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AAN > SEC Filings for AAN > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for AARON'S INC

Form 10-Q for AARON'S INC


9-May-2014

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, legal and regulatory proceedings, 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, 2013, 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 months ended March 31, 2014 and 2013, 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 2013 Annual Report. Subsequent Event
On April 14, 2014, the Company acquired a 100% ownership interest in Progressive Finance Holdings, LLC ("Progressive"), a virtual lease-to-own company, for $700 million in cash consideration. In connection with the acquisition, the Company amended and restated its revolving credit agreement, amended certain financing agreements and entered into two new note purchase agreements, which are described more fully in Note 8 to these consolidated financial statements. Business Overview
Aaron's, Inc. ("Aaron's" or the "Company") is a leading specialty retailer of consumer electronics, computers, furniture, household 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 the majority of the upholstered furniture and bedding leased and sold in our stores, and, from April 14, 2014, the Progressive business.
Historically, Aaron's has demonstrated revenue growth from the opening of new sales and lease ownership stores and increases in same store revenues from previously opened stores. We also use our franchise program to help us expand our sales and lease ownership concept more quickly and into more areas than through opening only Company-operated stores. Total revenues increased from $2.013 billion in 2011 to $2.235 billion in 2013, representing a compound annual growth rate of 5.4%. In addition, revenues from franchise royalties and fees for the year ended December 31, 2013 increased from $63.3 million in 2011 to $68.6 million in 2013, representing a compound annual growth rate of 4.1%. For the three months ended March 31, 2014, total revenues were $585.4 million, a decrease of $7.6 million, or 1.3%, over the comparable period in 2013 due primarily to a 2.1% decrease in Company-operated same store revenues for the 15-month period ended March 31, 2014. We believe Company-operated same store revenues were adversely impacted by the severe weather events that occurred during the first quarter, which we estimate negatively impacted total revenues in the range of $5.5 million to $6.5 million. In addition, revenues from franchise royalties and fees for the three months ended March 31, 2014 were $18.1 million, a decrease of $116,000, or .6%, over the comparable period in 2013.
Same Store Revenues. We believe that changes in same store revenues are a key performance indicator. For the three months ended March 31, 2014, we calculated this amount by comparing revenues for the three months ended March 31, 2014 to revenues for the comparable period in 2013 for all stores open for the entire 15-month period ended March 31, 2014, excluding stores that received lease agreements from other acquired, closed or merged stores. Business Environment and Company Outlook We believe the rent-to-own industry has suffered in recent periods due to challenges faced by our core customers, including increases in payroll taxes, changes to food stamps and decreases to unemployment benefits. Accordingly, we undertook a comprehensive review of our core business in order to position us to succeed over the long term. As a result, we are implementing a strategic plan focused on our core business as follows:
Renewing our focus on same store revenue growth for our core portfolio, through improved execution, optimization of merchandising and pricing and an enhanced go-to-market strategy;

Refining and growing our online platform;


Driving cost efficiency to recapture margin, including through selling, general and administrative cost savings and rationalizing underperforming stores;

Moderating new Company-operated store growth to 2% to 3% per year; and

Strengthening and growing the franchise store base.

Furthermore, like many industries, the rent-to-own industry has been transformed by the internet and virtual marketplace. We believe the Progressive acquisition will be strategically transformational for the Company and will strengthen our franchise. Progressive's results of operations will be included in the Company's consolidated financial statements beginning in the second quarter of this year. Key Components of Earnings
In this management's discussion and analysis section, we review our consolidated results. For the three months ended March 31, 2014, and the comparable prior year period, some of the key revenue and cost and expense items that affected earnings were as follows:
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 terms. Retail sales represent sales of both new and returned lease merchandise from our stores. Non-retail sales mainly represent new merchandise sales to our Aaron's Sales & Lease Ownership 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 primarily relate to revenues from leasing real estate properties to unrelated third parties, as well as 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 and delivery, among other expenses.
Depreciation of Lease Merchandise. Depreciation of lease merchandise reflects the expense associated with depreciating merchandise held for lease and leased to customers by our Company-operated stores.
Other Operating (Income) Expense, Net. Other operating (income) expense, net consists of gains or losses on sales of Company-operated stores and delivery vehicles, impairment charges on assets held for sale and gains or losses on other dispositions of property, plant and equipment. Critical Accounting Policies
Refer to the 2013 Annual Report.


