1999 Annual Report Growing Across America Contents Financial Highlights Letter to Shareholders Selected Financial Information Management’s Discussion and Analysis of Financial Condition and Results of Operations Consolidated Balance Sheets Consolidated Statements of Earnings Consolidated Statements of Shareholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Auditors Store Locations Board of Directors and Officers Corporate and Shareholder Information 1 2 13 14 17 18 19 20 21 27 28 29 29 Growing Across America Aaron Rents, Inc. Aaron Rents, Inc. is the leading U.S. company engaged in the combined businesses of the rental, rental purchase and specialty retailing of residential and office furniture, consumer electronics, household appliances and accessories with 475 stores in 40 states. The Company is positioned as “America’s Premier Name in Furniture Rental and Rental Purchase” and offers both individual and corporate customers a wide range of residential and office furniture, consumer electronics, household appliances and accessories for rental, rental purchase and sale. The Company’s major operations are the Aaron’s Rental Purchase division, the Rent- to-Rent division and MacTavish Furniture Industries, which manufactures much of the furniture for the Company’s rental and rental purchase stores. Strategically, the Company is focused on increasing the rental purchase business through opening new Company- operated stores and through its franchise program, which is unique in the industry, while expanding the rent-to-rent business by identifying and responding to new market opportunities. Financial Highlights Year Ended (Dollar Amounts in Thousands, December 31, December 31, Except Per Share) Year Ended 1998 1999 Revenues By Calendar Year Percentage Change Operating Results Revenues Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share $437,359 $379,659 15.2% 41,302 25,602 1.28 35,191 21,484 1.06 17.4 19.2 20.8 Assuming Dilution 1.26 1.04 21.2 Financial Position Total Assets $318,408 $272,174 17.0% 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 Rental Purchase Rental Purchase Franchised Rent-to-Rent Total Stores 219,831 72,760 183,718 194,163 51,727 168,871 9.22 28.4% 9.4 5.9 14.5 213 155 107 475 8.22 23.4% 9.3 5.7 15.1 182 136 109 427 13.2 40.7 8.8 12.2 17.0% 14.0 -1.8 11.2% ) s ’ 0 0 0 n i $ ( $450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 ’95 ’96 ’97 ’98 ’99 Rent-to-Rent Stores Company-Operated Rental Purchase Stores Net Earnings By Calendar Year ) s ’ 0 0 0 n i $ ( $30,000 $25,000 20,000 15,000 10,000 5,000 0 ’95 ’96 ’97 ’98 ’99 1 To Our Shareholders Eight consecutive years of record growth! The exceptional people of Aaron Rents, Inc. did it again in 1999. They set new records in both revenues and earnings for the eighth year in a row. They turned in a winning performance in both Company and franchised operations to make our 45th year one to celebrate. Aaron’s winning concept of customer service continued to gain market share across the country as we opened on the average a new store every week. In 1999 we expanded into 8 more states, and by year end our total store count reached 475 in 40 states. In the past two years we have opened 100 stores. Revenues for 1999 rose to a record $437.4 million, an increase of 15% over $379.7 million for 1998. Earnings increased to a record $25.6 million, gaining 19% over the $21.5 million for the previous year. Earnings per share reached $1.28 ($1.26 assuming dilution) compared to $1.06 ($1.04 assuming dilution) for 1998. The fourth quarter of 1999 was our 33rd consecutive quarter of record earnings and our 32nd consecutive quarter of record revenues. This confirms the validity of our concept and reflects the commitment of our people to the Aaron’s way of doing business. Last year our rental purchase franchising gained strong momentum. It was our best year of franchise sales. The Aaron’s Rental Purchase division again achieved record revenues with growth of 31% for the year, reaching $261.6 million compared to $200.0 million for 1998. This division accounted for 60% of total 1999 revenues, reflecting the success of the Aaron’s concept over the past six years. During that period, the number of rental purchase stores has increased from 82 to 368, including 155 franchised stores. In 1999 the Company acquired 17 franchised stores, while 41 new franchised stores were opened. Our backlog of franchised stores that will be opened in the future reached a record 122 stores at the end of 1999. Approximately three-fourths of these stores will be opened by existing fran- chise owners who continue to expand their territories, dramatic proof of our franchise program’s success among these experienced business people and successful entrepreneurs. A new financing plan has also given stronger impetus to our franchising program. The rent-to-rent division’s results did not meet our expectations due to market weak- nesses, while unusually strong pricing competi- tion affected revenues and earnings. However, this cash-generating division is implementing a plan to meet the challenges of the market and to improve profitability in 2000. Our manufacturing division, MacTavish Furniture Industries, turned in another record year, producing more than $50 million of furniture at cost and supplying a significant portion of the furniture needed in our stores. Our manufacturing capability, unmatched by any competitor, is supported by our own distribution system of five large centers in strategic locations across the country, giving Aaron’s competitive advantages in quick delivery and a wide selection of merchandise. The strong growth of our Company in 1999 required new management at various levels and new positions to meet current and future demands. B. Lee Landers, Jr., formerly with Southern Company, was appointed to the newly created position of Vice President, Chief Information Officer of Aaron Rents, confirming the increasing significance of technology in our businesses. David M. Rhodus, formerly with a Fortune 500 company, joined our corporate staff as Vice President, Legal. James L. Cates was elected Corporate Secretary of the Company in addition to serving as Vice President, Risk Management. Robert P. Sinclair, Jr. was named Vice President, Corporate Controller. James C. Johnson was named Vice President, Internal Audit. In our fast-expanding rental purchase division, two officers were promoted from regional managers to new positions: Joseph N. Fedorchak, Vice President, Eastern Operations, and David L. Buck, Vice President, Western Operations. 2 Despite the record growth of the Company, we are constantly challenged to achieve adequate recognition of the value of Aaron Rents on Wall Street. We were very pleased to be added to the S&P SmallCap 600 Index in 1999, a step that should help in attracting greater investor interest. Reflecting our commitment to add value, since September 1998 the Company has repurchased 1,595,900 shares of common stock including 859,500 in 1999. We believe that our strategy for building a strong company and expanding internally will ultimately receive recognition by the financial market. Entering this new century, we are very optimistic. We plan to increase substantially the number of rental purchase stores throughout the country and by year end could be near the 600-store mark. We intend to do this through solid internal growth led by the highly success- ful and increasingly profitable rental purchase division including its elite corps of multi-store franchise owners. We have developed the concept that rental purchase consumers love. If we will open the stores, they will come. That’s why we expect another record year in 2000. R. Charles Loudermilk, Sr. Chairman and Chief Executive Officer Robert C. Loudermilk, Jr. President and Chief Operating Officer 3 “We doubled revenues from 1998 to 1999, and expect to double again in 2000.” — Jimmy Day, Franchise Owner, Texas and Colorado Jimmy Day has been an Aaron’s Rental Purchase franchise owner since 1996. His company, DPR Investments, L.L.C., now has 11 stores located in Texas and Colorado. Two more are under construction. This franchise owner, a former rancher with an M.B.A. from the University of Texas, has a 19-store franchise. “We started the year with six stores and ended the year with 11 stores,” said Day. “I love to hear from our customers describing Aaron’s and saying, ‘They make us feel like family ’.” Wilma Ramos has been the manager of the Aaron’s Rental Purchase store in Kissimmee, Florida since 1997. She started her career with the Company in 1991 as a customer service representative at the same store, then managed two other stores before returning as manager at Kissimmee. Ms. Ramos