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United RentalsAR layout Final.wpc 4/24/98 8:23 AM Page 1 309 E. Paces Ferry Road, N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 C o r p o r at e I n f o r m at i o n Corporate Headquarters 309 E. Paces Ferry Rd., N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 http://www.aaronrents.com Subsidiary Aaron Investment Company 10th & Market Streets Mellon Bank Building 2nd Floor Wilmington, Delaware 19801 (302) 888-2351 S h a r e h o l d e r I n f o r m at i o n Annual Shareholders Meeting The annual meeting of the shareholders of Aaron Rents, Inc. will be held on Tuesday, May 5, 1998, at 10:00 a.m. E.D.T. at the First Union Plaza, 999 Peachtree Street, N.E., 28th Floor, Atlanta, Georgia 30309. Form 10-K Shareholders may obtain a copy of the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission upon written request, without charge. Such requests should be sent to the attention of Gilbert L. Danielson, Vice President, Finance, Chief Financial Officer, Aaron Rents, Inc., 309 E. Paces Ferry Rd., N.E., Atlanta, Georgia 30305-2377. Stock Listing RNT Aaron Rents Inc.’s Common Stock and Class A Common Stock are traded on the New York Stock Exchange under the symbols “RNT” and “RNT.A,” respectively. Transfer Agent and Registrar SunTrust Bank, Atlanta Atlanta, Georgia General Counsel Kilpatrick Stockton LLP Atlanta, Georgia America(cid:213)s Premier Name Furniture Rental In Rental & Purchase A n n u a l R e p o r t 1 9 9 7 AR layout Final.wpc 4/24/98 8:23 AM Page 3 Purchase Aaron Rents, Inc. is a U.S. leader in furniture rental and rental purchase with 393 stores in 31 states. Positioned as “America’s Premier Name in Furniture Rental and Rental Purchase,” the Company offers both individual and corporate customers a wide range of residential and office furniture, accessories, consumer electronics, and household appliances for rental, rental purchase and sale. The major operations are the Rent-to- Rent division, the Aaron’s Rental Purchase division, the Aaron Rents’ Convention Furnishings division, and MacTavish Furniture Industries, which supplies much of the furniture for the Company’s rental and rental purchase stores. Aaron Rents’ strategic focus is on expanding its higher growth rental purchase business while also growing its core rent-to- rent business in selected markets. America(cid:213)s Premier Name in Furniture Rental Rental& T a b l e o f C o n t e n t s Financial Highlights . . . . . . . . . . . .1 Letter to Shareholders . . . . . . . . .2 Business Review . . . . . . . . . . . . . . .4 Selected Financial Information . .13 Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . .14 Consolidated Balance Sheets . . . .16 Consolidated Statements of Earnings . . . . . . . . . . . . . . . . .17 Consolidated Statements of Shareholders’ Equity . . . . . . .17 Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . .18 Notes to Consolidated Financial Statements . . . . . . . . . .19 Report of Independent Auditors . . . . . . . . . . . . . . . . . . . .23 Store Locations . . . . . . . . . . . . . .24 Board of Directors and Officers . . . . . . . . . . . . . . . . .25 Corporate and Shareholder Information . . . . . . . . . .Back Cover F i n a n c i a l H i g h l i g h t s (Dollar Amounts in Thousands, Except Per Share) Year Ended December 31, 1997 Year Ended December 31, 1996 Percentage Change OPERATING RESULTS Revenues Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution $310,751 30,237 18,396 0.96 0.94 FINANCIAL POSITION Total Assets Rental Merchandise, Net Interest-Bearing Debt Shareholders’ Equity Book Value Per Share Debt to Capitalization Pre-Tax Profit Margin Net Profit Margin Return on Average Equity STORES OPEN Rent-to-Rent Rental Purchase Rental Purchase Franchise Convention Furnishings Total Stores $239,382 176,968 76,486 116,455 6.15 39.6% 9.7% 5.9% 16.4% 105 181 101 6 393 $274,245 25,179 15,393 0.81 0.77 $198,103 149,984 55,365 107,335 5.45 34.0% 9.2% 5.6% 15.5% 103 135 61 2 301 13.3% 20.1% 19.5% 18.5% 22.1% 20.8% 18.0% 38.1% 8.5% 12.8% 1 1.9% 34.1% 65.6% 200.0% 30.6% Revenues by Calendar Year Net Earnings by Calendar Year ($ in 000’s) $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 ’93 ’94 ’95 ’96 ’97 Rent-to-Rent Rental Purchase ($ in 000’s) $20,000 $15,000 $10,000 $5,000 $0 ’93 ’94 ’95 ’96 ’97 AR layout Final.wpc 4/24/98 8:23 AM Page 5 To O u r S h a r e h o l d e r s : 2 What a tremen d ou s year ! Aaron Rents expanded coast to coast and achieved record-breaking growth in all facets of the business in 1997 — the best year in our Company’s history. Total store count during the year increased nearly one-third to almost 400 stores, adding strong momentum going forward. We are now uniquely positioned for growth as “America’s Premier Name in Furniture Rental and Rental Purchase.” Record revenu es reach ed $31 0.8 mi lli on compared to $274.2 million last year, up 13%. Record earnings rose 20% to $18.4 million compared to $15.4 million in the previous year. Earnings per share were $.96 ($.94 assuming dilution) compared with $.81 ($.77 assuming dilution) for 1996. Your Company has now achieved over six consecutive years of record revenues and earnings. Aaron Rents expan d ed nati onwi d e du ri ng th e year and achieved our goal of having at least 100 franchise stores open by year end. We entered five new states in 1997, opening operations in California, Connecticut, Illinois, Iowa and Pennsylvania, increasing our state count to 31. The franchise division alone added 40 stores during the year, a 66% growth in stores open! A majo r acqu i siti on ad d ed 40 rental pu rchase stores in Texas, doubling our size in that state — the largest rental purchase market in the United States. In December, we acquired the assets of RentMart Rent-To-Own, Inc., including its stores in Dallas, Houston and San Antonio. All less than 18 months old, these stores fit naturally with the Aaron’s Rental Purchase store model, with bigger stores in more desirable market loca- tions. The RentMart transaction demonstrated our commitment to acquisitions when the fit is right. I n an oth er key acq u i s iti o n , we purchased the assets of Blackhawk Convention Services, Inc. in December, doubling the size of our convention furnishings division and extending that service nationwide. Blackhawk operations in the Chicago, New York and Las Vegas markets, combined with our existing presence in Atlanta, Cincinnati, Dallas and Orlando, will enable us to serve most of the major convention cities of the United States. We expect this acquisition will also result in spin-off business to our present and future rent-to-rent stores. Our rent-to-rent division posted record revenues and earnings with steady and profitable growth. We opened two new stores during 1997 and began a program of expanding this business at a stronger rate. The emphasis for this division in 1998 will be on adding corporate and national accounts while maintaining our superior relationships with existing customers. Th e fu rn itu re manu factu ri ng d ivi si on , MacTavish Furniture Industries, turned in another record year, increasing production to $45 million of furniture at cost, which was supplied primarily to our stores. We continued to invest in our manufacturing capacity with an 18,000 square foot plant addition and new equipment. Strength en i ng ou r management i n 19 97 , Robert C. Loudermilk, Jr., who had served as Vice President, Real Estate since 1993, was appointed President and Chief Operating Officer of Aaron Rents after more than a decade of experience in all aspects of the business. Ronald W. Allen, retired Chairman, President and Chief Executive Officer of Delta Air Lines, was named to the Aaron Rents’ Board of Directors, adding his insight and knowledge to our Company. I beli eve Aaron Rents i s on th e th resh old of the greatest opportunity for growth in its 43-year history. Our rent-to-rent business performs at a strong and consistent level and, to answer heightened market demand, we plan to expand this business in both existing and new markets in 1998. Over the next several years, we expect to enter some 20 new markets with this profitable core business. The pace of this growth will be controlled and conservative to minimize the normal effects of start-up costs, thereby allowing us to con- tinue solid profit gains. Rental pu rchase offers almo st u n limited potential for profitable expansion. Every town in America should have an Aaron’s Rental Purchase store. Our goal is to become the supplier of choice to the higher end of the lower-income segment of American consumers. Aaron’s will be the name in rental purchase. That is our vision. Through our fast- growing unique franchise program and our Company-operated stores, we plan to reach that goal within the next decade. In 1998 we expect 50 more franchise stores and 15 Company- operated stores to be opened, which will result in more than 345 rental purchase stores open by year end. With this base, and through internal growth alone, we should reach the 700-mark in total stores open in 2000. 