Annual Report 2004 Aaron Rents, Inc. serves consumers and businesses through the sale and lease ownership, rental and retailing of consumer electronics, residential and office furniture, household appliances, computers and accessories with over 1,050 Company-operated and franchised stores in the United States, Puerto Rico and Canada. The Company’s major operations are the Aaron’s Sales & Lease Ownership Division, the Rent-to-Rent Division and MacTavish Furniture Industries. Aaron Rents is the industry leader in catering to the moderate income consumer, offering affordable payment plans, quality merchandise and superior service. The Company’s strategic focus is on growing the sales and lease ownership business through the addition of new Company-operated stores by both internal expansion and acquisitions, as well as through our successful and expanding franchise program. Contents Financial Highlights . . . . . . . . . . . . . . 1 Letter to Shareholders . . . . . . . . . . . . 2 Aaron’s Sales & Lease Ownership . . . . . 5 Franchise Operations . . . . . . . . . . . . . 7 Acquisitions . . . . . . . . . . . . . . . . . . . 9 Rent-to-Rent . . . . . . . . . . . . . . . . . . 10 MacTavish Furniture Industries and Fulfillment Centers . . . . . . . . . . . 11 Aaron’s Community Outreach Program . 11 Selected Financial Information . . . . . . 12 Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . 13 Consolidated Balance Sheets . . . . . . . . 21 Consolidated Statements of Earnings . . 22 Consolidated Statements of Shareholders’ Equity . . . . . . . . . . . . . 22 Consolidated Statements of Cash Flows 23 Notes to Consolidated Financial Statements . . . . . . . . . . . . . 24 Management Report on Internal Control Over Financial Reporting . . . . . 33 Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . 34 Common Stock Market Prices & Dividends . . . . . . . . . . . . . .35 Store Locations . . . . . . . . . . . . . . . . 36 Board of Directors and Officers . . . . . . 37 Corporate and Shareholder Information . 37 Financial Highlights (Dollar Amounts in Thousands, Except Per Share) O P E R AT I N G R E S U LT S Revenues Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution F I N A N C I A L P O S I T I O N Total Assets Rental Merchandise, Net Credit Facilities Shareholders’ Equity Book Value Per Share Debt to Capitalization Pretax Profit Margin Net Profit Margin Return on Average Equity S T O R E S O P E N AT Y E A R E N D Sales & Lease Ownership Sales & Lease Ownership Franchised* Rent-to-Rent Total Stores Year Ended December 31, 2004 Year Ended December 31, 2003 Percentage Change $946,480 84,506 52,616 1.06 1.04 $700,288 425,567 116,655 375,178 7.54 23.7% 8.9 5.6 15.1 616 357 58 1,031 $766,797 57,843 36,426 .74 .73 $559,884 343,013 79,570 320,186 6.51 19.9% 7.5 4.8 12.1 500 287 60 847 23.4% 46.1 44.4 43.2 42.5 25.1% 24.1 46.6 17.2 15.8 23.2% 24.4 (3.3) 21.7% * Sales & Lease Ownership franchised stores are not owned or operated by Aaron Rents, Inc. Revenues By Year Net Earnings By Year $1,000,000 ) s 0 0 0 n i $ ( 800,000 600,000 400,000 200,000 0 ) s 0 0 0 n i $ ( $60,000 50,000 40,000 30,000 20,000 10,000 0 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 Company-Operated Sales & Lease Ownership Stores Rent-to-Rent Stores 1 To Our Shareholders Our advertising message to our customers is “Do the Math,” and we are proud to “Do the Math” on our outstanding results for 2004. Highlights for the year include: • It was the best year in the Company’s history. • Revenues for the year were $946.5 million, a 23% increase over the record 2003 performance. • Revenues in the Aaron’s Sales and Lease Ownership Division increased 27% during 2004, due to an 11.6% increase in same store revenues and our rapid store expansion. • Revenues at our franchised stores increased 28% for the year to $358.7 million. Revenues of franchisees, however, are not revenues of Aaron Rents, Inc. • Net earnings also set a record, up 44% for the year to $52.6 million. • We added a net of 186 Aaron’s Sales & Lease Ownership stores to our system including 70 new franchised stores, an overall increase in store count of 24%. At the end of 2004, we had 1,031 Company-operated and franchised stores open in 45 states, Puerto Rico, and Canada, including 58 stores in the rent-to-rent division. • We are particularly proud to note that 562 of our Company-operated and franchised Aaron’s Sales & Lease Ownership stores had annual revenues in excess of $1 million in 2004 and 32 of the stores had annual revenues in excess of $2 million. These revenue levels are much higher than competitors in our industry, and are a unique and important success factor in our store operating model. • During the year, we awarded area development agreements for the opening of 160 new franchised stores. At the end of December, we had 357 franchised stores open and another 301 stores scheduled to open over the next several years. • We added over 1,000 employees last year to service our growing store base. • We had our second 3-for-2 stock split within two years and began paying quarterly dividends. We also more than doubled our annual dividend payout. • Investors in our Company also “Did the Math” and our operating performance was reflected in stock market appreciation of 88% in 2004 with, for the first time, the Company’s market capitalization going over the $1 billion mark. 2 Total Company revenues in 2004 were $946.5 million, a 23% increase over the $766.8 million recorded in 2003. This revenue increase was the result of a 27% increase in revenues in the Aaron’s Sales & Lease Ownership Division. Same store revenues for the Aaron’s Sales & Lease Ownership stores opened in comparable periods increased 11.6% in 2004, an excellent performance, particularly given the 10.1% same store increase in 2003. Net earnings for the year were $52.6 million, an increase of 44% over the $36.4 million earned the previous year. Fully diluted earnings per share were $1.04 in 2004 compared to $.73 per diluted share in 2003. We plan to increase our store count by over 15% per annum over the next several years by opening both Company-operated and franchised Aaron’s Sales & Lease Ownership stores as well as seeking selected acquisitions. The grand opening of the 1,000th Aaron’s store in Swainsboro, Georgia. The business plan at Aaron Rents is to rapidly grow the Company. We have more than doubled our store count over the past five years, and approximately 40% of our Company-operated Aaron’s Sales & Lease Ownership stores have been added during the last two years. As these new stores, as well as older stores and our franchised stores, grow in revenues and earnings, we anticipate improvement in future operating margins. We are particularly proud of the opening of the 1,000th Aaron’s store at the end of the year in Swainsboro, Georgia. Our rent-to-rent division stabilized in 2004 after several years of declining revenues. The division remains an important source of revenues and earnings for Aaron Rents, and we see signs of a general improvement in business for the division, especially with corporate customers. Once again, MacTavish Furniture Industries, the Company’s manufacturing