is enthusiastic about Aaron’s. “The best program, the best prices, it all speaks for itself,” she said. “The way our showrooms look sets Aaron’s apart.” Customer service is the magic ingre- dient in it all, she says. “It has to start with myself being the example. My employees see that. The customer’s always the Number One priority. We’re up front with them.” The best reward, she feels, “is hearing the thanks of the customer.” “We will probably have all 19 built by the end of this year.” Stores are located in cities ranging from Denver with six stores to the little town of Harlingen, Texas, one of four towns with Aaron’s stores on the Rio Grande River bordering Mexico. “We really do give our customers the best product at the best price,” Day said. “It feels good to go about our work with our heads held high, knowing that we are helping people live better.” — Wilma Ramos, Store Manager, Kissimmee, Florida The Aaron Rents Concept Unique strengths are combined in the Aaron Rents concept, unmatched in the markets the Company serves. Consistency — For 45 years the Company has delivered high quality products and services, and for eight consecutive years it has built value for shareholders with record revenues and earnings. Profitability — Year after year the bottom line has grown at a strong rate — with a 5-year compounded annual growth rate of 19% in net earnings. Integrity — Since its founding, Aaron Rents has been known for its integrity and ethical business practices, beginning with first-rate products and services, full disclosure of terms and respect for the customer. Synergy — The Company’s business units afford a strong synergy with the rental purchase division providing the opportunity for rapid growth and the rent-to-rent division generating cash flow for expansion, while the manufacturing division complements both of these divisions. Creativity — Aaron Rents led the way as a pioneer in the rent-to-rent industry by seizing the opportunity to create and serve a new market, and in recent years by developing its highly successful rental purchase concept and franchising program. Efficiency — The Company’s manufacturing division, MacTavish Furniture Industries, and Aaron’s own distribution system create efficiencies and cost advantages from vertical integration and total control over product design, quality and inventory. The result is high quality, lower prices and prompt delivery of merchandise to customers. Aaron’s Rental Purchase Gives Back To Its Communities The Aaron’s Rental Purchase division gives back to the communities served by its stores through the Aaron Community Outreach Program (ACORP), which provides funds for charitable causes. Stores that qualify by meeting perform- ance goals receive $500 each month to be given to local charities by associates at the store. “Giving back through ACORP is but a small way we can say thank you to each community, to show our sense of community pride,” said Ken Butler, President of the Aaron’s Rental Purchase division. “It is the right thing to do for our own business and the people who support us every day.” During 1999 Aaron’s people gave to a wide range of causes including children’s hospitals, a homeless family, a homeless center, youth pro- grams and shelters, classroom computers, vic- tims of domestic and child abuse, cancer and cerebral palsy research, Girl Scouts, Boy Scouts and Little League teams. ACORP gives in other ways. In 1999 the outreach became a partner with Habitat for Humanity International, and volunteers from the Aaron’s Rental Purchase division helped in the Easter Morning Build ’99 in Americus, Georgia. In November teams of Aaron’s Rental Purchase volunteers built two Habitat houses simultaneously in Houston, Texas and Tampa, Florida. In each city 75 Aaron’s associ- ates volunteered for the house-building projects. One of the Aaron’s volunteers, Mike McNeil of Auburndale, Fla., spoke for all who had a part: “It was all worth it when I saw the smiles on the family’s faces the first time they opened the door on their finished home.” 5 Rental Purchase Aaron’s Rental Purchase division has reached “critical mass.” The Aaron’s concept is now rapidly gaining acceptance throughout America. In one market after another, our stores are finding a strong response, thanks to the quality of customer service and the products. Aaron’s brings con- sumers what they want. During 1999 the Company increased its rental purchase stores by 50, including fran- chised stores, boosting the total to 368 at year end. This means the 400-store threshold should be crossed by midyear, adding even more momentum to the growth and profitability of this fast-expanding division. Aaron’s market is the large segment of Americans who are not served adequately by conventional retailers and rent-to-own competi- tors. The distinct and unique concept of Aaron’s Rental Purchase is moving the business “to Main Street,” as Founder and Chief Executive Officer R. Charles Loudermilk, Sr. has said. Aaron’s strategy targets the higher end of the rental purchase market, which is estimated at one-third of all American households, with revenues exceeding $4 billion annually. To reach this desirable market sector, Aaron’s has designed larger and more attractive stores than typically seen in the old approach to this market. Aaron’s stores average 9,000 square feet, more than three times the size of conventional competing stores which average 2,500 square feet. With larger showrooms, Aaron’s displays a far wider selection of popular brand name merchandise as well as the Company’s own brands of furniture. The environment of Aaron’s stores is also different — usually suburban locations serving customers with higher incomes than typical rent-to-own consumers. The more upscale sites offer Aaron’s customers a greater product selection and a more pleasant shopping experience. Rental Purchase Rental Revenues Appliances 14% Computers 5% Other 1% Electronics 49% Furniture 31% Aaron’s Rental Purchase Systemwide Revenue Growth and Store Count $400,000 350,000 300,000 ) s ’ 0 0 0 n i $ ( 250,000 200,000 368* 318* 282* 150,000 198* 142* 100,000 50,000 0 ’95 ’96 ’97 ’98 ’99 Company-Operated Revenues Franchise Revenues *Number of Stores The key to Aaron’s success is its 12-month plan allowing customers to own merchandise by making only 12 monthly payments, a sharp contrast to the 18 to 36 months of weekly payments prevailing at most competing stores. Two other major competitive advantages are the Company’s furniture manufacturing divi- sion, unique in the industry, and the Aaron’s distribution system which relies on five large centers in strategic locations across the country. No competitor can match Aaron’s ability to pro- duce and deliver merchandise to the customer on the same or next day of the order. This is the key to success in rental purchase. Supporting the growth of Aaron’s Rental Purchase is a major expansion of national advertising to increase the division’s name recognition in its markets. In 1999, Aaron’s acquired the title sponsorship rights to the NASCAR Busch Grand National Car Race at the Atlanta Motor Speedway for three years beginning in 2000. This is the longest race of the Busch Grand National season with 312 miles, known as the “Aaron’s 312,” playing off the unique Aaron’s rental purchase concept — three ways to buy and a 12-month plan. The core message reaching this prime market for Aaron’s is that customers have three different ways to buy: with (1) cash or check, (2) credit card, and (3) the exclusive Aaron’s Lease Plus program that provides 12 month lease owner- ship with automatic pre-approval and the guaranteed lowest price. The “Aaron’s 312,” televised nationally on ABC, enables Aaron’s to reach the most brand loyal fans of any major sport, and the audience’s demographic profile matches exactly the Company’s target customer base. In addition to this NASCAR sponsorship, the Aaron’s message also reaches a national audience through spon- sorship of Atlanta Braves games broadcast over Superstation WTBS and other sports events. The division also has its own website, www.shopaarons.com, which is unique in its industry as no other rental purchase retailers feature both product and pricing. 