Results of Operations
As of March 31, 2014, the Company has four operating and reportable segments:
Sales and Lease Ownership, HomeSmart, Franchise and Manufacturing. In January 2014, the Company sold the 27 Company-operated RIMCO stores and the rights to five franchised stores. In all periods presented, RIMCO has been reclassified from the RIMCO segment to Other.
The Company's Sales and Lease Ownership, HomeSmart and Franchise segments accounted for substantially all of the operations of the Company and, therefore, unless otherwise noted, only material changes within these three segments are discussed. The production of our Manufacturing segment, consisting of the Woodhaven Furniture Industries division, is primarily leased or sold through the Company-operated and franchised stores, and consequently, substantially all of that segment's revenues and earnings before income taxes are eliminated through the elimination of intersegment revenues and intersegment profit. Results of Operations - Three months ended March 31, 2014 and 2013 Three Months Ended March 31, Change (In Thousands) 2014 2013 $ % REVENUES:

Lease Revenues and Fees               $ 459,816     $ 468,104     $  (8,288 )     (1.8 )%
Retail Sales                             14,510        14,419            91         .6
Non-Retail Sales                         91,625        90,955           670         .7
Franchise Royalties and Fees             18,084        18,200          (116 )      (.6 )
Other                                     1,388         1,332            56        4.2
                                        585,423       593,010        (7,587 )     (1.3 )
COSTS AND EXPENSES:
Retail Cost of Sales                      9,013         8,327           686        8.2
Non-Retail Cost of Sales                 82,907        82,455           452         .5
Operating Expenses                      264,374       249,626        14,748        5.9
Depreciation of Lease Merchandise       167,912       167,507           405         .2
Other Operating (Income) Expense, Net      (677 )       1,805        (2,482 )   (137.5 )
                                        523,529       509,720        13,809        2.7
OPERATING PROFIT                         61,894        83,290       (21,396 )    (25.7 )
Interest Income                             753           752             1         .1
Interest Expense                         (1,533 )      (1,511 )          22        1.5
Other Non-Operating Expense, Net           (404 )      (1,489 )      (1,085 )    (72.9 )
EARNINGS BEFORE INCOME TAXES             60,710        81,042       (20,332 )    (25.1 )
INCOME TAXES                             22,371        30,042        (7,671 )    (25.5 )
NET EARNINGS                          $  38,339     $  51,000     $ (12,661 )    (24.8 )%


Revenues
Information about our revenues by reportable segment is as follows:
                                             Three Months Ended
                                                   March 31,                            Change
(In Thousands)                             2014                2013             $                 %
REVENUES:
Sales and Lease Ownership1           $     548,711       $     551,711       $    (3,000 )         (.5 )%
HomeSmart1                                  17,404              16,937               467           2.8
Franchise2                                  18,084              18,200              (116 )         (.6 )
Manufacturing                               31,155              27,711             3,444          12.4
Other                                        1,898               5,849            (3,951 )       (67.6 )
Revenues of Reportable Segments            617,252             620,408            (3,156 )         (.5 )
Elimination of Intersegment Revenues       (30,258 )           (27,025 )          (3,233 )       (12.0 )
Cash to Accrual Adjustments                 (1,571 )              (373 )          (1,198 )      (321.2 )
Total Revenues from External
Customers                            $     585,423       $     593,010       $    (7,587 )        (1.3 )%

1 Segment revenue principally consists of lease revenues and fees, retail sales and non-retail sales. 2 Segment revenue consists of franchise royalties and fees.