division, posted record results, manufacturing more than $70 million (at cost) of furniture for our stores out of 10 production facilities. We also opened two additional fulfillment centers in 2004, bringing our total to 13, to accommodate store growth. We anticipate opening several more fulfillment centers in 2005. We continue to believe that vertical integration is a strategic advantage for the Company. During the year, there were numerous changes within the Aaron’s Sales & Lease Ownership Division, including the creation of two additional regional field operations, a reflection of the growth of the division. Kevin J. Hrvatin was promoted to Vice President, Western Operations, and Greg G. Bellof was promoted to Vice President, Mid-Atlantic Operations. In addition, Dave A. Boggan, having served most recently as Vice President of Marketing and Merchandising, was named Vice President, Mississippi Valley Operations. Mark A. Rudnick was named Vice President, Marketing, and Mitchell S. Paull was appointed Senior Vice President, Merchandising and Logistics. Finally, Michael W. Jarnagin, in his capacity as manager for our furniture manufacturing plants, was promoted to Vice President, Manufacturing. We are proud of the career opportunities with Aaron Rents, and it is gratifying to recognize and promote talented employees who have contributed to the Company’s success for a number of years. We are careful stewards of our financial resources and fund our growth with cash flow from opera- tions and external financing. Our balance sheet is very strong, and we believe we have the financial capability to continue to rapidly grow the Company. We believe we can have over 2,000 Aaron’s Sales & Lease Ownership stores in the United States, as experience has shown we can operate stores in a town or city that has a trading area of over 20,000 people. By continuing to grow as we have over the past several years, we feel it will not take long to achieve this goal. As we have stated before, our goal is unchanged: to build Aaron’s into the premier, market-dominant company in our industry, recognized by our customers and peers as the standard-bearer for integrity, honesty and fairness — and a company that earns a premium return for its shareholders. We will proudly mark our 50th anniversary in 2005. Your Company started with an investment of $500 and now has a billion dollar market capitalization. Do the Math. We appreciate all of the hard work by all of our associates, lenders, vendors, and other business partners which has so greatly contributed to the success of the Company. We are proud that over the years we have delivered superior performance and that these efforts have been reflected in the returns to our shareholders. R. Charles Loudermilk, Sr. Chairman and Chief Executive Officer Robert C. Loudermilk, Jr. President and Chief Operating Officer 3 4 Aaron’s Sales and Lease Ownership The Growth Formula With the Aaron’s Sales & Lease Ownership Division, the Company has pioneered a unique form of specialty retailing which is a hybrid of the best features of rent-to-own and traditional credit retailing, the typical financing offered by the home furnishings industry. The dis- tinctive Aaron’s Sales & Lease Ownership concept reaches and serves a broad market of lease owner- ship, credit retail and rental customers, offering an attractive method to lease and own quality home furnishings, electronics and appliances. Data compiled in the most recent U.S. census revealed that over 57% of U.S. households have total annual income under $50,000 with the median income under $43,000 — this is the market Aaron’s serves. The Aaron’s Sales & Lease Ownership program attracts a slightly higher economic profile customer than the typical rent-to-own consumer, illustrated by the fact that over 40% of our customers pay by either check or credit card. A typical rent-to-own consumer does not qualify for a credit card account, normally paying in cash, with weekly payments the industry norm. Aaron’s lease ownership program, on the other hand, is based on bi-monthly or monthly payments, resulting in somewhat lower processing expenses per customer as well as a slightly upgraded account base. Aaron’s customers are typically credit- constrained, but our losses, in periods of both eco- nomic expansion and contraction, are consistently between 2% and 3% of revenues. Setting the standard for customer service, Aaron’s offers consumers fast, easy, convenient shopping and a broad range of top quality brand-name products, rapid delivery and low-price guarantees leading to the option of affordable ownership. Because the transaction is a lease-to-own rather than a credit relationship, Aaron’s customers are automatically approved. The Company’s in-house manufacturing and fulfillment capabilities facilitate same-day or next-day delivery of merchandise. Aaron’s customers pay no delivery charges, no application fees, no repair fees, and no balloon payments. Terms are fully disclosed: cash and carry price, lease payment and total cost under the lease ownership plan. Payment options include cash, check and credit cards. The lease-to-own plan requires no long-term obligation so a customer is free to return merchandise at any time without additional financial responsibility. Aaron’s Sales & Lease Ownership stores are normally three times the size of a typical rent-to- own competitor’s store and feature more attractive merchandising and store décor. The stores are usually located in suburban areas and attract generally higher-income customers than a traditional rent-to-own business. Aaron’s product offerings are generally new, whereas many competitors primarily display rental returns. Professionally designed and coordinated furniture suites produced by the Company’s manufacturing division and other top national manufacturers better serve the slightly more upscale consumer and generate higher revenues per customer than a traditional rent-to-own trans- action. The Company’s line of accessories creates a significantly more attractive showroom floor and opportunities for add-on revenues. Aaron’s “Dream Products” lineup includes highly popular big-screen televisions and entertainment systems, stainless steel refrigerators, leather upholstered furniture and leading brands of appliances. Computers, a product line expanded over the past few years, continue to be a growth area, with the Dell and Hewlett Packard brand names providing a competitive advantage. The Company also is in the early stages of a program to lease computers to customers referred by Dell. These customers do not meet Dell’s credit requirements, and this referral program gives Aaron’s an opportunity to expand the distribution of computers. We believe the Company’s broad product line and commitment to service are the keys to turning the majority of Aaron’s 530,000 customers into repeat customers and consistently attracting over 30,000 new customers each quarter. The Company’s marketing program is built around the “Drive Dreams Home” sponsorship of NASCAR championship racing, which serves the prime demographic for Aaron’s products. To celebrate the Company’s 50th anniversary, the Company will