6 Rental Purchase Franchising The Rental Purchase Franchise Momentum. Franchising has moved into an exciting new stage of growth driven by multi-store franchise owners. These experienced business people and financially savvy entrepreneurs see an Aaron’s Rental Purchase franchise as a golden opportu- nity and they are making the most of it. During the past year thirteen current owners acquired the right to open 47 additional stores, while 14 new franchisees signed on to open 51 stores in the future. This “repeat business” is the ultimate testimony to the validity of the Aaron’s franchise program — the only major one in the industry — and validates the Company’s decision to develop multi-store ownership as the avenue to quality, rapid growth. The strong trend of current owners expanding enables the Aaron’s Rental Purchase franchise program to grow faster and more efficiently, resulting in higher profitability over the long term. Owners of existing stores can open new stores more rapidly and benefit from economies of scale and reduced costs. Our growth strategy gained new momentum in the past year with the improved Aaron’s financing program. This $52 million facility with four major banks, replacing a $40 million financing plan, provides the funding for new franchise owners and offers qualified, experi- enced owners access to a long-term, revolving credit facility. As expected, the availability of capital for new store openings accelerated the growth of the division. Franchise owners are able to open a larger number of stores more quickly and reach their profit goals, resulting in increasing profitability to them and the Company. Aaron’s consistently ranks among the best franchise programs in the entire country, placing near the top in national surveys. The criteria used in awarding the top rankings indicate the strength of the Aaron’s franchise program. Winners are selected on the basis of the company’s financial performance including revenues, franchise fees and propri- etary goods and services; the corporate manage- ment and the company’s growth and stability; the all-important relationship between fran- chisor and franchisee; and the opportunities for growth available to the franchisee. Judged on all these points, Aaron’s stands among the leaders year after year. 7 “Our stores far surpassed what we expected. Phenomenal monthly store revenues are well above what we expected.” and Kevin LaPierre — Franchise Owners, David Edwards Kevin LaPierre and David Edwards are partners in Bluesky Investments, Inc., which has Aaron’s Rental Purchase franchises in Massachusetts and Connecticut. They opened their first store in February 1998 in Springfield, Massachusetts and now have three stores in operation. “Our stores far surpassed what we expected,” LaPierre said. “We have the highest volume store in Aaron’s, $200,000 plus a month, in Springfield, and our Hartford, Connecticut store was named Store of the Year.” The franchise owners plan to open four more stores in the next year with a goal of 10 to 15 stores in their territory. LaPierre credits the success to the quality of his people and the Aaron’s concept. “It’s a better mousetrap,” he said. “It’s a very good system.” “What attracted me was the 12-month ownership plan and overall price — and I felt better about myself.” Allan Wee started with Aaron’s Rental Purchase as a customer accounts manager in 1995 after 10 years with a company in the conven- tional rent-to-own business. He became manager of the Aaron’s store in Irving, Texas within a few months after joining the Company. What appeals to Wee is the Aaron’s program allowing customers to own merchandise in only 12 months. “Other places it’s 18 months, 24 months to 36 months,” he said. “It just stands to reason when you do the math. There’s a 30 percent to 50 percent price difference in favor of the customer at Aaron’s,” Wee added. Wee’s store in Irving has gone from $60,000 to $120,000 in monthly revenues. Moving from a 3,000 square-foot store to a free-standing store with 8,000 square feet was a major factor in the growth. — Allan Wee, Store Manager, Irving, Texas The Aaron’s franchise support center provides the services critical to success. Assis- tance is provided in developing a successful business plan, the first step in the process. Aaron’s aids in selection of the store’s location and analysis of market competition. Training in the management and operation of the stores is provided, and the franchise owner benefits from purchasing discounts and valuable support in advertising and publicity. The Aaron’s approach is a two-way street of cooperation and mutual respect. A management team of franchisees serves on a rotating basis with corporate representatives. Team members are charged with giving leadership to the fran- chise program, to deal with operational and management concerns, and explore the range of ways by which support and cooperation can be improved to the benefit of both franchise owners and the Company. $32,000 $28,000 $24,000 $20,000 16,000 12,000 8,000 4,000 ) s ’ 0 0 0 n i $ ( Quarterly Revenues Of Franchised Stores 155* 142* 136* 138*136* 121* 116* 106* 101* 86* 76* 71* 61* 54* 45* 38* 36* 31* 28* 26* 24* 21* 18* 15* 13* 8* 6* 6* $0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1993 1994 1995 1996 1997 1998 1999 *Number of Stores 9 Rent-to-Rent Providing Home and Office Furnishings for the Corporate and Individual Customer. The rent-to-rent division has been a market leader from its formation in 1955 as the original business line of Aaron Rents, Inc. Today the division continues its leadership in meeting the needs of a changing market with more than 100 stores throughout the country. High standards, stylish name-brand and proprietary furnishings, distinctive yet functional products, fast delivery and flexible customer service, rent, buy or lease-purchase — these are among the hallmarks of this division. Aaron Rents’ leadership is reflected by its standing as the second largest business in the industry, com- manding approximately 30 percent of the estimat- ed $600 million market in the United States. Aaron Rents provides residential and office furniture to individuals and corporations who have temporary needs. Within these sectors the forces of change constantly drive the division’s product line and niche targeting of emerging market segments. The corporate relocation market and the small office/home office (SO/HO) market represent two areas of opportunity for growth. Aaron Rents has developed new approaches to serve these sectors. For the corporate relocation client, the Company offers an outstanding selection of office and residential furnishings, from work- station environment systems for temporary offices to furniture, housewares, appliances and electronics for temporary housing, usually apartments. Also, the Company has expanded the number of office furniture stores to meet increasing demand. Spinoffs of existing stores in several areas last year enable the Company to focus more sharply on both the office and residential customers. Aaron Direct, our warehouse concept, now has a presence in six markets serving national customers who provide interim housing for companies relocating employees. The Aaron Direct centers serve third party providers and national accounts as well as corporations that desire furniture, housewares and other products to furnish apartments for temporary housing for companies relocating employees. Aaron Rents is also targeting the growing small office/home office market — which holds strong potential for office furniture, based on projections by researchers. The number of income-producing home office households has expanded from 27 million in 1995 to 41 million in 1999, according to International Data Corp. Retail sales of furniture to this market sector jumped from $800 million in 1996 to $1.2 billion in 1998, and the number of at-home workers is rapidly increasing. The growing use of home computers means that many homes will have a computer-office type room — which will need furnishings. Aaron Rents is getting in front of the customers through its website, www. aaronrentsfurniture.com. Potential customers call to receive information upon viewing the website. A marketing approach targeting these customers is the new Lease Plus program. It allows ownership of furniture in 12 months, 18 months or longer, depending on the desires of the customer. Lease Plus is proving to be a significant marketing tool for the division. Another key to success is the ability of Aaron Rents to quickly fill a customer’s order, whether residential or office. The typical customer wants delivery the next day. Aaron Rents can meet that demand, thanks to its on-premises ware- housing, and the manufacturing capabilities of MacTavish Furniture Industries, a major part of the Company’s synergistic plan for competitive advantages. Aaron Rents has the best of both worlds, offering leading brands and its own MacTavish- made lines. Aaron Rents is also the nation’s largest La-Z-Boy business furniture rental company. 