Sales and Lease Ownership. Sales and Lease Ownership segment revenues decreased $3.0 million to $548.7 million primarily due to a $4.7 million decrease in lease revenues and fees, partially offset by an $885,000 increase in retail sales. Lease revenues and fees within the Sales and Lease Ownership segment decreased due to a 2.2% decrease in same store revenues, which more than offset the impact of net additions of 35 Company-operated stores during the 15-month period ended March 31, 2014.
HomeSmart. HomeSmart segment revenues increased $467,000 to $17.4 million primarily due to a 2.7% increase in lease revenues and fees. Lease revenues and fees within the HomeSmart segment increased due to a 1.4% increase in same store revenues.
Franchise. Franchise segment revenues decreased $116,000 to $18.1 million due to a 1.0% decrease in same store revenues of existing franchised stores, which more than offset the impact of net additions of 38 franchised stores during the 15-month period ended March 31, 2014.
Other. Revenues in the "Other" segment are primarily revenues attributable to
(i) the RIMCO segment through the date of sale in January 2014, (ii) leasing space to unrelated third parties in the corporate headquarters building and
(iii) revenues from several minor unrelated activities. Cost and Expenses
Retail cost of sales. Retail cost of sales increased $686,000, or 8.2%, to $9.0 million during the three months ended March 31, 2014, from $8.3 million for the comparable period in 2013, and as a percentage of retail sales, increased to 62.1% from 57.8% due to a change in the mix of products.
Non-retail cost of sales. Non-retail cost of sales increased $452,000, or .5%, to $82.9 million during the three months ended March 31, 2014, from $82.5 million for the comparable period in 2013 due to greater demand from our franchisees for merchandise we sell to them, and as a percentage of non-retail sales, decreased slightly to 90.5% in 2014 from 90.7% in 2013.
Operating expenses. Operating expenses increased $14.7 million, or 5.9%, to $264.4 million during the three months ended March 31, 2014, from $249.6 million for the comparable period in 2013. As a percentage of total revenues, operating expenses increased to 45.2% in 2014 from 42.1% in 2013 primarily as a result of increased personnel and advertising costs incurred to support growth. Depreciation of lease merchandise. Depreciation of lease merchandise increased $405,000, or .2%, to $167.9 million during the three months ended March 31, 2014, from $167.5 million during the comparable period in 2013. Levels of merchandise on lease remained consistent year over year, resulting in idle merchandise representing approximately 6% of total depreciation expense in 2014 and 2013. As a percentage of total lease revenues and fees, depreciation of lease merchandise increased slightly to 36.5% from 35.8% in the prior year.


Other Operating (Income) Expense, Net
Other operating (income) expense, net consists of gains or losses on sales of
Company-operated stores and delivery vehicles, impairment charges on assets held
for sale and gains or losses on other dispositions of property, plant and
equipment. Information about the components of other operating (income) expense,
net is as follows:
                                                                    Three Months Ended March 31,
(In Thousands)                                                         2014                2013
Gains on sales of stores and delivery vehicles                   $       (1,805 )     $       (577 )
Impairment charges and losses on asset dispositions                       1,128              2,382
Other Operating (Income) Expense, Net                            $         (677 )     $      1,805

During the three months ended March 31, 2014, other operating income, net included $718,000 in losses incurred on the sale of the 27 Company-operated RIMCO stores in January 2014. In addition, the Company recognized gains of $1.5 million from the sale of five Aaron's Sales & Lease Ownership stores during the three months ended March 31, 2014.
During the three months ended March 31, 2013, other operating expense, net included $2.1 million related to the impairment of various land outparcels and buildings that the Company decided not to utilize for future expansion. Operating Profit
Interest income. Interest income increased slightly to $753,000 during the three months ended March 31, 2014 compared with $752,000 for the comparable period in 2013.
Interest expense. Interest expense remained consistent at $1.5 million for the three months ended March 31, 2014 and 2013 due to consistent average debt levels for the three months ended March 31, 2014 as compared to the same period in the prior year.
Other non-operating expense, net. Other non-operating expense, net includes the impact of foreign currency exchange gains and losses, as well as gains and losses resulting from changes in the cash surrender value of Company-owned life insurance related to the Company's deferred compensation plan. Included in other non-operating expense, net were foreign exchange transaction losses of $401,000 and $1.9 million during the three months ended March 31, 2014 and 2013, respectively. Changes in the cash surrender value of Company-owned life insurance were not significant during the three months ended March 31, 2014 and resulted in gains of $362,000 during the three months ended March 31, 2013. Earnings Before Income Taxes
Information about our earnings (loss) before income taxes by reportable segment is as follows:

Three Months Ended March 31, Change
2014 vs. 2013
(In Thousands) 2014 2013 $ % EARNINGS (LOSS) BEFORE INCOME TAXES:
Sales and Lease Ownership            $      55,619       $      63,825     $   (8,206 )       (12.9 )%
HomeSmart                                      (69 )              (209 )          140          67.0
Franchise                                   14,558              14,509             49            .3
Manufacturing                                  547                 593            (46 )        (7.8 )
Other                                       (9,927 )            (2,699 )       (7,228 )      (267.8 )
Earnings Before Income Taxes for
Reportable Segments                         60,728              76,019        (15,291 )       (20.1 )
Elimination of Intersegment Profit            (509 )              (604 )           95          15.7
Cash to Accrual and Other
Adjustments                                    491               5,627         (5,136 )       (91.3 )
Total                                $      60,710       $      81,042     $  (20,332 )       (25.1 )%


Income Tax Expense
Income tax expense decreased $7.7 million to $22.4 million for the three months ended March 31, 2014, compared to $30.0 million for the comparable period in 2013, representing a 25.5% decrease. The effective tax rate decreased slightly to 36.8% for the first quarter of 2014 from 37.1% for the first quarter of 2013. Net Earnings
Net earnings decreased $12.7 million to $38.3 million during the three months ended March 31, 2014 from $51.0 million during the three months ended March 31, 2013, representing a 24.8% decrease. As a percentage of total revenues, net earnings were 6.5% and 8.6% in 2014 and 2013, respectively. Balance Sheet
The Company's cash balance increased to $290.7 million at March 31, 2014 from $231.1 million at December 31, 2013. For additional information related to the $59.6 million increase in cash and cash equivalents, refer to the "Liquidity and Capital Resources" section below.

Accounts payable and accrued expenses increased $26.3 million to $270.2 million at March 31, 2014 from $243.9 million at December 31, 2013. In addition, deferred income taxes payable decreased $27.1 million to $199.8 million at March 31, 2014 from $227.0 million at December 31, 2013. Both the increase in accounts payable and accrued expenses and the decrease in deferred income taxes payable are primarily as a result of the reversal of bonus depreciation deductions on lease merchandise included in the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010 (the "2010 TRA") and the American Taxpayer Relief Act of 2012 (the "2012 TRA") (collectively, the "Tax Acts"). Refer to the "Commitments" section below for additional information regarding the impact of the Tax Acts.
Liquidity and Capital Resources
General
Cash flows from operating activities for the three months ended March 31, 2014 and 2013 were $55.7 million and $102.3 million, respectively. The $46.6 million decrease in cash flows from operating activities during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 was due primarily to the effects of the Tax Acts and lower pretax earnings. The 2012 TRA was enacted on January 2, 2013, which extended bonus depreciation on eligible inventory held during 2012 and 2013. In 2012, the Company made payments based on enacted law, resulting in an overpayment when the 2012 TRA was signed and, consequently, higher-than-expected operating cash flows in the three months ended March 31, 2013. Additionally, due to the provisions of the Tax Acts, the Company is making increased tax payments as a result of the reversal of the accelerated depreciation deductions that were taken in 2013 and prior periods. Refer to the "Commitments" section below for additional regarding the impact of the Tax Acts.

Purchases of sales and lease ownership stores have a positive impact on our operating cash flows. The positive impact on operating cash flows from purchasing stores occurs as the result of lease merchandise, other assets and intangibles acquired in these purchases being treated as an investing cash outflow. As such, the operating cash flows attributable to the newly purchased stores usually have an initial positive effect on operating cash flows that may not be indicative of the extent of their contributions in future periods. The amount of lease merchandise purchased in acquisitions and shown under investing activities was $431,000 and $608,000 during the three months ended March 31, 2014 and 2013, respectively.