award a grand prize of a 1955 mint condition Chevrolet Bel Air to commemorate the year the first Aaron’s store was opened. The “Drive Away in our ’55 Chevy” prize will be awarded at the Texas Motor Speedway in November 2005. Aaron’s Sales & Lease Ownership is a sponsor of the #99 NASCAR Busch Grand National Dream Machine driven by Michael Waltrip. In 2005, Waltrip will drive the Aaron’s Dream Machine 5 in 14 NASCAR Busch Series races and field four NASCAR NEXTEL Cup cars with veteran driver Kenny Wallace. Aaron’s is now the title sponsor of the “Aaron’s 312” Busch Series races at Talladega Super Speedway and the Atlanta Motor Speedway and the “Aaron’s 499” Nextel Cup race at Talladega. The NASCAR sponsorship is integrat- ed into advertising and marketing initiatives, signifi- cantly raising the Company’s brand awareness and promoting our vendors’ products. Aaron’s is also one of four major sponsors of the Arena Football League. Aaron’s Sales & Lease Ownership is featured in in-arena promotions including public address and scoreboard video announcements, premium give-away opportunities and one promotional night in each of the AFL’s 19 team markets. The AFL will be featured in over 800 Aaron’s stores with in-store marketing materials and direct-mail circulars. This AFL partnership includes logo identification on the jerseys of all visiting teams. Arena football, growing in popularity, is featured in live broadcasts each Sunday on NBC, with the Friday and Saturday games being broadcast live, for the first time, on FOX Sports. In the spring of 2004, Aaron Rents sponsored the Tour de Georgia professional cycling 641-mile stage race, featuring six-time Tour de France winner Lance Armstrong. The six-day race passed through 23 Georgia cities, drawing nearly 750,000 spectators. The Company will return as a sponsor for the 2005 Tour de Georgia in which Lance Armstrong will compete again. Other elements of the marketing program include sponsorship of the athletic programs of the Univer- sity of Texas and Georgia Institute of Technology (Georgia Tech). In addition, Aaron’s effectively uses direct-mail advertising, with more than 20 million flyers mailed monthly to homes in the markets served by Aaron’s stores. The Company’s in-house advertising department ensures a responsive, flexible and dedicated advertising program. Operational improvements and uniformity of customer experience continue to be priorities. The 30-course curriculum of the Aaron’s University program designed for Company and franchise managers is a key element for ensuring uniformity of 6 execution and the development of strong operating talent. A proprietary management information system allows the Company to track a broad range of operating statistics including customer count, inventory list and activity, early/full payouts, aging reports, and cost and revenue by item. The Company has imple- mented automated telephone calling to customers, to remind them of lease renewal payments due and for marketing purposes, and has introduced bar- coding into store inventory management, achieving significant improvements in both efficiency and customer service. The Aaron’s Sales & Lease Ownership concept has been successfully executed in both large and smaller markets. The strength of this business model has been demonstrated by the rapid market penetration of new stores. At year-end the division had 973 Company-operated and franchised stores across the United States (45 states) and in Puerto Rico and Canada, a 24% growth rate in store count over the past year on the heels of a 22% increase in 2003. During the year, the Aaron’s Sales & Lease Ownership Division added a net of 186 new stores, including 61 Company-operated stores added through acquisitions (17 of which were acquired from franchisees). At year-end, Aaron’s operated 616 Company-operated sales and lease ownership stores. The Aaron’s Sales & Lease Ownership concept continues to be the key growth vehicle for the Company. This division posted a 27% increase in revenues in 2004, following a 26% gain in 2003. Same store revenues increased 11.6% in 2004, following a 10.1% increase in 2003, clearly one of the stronger performances in the retailing industry. A large number of Aaron’s Sales & Lease Ownership stores opened over the past five years and are now in the maturation phase, experiencing margin expansion and solidifying market share. We continue to believe that the Aaron’s Sales & Lease Ownership Division will post profit margin expansion over the next several years. Aaron’s Sales & Lease Ownership offers its “Dream Products” on the Internet at www.shopaarons.com. Aggressive Store Expansion Company-Operated Sales & Lease Ownership Store Rental Revenues Other 1% 1,200 1,000 800 600 400 200 0 ) s e r o t s ( 1999 2000 2001 2002 2003 2004 Electronics and Appliances 52% Franchised Sales & Lease Ownership Stores Company-Operated Sales & Lease Ownership Stores Rent-to-Rent Stores Furniture 35% Computers 12% Franchise Operations A Growth Multiplier The Aaron’s Sales & Lease Ownership franchise program set new records in 2004, the 12th year of the Company’s franchising history. Area development agreements for a record 160 stores were awarded, a 43% increase over the number of 2003 awards. Aaron’s franchise program has been highly beneficial to both franchisees and the Company. The franchisees benefit from Aaron’s national reputation, industry experience, operating standards and purchasing, manufacturing and distribution systems. The benefits to Aaron’s include a steadily growing stream of franchise revenues and the opportunity to accelerate store growth. The number of franchised stores has more than doubled over the past four years, and the pipeline of stores scheduled to open over the next few years (301) is nearly as great as the 2004 year-end franchised store count of 357. From the development of an individual business plan during the start-up phase, Aaron’s supports franchise principals with a full range of services. Franchisees utilize the expertise of the Aaron’s system in the store site selection process. In addition, Aaron’s provides franchise principals with initial and ongoing training in the management and operation of Aaron’s stores as well as necessary computer software and assistance in advertising, marketing and publicity. Aaron’s willingness to repurchase stores from time to time provides an exit strategy for franchisees and attractive acquisition opportunities for the Company. The Aaron’s Sales & Lease Ownership franchise program has attracted a variety of experienced business professionals, including former executives in banking, broadcasting, multi-unit restaurant operations and manufacturing. Aaron’s franchisees achieving strong and profitable growth with their first Aaron’s stores often acquire additional franchise territories. The typical franchisee owns and operates three to four store locations, but some major groups operate more than 30 locations. Franchisees operate stores in 43 states and Canada. 