3 Aaron Rents has th e fi nancial resou rces to execute our ambitious plan for growth. During the year, we negotiated a new $40 million credit facility to provide fund- ing to franchisees for growing our franchise program. Our revolving credit facility with four banks was increased during the year to $90 million. The Company’s foundation is our conservative fiscal policy and stringent financial controls of our internal and franchise operations. We are committed to maintaining our strong balance sheet, assuring our ability to prosper in any economic cycle. During the year, the Company was named by Forbes Magazine as one of the 200 best small companies in America. We are proud of this recognition which sets us apart from others in our industry. Your Company’s stock price excelled in 1997, with the Common Stock closing at the end of the year at $19.375. At December 31, 1997, the five-year total return for the Common Stock was 36.9%, a significant achievement. On March 20, 1998, the Company’s Common Stock and Class A Common Stock were listed on the New York Stock Exchange under the symbols RNT and RNT.A, respec- tively. Our move to the New York Stock Exchange should increase the Company’s visibility in the investment community and expand our potential investor base. The future of our Company looks stronger now than at any time since its founding in 1955. It’s exciting to be part of Aaron Rents today! R. Charles Loudermilk, Sr. Chairman and Chief Executive Officer AR layout Final.wpc 4/24/98 8:23 AM Page 7 Aaron Rents, Inc. America(cid:213)s Premier Name in Furniture Rental Rental& Purchase Aaron Rents commands a unique position in the furniture rental and rental purchase industries. The Aaron Rents’ concept, which distinguishes it from competitors, has created major advantages in the marketplace and spurred record growth. These are the distinctive features of Aaron Rents, Inc.: 4 Th e lea d e r i n eth i ca l b u s i n e s s p racti c e s , offering customers first-rate products and service at competitive prices with full disclosure of terms, backed by the Aaron Rents’ reputation for integrity established over 43 years of doing business. Th e combi nati on of two bu si n esses, rent-to-rent and rental purchase, providing a powerful synergy for success — with the rent-to-rent business generating cash flow in all economic cycles and rental purchase, led by franchising, creating the opportunity for rapid growth. Th e effi ci ency an d co st advantages of vertical integration — unique within the rental industry. Aaron Rents has its own furniture manufacturing plants, allowing lower pricing, overnight delivery and quick change of designs. In addition, Aaron Rents has its own network of distribution centers, strategically located to support fast delivery to customers. Th e targeti ng of the expanding mid-range office furniture rental market, a niche especially receptive to our competitive pricing, and representing a growing market for the Company. Th e creation of our own market niche — the upper end of the rental purchase market — to whom we offer our unique product. This niche appreciates our level of customer service, our quality merchandise offered at the lowest prices in the industry, our larger, more attractive stores in better locations compared to typical competing stores, and our agreement structure that enables ownership of merchandise in only 12 months. Th e development of our rental purchase franchise program, also unique in the industry, with strong growth resulting from the success of the Aaron’s Rental Purchase concept in the marketplace. The Aaron Rents strategy is to grow the rent-to-rent business through opening new stores in established and new markets, focusing on the profitable office furniture segment and the growing residential corporate relocation business; and to expand the faster-growing rental purchase busi- ness through accelerated franchise store openings primarily in smaller mar- kets, augmented by additional Company-operated stores in major markets. The success of this approach has been demonstrated over the past several years. Rent- Rent- to- to- Rent Rent 5 Aaron Rents ranks as the second largest rent-to-rent company in the United States, with 105 stores commanding 30% of a total market estimated at more than $600 million. This division, the Company’s original business founded in 1955, serves a broad spectrum of people requiring temporary rentals of residential or office furniture, accessories or appliances for a few weeks or months. Customers range from individuals to corporate entities: people who need the temporary use of residential and office furniture and related merchandise. Corporate customers comprise a major market segment. These include large corporations and newly formed businesses, professionals such as accoun- tants and attorneys, property managers and real estate investors. Their needs may be the furnishing of new offices or rental of equipment for special projects and seasonal events. Growing demand is being spurred by the relocation of both temporary and permanent corporate employees, the growth in white-collar desk jobs, and the generally strong need for office furniture and equipment rentals. To Meet national account demand, Aaron Rents’ Rent-to-Rent Division opened its first three furniture warehouse facilities in early 1998. These corporate service centers bring greater convenience and cost savings resulting from lower overhead at these centralized facilities. AR layout Final.wpc 4/24/98 8:24 AM Page 9 Aaron Rents’ stores average 21,000 square feet and carry a large selection of brand-name merchandise for rental or sale. As a combined result of the Company’s volume pur- chasing power and its own manufacturing division, MacTavish Furniture Industries, Aaron Rents is able to offer significant price savings to its customers. Next-day delivery is provided from each store’s on-site warehouse. Clearance cen- ters sell both rental return and new merchandise. Office fur- niture accounts for 33% of the rent-to-rent rental revenues, while residential furniture represents almost 60%. Electronics and other types of merchandise account for the remaining 7% of rental revenues. Early in 1998, the Company opened its first three furni- ture warehouse facilities in response to demand by national accounts. These centralized warehouses, strategically located in Florida, Pennsylvania and are designed as corporate service centers. Their lower overhead allows savings to be passed on to customers. Our national cus- tomers, already familiar with Aaron’s quality products, enjoy the convenience and quick response of simply telephoning in or sending orders via facsimile. Illinois, 6 Rental Rental Pu rchase Pu rchase Rent-to-Rent Rental Revenues Residential Furniture — 60% Office Furniture — 33% Electronics & Other — 7% 7 Th e Aaron(cid:213)s Rental Pu rchase division increased by 86 stores, or 44%, to a total of 282 stores at the end of 1997 — opening stores at the rate of one every four days. In keeping with the vision of founder R. Charles Loudermilk, Sr. for Aaron’s Rental Purchase to be “the name in rental purchase,” a continued strong rate of expansion is planned for this year and beyond. We are uniquely positioned to gain an ever-increasing share of the $4.1 billion rental purchase market, composed of an estimated 19.6 million U.S. households with only 25% currently served by the industry. Aaron’s Rental Purchase offers larger, more attractive stores averaging 8,500 square feet compared to typical competing stores with 2,500 to 3,000 square feet. Aaron’s Rental Purchase stores are also located in more appealing areas with a wider selection of quality, name-brand furniture, electronics, appliances and other merchandise. Electronics represent 54% of the rental purchase rental revenues. Furniture, appliances and other account for the remaining 30%, 14% and 2%, respectively. Inviting, colorful Aaron’s Rental Purchase stores in customer- friendly locations offer the advantages of larger showrooms and a wider selection