10 Rent-to-Rent Rental Revenues Electronics & Appliances – 6% Office Furniture – 34% Residential Furniture – 60% “Our lease ownership differentiates us from competitors. Our customers come in, select what they need, pay the first month’s rent and after 12 months they own it.” Tucson, Arizona — Keith Blades, Store Manager,Rent-to-Rent, Keith Blades began his rental career with Aaron Rents in Phoenix and moved to Tucson in 1995. His store has benefited from a strong local economy and the influx of new people being transferred in by major corporations. Serving such reloca- tions is the forté of Aaron Rents. “This is primarily residential furnish- ings for corporate housing,” said Blades. “A third party provider contracts with the Company for the furniture, and we partner with that provider. The corporation also rented a lot of office furniture from us.” Blades said the focus now is on lease ownership, new in the Tucson market, which is showing a favorable response. In addition, the rent-to- rent store always has a busy spring providing furniture for three baseball teams in spring training at Tucson — the Arizona Diamondbacks, the Chicago White Sox and the Colorado Rockies. “Our office systems have been — David Culley, Regional Manager, Florida Rent-to-Rent very successful, and we are getting a lot of activity from our Web page.” David Culley was an office furniture rental store manager before becoming the Florida regional man- ager in 1999. He now has responsi- bility for seven office furniture rental stores in the strong Florida market. The division’s Web page is becoming an important marketing tool that brings in new business, he said. “It gets us out in front of the customers, and we literally have people looking at the Web page while they’re on the telephone with us.” “Our Lease Plus program is very strong for us,” Culley said. “It has become very popular.” Lease Plus tailors a plan allowing the customer 12 to 18 months or longer to own the furniture. Also popular are work- station environment systems with built-in modular components. MacTavish Furniture Industries and Distribution Centers Providing the Competitive Edge in Delivering Merchandise Within 24 Hours. A unique advantage for Aaron Rents is its furniture manufacturing division, MacTavish Furniture Industries — which attains even greater impact in customer service through the Company’s network of distribution centers in key areas across the United States. Only Aaron Rents has its own manufacturing capability, the result of a decision made decades ago to assure the Company’s stores of ample inventory and its customers of the quick turn- around of orders absolutely essential to success in the rental and rental purchase businesses. During the past year, the 11 MacTavish plants produced more than $50 million of furniture, accessories and bedding at cost. This ranks the division among the major furniture manufacturers in the country. More importantly, MacTavish supplied most of the furniture for the nearly 500 stores of Aaron Rents, providing the competitive edge in getting merchandise to the customer on the same or next day and keep- ing the store warehouses and the distribution centers fully stocked. The MacTavish lines are high quality, distinctive and functional. Yet all MacTavish furniture is constructed to withstand the multiple shipping and handling necessary to reach the showroom floor and the customer’s home or office. MacTavish adheres to its own rigid standards of excellence to produce stylish designer-inspired packages of furniture to suit a wide range of needs and price ranges. Technology plays an increasing role in MacTavish’s commitment to quality as the division utilizes computer-aided design and computer-controlled cutting techniques. Still another dimension of the Aaron Rents vertical integration provides the coordinated rooms demanded by customers. Lamps Forever, Inc., led by Avi Yofan, creates exclusive lines of designer lamps, tables and accessories. These add tremendous appeal to the showroom groupings of living room, dining room and bedroom furniture in the stores. To complement the manufacturing division, Aaron Rents has developed a network of five distribution centers to serve the rapidly growing number of rental purchase stores. These centers enable the division to deliver merchandise to customers on a same or next day basis and to do so more consistently than can competitors lacking the resources of MacTavish and the distribution network. MacTavish and the network of distribution centers are two more reasons why the Aaron’s concept is unique — and why it works so successfully. 12 Selected Financial Information Twelve Year Ended Months Ended Year Ended (Dollar Amounts in Thousands December 31, December 31, December 31, December 31, December 31, 1998 Except Per Share) Year Ended Year Ended 1996 1999 1997 1995 (unaudited) Operating Results Systemwide Revenues1 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 At Year End Stores Open: Company-Operated Franchised Rental Agreements in Effect Number of Employees $547,255 $464,175 $364,306 $306,200 $256,500 $318,154 $289,272 $231,207 $208,463 $182,311 107,690 11,515 437,359 87,705 201,923 102,324 4,105 396,057 41,302 15,700 $ 25,602 $ 1.28 81,561 8,826 379,659 62,017 189,719 89,171 3,561 344,468 35,191 13,707 $ 21,484 $ 1.06 73,223 6,321 310,751 55,914 149,728 71,151 3,721 280,514 30,237 11,841 $ 18,396 $ .96 1.26 1.04 $ .04 .04 $ .04 .04 $ .94 .04 .04 61,527 4,255 274,245 46,168 135,012 64,437 3,449 249,066 25,179 9,786 $ 15,393 $ .81 .77 .04 .04 $ 52,999 2,465 237,775 38,274 119,590 55,408 3,172 216,444 21,331 8,113 $ 13,218 $ .68 .66 .05 .02 $ $219,831 $194,163 $176,968 $149,984 $122,311 55,918 318,408 72,760 183,718 320 155 295,000 3,600 50,113 272,174 51,727 168,871 291 136 227,400 3,400 39,757 239,382 76,486 116,455 292 101 219,800 3,100 33,267 198,103 55,365 107,335 240 61 179,600 2,550 23,492 158,645 37,479 91,094 212 36 158,900 2,160 1Systemwide revenues include rental revenues of franchised Aaron’s Rental Purchase stores. 13 Management’s Discussion and Analysis of Financial Condition and Results of Operations Change in Fiscal Year End 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 com- parative 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, 1999, December 31, 1998, December 31, 1997 and December 31, 1996. Results of Operations Year Ended December 31, 1999 versus Year Ended December 31, 1998 Total revenues for 1999 increased $57.7 million (15.2%) to $437.4 million compared to $379.7 million in 1998 due primarily to a $28.9 million (10.0%) increase in rentals and fees revenues, plus a $26.4 million (139.1%) increase in non-retail sales. Of this increase in rentals and fees revenues, $32.7 million was attributable to the Aaron’s Rental Purchase division. Rentals and fees from the Company’s rent-to-rent operations increased $2.0 million excluding $5.8 million of rentals and fees from the Company’s convention furnishings division, which was sold in the fourth quarter of 1998. Revenues from retail sales decreased $280,000 (.4%) to $62.3 million in 1999 from $62.6 million for the same period last year. The decrease was the result of new sales in the rent-to-rent division decreasing and the discontinued sale of prepaid cellular air time in the rental purchase division. Non-retail sales, which primarily represent merchandise sold to Aaron’s Rental Purchase franchisees, increased $26.4 million (139.1%) to $45.4 million compared to $19.0 million for the same period last year. The increased sales are due to the growth of the franchise operations coupled with the addition of a new distribution center. Other revenues for 1999 increased $2.7 million (30.5%) to $11.5 million compared to $8.8 million in 1998. This increase was attributable to franchise fee and royalty income increasing $1.8 million (25.3%) to $9.1 million compared to $7.3 million last year, reflecting the net addition of 19 new franchised stores in 1999 and increasing operating revenues at mature franchised stores. Cost of sales from retail sales increased $868,000 (2.0%) to $45.3 million compared to $44.4 million, and as a per- centage of sales, increased slightly to 72.6% from 70.9% primarily due to product mix. Cost of sales from non-retail sales increased $24.8 million (140.8%) to $42.5 million from $17.6 million, and as a percentage of sales, increased to 93.5% from 92.9%. The reduced margins on non-retail sales was primarily the result of lower margins on certain products sold to franchisees. Operating expenses increased $12.2 million (6.4%) to $201.9 million from $189.7 million. As a percentage of total revenues, operating expenses were 46.2% in 1999 and 50.0% in 1998. Operating expenses decreased as a percentage of total revenues between years primarily due to increased revenues in the Aaron’s Rental Purchase division and