7 Aaron’s leadership in franchising is confirmed through annual surveys of franchise programs. The Company, for many years, consistently has placed at or near the top in its category of appliance and furniture rentals in surveys sponsored by Entrepreneur magazine. The program also has ranked in the top 100 franchise chains by worldwide sales in the Franchise Times. To win the coveted upper-tier ratings, Aaron’s must meet high standards of financial performance based on growth of revenues, franchise fees, and the Company’s proprietary products and services. In addition, Aaron’s is judged on the performance and strength of its management, the relationship with franchise owners, and the opportunities available for the growth of franchised stores. The shared experience and expertise of the franchise principals and operating management of Company-operated stores benefit the entire Aaron’s organization. The Aaron’s Franchise Association and the Aaron’s Management Team, comprised of both franchise principals and repre- sentatives of the Company, provide opportunities for communication and cross-fertilization. Company Revenues From Franchising Company Pretax Profit From Franchising $20,000 15,000 10,000 ) s 0 0 0 n i $ ( 5,000 0 1999 2000 2001 2002 2003 2004 1999 2000 2001 2002 2003 2004 ) s 0 0 0 n i $ ( $30,000 25,000 20,000 15,000 10,000 5,000 0 8 Quarterly Revenues of Franchised Stores** $100,000 ) s 0 0 0 n i $ ( 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 357* 343* 312* 324* 240* 287* 243* 249* 211* 232* 225* 217* 194* 209* 201*199* 193* 186* 166*179* 155* 142* 138*136* 136* 121* 116* 106* 101* 86* 76* 71* 61* 54* 38* 45* 28* 31* 36* 24* 26* 18* 21* 15* 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 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 *Number of stores **Revenues of franchised stores are not revenues of Aaron Rents, Inc. Acquisitions Adding to Our Store Base During 2004, the Aaron’s Sales & Lease Ownership Division acquired a net of 61 stores, 17 of which were purchased from franchisees. The Company continues to pursue acquisition opportunities to complement new store openings and to achieve economies of scale in such areas as distribution and marketing. In terms of economic returns, the most attractive targets are competitive stores where the acquisition excludes storefronts and real estate obligations and the book of contracts is folded into an existing Aaron’s store, significantly leveraging fixed costs. The Company also seeks acquisitions of small chains and single units to increase penetration in existing markets and to enter new markets. Generally, these acquisitions are based on a multiple of rental revenue, and the stores are converted to the Aaron’s name as quickly as possible in order to take advantage of Aaron’s advertising and name recognition. 9 Rent-to-Rent Fine-tuning the Formula The Rent-to-Rent Division of Aaron Rents, the Company’s original line of business, generates solid earnings and cash flow important to the Company’s growth and continues to adapt to changing industry dynamics. This division, with 58 stores in 14 states, offers customers a diverse, high quality product line and high service standards. Customers select from a diverse assortment of living room, dining room and bedroom furnishings and accessories, as well as big-screen televisions and personal computers. Aaron Rents offers special housewares and linen rental programs, offering customers a complete, one-stop shopping experience. The Company’s MacTavish Furniture Industries Division manufactures the majority of the Company’s wide range of rent-to-rent products, but Aaron’s has also long been among the leaders in rentals of La-Z-Boy furniture and other popular brands. Aaron’s leverages the overhead of the rent- to-rent stores by using those locations as clearance centers for rental return merchandise. Historically, the Rent-to-Rent Division served residential and business customers (e.g. students, military personnel, new businesses, and corporations with temporary rental needs). Because a typical rent-to-rent customer now has more options (e.g. sales and lease ownership), the residential business of the Rent-to-Rent Division is now largely tied to corporate relocations, which are also serviced by extended stay hotels and furnished apartments. 10 Corporate business (office furniture and residential furniture for employee relocations) now represents the majority of divisional revenues. To the corporate market, Aaron’s is the “Source for Workplace Solutions,” offering free in-office consultation and short-term or special event rentals. Customers can expect next-day delivery on a broad range of office furnishings, including panel systems, and have the option of purchasing previously rented furniture. The reputation of Aaron Rents as an industry leader has been built over 50 years, customer by customer, order by order. Aaron Rents stakes its corporate reputation on a commitment to com- petitive prices, high-quality products and first-rate service, including next-day delivery of in-stock merchandise; the replacement without charge of any furniture the customer considers unsatisfactory, regardless of the reason; and the right of the customer to return furniture for a full refund during the first week after delivery. After several years of industry contraction and internal restructuring efforts, the Rent-to-Rent Division performed well in 2004, and future prospects are promising. MacTavish Furniture Industries and Fulfillment Centers Adding Value to Customers During 2004, MacTavish produced more than $70 million in furniture, accessories and bedding at cost, ranking this division among the top furniture manufacturers in the United States. Aaron’s vertical integration and volume purchasing are competitive advantages and key factors in assuring timely delivery of merchandise to cus- tomers. Unique in its industry, Aaron’s produces the majority of the furniture for its stores at ten MacTavish Furniture Industries facilities which comprise the Company’s manufacturing division, creating cost benefits that are passed on to cus- tomers. More importantly, the manufacturing division adds value to customers. Aaron’s specialists adapt best-selling designs and add extra hardwood to frames, more coils and higher- grade foam to provide a more durable and more comfortable product. Vertical integration allows the Company to control design and quality, ensuring the functionality and durability required for multiple rentals. Supporting this manufacturing capability is a network of ful- fillment centers, a dedicated store service system unmatched by any competitor. Thirteen fulfillment centers are strategically located in 12 states, enabling stores to provide same-day or next-day delivery, another competitive edge. The Company plans to open several more fulfillment centers in 2005 to accommodate the expected store growth. Aaron’s Community Outreach Program Adding Time and Talent to Our Communities to help single mothers become first-time homeown- ers. Through these two programs, NFL football greats Warrick Dunn and Kurt Warner make the down payments on new houses and work with local organizations to equip and furnish the homes. Aaron’s Sales & Lease Ownership has provided all of the furniture for homes in Atlanta, Tampa and Baton Rouge. Aaron’s associates