of top quality merchandise. The Aaron’s plan of ownership, after only 12 monthly payments, is a major reason for this division’s rapid growth. AR layout Final.wpc 4/24/98 8:24 AM Page 11 Aaron’s Rental Purchase has created a better way to provide the basic necessities of home furnishings, and some of the extras of life, to a large, under-served segment of society. The Company prides itself on its policy of full disclosure. Transactions are effected in a pro- fessional manner with all terms explained. We educate our clientele on the value they receive. This honest approach with our customers helps explain our robust repeat business. Customers include white-collar professionals, blue-collar workers, young couples and retirees. Attracting the higher end of this generally lower-income market, the Aaron’s Rental Purchase concept stands alone. Aaron’s Rental Purchase offers the lowest possible prices with its centerpiece 12-month ownership plan. This unique plan allows a customer to own merchandise after only 12 monthly payments, a sharp contrast to the industry norm of 18 to 24 months of weekly payments. Aaron’s has effectively reinvented the basis of competition in the industry with an entirely new retailing concept, creating a bridge to the larger retail market as well as the rental purchase market. On most products, the Aaron’s Rental Purchase price is very competitive with the total price of comparable products at a conventional credit retailer after the retailer adds interest and service charges. In addition, Aaron’s Rental Purchase customers avoid debt and credit with no obligation beyond the current rental payment due, and they have the privilege of returning merchandise at any time. Company-operated rental purchase stores increased by 46 in 1997 to 181 stores open at year end. Included in the increase were 40 stores from the Company’s first major acquisition in recent years. Aaron Rents acquired the assets of RentMart Rent-To-Own, Inc. with its stores in Dallas, Houston and San Antonio, Texas, and more than doubled the number of Aaron’s Rental Purchase outlets in that state. The RentMart stores provided an excellent fit with the Aaron’s Rental Purchase model with larger and more attractive showrooms in more appealing locations and a wider selection of top quality merchandise. At the time of acquisition, all of the RentMart stores were less than 18 months old and had demonstrated a rapid rate of growth. Aaron’s Rental Purchase Systemwide Revenue Growth and Store Count 282* 196* 142* 118* 82* ’93 ’94 ’95 ’96 ’97 ($ in 000’s) $200,000 $150,000 $100,000 $50,000 $0 Company-Operated Revenues Franchise Revenues *Number of Stores 8 Rental Purchase Rental Revenues Electronics — 54% Furniture — 30% Appliances — 14% Other — 2% Rental Rental Pu rchase Pu rchase Franch i se Franch i se 9 Aaro n (cid:213) s Rental P u rchas e Fran ch i s e s are multi- plying rapidly with stores opening at the rate of one every nine days in 1997. Multi-store franchises are the predominant factor behind the growth and succeeded in pushing the fran- chise division beyond the 100-store level late last year. This base of stores is expected to begin generating a more significant profit contribution and provide momentum for continuing growth. A total of 40 franchise stores were added during the year, including our first store in California, which gave Aaron’s Rental Purchase a presence in all major regions of the coun- try. Plans call for the opening of 50 additional stores in 1998, most of which are already sold and in the pipeline, which will result in over 150 franchise stores by the close of the year. Aaron’s Rental Purchase is a recognized leader in franchising, based on the Company’s relationship with franchise owners and its financial performance, the growth opportunities for franchise stores, and the strength and stability of corporate man- agement. This track record is attracting experienced business people to acquire Aaron’s Rental Purchase franchises. Typically, a franchise owner has significant ownership or operational experience in the including video outlets, fast food stores, rental or retail setting, furniture and appliance stores and automobile dealerships. The nationally recognized Aaron’s Rental Purchase franchise program attracts business people with the experience and financial capacity to acquire and operate profitable multi-store franchises. These own- ers are generating momentum for continuing strong growth. AR layout Final.wpc 4/24/98 8:24 AM Page 13 Quarterly Revenues of Franchise Stores ($ in 000’s) $20,000 $15,000 $10,000 $5,000 2* 1* 0 101* 86* 76* 71* 61* 54* 45* 38* 36* 31* 28* 26* 24* 21* 3* 18* 8* 6* 6* 15* 14* Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1992 1993 1994 1996 1995 1997 *Number of Stores Open Aaron’s Rental Purchase provides substantial support to franchise owners. From helping create an effective business plan to shopping the competition in the area, the Company is there to assist with site selection, training, publicity, financ- ing, purchasing discounts and advertising. All aspects of oper- ating a profitable rental purchase business are covered in a comprehensive training course for the franchise owner. After the opening of the store, ongoing training and support are provided by our field consultants. Full data on sales and oper- ational controls are supplied to franchise owners via the Aaron’s Customer Tracking System (ACTS). A major advantage for the Aaron’s Rental Purchase franchise owner is the Company’s volume purchasing plan that passes on price benefits to the store, allowing more competitive prices to the consumer — a key success factor of the Aaron’s concept. The franchise owner receives further cost benefits by obtaining furniture supplied by the Company’s own manufacturing division. To enhance the growth rate of the franchise effort, a new financing program was developed in 1997 and implemented in early 1998, increasing cap- ital available to franchisees for new store openings. The $40 million financing facility with four major banks pro- vides inventory financing for new franchise owners. It also offers long-term inventory and working capital funds for multi-store and experienced franchisees. Ranked among the top franchises nationally, the Aaron’s Rental Purchase franchise program is growing at a rapid rate. 1 0 Conventi on Conventi on Fu rn i sh i ngs Fu rn i sh i ngs 1 1 Aaron Rents doubled the size of its Convention Furnishings division and expanded its reach nationwide with the acquisition of the assets of Blackhawk Convention Services, Inc. last year. This acquisition enables the division to service any city in the United States through offices located in most of the major convention markets, opening new oppor- tunities in a growing industry. Blackhawk’s three locations in the Chicago, New York and Las Vegas markets were added to the existing Aaron Rents’ Convention Furnishings locations in Atlanta, Cincinnati, Orlando and Dallas. The acquisition provided our initial penetration of the Chicago market and paved the way for the Company’s rent-to-rent business to open a store in the area in early 1998. The Aaron Rents’ Convention Furnishings division provides for the temporary needs of a wide range of meetings, from trade shows to major events like the Super Bowl and national political conventions. AR layout Final.wpc 4/24/98 8:24 AM Page 15 MacTavish MacTavish Furniture Furniture Industries Industries 1 2 Reco rd growth was achieved again as MacTavish Furniture Industries produced $45 million of merchandise at cost. This Aaron Rents’ division manufac- tured 49% of the furniture rented or sold by the Company’s rent-to-rent and rental purchase stores. MacTavish ranks among the largest furniture manufactur- ers in the United States, with a reputation for high-quality, durable and stylish furniture for both residential and office uses. Made especially for rental, MacTavish furniture incor- porates unique features especially valuable for the rental industry, including reinforced frames, highly resilient foam and heavy-duty springs. The growing demands of the ever-increasing number of stores, both Company-operated and franchise, required a facility expansion at MacTavish last year. Currently, the Company manufactures furniture at five plants and pro- duces bedding at four facilities — a part of the vertical integration that makes Aaron Rents unique in the industry. S e l e c t e d F i n a n c i a l I n f o r m at i o n Twelve Nine Nine Distribution Distribution Centers Centers Th e company continues to expand