the sale of the Company’s convention furnishings division which had higher operating expenses than traditional rent-to-rent and rental purchase operations. Depreciation of rental merchandise increased $13.2 million (14.8%) to $102.3 million, from $89.2 million, and as a percentage of total rentals and fees, was 32.2% compared to 30.8% in 1998. The increase as a percentage of rentals and fees is primarily due to a greater percentage of the Company’s rentals and fees coming from the Aaron’s Rental Purchase division which depreciates its rental merchandise at a faster rate than the rent-to-rent division. Interest expense increased $544,000 (15.3%) to $4.1 million compared to $3.6 million. As a percentage of total revenues, interest expense remained unchanged at 0.9%. The Company manages its exposure to changes in short- term interest rates, particularly to reduce the impact on its floating-rate term notes, by entering into interest rate swap agreements. The counterparties to these contracts are high credit quality commercial banks. Consequently, credit risk, which is inherent in all swaps, has been minimized to a large extent. Interest expense is adjusted for the differential to be paid or received as interest rates change. The effect of such adjustments on interest expense has not been significant. The level of floating-rate debt fixed by swap agreements was $40.0 million during the year and the Company does not expect a significant change in this amount in 2000. Accordingly, the Company does not believe it has material exposure of potential, near-term losses in future earnings, and/or cash flows from reasonably possible near-term changes in market rates. 14 Income tax expense increased $2.0 million (14.5%) to $15.7 million compared to $13.7 million. The Company’s effective tax rate was 38.0% in 1999 compared to 39.0% in 1998. As a result, net earnings increased $4.1 million (19.2%) to $25.6 million for 1999 compared to $21.5 million for the same period in 1998. As a percentage of total revenues, net earnings were 5.9% in 1999 and 5.7% in 1998. Year Ended December 31, 1998 versus Year Ended December 31, 1997 Total revenues for 1998 increased $68.9 million (22.2%) to $379.7 million compared to $310.8 million in 1997 due primarily to a $58.1 million (25.1%) increase in rentals and fees revenues, plus an $8.3 million (11.4%) increase in sales. Of this increase in rentals and fees revenues, $46.5 million (80.0%) was attributable to the Aaron’s Rental Purchase division. Rentals and fees revenues from the Company’s rent-to-rent operations increased $11.5 million (10.5%) during the same period. Revenues from retail sales increased $4.0 million (6.8%) to $62.6 million in 1998, from $58.6 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 and rental purchase divisions. Non-retail sales, which primarily represent merchandise sold to Aaron’s Rental Purchase franchisees, increased $4.4 million (29.8%) to $19.0 million compared to $14.6 million for the same period last year. The increased sales are due to the growth of the franchise operations. Other revenues for 1998 increased $2.5 million (39.6%) to $8.8 million compared to $6.3 million in 1997. This increase was attributable to franchise fee and royalty income increasing $2.3 million (46.0%) to $7.3 million compared to $5.0 million last year, reflecting the net addition of 35 new franchised stores in 1998 and increasing operating revenues at mature franchised stores. Cost of sales from retail sales increased $2.1 million (5.0%) to $44.4 million compared to $42.3 million, and as a percentage of sales, decreased slightly to 70.9% from 72.1% primarily due to product mix. Cost of sales from non- retail sales increased $4.0 million (29.2%) to $17.6 million from $13.7 million, and as a percentage of sales, decreased to 92.9% from 93.4%. The decrease in 1998 in cost of sales as a percentage of sales is due to slightly higher margins on sales through the Company’s distribution centers. Operating expenses increased $40.0 million (26.7%) to $189.7 million from $149.7 million. As a percentage of total revenues, operating expenses were 50.0% in 1998 and 48.2% in 1997. Operating expenses increased as a percentage of total revenues between years primarily due to the Company’s acquisitions of RentMart Rent-To-Own, Inc. and Blackhawk Convention Services both in December 1997. The RentMart stores were relatively immature and had lower revenues over which to spread expenses and Blackhawk’s convention furnishings business had higher operating expenses as a percentage of revenues than traditional rent-to-rent and rental purchase operations. Depreciation of rental merchandise increased $18.0 million (25.3%) to $89.2 million, from $71.2 million, and as a percentage of total rentals and fees, was 30.8% for both years. Interest expense decreased $160,000 (4.3%) to $3.6 million compared to $3.7 million. As a percentage of total revenues, interest expense was 0.9% in 1998 compared to 1.2% in 1997. Income tax expense increased $1.9 million (15.8%) to $13.7 million compared to $11.8 million. The Company’s effective tax rate was 39.0% in 1998 compared to 39.2% in 1997. As a result, net earnings increased $3.1 million (16.8%) to $21.5 million for 1998 compared to $18.4 million for the same period in 1997. As a percentage of total revenues, net earnings were 5.7% in 1998 and 5.9% in 1997. Liquidity and Capital Resources Cash flows from operations for the years ended December 31, 1999 and 1998 were $140.3 million and $120.6 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 requirements historically have been financed through bank credit, cash flow from operations, trade credit, proceeds from the sale of rental return merchandise and stock offerings. 15 Impact of Year 2000 In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $500,000 during 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. The Company has financed its growth through a revolving credit agreement with several banks, trade credit and internally generated funds. The revolving credit agree- ment 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, 1999, an aggregate of $72.2 million was outstanding under this facility, bearing interest at a weighted average variable rate of 6.88%. The Company uses interest rate swap agreements as part of its overall long-term financing program. At December 31, 1999, 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%. On April 28, 1998, the Company issued through a public offering 2.1 million shares of Common Stock. The net proceeds to the Company after deducting underwriting discounts and offering expenses were $40.0 million. The proceeds were used to reduce bank debt.The Company believes that the expected cash flows from operations, proceeds from the sale of rental return merchandise, bank borrowings and vendor credit will be sufficient to fund the Company’s capital and liquidity needs for at least the next 24 months. In February 1999, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s Common Stock and/or Class A Common Stock in addition to the 471,690 shares at December 31,1999; previously authorized. During 1999, 859,500 shares of the Company’s stock were purchased at an aggregate cost of $12.7 million and the Company was authorized to purchase an additional 1,612,190 shares at December 31, 1999. The Company has paid dividends for thirteen consecutive years. A $.02 per share dividend on Common Stock and on Class A Common Stock was paid in January 1999 and July 1999, for a total fiscal year cash outlay of $816,000. The Company currently expects to continue its policy of paying dividends. 1616 Consolidated Balance Sheets (In Thousands, Except Share Data) December 31, December 31, 1999 1998 Assets Cash Accounts Receivable Rental Merchandise Less: Accumulated Depreciation Property, Plant & Equipment, Net Prepaid Expenses & Other Assets Total Assets Liabilities & Shareholders’ Equity 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: 18,270,987 Class A Common Stock, 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, 2,177,956 Shares at December 31, 1999 & 1,558,991 Shares at December 31, 1998 Class A Common Stock, 1,532,255 Shares at December 31, 1999 & 1,525,255 Shares at December 31, 1998 Total Shareholders’ Equity Total Liabilities & Shareholders’ Equity $ 99 $ 95 21,030 316,294 (96,463) 219,831 55,918 21,530 16,226 277,505 (83,342) 194,163 50,113 11,577 $318,408 $272,174 $ 36,941 $ 33,461 399 14,410 10,180 72,225 535 134,690 415 7,811 9,889 50,411 1,316 103,303 9,135 9,135 2,681 54,181 159,313 225,310 2,681 54,284 134,511 200,611 (27,356) (17,604) (14,236) 183,718 (14,136) 168,871 $318,408 $272,174 The accompanying notes are an integral part of the Consolidated Financial Statements. 