continue to give their time and talents as volunteers in many worthy causes, and Aaron’s Community Outreach Program (ACORP) has made substantial contributions to communities served by the Company’s stores. Through this program, a store may earn, based on attained performance goals, up to $500 each month to be donated to local charities selected by the store’s associates. Recipients of the Aaron’s donations represent a wide range of organizations, including Boys and Girls Clubs, the Make-A-Wish Foundation, the Muscular Dystrophy Association and Toys For Tots. Since 1999, ACORP has donated more than $2.2 million to deserving charities in communities served by Aaron’s stores, a tangible expression of the spirit of giving of Aaron’s associates. In 2004, ACORP was proud to again partner with the Warrick Dunn Foundation and Kurt Warner’s First Things First in “Homes for the Holidays,” an initiative 11 Selected Financial Information (Dollar Amounts in Thousands, Except Per Share) OPERATING RESULTS 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 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 Year Ended December 31, 2004 Year Ended December 31, 2003 Year Ended December 31, 2002 Year Ended December 31, 2001 Year Ended December 31, 2000 $694,293 56,259 160,774 35,154 946,480 39,380 149,207 414,518 253,456 5,413 861,974 84,506 31,890 $ 52,616 1.06 $ 1.04 $ .039 .039 $425,567 111,118 700,288 116,655 375,178 674 357 582,000 6,400 $553,773 68,786 120,355 23,883 766,797 50,913 111,714 344,884 195,661 5,782 708,954 57,843 21,417 $ 36,426 .74 $ .73 $ .022 .022 $343,013 99,584 559,884 79,570 320,186 560 287 464,800 5,400 $459,179 72,698 88,969 19,842 640,688 53,856 82,407 293,346 162,660 4,767 597,036 43,652 16,212 $ 27,440 .58 $ .57 $ .018 .018 $317,287 87,094 487,468 73,265 280,545 482 232 369,000 4,800 $403,385 60,481 66,212 16,603 546,681 43,987 61,999 276,682 137,900 6,258 526,826 19,855 7,519 $ 12,336 .28 $ .27 $ .018 .018 $258,932 77,282 403,881 77,713 219,967 439 209 314,600 4,200 $359,880 62,417 65,498 15,125 502,920 44,156 60,996 227,587 120,650 5,625 459,014 43,906 16,645 $ 27,261 .61 $ .61 $ .018 .018 $267,713 63,174 387,657 104,769 208,538 361 193 281,000 3,900 The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002. If the Company had applied the non-amortization provisions of Statement 142 for all periods presented, net earnings and diluted net earnings per share would have increased by approximately $688,000 ($.013 per share) and $431,000 ($.009 per share) for the years ended December 31, 2001 and 2000, respectively. 12 Management’s Discussion and Analysis of Financial Condition and Results of Operations Executive Summary Aaron Rents, Inc. is a leading U.S. company engaged in the combined businesses of the rental, lease ownership and specialty retailing of consumer electronics, residential and office furniture, household appliances, and accessories. As of December 31, 2004, we had 1,031 stores, which includes both our Company-operated and franchised stores, and operated in 45 states, Puerto Rico and Canada. Our major operating divisions are the Aaron’s Sales & Lease Ownership division, the Aaron Rents’ Rent-to-Rent division, and the MacTavish Furniture Industries division. • Our sales and lease ownership division now operates in excess of 600 stores and has more than 350 franchised stores in 45 states, Puerto Rico and Canada. Our sales and lease ownership division represents the fastest growing segment of our business, accounting for 88%, 86%, and 81% of our total revenues in 2004, 2003, and 2002, respectively. • Our rent-to-rent division, which we have operated since our Company was founded in 1955, remains an important part of our business. The rent-to-rent division is one of the largest providers of temporary rental furni- ture in the United States, operating 58 stores in 14 states as of December 31, 2004. Over the last few years, we have consolidated and closed stores in the rent-to-rent division as we focus on maintaining the profitability of the division. • Our MacTavish Furniture Industries division manufac- tures and supplies nearly one-half of the furniture and related accessories rented and sold in our stores. Most of our growth comes from the opening of new sales and lease ownership stores and increases in same store revenues for previously opened stores. We added a net of 186 sales and lease ownership stores in 2004, through the opening of new Company-operated stores, franchise stores, and acquisitions. We acquire sales and lease ownership stores from time to time, generally either from small operators of rental stores or from our franchisees. In 2004, we added 44 stores acquired from other operators and 17 stores acquired from our franchisees. We expect to open approximately 80 Company-operated stores in 2005. In 2001, we accelerated the growth of our sales and lease ownership store openings when we acquired the real estate locations of approximately 80 retail stores from a furniture retailer in bankruptcy pro- ceedings. While this accelerated schedule depressed our earnings during the start-up period of these stores, we have been pleased with the performance of these new locations which are now accretive to earnings. We also use our franchise program to help us expand our sales and lease ownership concept more quickly and into more areas than we otherwise would by opening only Company-operated stores. Our franchisees opened 91 stores in 2004, which included conversion of 10 stores of third party rental operators and two Company-operated stores to franchise stores. We expect to open approximately 80 franchise stores in 2005. Franchise royalties and other related fees represent a growing source of revenue for us, accounting for 2.7%, 2.5%, and 2.6% of our total revenues in 2004, 2003, and 2002, respectively. Key Components of Income In this management’s discussion and analysis section, we review the results of our sales and lease ownership and rent-to-rent divisions, as well as the four components of our revenues: rentals and fees, retail sales, non-retail sales and other revenues. We separate our cost of sales into two components: retail and non-retail. Revenues. We separate our total revenues into four components: rentals and fees, retail sales, non-retail sales, and other revenues. Rentals and fees includes all revenues derived from rental agreements from our sales and lease ownership and rent-to-rent stores, including agreements that result in our customers acquiring ownership at the end of the term. Retail sales represents sales of both new and rental return merchandise from our sales and lease ownership and rent-to-rent stores. Non-retail sales mainly represents mer- chandise sales to our franchisees from our sales and lease ownership division. Other revenues includes franchise fees, royalty income and other related income from our franchise stores, and other miscellaneous revenues. Cost of Sales. We separate our cost of sales into two components: retail and non-retail. Retail cost of sales represents the original or depreciated cost of merchandise sold through our Company-operated stores. Non-retail cost of sales primarily represents the cost of merchandise