its distri- bution system, another unique feature of Aaron Rents and a key competitive advantage. These distribution centers, with a combined warehouse space of 367,000 square feet, enable Aaron Rents to guarantee quick delivery to customers and support the continuing growth of the business. Merchandise is warehoused in five distribution centers that are strategi- cally located across the United States. A new facility to serve the northern United States and a 200,000 square foot national distribution center in southern Georgia are slated to open in 1998. (Dollar Amounts in Thousands Except Per Share) O p e r a t i n g R e s u l t s Systemwide Revenues (1) Revenues: Rentals & Fees Sales Other Costs & Expenses: Cost of Sales Operating Expenses Depreciation of Rental Merchandise Interest Earnings Before Income Taxes Income Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution Dividends Per Share: Common Class A Financial Position Rental Merchandise, Net Property, Plant & Equipment, Net Total Assets Interest-Bearing Debt Shareholders’ Equity A t Ye a r E n d Stores Open: Year Ended Year Ended Months Ended Months Ended Months Ended December 31, December 31, December 31, December 31, December 31, 1994 (unaudited) 1995 (unaudited) 1997 1996 1995 Year Ended March 31, 1995 Year Ended March 31, 1994 $364,306 $306,200 $256,500 $192,953 $177,773 $241,286 $189,781 231,207 73,223 6,321 310,751 55,914 149,728 71,151 3,721 280,514 208,463 61,527 4,255 274,245 46,168 135,012 64,437 3,449 249,066 182,311 52,999 2,465 237,775 38,274 119,590 55,408 3,172 216,444 30,237 11,841 $ 18,396 .96 $ 25,179 9,786 $ 15,393 .81 $ 21,331 8,113 $ 13,218 .68 $ .94 .04 .04 $ .77 .04 .04 $ .66 .05 .02 $ 137,098 39,218 1,908 178,224 28,350 90,027 41,612 2,323 162,312 15,912 6,032 9,880 .51 .49 .05 .02 $ $ $ 127,995 39,875 1,471 169,341 28,772 85,464 39,912 2,185 156,333 13,008 5,021 7,987 .42 .40 .05 .02 $ $ $ 173,208 53,655 2,029 228,892 38,696 115,028 53,708 3,033 210,465 18,427 7,102 $ 11,325 .59 $ .58 .045 .025 $ 130,962 53,139 1,083 185,184 38,879 91,927 37,310 2,063 170,179 15,005 6,209 8,796 .52 .51 .04 .03 $ $ $ 13 $176,968 $149,984 $122,311 $122,311 $119,781 $121,356 $113,599 39,757 239,382 76,486 116,455 33,267 198,103 55,365 107,335 23,492 158,645 37,479 91,094 23,492 158,645 37,479 91,094 23,532 155,914 46,894 81,418 24,181 157,527 43,159 84,951 18,819 144,917 53,123 59,830 High-quality furniture is the hallmark of MacTavish Furniture Industries, known nationally for its craftsmanship. MacTavish furniture is not only well designed and stylish, but is designed to meet the tough demands of the rental industry. Company-Operated Franchise 292 101 Rental Agreements in Effect 219,800 3,100 Number of Employees 240 61 179,600 2,550 212 36 158,900 2,160 212 36 158,900 2,160 203 24 152,100 2,150 203 26 156,600 2,200 200 15 126,700 2,100 (1) Systemwide revenues include rental revenues of franchise Aaron’s Rental Purchase stores. AR layout Final.wpc 4/24/98 8:24 AM Page 17 Management(cid:213)s Discu ssion and Analysis of Financial Condition and Resu lts of Operations 14 Change i n Fi scal Year En d During 1995, the Company changed its fiscal year end from March 31 to December 31, which resulted in a nine-month fiscal year ended December 31, 1995. The decision to change the fiscal year end was made for more convenience in both internal and external communications. To aid comparative analysis, the Company has elected to present the results of operations for the twelve months ended December 31, 1995 (unaudited), along with the years ended December 31, 1997 and December 31, 1996. Resu lts o f O perati ons Year Ended December 31, 1997 versus Year Ended December 31, 1996 Total revenues for 1997 increased $36.5 million (13.3%) to $310.8 million compared to $274.2 million in 1996 due pri- marily to a $22.7 million (10.9%) increase in rentals and fees revenues, plus an $11.7 million (19.0%) increase in sales. Of this increase in rentals and fees revenues, $19.2 million (84.4%) was attributable to the Aaron’s Rental Purchase division. Rentals and fees revenues from the Company’s rent- to-rent operations increased $3.5 million (3.3%) during the same period. Revenues from retail sales increased $5.8 million (11.1%) to $58.6 million in 1997, from $52.8 million for the same period last year. This increase was due to increased sales of both new and rental return furniture in the rent-to-rent division. Non-retail sales, which primarily represent mer- chandise sold to Aaron’s Rental Purchase franchisees, increased $5.9 million (66.7%) to $14.6 million compared to $8.8 million for the same period last year. The increased sales are due to the growth of the franchise operations. Other revenues for 1997 increased $2.1 million (48.6%) to $6.3 million compared to $4.3 million in 1996. This increase was attributable to franchise fee and royalty income increas- ing $2.1 million (70.8%) to $5.0 million compared to $2.9 million last year, reflecting the addition of 40 new franchise stores in 1997 and improved operating revenues at mature franchise stores. Cost of sales from retail sales increased $4.4 million (11.7%) to $42.3 million compared to $37.8 million, and as a per- centage of sales, increased slightly to 72.1% from 71.7% primarily due to product mix. Cost of sales from non-retail sales increased $5.3 million (64.1%) to $13.7 million from $8.3 million, and as a percentage of sales, decreased to 93.4% from 94.9%. The decrease in 1997 in cost of sales as a per- centage of sales is due to slightly higher margins on sales through the Company’s distribution centers. Operating expenses increased $14.7 million (10.9%) to $149.7 million from $135.0 million. As a percentage of total revenues, operating expenses were 48.2% in 1997 and 49.2% in 1996. Operating expenses declined as a percentage of total revenues between years due to the spreading of expenses over higher revenues. Depreciation of rental merchandise increased $6.7 million (10.4%) to $71.2 million, from $64.4 million, and as a percent- age of total rentals and fees, decreased to 30.8% from 30.9%. Interest expense increased $272,000 (7.9%) to $3.7 million compared to $3.4 million. As a percentage of total revenues, interest expense was 1.2% in 1997 compared to 1.3% in 1996. The slight decrease in interest expense as a percentage of revenues was due to the effect of lower debt levels as a percentage of revenues throughout the year being offset by slightly higher interest rates. Income tax expense increased $2.1 million (21.0%) to $11.8 million compared to $9.8 million. The Company’s effective tax rate was 39.2% in 1997 compared to 38.9% in 1996, pri- marily due to higher state income taxes. As a result, net earnings increased $3.0 million (19.5%) to $18.4 million for 1997 compared to $15.4 million for the same period in 1996. As a percentage of total revenues, net earnings were 5.9% in 1997 and 5.6% in 1996. Year Ended December 31, 1996 verses Twelve Months Ended December 31, 1995 (unaudited) Total revenues for 1996 increased $36.5 million (15.3%) to $274.2 million compared to $237.8 million in 1995 due pri- marily to a $26.2 million (14.3%) increase in rentals and fees revenues, plus an $8.5 million (16.1%) increase in sales. Of this increase in rentals and fees revenues, $16.6 million (19.6%) was attributable to the Aaron’s Rental Purchase division. Rentals and fees revenues from the Company’s rent- to-rent operations increased $9.5 million (9.8%) during the same period. The Company has financed its growth through a revolving credit agreement with several banks, trade credit and inter- nally generated funds. The revolving credit agreement provides for unsecured borrowings up to $90.0 million which includes a $6.0 million credit line to fund daily working capital requirements. At December 31, 1997, an aggregate of $75.9 million was outstanding under this facility, bearing interest at an average fixed rate of 6.57%. The Company uses interest rate swap agreements as part of its overall long-term financing program. At December 31, 1997, the Company had swap agreements with notional principal amounts of $40.0 million which effectively fixed the interest rates on an equal amount of the Company’s revolving credit agreement at 6.93%. The Company believes that the expected cash flows from operations, proceeds from the sale of rental return merchan- dise, bank borrowings and vendor credit, together with the proceeds of a proposed stock offering (see Note M in the Notes to Consolidated Financial Statements), will be sufficient to fund the Company’s capital and