1717 Consolidated Statements of Earnings (In Thousands, Except Per Share) Revenues Rentals & Fees Retail Sales Non-Retail Sales Other Costs & Expenses 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, 1999 Year Ended December 31, 1998 Year Ended December 31, 1997 $318,154 62,296 45,394 11,515 437,359 45,254 42,451 201,923 102,324 4,105 396,057 41,302 15,700 $ 25,602 $ 1.28 1.26 $289,272 62,576 18,985 8,826 379,659 44,386 17,631 189,719 89,171 3,561 344,468 35,191 13,707 $ 21,484 $ 1.06 1.04 $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 The accompanying notes are an integral part of the Consolidated Financial Statements. 1818 Consolidated Statements of Shareholders’ Equity (In Thousands) Treasury Stock Shares Amount Common Stock Common Class A Additional Paid-In Capital Retained Earnings Balance, December 31, 1996 (1,835) ($15,102) $8,085 $2,681 $15,445 $ 96,226 Reacquired Shares Dividends Reissued Shares Net Earnings (795) (8,918) 47 361 Balance, December 31, 1997 (2,583) (23,659) Stock Offering Reacquired Shares Dividends Reissued Shares Net Earnings (736) (10,560) 235 2,479 8,085 1,050 2,681 39 15,484 38,908 (108) (758) 18,396 113,864 (837) 21,484 Balance, December 31, 1998 (3,084) (31,740) 9,135 2,681 54,284 134,511 Reacquired Shares Dividends Reissued Shares Net Earnings (860) (12,673) 234 2,821 (103) (800) 25,602 Balance, December 31, 1999 (3,710) ($41,592) $9,135 $2,681 $54,181 $159,313 The accompanying notes are an integral part of the Consolidated Financial Statements. 1919 Consolidated Statements of Cash Flows Cash Provided by Operating Activities 140,293 120,628 (In Thousands) Operating Activities Net Earnings Depreciation & Amortization Deferred Income Taxes Change in Accounts Payable & Accrued Expenses Change in Accounts Receivable Other Changes, Net Investing Activities 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 Financing Activities Proceeds from Revolving Credit Agreement Repayments on Revolving Credit Agreement Proceeds from Common Stock Offering (Decrease) Increase in Other Debt Dividends Paid Acquisition of Treasury Stock Issuance of Stock Under Stock Option Plan Cash Provided by Financing Activities Increase (Decrease) in Cash Cash at Beginning of Year Cash at End of Year Cash Paid During the Year: Interest Income Taxes Year Ended December 31, 1999 Year Ended December 31, 1998 Year Ended December 31, 1997 $ 25,602 $ 21,484 $ 18,396 112,746 6,599 3,480 (4,804) (3,330) 98,090 1,124 3,109 (4,432) 1,253 (21,030) 5,833 (218,933) 95,840 (11,393) (149,683) 180,213 (158,399) (781) (816) (12,673) 1,850 9,394 4 95 99 $ (22,209) 3,521 (174,496) 69,018 (1,841) (126,007) 157,622 (183,115) 39,958 734 (801) (10,560) 1,540 5,378 (1) 96 95 $ 77,487 3,805 5,103 (1,083) 1,587 105,295 (15,165) 6,531 (145,262) 58,436 (21,665) (117,125) 118,545 (97,766) 342 (761) (8,918) 400 11,842 12 84 96 $ $ 4,025 15,289 $ 4,082 10,004 $ 3,713 6,989 The accompanying notes are an integral part of the Consolidated Financial Statements. 2020 Notes to Consolidated Financial Statements As of December 31, 1999 and 1998, and for the Years Ended December 31, 1999, 1998 and 1997. Note A: Summary of Significant Accounting Policies Basis of Presentation — The consolidated financial state- ments include the accounts of Aaron Rents, Inc. and its wholly-owned subsidiary, Aaron Investment Company (the Company). All significant intercompany accounts and transactions 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, consumer electronics, appliances and other merchandise throughout the U.S. The Company manufactures furniture principally for its rental and sales operations. Rental Merchandise consists primarily of residential and office furniture, consumer electronics, appliances and other merchandise and is recorded at cost. The rental purchase division depreciates merchandise over the agreement period, generally 12 months, when on rent, and 36 months, when not on rent, to a 0% salvage value. This method is similar to a method referred to as the income forecasting method in the rental purchase industry. The rent-to-rent division depreciates merchandise over its estimated useful life which ranges from 6 months to 60 months, net of its salvage value which ranges from 0% to 60%. All rental merchandise is available for rental and sale. 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. Deferred Income Taxes are provided for temporary differences between the amounts of assets and liabilities for financial and tax reporting purposes. Such temporary differences arise principally from the use of accelerated depre- ciation methods on rental merchandise for tax purposes. Cost of Sales includes the net book value of merchandise sold, primarily using specific identification in the rental purchase division and first-in, first-out in the rent-to-rent division. It is not practicable to allocate operating expenses between selling and rental operations. Advertising — The Company expenses advertising costs as incurred. Such costs aggregated $12,496,000 in 1999, $11,523,000 in 1998, and $9,530,000 in 1997. 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 amortized 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 impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. Measurement of an impairment loss is based on the estimated fair value of the asset. Fair Value of Financial Instruments — The carrying amounts reflected in the consolidated balance sheets for cash, accounts receivable, bank and other debt approximate their respective fair values. Revenue Recognition — Rental revenues are recognized as revenue in the month they are due. Rental payments received prior to the month due are recorded as deferred rental revenue. Revenues from the sale of residential and office furniture and other merchandise are recognized at the time of shipment. Comprehensive Income — As of January 1, 1998, the Company adopted Financial Accounting Standards Board (“FASB”) Statement No.130, Reporting Comprehensive Income. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. Statement 130 requires foreign currency translation adjustments and other items to be included in other comprehensive income. There were no differences between net income and comprehensive income in 1999, 1998 or 1997. Reclassifications — Certain prior year amounts have been reclassified to conform with current year presentation. 2121 New Accounting Pronouncements — In June 1998, the FASB issued Statement No.133, Accounting for Derivative Instruments and Hedging Activities. The statement requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in comprehensive income until the hedged item is recognized in earnings. The ineffec- tive portion of a derivative’s change in fair value will be immediately recognized in earnings. The Company is required to adopt Statement 133 in 2001, however, management does not expect its adoption to have a significant impact on the Company’s financial position or results of operations. Note B: Earnings Per Share Earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the year which were 20,062,000 shares in 1999, 20,312,000 shares in 1998, and 19,165,000 shares in 1997. 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 273,000, 421,000 and 497,000 in 1999, 1998 and 1997, respectively. Note C: Property, Plant & Equipment (In Thousands) Land Buildings & Improvements Leasehold Improvements & Signs Fixtures & Equipment Construction in Progress Less: Accumulated Depreciation & Amortization December 31, 1999 December 31, 1998 $ 8,837 $ 6,342 25,612 31,294 24,622 1,043 91,408 21,770 27,069 19,450 4,958 79,589 (35,490) $ 55,918 (29,476) $ 50,113 Note D: Debt Bank Debt — The Company has a revolving credit agree- ment 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, 1999 and 1998, an aggregate of $72,225,000 (bearing interest at 6.88%) and $50,411,000 (bearing interest at 6.12%), respectively, was outstanding under this agreement. 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 5.94% in 1999, 6.41% in 1998, and 6.29% in 1997. The effects of interest rate swaps on the weighted average interest rate were not material. The Company has entered into interest rate swap agree- ments that effectively fix the interest rate on $20,000,000 of borrowings 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 pay- ment of amounts when the fixed rates exceed the floating rates in such agreements over the life of the agreements. The differential 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 gains under the swap agreements aggregated $670,000 at December 31, 1999. The revolving credit agreement may be terminated on ninety 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. 