sold to our franchisees. Depreciation of Rental Merchandise. Depreciation of rental merchandise reflects the expense associated with depreciating merchandise held for rent and rented to customers by our Company-operated sales and lease ownership and rent-to-rent stores. Critical Accounting Policies Revenue Recognition Rental revenues are recognized in the month they are due on the accrual basis of accounting. For internal management reporting purposes, rental revenues from the sales and lease ownership division are recognized as revenue in the month the cash is collected. On a monthly basis, we record an accrual for rental revenues due but not yet received, net of allowances, and a deferral of revenue for rental payments received prior to the month due. Our revenue recognition accounting policy matches the rental revenue with the corresponding costs, mainly depreciation, associated with the rental merchandise. At the years ended December 31, 2004 and 2003, we had a revenue deferral representing cash collected in advance of being due or otherwise earned totaling approximately $15.9 million and $12.4 million, 13 and an accrued revenue receivable net of allowance for doubtful accounts based on historical collection rates of approximately $4.1 million and $3.0 million, respectively. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt by the franchisee, and revenues from such sales to other customers are recognized at the time of shipment. Rental Merchandise Our sales and lease ownership division depreciates mer- chandise over the agreement period, generally 12 to 24 months when rented, and 36 months when not rented, to 0% salvage value. Our rent-to-rent division depreciates merchandise over its estimated useful life, which ranges from six months to 60 months, net of salvage value, which ranges from 0% to 60%. Sales and lease ownership merchandise is generally depreciated at a faster rate than our rent-to-rent merchandise. As sales and lease ownership revenues continue to comprise an increasing percentage of total revenues, we expect rental merchandise depreciation to increase at a correspondingly faster rate. Our policies require weekly rental merchandise counts by store managers and write-offs for unsalable, damaged, or missing merchandise inventories. Full physical inventories are generally taken at our fulfillment and manufacturing facilities on a quarterly basis with appropriate provisions made for missing, damaged and unsalable merchandise. In addition, we monitor rental merchandise levels and mix by division, store and fulfillment center, as well as the average age of merchandise on hand. If unsalable rental merchandise cannot be returned to vendors, its carrying value is adjusted to net realizable value or written off. All rental merchandise is available for rental and sale. Effective September 30, 2004, we began recording rental merchandise carrying value adjustments on the allowance method, which estimates the merchandise losses incurred but not yet identified by management as of the end of the accounting period. Previously, we accounted for merchandise inventory adjustments using the direct write-off method, which recognized merchandise losses only after they were specifically identified. This adoption of the allowance method had the effect of increasing expenses in the third quarter of 2004 for a one-time adjustment of approximately $2.5 million to establish a rental merchandise allowance reserve on our balance sheet. We expect rental merchandise adjustments in the future under this new method to be materially consistent with the prior years’ adjustments under the direct write-off method. Rental merchandise adjustments, including the effect of the establishment of the reserve mentioned above, totaled approximately $18.0 million, $11.9 million, and $10.1 million during the years ended December 31, 2004, 2003, and 2002, respectively. Leases and Closed Store Reserves The majority of our Company-operated stores are operated from leased facilities under operating lease agreements. The substantial majority of these leases are for periods that do not exceed five years. Leasehold improvements related to these leases are generally amortized over periods that do not exceed the lesser of the lease term or five years. While a majority of our leases do not require escalating payments, for the leases which do contain such provisions we record the related lease expense on a straight-line basis over the lease term. Finally, we do not generally obtain significant amounts 14 of lease incentives or allowances from landlords. The total amount received in 2004, 2003, and 2002 totaled approxi- mately $1.3 million, $.6 million, and $.4 million, respective- ly. Such amounts are recognized ratably over the lease term. From time to time, we close or consolidate retail stores. We record an estimate of the future obligation related to closed stores based upon the present value of the future lease payments and related commitments, net of estimated sublease income which we base upon historical experience. At each of the years ended December 31, 2004 and 2003, our reserve for closed stores was $2.2 million. If our estimates related to sublease income are not correct, our actual liability may be more or less than the liability recorded at December 31, 2004. Insurance Programs Aaron Rents maintains insurance contracts to fund workers compensation and group health insurance claims. Using actuarial analysis and projections, we estimate the liabilities associated with open and incurred but not reported workers compensation claims. This analysis is based upon an assessment of the likely outcome or historical experience, net of any stop loss or other supplementary coverages. We also calculate the projected outstanding plan liability for our group health insurance program. Effective September 30, 2004, we revised certain estimates related to our accrual for group health self-insurance based on our experience that the time periods between our liability for a claim being incurred and the claim being reported had declined and on favorable claims experience which resulted in a reduction in expenses of $1.4 million for the nine-month period ended September 30, 2004. Our liability for workers compensation insurance claims and group health insurance was approximately $3.2 million and $3.8 million at the years ended December 31, 2004 and 2003, respectively. If we resolve existing workers compensation claims for amounts that are in excess of our current estimates and within policy stop loss limits, we will be required to pay additional amounts beyond those accrued at December 31, 2004. Additionally, if the actual group health insurance liability exceeds our projections, we will be required to pay additional amounts beyond those accrued at December 31, 2004. The assumptions and conditions described above reflect management’s best assumptions and estimates, but these items involve inherent uncertainties as described above, which may or may not be controllable by management. As a result, the accounting for such items could result in different amounts if management used different assumptions or if dif- ferent conditions