liquidity needs for at least the next 24 months. In February 1997, the Company’s Board of Directors autho- rized the repurchase of up to 1,000,000 shares of the Company’s Common Stock and Class A Common Stock. During 1997, 795,000 shares were purchased at an aggregate cost of $8.9 million. The Company has paid dividends for eleven consecutive years. A $.02 per share dividend on Common Stock and on ClassA Common Stock was paid in January 1997 and July 1997, for a total fiscal year cash outlay of $761,000. The Company cur- rently expects to continue its policy of paying dividends. Year 20 0 0 15 The Year 2000 issue arises from the widespread use of com- puter programs that rely on two-digit date codes to perform computations or decision-making functions. The Company’s significant computer programs, including financial, account- ing, store operating and point-of-sale software, have recently been or are in the process of being updated. The upgrading and rewriting of the Company’s software is being done to gain further strategic advantages over competitors and is not the result of any anticipated Year 2000 issues. However, as part of the Company’s continuing process to update systems, management has required that vendor-purchased and inter- nally developed software be Year 2000 compliant. Therefore, based on recent and continuing strategic enhancement of the Company’s software, management does not expect any material impact to the Company’s business, operations or financial condition as a result of Year 2000 issues. Revenues from retail sales increased $5.6 million (11.8%) to $52.8 million in 1996, from $47.2 million for the same peri- od last year. This increase was due to increased sales of both new and rental return furniture in the rent-to-rent division. Non-retail sales, which primarily represent merchandise sold to Aaron’s Rental Purchase franchisees, increased $3.0 mil- lion (51.0%) to $8.8 million compared to $5.8 million for the same period last year. The increased sales are due to the growth of the franchise operations. Other revenues increased $1.5 million (105.4%) to $2.9 mil- lion compared to $1.4 million last year. This increase was due to adding 25 new franchise stores in 1996 as well as older franchise stores gaining in revenues. Cost of sales from retail sales increased $4.8 million (14.5%) to $37.8 million compared to $33.1 million, and as a per- centage of sales, increased slightly to 71.7% from 70.1% primarily due to product mix. Cost of sales from non-retail sales increased $3.1 million (59.5%) to $8.3 million from $5.2 million, and as a percentage of sales, increased to 94.9% from 89.8%. The increase in cost of sales as a percentage of sales is due to a larger percentage of franchise sales in 1996, which are at lower margins than other miscellaneous wholesale sales. Operating expenses increased $15.4 million (12.9%) to $135.0 million from $119.6 million. As a percentage of total revenues, operating expenses were 49.2% in 1996 and 50.3% in 1995. Operating expenses declined as a percentage of total revenues between years due to the spreading of expenses over higher revenues. Depreciation of rental merchandise increased $9.0 million (16.3%) to $64.4 million and, as a percentage of total rentals and fees, increased to 30.9% from 30.4%. This increase is pri- marily due to a change in the rental merchandise mix during the year. Interest expense increased $277,000 (8.7%) to $3.4 million compared to $3.2 million. As a percentage of total revenues, interest is unchanged at 1.3% due to stability in interest rates during 1996. Income tax expense increased $1.7 million (20.6%) to $9.8 million compared to $8.1 million. The Company’s effective tax rate was 38.9% in 1996 versus 38.0% for the same peri- od in 1995. As a result, net earnings increased $2.2 million (16.5%) to $15.4 million for 1996 compared to $13.2 million for the same period in 1995. As a percentage of total revenues, net earnings were 5.6% in both 1996 and 1995. Liqu i dity and Capital Resou rces Cash flows from operations for the years ended December 31, 1997 and 1996 was $105.3 million and $89.5 million, respectively. Such cash flows include profits on the sale of rental return merchandise. The Company’s primary capital requirements consist of acquiring rental merchandise for both rent-to-rent and Company-operated Aaron’s Rental Purchase stores. As the Company continues to grow, the need for additional rental merchandise will continue to be the Company’s major capital requirement. These capital require- ments historically have been financed through bank credit, cash flow from operations, trade credit and proceeds from the sale of rental return merchandise. AR layout Final.wpc 4/24/98 8:24 AM Page 19 Conso li dated Balance Sh eets (In Thousands, Except Share Data) A s s e t s Cash Accounts Receivable Rental Merchandise Less: Accumulated Depreciation Property, Plant & Equipment, Net Prepaid Expenses & Other Assets Total Assets 1 6 L i a b i l i t i e s & S h a r e h o l d e r s ’ E q u i t y Accounts Payable & Accrued Expenses Dividends Payable Deferred Income Taxes Payable Customer Deposits & Advance Payments Bank Debt Other Debt Total Liabilities Commitments & Contingencies Shareholders’ Equity Common Stock, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 16,170,987 Common Stock, Class A, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 5,361,761 Additional Paid-In Capital Retained Earnings Less: Treasury Shares at Cost, Common Stock, 1,058,041 Shares at December 31, 1997 and 415,941 Shares at December 31, 1996 Class A Common Stock, 1,525,255 Shares at December 31, 1997 and 1,418,855 Shares at December 31, 1996 Total Shareholders’ Equity Total Liabilities & Shareholders’ Equity December 31, 1997 December 31, 1996 $ 96 11,794 246,498 (69,530) 176,968 39,757 10,767 $239,382 $ 31,071 379 6,687 8,304 75,904 582 122,927 $ 84 10,491 210,516 (60,532) 149,984 33,267 4,277 $198,103 $ 24,999 382 2,882 7,140 55,125 240 90,768 8,085 8,085 2,681 15,484 113,864 140,114 2,681 15,445 96,226 122,437 (9,523) (2,315) (14,136) 116,455 $239,382 (12,787) 107,335 $198,103 The accompanying notes are an integral part of the Consolidated Financial Statements. Consoli dated Statements o f Earn i ngs (In Thousands, Except Per Share) R e v e n u e s Rentals and Fees Retail Sales Non-Retail Sales Other C o s t s & E x p e n s e s Retail Cost of Sales Non-Retail Cost of Sales Operating Expenses Depreciation of Rental Merchandise Interest Earnings Before Income Taxes Income Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution Year Ended December 31, 1997 Year Ended Nine Months Ended December 31, December 31, 1996 1995 $231,207 58,602 14,621 6,321 310,751 42,264 13,650 149,728 71,151 3,721 280,514 30,237 11,841 $ 18,396 .96 $ .94 $208,463 52,757 8,770 4,255 274,245 37,848 8,320 135,012 64,437 3,449 249,066 25,179 9,786 $ 15,393 .81 $ .77 $137,098 35,537 3,681 1,908 178,224 24,983 3,367 90,027 41,612 2,323 162,312 15,912 6,032 9,880 .51 .49 $ $ Consoli dated Statements of Sharehold ers(cid:213) Equ ity 1 7 (In Thousands) Balance, March 31, 1995 Reacquired Shares Dividends Reissued Shares Net Earnings Treasury Stock Common Stock Shares Amount Common Class A Additional Paid-In Capital Retained Earnings (2,179) (194) $(13,578) (3,134) $ 3,318 $ 2,681 $ 15,314 $ 77,216 13 72 56 Balance, December 31, 1995 (2,360) (16,640) Stock Dividend Reacquired Shares Dividends Reissued Shares Net Earnings Balance, December 31, 1996 Reacquired Shares Dividends Reissued Shares Net Earnings (164) (2,889) 689 4,427 (1,835) (795) (15,102) (8,918) 47 361 3,318 4,767 2,681 15,370 75 8,085 2,681 15,445 96,226 39 (758) 18,396 Balance, December 31, 1997 (2,583) $ (23,659) $ 8,085 $ 2,681 $15,484 $113,864 The accompanying notes are an integral part of the Consolidated Financial Statements. (732) 1 9,880 86,365 (4,767) (765) 15,393 AR layout Final.wpc 4/24/98 8:24 AM Page 21 Conso li dated Statements o f Cash Flows Notes to Conso li dated Fi nancial Statements Year Ended December 31, 1997 Year Ended Months Ended December 31, December 31, 1996 1995 Nine (In Thousands) O p e r a t i n g A c t i v i t i e s Net Earnings Depreciation & Amortization Deferred Income Taxes Change in Accounts Payable & Accrued Expenses Change in Accounts Receivable Other Changes, Net Cash Provided by Operating Activities I n v e s t i n g A c t i v i t i e s $ 18,396 77,487 3,805 $ 15,393 70,693 (899) 5,103 (1,083) 1,587 105,295 $ 9,880 45,798 (345) 242 255 (711) 55,119 (5,476) 1,979 (72,926) 30,892 (533) (46,064) 51,933 (56,845) (768) (367) (3,134) 129 (9,052) 3 95 98 $ 5,695 (2,339) 982 89,525 (17,534) 1,823 (137,023) 48,352 (3,891) (108,273) 85,299 (67,434) 21 (765) (2,889) 4,502 18,734 (14) 98 84 $ $ 1 8 Additions to Property, Plant & Equipment Book Value of Property Retired or Sold Additions to Rental Merchandise Book Value of Rental Merchandise Sold Contracts & Other Assets Acquired Cash Used by Investing Activities (15,165) 6,531 (145,262) 58,436 (21,665) (117,125) F i n a n c i n g A c t i v i t i e s Proceeds from Revolving Credit Agreement Repayments on Revolving Credit Agreement Increase (Decrease) in Other Debt Dividends Paid Acquisition of Treasury Stock Issuance of Stock Under Stock Option Plan Cash Provided (Used) by Financing Activities Increase (Decrease) in Cash Cash at Beginning of Year Cash at End of Year $ 118,545 (97,766) 342 (761) (8,918) 400 11,842 12 84 96 Cash Paid During the Year: Interest Income Taxes $ 3,713 6,989 The accompanying notes are an integral part of the Consolidated Financial Statements. 