22 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 additional borrowings and requires the maintenance of certain financial ratios. At December 31, 1999, $50,450,000 of retained earnings were available for dividend payments and stock repurchases under the debt restrictions. Other Debt — Other debt of $535,000 at December 31, 1999 and $1,316,000 at December 31, 1998 primarily represents software financing and insurance premium agree- ments with interest rates ranging from 4.94% to 5.68%. Other debt matures in 2000. Note E: Income Taxes (In Thousands) Current Income Tax Expense: Federal State Deferred Income Tax Expense: Federal State Year Ended Year Ended Year Ended December 31, December 31, December 31, 1998 1999 1997 $8,020 1,081 9,101 5,989 610 6,599 $15,700 $11,422 1,161 12,583 949 175 1,124 $13,707 $7,375 661 8,036 3,287 518 3,805 $11,841 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 December 31, December 31, 1999 1998 $19,345 577 19,922 961 2,858 1,693 5,512 $12,184 451 12,635 836 2,725 1,263 4,824 Net Deferred Tax Liabilities $14,410 $7,811 The Company’s effective tax rate differs from the federal income tax statutory rate as follows: (In Thousands) Year Ended Year Ended Year Ended December 31, December 31, December 31, 1998 1997 1999 Statutory Rate 35.0% 35.0% 35.0% Increases in Taxes Resulting From: State Income Taxes, Net of Federal Income Tax Benefit Other, Net 2.7 0.3 2.4 1.6 2.5 1.7 Effective Tax Rate 38.0% 39.0% 39.2% Note F: Commitments The Company leases warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2013. 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 leases transportation equipment under operating leases expiring during the next 3 years. Management expects that most leases 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 initial or remaining non-cancelable terms in excess of one year as of December 31, 1999, are as follows: $24,693,000 in 2000; $20,404,000 in 2001; $12,682,000 in 2002; $7,714,000 in 2003; $4,771,000 in 2004; and $8,037,000 thereafter. Rental expense was $28,851,000 in 1999, $25,563,000 in 1998, and $22,146,000 in 1997. The Company leases one building from an officer of the Company under a lease expiring in 2008 for annual rentals aggregating $212,700. 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 $483,000 in 1999, $415,000 in 1998, and $357,000 in 1997. 23 Note G: Shareholders’ Equity In February 1999, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s Common Stock and/or Class A Common Stock. During 1999, 859,500 shares of the Company’s common shares were purchased at an aggregate cost of $12,673,000 and the Company was authorized to purchase an additional 1,612,190 shares at December 31, 1999. At December 31, 1999, the Company held a total of 3,710,211 common shares in its treasury. On April 28, 1998, the Company issued, through a public offering, 2,100,000 shares of Common Stock. The net proceeds to the Company after deducting underwriting discounts and offering expenses were $39,958,000. The net proceeds were used to reduce indebtedness and for general business purposes. 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 H: Stock Options 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 termination of service. Under the plans, 1,533,000 of the Company shares are reserved for issuance at December 31, 1999. The weighted average fair value of options granted was $9.55 in 1999, $9.26 in 1998, and $8.58 in 1997. Pro forma information regarding net earnings and earn- ings per share is required by FAS 123, and has been deter- mined as if the Company had accounted for its employee stock options granted in 1999, 1998 and 1997 under the fair value method. 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 1999, 1998 and 1997, respectively: risk-free interest rates of 6.36%, 5.36% and 5.88%; a dividend yield of .23%, .26% and .25%; a volatility factor of the expected market price of the Company’s Common Stock of .42, .43 and .39; 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 subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’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’ vesting period. The Company’s pro forma infor- mation follows: (In Thousands Except Per Share) Years Ended December 31, 1998 1997 1999 Pro Forma Net Earnings $24,424 $20,076 $17,508 Pro Forma Earnings Per Share 1.22 Pro Forma Earnings Per Share Assuming Dilution 1.20 .99 .97 .91 .89 The table below summarizes option activity for the periods indicated in the Company’s stock option plans. (In Thousands Except Per Share) Options Outstanding at December 31, 1996 Granted Exercised Forfeited Outstanding at December 31, 1997 Granted Exercised Forfeited Outstanding at December 31, 1998 Granted Exercised Forfeited Outstanding at December 31, 1999 Exercisable at December 31, 1999 1,319 322 (47) (9) 1,585 133 (235) (101) 1,382 230 (233) (77) 1,302 779 Weighted Average Exercise Price $ 8.48 15.95 5.28 10.83 10.07 16.73 6.53 15.47 10.92 16.74 7.91 16.33 12.17 $ 9.38 2424 The following table summarizes information about stock options outstanding at December 31, 1999. Range of Exercise Prices $ 6.94 – $10.00 $10.01 – $15.00 $15.01 – $20.25 $ 6.94 – $20.25 Options Outstanding Options Exercisable Number Outstanding December 31, 1999 Weighted Average Weighted Average Exercise Price Remaining Contractual Life Number Exercisable December 31, 1999 Weighted Average Exercise Price 779,000 96,000 427,250 1,302,250 5.2 years 9.1 years 8.6 years 6.6 years $ 9.38 13.13 17.04 $12.17 779,000 $ 9.38 779,000 $ 9.38 Note I: Franchising of Aaron’s Rental Purchase Stores The Company franchises Aaron’s Rental Purchase stores. As of December 31, 1999 and December 31, 1998, 277 and 227 franchises had been awarded, respectively. Franchisees pay a non-refundable initial franchise fee of $35,000 and an ongoing royalty of 5% of cash receipts. Franchise fees and area development franchise fees are generated from the sale of rights to develop, own and operate Aaron’s Rental Purchase stores. These fees are recognized when substantially all of the Company’s obligations per location are satisfied (generally at the date of the store opening). Franchise fees and area development fees received prior to the substantial completion of the Company’s obligations are deferred. The Company includes this income in Other Revenues in the Consolidated Statement of Earnings. The Company has guaranteed certain debt obligations of some of the franchisees amounting to $23,196,745 at December 31, 1999. The Company receives a guarantee and servicing fee based on such franchisees’ outstanding debt obligations which it recognizes as income over the fee period. The Company has recourse rights to the assets securing the debt obligations. As a result, the Company does not expect to incur any significant losses under these guarantees. Note J: Acquisitions and Dispositions 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. Also, 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 approxi- mately $2,700,000. During 1998, the Company acquired five rental purchase stores from a franchisee and acquired a lamp designer and manufacturer, Lamps Forever, Inc. The aggregate purchase price of these 1998 acquisitions was not significant. In 1999, the Company acquired 18 rental pur- chase stores with an aggregate purchase price of $10,252,000. The excess cost over the fair market value of tangible assets acquired was approximately $5,985,000. Also in 1999, the Company acquired two rent-to-rent stores. The aggregate purchase price of these 1999 acquisitions was not significant. These 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 1999, 1998 and 1997 consolidated financial statements was not significant. In October 1998, the Company sold substantially all of the assets of its convention furnishings division. The effect of the sale on the 1998 consolidated financial statements was not significant. In 1999, the Company sold four of its rent-to-rent stores. The effect of the sale on the consolidated financial statements was not significant. 