occur in future periods. Same Store Revenues We refer to changes in same store revenues as a key performance indicator. For the year ended December 31, 2004, we calculated this amount by comparing revenues as of December 31, 2004 and 2003 for all stores open for the entire 24-month period ended December 31, 2004, excluding stores that received rental agreements from other closed or merged stores. For the year ended December 31, 2003, we calculated this amount by comparing revenues as of December 31, 2003 and 2002 for all stores open for the entire 24-month period ended December 31, 2003, excluding stores that received rental agreements from other closed or merged stores. Results of Operations Year Ended December 31, 2004 Versus Year Ended December 31, 2003 The following table shows key selected financial data for the years ended December 31, 2004 and 2003, and the changes in dollars and as a percentage to 2004 from 2003. (In Thousands) REVENUES: Rentals and Fees Retail Sales Non-Retail Sales Other COSTS AND 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 Revenues The 23.4% increase in total revenues in 2004 from 2003 is primarily attributable to continued growth in our sales and lease ownership division, from both the opening and acquisition of new Company-operated stores and improve- ment in same store revenues. Revenues for our sales and lease ownership division increased $174.6 million to $831.1 million in 2004 compared with $656.5 million in 2003, a 26.6% increase. This increase was attributable to an 11.6% increase in same store revenues and the addition of 204 Company-operated stores since the beginning of 2003. The 25.4% increase in rentals and fees revenues was attributable to a $139.8 million increase from our sales and lease ownership division related to the growth in same store revenues and the increase in the number of stores described above. Rental revenues in our rent-to-rent division increased by $0.7 million to $76.0 million in 2004 from $75.3 million in 2003. Revenues from retail sales fell 18.2% due to a decline of $11.6 million in our sales and lease ownership division, which reflects a decreased focus on retail sales in certain stores and the impact of the introduction of an alternative shorter-term lease, which we believe replaced many retail sales. The 33.6% increase in non-retail sales in 2004 reflects the significant growth of our franchise operations. The 47.2% increase in other revenues is primarily attributable to recognition of a $5.5 million pretax gain on the sale of our holdings of Rainbow Rentals common stock in connection with that company’s merger with Rent- A-Center, Inc., and franchise fees, royalty income, and other related revenues from our franchise operations increasing $5.8 million, or 29.8%, to $25.1 million in 2004 compared with $19.3 million for 2003. Of this increase, royalty income from franchisees increased $3.8 million to $17.8 million in 2004 compared to $14.0 million in 2003, with increased Year Ended December 31, 2004 Year Ended December 31, 2003 Increase/ (Decrease) in Dollars to 2004 from 2003 % Increase/ (Decrease) to 2004 from 2003 $694,293 56,259 160,774 35,154 946,480 39,380 149,207 414,518 253,456 5,413 861,974 84,506 31,890 $ 52,616 $553,773 68,786 120,355 23,883 766,797 50,913 111,714 344,884 195,661 5,782 708,954 57,843 21,417 $ 36,426 $140,520 (12,527) 40,419 11,271 179,683 (11,533) 37,493 69,634 57,795 (369) 153,020 26,663 10,473 $ 16,190 25.4% (18.2) 33.6 47.2 23.4 (22.7) 33.6 20.2 29.5 (6.4) 21.6 46.1 48.9 44.4% franchise and financing fee revenues comprising the majority of the remainder. This franchisee-related revenue growth reflects the net addition of 125 franchised stores since the beginning of 2003 and improving operating revenues at maturing franchised stores. Cost of Sales The 22.7% decrease in retail cost of sales is primarily a result of a decrease in retail sales in our sales and lease ownership division for the same reasons discussed under retail sales revenue above. Retail cost of sales as a percentage of retail sales decreased to 70.0% in 2004 from 74.0% in 2003 due to the 2004 discontinuation of certain low-margin retail sales. Cost of sales from non-retail sales increased 33.6%, primarily due to the growth of our franchise operations as described above, corresponding to the similar increase in non-retail sales. As a percentage of non-retail sales, non-retail cost of sales remained steady at 92.8% in both 2004 and 2003. Expenses The 20.2% increase in 2004 operating expenses was due primarily to the growth of our sales and lease ownership division described above. As a percentage of total revenues, operating expenses improved to 43.8% for 2004 from 45.0% for 2003, with the decrease driven by the maturing of new Company-operated sales and lease ownership stores added over the past several years and an 11.6% increase in same store revenues. As explained in our discussion of critical accounting policies above, effective September 30, 2004, we began recording rental merchandise carrying value adjustments on the allowance method rather than the direct write-off method. In connection with the change of methods, we recorded a catch-up adjustment of approximately $2.5 15 million to establish a rental merchandise allowance reserve. We expect rental merchandise adjustments in the future under this new method to be materially consistent with adjustments under the former method. In addition, as dis- cussed above, the revision of certain estimates related to our accrual for group health self-insurance resulted in a reduction in expenses of $1.4 million in 2004, partially offsetting the merchandise allowance reserve expense. The 29.5% increase in depreciation of rental merchandise was driven by the growth of our sales and lease ownership division described above. As a percentage of total rentals and fees, depreciation of rental merchandise increased slightly to 36.5% in 2004 from 35.3% in 2003. The increase as a percentage of rentals and fees reflects increased depreciation expense as a result of a larger number of short-term leases in 2004 as described above under retail sales. The decrease in interest expense as a percentage of total revenues is primarily due to the growth of our sales and lease ownership division related to increased same-store revenues and store count described above. The 48.9% increase in income tax expense between years is primarily attributable to a comparable increase in pretax income in addition to a slightly higher effective tax rate of 37.7% in 2004 compared to 37.0% in 2003 arising from higher state income taxes. Net Earnings The 44.4% increase in net earnings was primarily due to the maturing of Company-operated sales and lease ownership stores opened and acquired over the past several years; an 11.6% increase in same store revenues; a 29.8% increase in franchise fees, royalty income, and other related franchise income; and the recognition of a $3.4 million after-tax gain on the sale of Rainbow Rentals common stock. As a percentage of total revenues, net earnings improved to 5.6% in 2004 from 4.8% in 2003. Year Ended December 31, 2003 Versus Year Ended December 31, 2002 The following