Sales of Company-operated stores are an additional source of investing cash flows. Proceeds from such sales were $13.3 million during the three months ended March 31, 2014 and include cash consideration of $10.0 million from a third party in connection with the sale of the 27 Company-operated RIMCO stores and the rights to five franchised RIMCO stores in January 2014. The amount of lease merchandise sold in these sales and shown under investing activities was $2.7 million during the three months ended March 31, 2014. There were no sales of Company-operated stores during the three months ended March 31, 2013. Our primary capital requirements consist of buying lease merchandise for sales and lease ownership stores. As we continue to grow, the need for additional lease merchandise is expected to remain our major capital requirement. Other capital requirements include purchases of property, plant and equipment and expenditures for acquisitions and income tax payments. These capital requirements historically have been financed through:
cash flows from operations;

trade credit with vendors;


proceeds from the sale of lease return merchandise;

bank credit;

private debt offerings; and

stock offerings.

Debt Financing
At March 31, 2014, there was no outstanding balance under our revolving credit agreement. Our current revolving credit facility expires December 13, 2017 and the total available credit on the facility as of March 31, 2014 is $140.0 million. As of March 31, 2014, the Company had outstanding $125.0 million in senior unsecured notes, originally issued to several insurance companies in a private placement in July 2011. The notes bear interest at the rate of 3.75% per year and mature on April 27, 2018. Payments of interest are due quarterly, commencing July 27, 2011, with principal payments of $25.0 million each due annually commencing April 27, 2014.
In connection with the Company's acquisition of Progressive on April 14, 2014, the Company amended and restated its revolving credit agreement, amended certain financing agreements and entered into two new note purchase agreements, which are discussed in further detail in Note 8 to these consolidated financial statements.
Our revolving credit agreement and senior unsecured notes, and our franchisee loan agreement discussed below, contain certain financial covenants. These covenants include requirements that we maintain ratios of: (1) EBITDA plus lease expense to fixed charges of no less than 2:1; and (2) total debt to EBITDA of no greater than 3:1 ("EBITDA" in each case means consolidated net income before interest and tax expense, depreciation (other than lease merchandise depreciation) and amortization expense and other non-cash charges). If we fail to comply with these covenants, we will be in default under these agreements, and all amounts will become due immediately. We were in compliance with all of these covenants at March 31, 2014 and believe that we will continue to be in compliance in the future.
Share Repurchases
We purchase our stock in the market from time to time as authorized by our Board of Directors. As described in more detail in Note 1 to these consolidated financial statements, in December 2013, the Company paid $125.0 million under an accelerated share repurchase program with a third party financial institution and received an initial delivery of 3,502,627 shares. In February 2014, the accelerated share repurchase program was completed and the Company received an additional 1,000,952 of common stock. As of March 31, 2014, we have the authority to purchase 10,496,421 additional shares. Dividends
We have a consistent history of paying dividends, having paid dividends for 27 consecutive years. At its November 2013 meeting, our Board of Directors increased the quarterly dividend by 23.5%, raising it to $.021 per share from $.017 per share. Aggregate dividend payments for the three months ended March 31, 2014 were $3.1 million, representing dividends that were declared during the fourth quarter of 2013 and the first quarter of 2014. Subject to sufficient operating profits, any future capital needs and other contingencies, we currently expect to continue our policy of paying dividends.
If we achieve our expected level of growth in our operations, we anticipate we will supplement our expected cash flows from operations, existing credit facilities, vendor credit and proceeds from the sale of lease return merchandise by expanding our existing credit facilities, by securing additional debt financing, or by seeking other sources of capital to ensure we will be able to fund our capital and liquidity needs for at least the next 12 to 24 months. Commitments
Income Taxes. During the three months ended March 31, 2014, we made $29.5 million in federal and state income tax payments. Within the next nine months, we anticipate that we will make cash payments for federal and state income taxes of approximately $158.5 million.
The 2010 TRA allowed for a deduction of 100% of the adjusted basis of qualified property for assets placed in service after September 8, 2010 and before December 31, 2011. The 2012 TRA extended bonus depreciation of 50% through the end of 2013. Accordingly, our cash flow in prior years benefited from having a . . .

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