3,384 7,531 $ 2,642 7,677 At December 31, 1997 and 1996, and for the Years Ended December 31, 1997 and 1996, and the Nine Months Ended December 31, 1995. Note A: Summary o f Si gn i ficant Accou nti ng Po li ci es Principles of Consolidation — The consolidated financial statements include the accounts of Aaron Rents, Inc. and its wholly-owned subsidiary, Aaron Investment Company (the Company). All significant intercompany accounts and trans- actions have been eliminated. The preparation of the Company’s consolidated financial statements in conformity with generally accepted accounting principles requires man- agement to make estimates and assumptions that affect the amounts reported in these financial statements and accompa- nying notes. Actual results could differ from those estimates. Line of Business — The Company is engaged in the business of renting and selling residential and office furniture and other merchandise throughout the U.S. The Company manufac- tures furniture principally for its rental and sales operations. Rental Merchandise consists primarily of residential and office furniture, consumer electronics and other merchandise and is recorded at cost. Prior to January 1, 1996, depreciation was provided using the straight-line method over the esti- mated useful life of the merchandise, principally from 1 to 5 years, after allowing for a salvage value of 5% to 60%. Effective January 1, 1996, the Company prospectively changed its depreciation method on merchandise in the rental purchase division acquired after December 31, 1995, from generally 14 months straight-line with a 5% salvage value to a method that depreciates the merchandise over the agreement period, generally 12 months, when on rent, and 36 months, when not on rent, to a 0% salvage value. This new method is similar to a method referred to as the income fore- casting method in the rental purchase industry. The Company adopted the new method because management believes that it provides a more systematic and rational allo- cation of the cost of rental purchase merchandise over its useful life. The effect for the year ended December 31, 1996 of the change in the depreciation method on merchandise purchased after December 31, 1995 was to decrease net income by approximately $850,000 ($.04 per share). In addition, based on an analysis of the average composite life of the division’s rental purchase merchandise on rent or on hand at December 31, 1995, the Company extended the depreciable lives of that merchandise from generally 14 months to 18 months, and made other refinements to depre- ciation rates on rental and rental purchase merchandise. The effect of such change in depreciable lives and other refine- ments was to increase net income for the year ended December 31, 1996 by approximately $709,000 ($.04 per share). The Company recognizes rental revenues over the rental period and recognizes all costs of servicing and main- taining merchandise on rent as incurred. Property, Plant and Equipment are recorded at cost. Depreciation and amortization are computed on a straight- line basis over the estimated useful lives of the respective assets, which are from 8 to 27 years for buildings and improvements and from 2 to 5 years for other depreciable property and equipment. Gains and losses related to disposi- tions and retirements are included in income. Maintenance and repairs are charged to income as incurred; renewals and betterments are capitalized. The Company adopted Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” (SFAS 121), in the first quarter of 1996. The effect of the adoption was not material. Deferred Income Taxes are provided for temporary differ- ences between the amounts of assets and liabilities for finan- cial and tax reporting purposes. Such temporary differences arise principally from the use of accelerated depreciation methods on rental merchandise for tax purposes. Cost of Sales includes the depreciated cost of rental return residential and office merchandise sold and the cost of new residential and office merchandise sold. It is not practicable to allocate operating expenses between selling and rental operations. Advertising — The Company expenses advertising costs as incurred. Such costs aggregated $9,530,000 in 1997, $10,422,000 in 1996, and $6,258,000 for the nine months ended December 31, 1995. Stock Based Compensation — The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”(APB 25) and related Interpretations in accounting for its employee stock options and adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (FAS 123). The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant and, accordingly, recognizes no compensation expense for the stock option grants. Excess Costs over Net Assets Acquired — Goodwill is amor- tized on a straight-line basis over a period of twenty years. Long-lived assets, including goodwill, are periodically reviewed for impairment based on an assessment of future operations. The Company records impairment losses on long- lived assets used in operations when indicators of impair- ment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. 19 AR layout Final.wpc 4/24/98 8:25 AM Page 23 Impact of Recently Issued Accounting Standard — In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (FAS 131), which is effective for 1998. FAS 131 establishes standards for the way that public companies report information about operating segments in annual finan- cial statements and requires that those companies report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company will adopt the new requirements in its annual financial statements in 1998. Management has not completed its analysis of the effect of FAS 131 on its reported segments. 497,000 and 885,000 in 1997 and 1996, respectively, and 576,000 shares in the nine months ended December 31, 1995. Note D: Property, Plant & Equ i pment (In Thousands) Land Buildings & Improvements Leasehold Improvements & Signs Fixtures & Equipment Construction in Progress December 31, 1997 December 31, 1996 $ 4,643 17,698 19,243 19,402 3,380 64,366 $ 3,662 15,787 16,068 15,738 2,726 53,981 (24,609) $ 39,757 (20,714) $ 33,267 Note B: Change i n Fi scal Year En d Less: Accumulated Depreciation & Amortization 20 During 1995, the Company changed its fiscal year end from March 31 to December 31, which resulted in a nine-month fiscal year ended December 31, 1995. The decision to change the fiscal year end was made for more convenience in both internal and external reporting. Results of operations (condensed) for the nine-month peri- ods ended December 31, 1995 and December 31, 1994 are shown below: (In Thousands, Except Per Share Amounts) Revenues Cost of Sales Operating and Other Expenses Depreciation of Rental Merchandise Earnings Before Income Taxes Income Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution Nine Months Ended December 31, 1995 December 31, 1994 (unaudited) $178,224 28,350 92,350 41,612 15,912 6,032 9,880 .51 $ $ $169,341 28,772 87,649 39,912 13,008 5,021 $ 7,987 .42 $ .49 .40 Note C: Earn i ngs Per Share During 1997, the Company adopted Statement of Financial Accounting Standards No. 128, “Earnings per Share”, (FAS 128). FAS 128 replaced the calculation of primary and fully diluted earnings per share with earnings per share and earnings per share assuming dilution. Earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the year which were 19,165,000 shares in 1997, 19,099,000 shares in 1996, and 19,461,000 shares in the nine months ended December 31, 1995. The computation of earnings per share assuming dilution