                     136,727                   85,117                   62.3
Interest Income                                      2,708                         934                    1,774                  189.9
Interest Expense                                    (4,889 )                    (3,023 )                  1,866                   61.7

EARNINGS BEFORE INCOME TAXES                       219,663                     134,638                   85,025                   63.2
INCOME TAXES                                        83,252                      51,405                   31,847                   62.0

NET EARNINGS                          $            136,411        $             83,233        $          53,178                   63.9 %


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Revenues

The 10.3% increase in total revenues, to $1.654 billion for the nine months ended September 30, 2012, from $1.500 billion for the comparable period in 2011, was due mainly to a $109.2 million, or 7.6%, increase in revenues from the Sales and Lease Ownership segment, a $33.6 million increase in revenues from the HomeSmart segment and a $2.2 million, or 4.7%, increase in revenues from the Franchise segment.

Sales and Lease Ownership segment revenues increased due to a 7.4% increase in lease revenues and fees and 10.3% increase in non-retail sales, partially offset by the 1.2% decrease in retail sales. Lease revenues and fees within the Sales and Lease Ownership segment increased due to a net addition of 58 Company-operated stores since September 30, 2011 and a 4.8% increase in same store revenues. Non-retail sales increased primarily due to the net addition of 25 franchised stores since September 30, 2011, and a 5.0% increase in same store revenues of existing franchised stores. Retail sales decreased primarily as a result of the Company discouraging the clearance sale of previously leased product in favor of refurbishing and re-leasing the merchandise.

HomeSmart segment revenues increased by $33.6 million primarily due to the growth in the number of HomeSmart stores to 78, reflecting a net addition of 22 stores since September 30, 2011.

Franchise segment revenues increased primarily due to a $3.3 million, or 8.6%, increase in royalty income from franchisees, partially offset by decreases in franchise fees. Franchise royalty income increased primarily due to the growth in the number of franchised stores and a 5.0% increase in same store revenues of existing franchised stores. The total number of franchised sales and lease ownership stores at September 30, 2012 was 724, reflecting a net addition of 25 stores since September 30, 2011.

The $124.9 million increase in lease revenues and fees, the $28.0 million increase in non-retail sales and the $372,000 decrease in retail sales were primarily attributable to our Sales and Lease Ownership segment discussed above. The $2.2 million increase in franchise royalties and fees was attributable to our Franchise segment also discussed above.

Included in other revenues for the first nine months ended September 30, 2012 and 2011 are gains of $2,000 and $2.7 million, respectively, on sales of Company-operated stores.

Cost and Expenses

Retail cost of sales decreased $1.0 million, or 5.7%, to $17.1 million for the nine months ended September 30, 2012, from $18.2 million for the comparable period in 2011, and as a percentage of retail sales, decreased to 56.8% from 59.5% due to a change in the mix of products.

Non-retail cost of sales increased 10.7% to $273.1 million for the nine months ended September 30, 2012, from $246.7 million for the comparable period in 2011, and as a percentage of non-retail sales, increased slightly to 91.3% from 91.0% due to a change in the mix of products.

Operating expenses for the nine months ended September 30, 2012 increased $63.7 million, or 9.9%, to $709.8 million from $646.1 million for the comparable period in 2011 primarily as a result of increased operating expenses related to the growth of the sales and lease ownership business and increased legal fees and expenses associated with the Company's privacy and data security initiatives. As a percentage of total revenues, operating expenses were 42.9% for the nine months ended September 30, 2012, and 43.1% for the comparable period in 2011.

Lawsuit (income) expense for the nine months ended September 30, 2012 decreased $72.0 million from the comparable period due to the reversal of $35.5 million in conjunction with a lawsuit settlement for which the Company had accrued $36.5 million during the nine months ended September 30, 2011.

Retirement charge for the nine months ended September 30, 2012 was $10.4 million, representing costs associated with the retirement of the Company's founder and Chairman of the Board.

Depreciation of lease merchandise increased $41.9 million to $457.4 million for the nine months ended September 30, 2012 from $415.4 million during the comparable period in 2011, a 10.1% increase. As a percentage of total lease revenues and fees, depreciation of lease merchandise decreased slightly to 36.2% for the nine months ended September 30, 2012 from 36.4% for the nine months ended September 30, 2011.


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Operating Profit

Interest income increased to $2.7 million for the nine months ended September 30, 2012, compared with $934,000 for the comparable period in 2011, a 189.9% increase. The increase in interest income is due to higher average investment balances during the nine months ended September 30,2012, resulting in higher returns.

Interest expense increased to $4.9 million for the nine months ended September 30, 2012, compared with $3.0 million for the comparable period in 2011, a 61.7% increase. The increase in interest expense was due to higher average debt levels during the first nine months of 2012 as a result of the issuance of $125 million senior unsecured notes on July 5, 2011.

Income Taxes. Income tax expense increased $31.8 million to $83.3 million for the nine months ended September 30, 2012, compared to $51.4 million for the comparable period in 2011, representing a 62.0% increase. The effective tax rate was 37.9% and 38.2% for the nine months ended September 30, 2012 and 2011, respectively. The decrease in the effective tax rate to 37.9% in the nine months ended September 30, 2012, from 38.2% in the comparable period in 2011, was due to changes in permanent items, principally the anticipated availability of the
Section 199 domestic manufacturing deduction in 2012. The deduction was not . . .

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