25 25 Note K: Segments Description of Products and Services of Reportable Segments Aaron Rents, Inc. has four reportable segments: rental pur- chase, rent-to-rent, franchise and manufacturing. The rental purchase division offers electronics, residential furniture and appliances to consumers on a monthly payment basis with no credit requirements. The rent-to-rent division rents and sells residential and office furniture to businesses and consumers who meet certain minimum credit requirements. The Company’s franchise operation sells and supports franchises of its rental purchase concept. The manufacturing division manufactures upholstery, bedroom and office furniture, lamps and accessories, and bedding predominantly for use by the other divisions. The principal source of revenue in the “Other” category was the Company’s convention furnishings division which was sold during 1998. Measurement of Segment Profit or Loss and Segment Assets The Company evaluates performance and allocates resources based on revenue growth and pretax profit or loss from operations. The accounting policies of the reportable seg- ments are the same as those described in the summary of significant accounting policies except that the rental purchase division revenues and certain other items are presented on a cash basis. Intersegment sales are completed at internally negotiated amounts ensuring competitiveness with outside vendors. Since the intersegment profit and loss affect inventory valuation, depreciation and cost of goods sold are adjusted when intersegment profit is eliminated in consolidation. Factors Used by Management to Identify the Reportable Segments Aaron Rents, Inc.’s reportable segments are business units that service different customer profiles using distinct payment arrangements. The reportable segments are each managed separately because of differences in both customer base and infrastructure. Information on segments and a reconciliation to earnings before income taxes are as follows: (In Thousands) Years Ended December 31, 1997 1998 1999 Revenues From External Customers: Rental Purchase Rent-to-Rent Franchise Other Manufacturing Elimination of Intersegment Revenues Cash to Accrual Adjustments Total Revenues From External Customers Earnings Before Income Taxes: Rental Purchase Rent-to-Rent Franchise Other Manufacturing Earnings Before Income Taxes For Reportable Segments Elimination of Intersegment Profit Cash to Accrual Adjustments Other Allocations & Adjustments Total Earnings Before $252,284 173,579 9,079 1,551 54,550 $193,283 173,657 7,209 5,470 52,628 $139,893 163,263 4,880 2,089 49,302 (53,941) 257 (52,067) (521) (48,344) (332) $437,359 $379,659 $310,751 $ 20,630 14,369 5,042 (1,072) 717 $ 11,668 19,565 3,607 (744) 1,068 $ 10,807 18,883 1,880 (743) 2,877 39,686 35,164 33,704 (357) 855 (901) (344) (2,856) (271) 1,118 1,272 (340) Income Taxes $ 41,302 $ 35,191 $ 30,237 Assets: Rental Purchase Rent-to-Rent Franchise Other Manufacturing Total Assets Depreciation & Amortization: Rental Purchase Rent-to-Rent Franchise Other Manufacturing $139,177 138,349 10,755 16,097 14,030 $318,408 $ 78,385 32,946 347 492 576 $103,930 138,734 5,415 9,286 14,809 $272,174 $ 67,401 29,327 276 562 524 $ 83,742 135,094 3,287 5,453 11,806 $239,382 $ 48,879 27,685 197 224 502 Total Depreciation & Amortization $112,746 $ 98,090 $ 77,487 Interest Expense: Rental Purchase Rent-to-Rent Franchise Other Manufacturing Elimination of $1,702 2,317 117 (31) Intersegment Allocations Total Interest Expense $4,105 $2,826 1,698 48 (1,011) 406 (406) $3,561 $1,646 1,648 9 418 $3,721 2626 Note L: Quarterly Financial Information (Unaudited) (In Thousands Except Per Share) Year Ended December 31, 1999 Revenues Gross Profit Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution Year Ended December 31, 1998 Revenues Gross Profit Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution First Quarter Second Quarter Third Quarter Fourth Quarter $104,303 $107,364 $109,379 $116,313 57,706 10,779 6,679 .33 .33 $ 59,246 10,615 6,575 .33 .32 $ 59,340 9,860 6,108 .30 .30 $ 59,523 10,048 6,240 .32 .31 $ $ 92,809 $ 93,832 $ 95,882 $ 97,136 54,244 8,680 5,286 .28 .27 $ 55,020 9,090 5,554 .27 .27 $ 55,413 8,029 4,906 .23 .23 $ 54,968 9,392 5,738 .28 .27 $ Report of Independent Auditors 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, 1999 and 1998, and the related consolidated statements of earnings, shareholders’ equity and cash flows for the years ended December 31, 1999, 1998 and 1997. These financial statements are the responsibility of the Company’s manage- ment. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 statement presentation. We believe that our audits provide a reasonable 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, 1999 and 1998, and the consolidated results of their operations and their cash flows for the years ended December 31, 1999, 1998 and 1997, in conformity with accounting principles generally accepted in the United States. Atlanta, Georgia February 18, 2000 2727 Common Stock High Low Common Stock Market Prices & Dividends 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 and the cash dividends declared per share. 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. 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 15, 2000, was 6,000. The closing price for the Common Stock and Class A Common Stock on March 15, 2000, was $14.81, and $17.63, respectively. Store Location Map December 31, 1999 First Quarter Second Quarter Third Quarter Fourth Quarter December 31, 1998 First Quarter Second Quarter Third Quarter Fourth Quarter Class A Common Stock December 31, 1999 First Quarter Second Quarter Third Quarter Fourth Quarter December 31, 1998 First Quarter Second Quarter Third Quarter Fourth Quarter Cash Dividends Per Share $.02 .02 .02 $.02 .02 .02 $17.00 22.25 22.00 20.00 $24.31 24.13 23.50 15.94 $12.88 15.06 16.50 15.25 $16.38 17.38 11.88 11.13 High Low Cash Dividends Per Share $15.50 18.00 18.56 20.00 $26.00 22.75 21.00 15.13 $11.63 11.88 14.75 14.75 $15.75 18.13 11.50 10.56 $.02 .02 .02 $.02 .02 .02 At December 31, 1999 Company-Operated Rental Purchase Franchised Rental Purchase Rent-to-Rent Total Stores Manufacturing & Distribution Centers 213 155 107 475 16 28 R. Charles Loudermilk, Sr. Chairman of the Board, Chief Executive Officer, Aaron Rents, Inc. Ronald W. Allen Retired Chairman, President and Chief Executive Officer of Delta Air Lines Leo Benatar (1), (2) Sr. Partner and Associate Consultant, A.T. Kearney R. Charles Loudermilk, Sr. Chairman of the Board, Chief Executive Officer, Aaron Rents, Inc. Robert C. Loudermilk, Jr. President, Chief Operating Officer, Aaron Rents, Inc. Gilbert L. Danielson Executive Vice President, Chief Financial Officer William K. Butler, Jr. President, Aaron’s Rental Purchase Division Brian E. Stahl President, Aaron Rents’ Rent-to-Rent Division James L. Cates Vice President, Risk Management, and Secretary B. Lee Landers, Jr. Vice President, Chief Information Officer David M. Rhodus Vice President, Legal Corporate Information 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 Board of Directors Gilbert L. Danielson Executive Vice President, Chief Financial Officer, Aaron Rents, Inc. Earl Dolive (1) Vice Chairman of the Board, Emeritus, Genuine Parts Company J. Rex Fuqua Vice Chairman, Fuqua Enterprises, 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. Lt. Gen. M. Collier Ross (1) U.S. Army (retired) Officers Robert P. Sinclair, Jr. Vice President, Corporate Controller James D. Almond Vice President, Franchise Operations, Aaron’s Rental Purchase Division Ronald Benedit Vice President, Southeastern Office Region David L. Buck Vice President, Western Operations, Aaron’s Rental Purchase Division D. Bruce Cox Vice President, Northeast Residential Region Bennett E. Creasman Senior Vice President, Mid-Eastern Office Region David M. Deignan Vice President, Marketing and Merchandising, Aaron’s Rental Purchase Division Joseph N. Fedorchak Vice President, Eastern Operations, Aaron’s Rental Purchase Division Shareholder Information Annual Shareholders Meeting The annual meeting of the shareholders of Aaron Rents, Inc. will be held on Tuesday, May 2, 2000, at 10:00 a.m. E.D.T. on the 10th floor, SunTrust Plaza, 303 Peachtree Street, Atlanta, Georgia 30303. 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, Executive Vice President, Chief Financial Officer, Aaron Rents, Inc., 309 E. Paces Ferry Rd., N.E., Atlanta, Georgia 30305-2377. Richard D. Gaskins Vice President, Texas Mid-West Residential Region Michael B. Hickey Vice President, Management Development, Aaron’s Rental Purchase Division James C. Johnson Vice President, Internal Audit Richard L. Levine Vice President, Purchasing and Distribution Eduardo Quiñones Vice President, Southeast Residential Region Sandra W. Richards Vice President, West Residential Region Marc S. Rogovin Vice President, Real Estate and Construction Wayne Walter Vice President, Western Office Region Stock Listing RNT Aaron Rents Inc.’s Common Stock and Class A Common Stock are trad- ed on the New York Stock Exchange under the sym- bols “RNT” and “RNT.A,” respectively. Transfer Agent and Registrar SunTrust Bank, Atlanta Atlanta, Georgia General Counsel Kilpatrick Stockton LLP Atlanta, Georgia (1) Member of Audit Committee (2) Member of Stock Option Committee 29 309 East Paces Ferry Road, N.E. Atlanta, Georgia 30305-2377 404.231.0011