includes the dilutive effect of stock options. Such stock options had the effect of increasing the weighted average shares outstanding assuming dilution by Note E: Debt Bank Debt — The Company has a revolving credit agreement with four banks providing for unsecured borrowings up to $90,000,000, which includes a $6,000,000 credit line to fund daily working capital requirements. Amounts borrowed bear interest at the lower of the lender’s prime rate, LIBOR plus .50%, or the rate at which certificates of deposit are offered in the secondary market plus .625%. The pricing under the working capital line is based upon overnight bank borrowing rates. At December 31, 1997 and 1996, an aggre- gate of $75,904,000 (bearing interest of 6.57%) and $55,125,000, respectively, was outstanding under this agree- ment. The Company pays a .22% commitment fee on unused balances. The weighted average interest rate on borrowings under the revolving credit agreement (before giving effect to interest rate swaps) was 6.29% in 1997, 6.17% in 1996 and 6.99% for the nine months ended December 31, 1995. The effect of interest rate swaps on the weighted average interest rate was not material. The Company has entered into interest rate swap agreements that effectively fix the interest rate on $20,000,000 of bor- rowings under the revolving credit agreement at an average rate of 7.0% until November 2003 and an additional $20,000,000 at an average rate of 6.85% until June 2005. These swap agreements involve the receipt of amounts when the floating rates exceed the fixed rates and the payment of amounts when the fixed rates exceed the floating rates in such agreements over the life of the agreements. The differ- ential to be paid or received is accrued as interest rates change and is recognized as an adjustment to the floating rate interest expense related to the debt. The related amount payable to or receivable from counterparties is included in accrued liabilities or other assets. Unrealized losses under the swap agreements aggregated $926,000 at December 31, 1997. The fair value of the Company’s bank debt approxi- mates its carrying value. The revolving credit agreement may be terminated on nine- ty days’ notice by the Company or six months’ notice by the lenders. The debt is payable in 60 monthly installments following the termination date if terminated by the lenders. The agreement requires that the Company not permit its consolidated net worth as of the last day of any fiscal quarter to be less than the sum of (a) $105,000,000 plus (b) 50% of the Company’s consolidated net income (but not loss) for the period beginning July 1, 1997 and ending on the last day of such fiscal quarter. It also places other restrictions on addi- tional borrowings and requires the maintenance of certain financial ratios. At December 31, 1997, $6.7 million of retained earnings was available for dividend payments and stock repurchases under the debt restrictions. Other Debt — Other debt of $582,000 at December 31, 1997 and $240,000 at December 31, 1996 primarily repre- sents an insurance premium financing agreement bearing interest at 6.22%. Other debt matures in 1998. Note F: I ncome Taxes (In Thousands) Current Income Tax Expense: Federal State Deferred Income Tax Expense (Benefit): Federal State Year Ended Year Ended December 31, December 31, December 31, 1996 1997 1995 Nine Months Ended $ 7,375 661 8,036 $ 9,503 1,182 10,685 $5,577 800 6,377 3,287 518 3,805 $11,841 (889) (10) (899) $ 9,786 (302) (43) (345) $6,032 Significant components of the Company’s deferred income tax liabilities and assets are as follows: (In Thousands) Deferred Tax Liabilities: Rental Merchandise and Property, Plant & Equipment Other, Net Total Deferred Tax Liabilities Deferred Tax Assets: Accrued Liabilities Advance Payments Other, Net Total Deferred Tax Assets Net Deferred Tax Liabilities December 31, December 31, 1997 1996 $ 9,265 1,244 10,509 1,015 2,276 531 3,822 $ 6,687 $5,486 1,141 6,627 892 2,150 703 3,745 $2,882 The Company’s effective tax rate differs from the federal income tax statutory rate as follows: Year Ended Year Ended December 31, December 31, December 31, 1996 1997 1995 Nine Months Ended Statutory Rate 35.0% 35.0% 35.0% Increases in Taxes Resulting From State Income Taxes, Net of Federal Income Tax Benefit Other, Net 2.5 1.7 3.0% .9% 3.2% (.3) Effective Tax Rate 39.2% 38.9% 37.9% Note G: Commitments The Company leases warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2007. Most of the leases contain renewal options for additional periods ranging from 1 to 15 years or provide for options to purchase the related property at predetermined purchase prices which do not represent bargain purchase options. The Company also leas- es transportation equipment under operating leases expiring during the next 3 years. Management expects that most leas- es will be renewed or replaced by other leases in the normal course of business. Future minimum rental payments, including guaranteed residual values, required under operating leases that have ini- tial or remaining non-cancelable terms in excess of one year as of December 31, 1997, are as follows: $20,838,000 in 1998; $16,819,000 in 1999; $12,444,000 in 2000; $19,319,000 in 2001; $4,164,000 in 2002; and $4,457,000 thereafter. Rental expense was $22,146,000 in 1997, $17,886,000 in 1996 and $11,513,000 for the nine months ended December 31, 1995. The Company leases five buildings from certain officers of the Company under leases expiring through 1998 for annual rentals aggregating $383,000. The Company maintains a 401(k) savings plan for all full- time employees with at least one year of service with the Company and who meet certain eligibility requirements. The plan allows employees to contribute up to 10% of their annual compensation with 50% matching by the Company on the first 4% of compensation. The Company’s expense related to the plan was $357,000 in 1997, $308,000 in 1996 and $162,000 for the nine months ended December 31, 1995. 2 1 AR layout Final.wpc 4/24/98 8:25 AM Page 25 Note H: Shareh old ers(cid:213) Equ ity During 1996, the Company declared a 100% stock dividend on its Common Stock and Class A Common Stock. Each stockholder received one share of Common Stock for each share of Common Stock and Class A Common Stock held. All share and per share amounts have been restated to reflect the 100% stock dividend. Common stock is non-voting. At December 31, 1997, the Company held a total of 2,583,296 common shares in its treasury, and is authorized by the Board of Directors to acquire up to an additional 208,090 shares. The Company has 1,000,000 shares of preferred stock authorized. The shares are issuable in series with terms for each series fixed by the Board and such issuance is subject to approval by the Board of Directors. No preferred shares have been issued. Note I: Sto ck O pti ons The Company has stock option plans under which options to purchase shares of the Company’s Common Stock are granted to certain key employees. Under the plans, options granted become exercisable after a period of two or three years and unexercised options lapse five or ten years after the date of the grant. Options are subject to forfeiture upon ter- mination of service. Under the plans, 2,000,500 of the Company shares are reserved for issuance at December 31, 1997. The weighted-average fair value of options granted was $8.58 in 1997 and $4.99 in 1996. Pro forma information regarding net earnings and earnings per share is required by FAS 123, and has been determined as if the Company has accounted for its employee stock options granted in 1997 and 1996 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996, respectively: risk-free inter- est rates of 5.88% and 6.72%; a dividend yield of .25% and .4%; volatility factor of the expected market price of the Company’s common stock of .39 and .335; and a weighted- average expected life of the option of 8 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjec- tive assumptions including the expected stock price vola- tility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assump- tions can materially affect the fair value estimate, in manage- ment’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vest- ing period. The Company’s pro forma information follows (in thousands except for earnings per share information): Pro forma net earnings Pro forma earnings per share Pro forma earnings per share assuming dilution Year Ended Year Ended December 31, December 31, 1997 $17,508 .91 1996 $14,825 .78 .89 .74 Because Statement 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until future years. The table below summarizes option activity for the periods indicated in the Company’s stock option plans. (In Thousands, Except Price Per Share) Options Outstanding at April 1, 1995 Exercised Forfeited Outstanding at December 31, 1995 Granted Exercised Forfeited Outstanding at December 31, 1996 Granted Exercised Forfeited Outstanding at December 31, 1997 Exercisable at December 31, 1997 1,294 (24) (22) 1,248 780 (701) (8) 1,319 322 (47) (9) 1,585 501 Weighted Average Exercise Price $ 4.54 3.00 6.68 4.54 9.88 3.00 9.68 8.48 15.95 5.28 10.83 $10.07 $ 6.62 Exercise prices for options outstanding as of December 31, 1997 ranged from $4.88 to $16.50. The weighted-average remaining contractual life of those options is 6.58 years. 22 Note J: Quarterly Fi nancial I n fo rmation (U nau d ited) (In Thousands Except Per Share) First Quarter Second Quarter Third Quarter Fourth Quarter Year ended December 31, 1997 Revenues Gross Profit Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share $76,480 43,574 7,080 4,312 .22 $ $77,465 44,236 7,608 4,633 .24 $ $76,238 43,996 7,883 4,805 .25 $ $80,568 45,559 7,666 4,646 .25 $ Assuming Dilution .22 .24 .25 .24 Year ended December 31, 1996 Revenues Gross Profit Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share $64,693 38,873 6,791 4,159 .22 $ $67,610 39,980 6,375 3,914 .21 $ $71,224 41,273 6,198 3,787 .20 $ $70,718 39,259 5,815 3,533 .18 $ Assuming Dilution .21 .20 .19 .18 Note K: Franch i si ng o f Aaron(cid:213)s Rental Pu rchase Stores The Company franchises Aaron’s Rental Purchase stores. As of December 31, 1997 and December 31, 1996, 186 and 155 franchises had been awarded, respectively. Franchisees pay a non-refundable initial franchise fee of $35,000 and an ongo- ing royalty of 5% of cash receipts. The Company recognizes this income as earned and includes it in Other Revenues in the Consolidated Statements of Earnings. The Company has guaranteed certain lease and debt obligations (primarily extending through 1999) of some of the franchisees amount- ing to $127,000 and $8,131,000, respectively, at December 31, 1997. The Company receives a guarantee and servicing fee based on such franchisees’ outstanding debt obligations which it recognizes as income over the guarantee and servic- ing period. The Company has recourse rights to the leased property and to the assets securing the debt obligations. As a result, the Company does not expect to incur any significant losses under these guarantees. Note L: Acqu i siti ons In December 1997, the Company acquired substantially all of the assets of RentMart Rent-To-Own, Inc., a wholly- owned subsidiary of the Associates Capital Corporation, for $18,012,000 in cash. The excess cost over the fair market value of tangible assets acquired was approximately $4,300,000. In December 1997, the Company acquired substantially all of the assets of Blackhawk Convention Services, Inc. for $3,500,000 in cash. The excess cost over the fair market value of tangible assets acquired was approximately $2,700,000. Both acquisitions were accounted for under the purchase method and, accordingly, the results of operations of the acquired businesses are included in the Company’s results of operations from their dates of acquisition. The effect of these acquisitions on the 1997 consolidated financial statements was not significant. Note M: Propo sed Sto ck Offeri ng On or about March 31, 1998, the Company intends to file a registration statement for the sale by the Company of 2,100,000 shares of Common Stock. The proceeds of the offering, if consummated, would be used to reduce indebt- edness and for general business purposes, including opening additional rent-to-rent and rental purchase stores and expanding manufacturing and distribution capacity. Repo rt o f I n d epen d ent Au d itors To the Board of Directors and Shareholders of Aaron Rents, Inc.: We have audited the accompanying consolidated balance sheets of Aaron Rents, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, shareholders’ equity and cash flows for the years ended December 31, 1997 and 1996, and the nine months ended December 31, 1995. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial state- ment presentation. We believe that our audits provide a rea- sonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated finan- cial position of Aaron Rents, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for the years ended December 31, 1997 and 1996, and the nine months ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in Note A to the Consolidated Financial Statements, in 1996, the Company changed its method of accounting for depreciation of rental purchase merchandise. Atlanta, Georgia March 23, 1998 23 AR layout Final.wpc 4/24/98 8:25 AM Page 27 Common Sto ck Market Pri ces & Divi d en d s On March 20, 1998, the Company’s Common Stock and Class A Common Stock were listed on the New York Stock Exchange under the symbols “RNT” and “RNT.A,” respectively. Previously, the Company’s Common Stock and Class A Common Stock were traded on The NASDAQ Stock Market under the symbols “ARON” and “ARONA,” respectively. The approximate number of shareholders of the Company’s Common Stock and Class A Common Stock at March 23, 1998, was 4,500. The following table shows, for the periods indicated, the range of high and low prices per share for the Common Stock and Class A Common Stock as reported by NASDAQ, and the cash dividends declared per share. The closing price for the Common Stock and Class A Common Stock on March 23, 1998, was $23.438 and $22.625, respectively. The Company currently expects to continue its policy of paying dividends. Common Stock High Low December 31, 1997 First Quarter Second Quarter Third Quarter Fourth Quarter December 31, 1996 First Quarter Second Quarter Third Quarter Fourth Quarter Class A Common Stock December 31, 1997 First Quarter Second Quarter Third Quarter Fourth Quarter December 31, 1996 First Quarter Second Quarter Third Quarter Fourth Quarter $12.875 13.375 18.250 20.250 $10.375 15.000 14.250 14.625 $10.063 10.375 12.750 15.500 $ 9.000 9.688 11.000 10.750 High Low $14.000 13.750 18.000 18.500 $11.250 16.000 16.250 15.750 $ 9.750 10.000 11.938 14.500 $ 8.875 10.750 12.750 12.625 Cash Dividends Per Share $ .02 .02 $ .02 .02 Cash Dividends Per Share $ .02 .02 $ .02 .02 B oard of Di recto rs R. Charles Loudermilk, Sr. Chief Executive Officer, Chairman of the Board Aaron Rents, Inc. Ronald W. Allen Retired Chairman, President and Chief Executive Officer Delta Air Lines Leo Benatar (1), (2) Sr. Partner and Associate Consultant A.T. Kearney Gilbert L. Danielson Vice President, Finance, Chief Financial Officer Aaron Rents, Inc. Earl Dolive (1) Vice Chairman of the Board, Emeritus Genuine Parts Company 24 S t o r e a n d F a c i l i t y L o c at i o n s J. Rex Fuqua Vice Chairman, Fuqua Enterprises, Inc. Keith C. Groen Vice President, Legal, and Secretary Aaron Rents, Inc. Ingrid Saunders Jones (2) Vice President, Corporate External Affairs The Coca-Cola Company Robert C. Loudermilk, Jr. President, Chief Operating Officer Aaron Rents, Inc. Officers R. Charles Loudermilk, Sr. Chairman of the Board, Chief Executive Officer Robert C. Loudermilk, Jr. President, Chief Operating Officer Gilbert L. Danielson Vice President, Finance, Chief Financial Officer William K. Butler, Jr. President, Aaron’s Rental Purchase Division Brian E. Stahl President, Aaron Rents’ Rent-to-Rent Division William J. Sammons President, Aaron Rents’ Convention Furnishings Division Keith C. Groen Vice President, Legal, and Secretary D. Bruce Cox Vice President, Mid Atlantic Region Bennett E. Creasman Vice President, South Region Lyle M. Digby Vice President, Western Region Richard L. Levine Vice President, Purchasing and Distribution Michael J. Malone Vice President, Aaron Rents’ Convention Furnishings Division Daniel J. Nold Vice President, Midwest Region Mitchell S. Paull Vice President, Treasurer Eduardo Quiñones Vice President, Florida Region Lt. Gen. M. Collier Ross (1) U.S. Army (retired) R. K. Sehgal Vice Chairman and Chief Executive Officer H. J. Russell and Company James L. Cates Vice President, Risk Management Robert P. Sinclair, Jr. Corporate Controller (1) Member of Audit Committee (2) Member of Stock Option Committee At December 31, 1997 Rent-to-Rent Company-Operated Rental Purchase Franchised Rental Purchase Convention Furnishings Total Stores 105 181 101 6 393 Manufacturing & Distribution Centers 14
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