table shows key selected financial data for the years ended December 31, 2003 and 2002, and the changes in dollars and as a percentage to 2003 from 2002. Revenues The 19.7% increase in total revenues in 2003 from 2002 is primarily attributable to continued growth in our sales and lease ownership division from both the opening and acquisition of new Company-operated stores and improve- ment in same store revenues. Revenues for our sales and lease ownership division increased $137.5 million to $656.5 million in 2003 compared with $519.0 million in 2002, a 26.5% increase. This increase was attributable to a 10.1% increase in same store revenues and the addition of 136 Company-operated stores since the beginning of 2002. Total revenues were impacted by a decrease in rent-to-rent division revenues, which decreased $11.4 million to $110.3 million in 2003 from $121.7 million in 2002, a 9.3% decrease, due primarily to a decline in same store revenues as well as a net reduction of 15 stores since the beginning of 2002. The 20.6% increase in rentals and fees revenues was attributable to a $100.9 million increase from our sales and lease ownership division related to the growth in same store revenues and the increase in the number of stores described above. The growth in our sales and lease ownership division was offset by a $6.3 million decrease in rental revenues in our rent-to-rent division. The decrease in rent-to-rent division revenues is primarily the result of the decline in same store revenues and the net reduction in stores described above. Revenues from retail sales fell 5.4% due to a decrease of $4.6 million in our rent-to-rent division caused by the decline in same store revenues and the store closures described above, partially offset by an increase of $0.7 million in our sales and lease ownership division caused by the increase in same store revenues and the increase in the number of stores also described above. This increase in our sales and lease ownership division was negatively impacted by the intro- duction of an alternative shorter-term lease, which replaced many retail sales. The 35.3% increase in non-retail sales in 2003 reflects the significant growth of our franchise operations. The 20.4% increase in other revenues was primarily attributable to franchise fees, royalty income, and other related revenues from our franchise stores increasing $2.7 million, or 16.5%, to $19.3 million compared with $16.6 (In Thousands) REVENUES: Rentals and Fees Retail Sales Non-Retail Sales Other COSTS AND 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 16 Year Ended December 31, 2003 Year Ended December 31, 2002 Increase/ (Decrease) in Dollars to 2003 from 2002 % Increase/ (Decrease) to 2003 from 2002 $553,773 68,786 120,355 23,883 766,797 50,913 111,714 344,884 195,661 5,782 708,954 57,843 21,417 $ 36,426 $459,179 72,698 88,969 19,842 640,688 53,856 82,407 293,346 162,660 4,767 597,036 43,652 16,212 $ 27,440 $ 94,594 (3,912) 31,386 4,041 126,109 (2,943) 29,307 51,538 33,001 1,015 111,918 14,191 5,205 $ 8,986 20.6% (5.4) 35.3 20.4 19.7 (5.5) 35.6 17.6 20.3 21.3 18.7 32.5 32.1 32.7% million in 2002, reflecting the net addition of 78 franchised stores since the beginning of 2002 and improved operating revenues at older franchised stores. Cost of Sales The 5.5% decrease in retail cost of sales is primarily a result of a decrease in sales in our rent-to-rent division, where sales decreased $3.9 million to $25.2 million in 2003 from $29.1 million in 2002, a 13.4% decline. This decrease was primarily due to the decline in same store revenues and to closing or merging under-performing stores. This decrease is partially offset by a $1.0 million increase to $25.7 million in 2003 from $24.7 million in 2002, representing a 3.9% increase, in our sales and lease ownership division driven by the increases in same store revenues and additional store openings described above. Retail cost of sales as a percentage of retail sales remained comparable between 2003 and 2002. Cost of sales from non-retail sales increased 35.6%, primarily due to the growth of our franchise operations as described above, corresponding to the similar increase in non-retail sales. As a percentage of non-retail sales, non-retail cost of sales increased slightly to 92.8% in 2003 as compared to 92.6% in 2002, primarily due to changes in product mix. Expenses The 17.6% increase in 2003 operating expenses was driven by the growth of our sales and lease ownership division described above. As a percentage of total revenues, operating expenses improved to 45.0% for 2003 from 45.8% for 2002, with the decrease driven by the maturing of new Company- operated sales and lease ownership stores added over the past several years and a 10.1% increase in same store revenues. The 20.3% increase in depreciation of rental merchandise was driven by the growth of our sales and lease ownership division described above. As a percentage of total rentals and fees, depreciation of rental merchandise decreased slightly to 35.3% in 2003 from 35.4% in 2002. The decrease as a per- centage of rentals and fees reflects an improvement in rental margins, partially offset by increased depreciation expense as a result of a larger number of short-term leases in 2003. The increase in interest expense as a percentage of total revenues was primarily due to a higher long-term average debt balance during 2003 arising from the Company’s August 2002 private debt placement. The 32.1% increase in income tax expense between years was driven primarily by a comparable increase in pretax income, offset by a slightly lower effective tax rate of 37.0% in 2003 compared to 37.1% in 2002. Net Earnings The 32.7% increase in net earnings was primarily due to the maturing of new Company-operated sales and lease ownership stores added over the past several years; a 10.1% increase in same store revenues; and a 16.5% increase in franchise fees, royalty income, and other related franchise income. As a percentage of total revenues, net earnings improved to 4.8% in 2003 from 4.3% in 2002. Balance Sheet Cash. In prior balance sheet and statement of cash flow presentations, checks outstanding were classified as a reduction to cash. Since the financial institutions with checks outstanding and those with deposits on hand did not and do not have legal right of offset, we have reclassified checks out- standing in certain zero balance bank accounts to accounts payable at December 31, 2004 and for all consolidated balance sheets and consolidated statements of cash flows presented. This reclassification has the effect of increasing both cash and accounts payable and accrued expenses by $4.6 million, $3.8 million, and $6.7 million for the years ended December 31, 2003, 2002, and 2001, respectively. Rental Merchandise. The increase of $82.6 million in rental merchandise, net of accumulated depreciation, to $425.6 million from $343.0 million at December 31, 2004 and 2003, respectively, is primarily the result of a net increase of 116 Company-operated sales and lease ownership stores and two fulfillment centers since December 31, 2003. Prepaid Expenses and Other Assets. The increase of $23.9 million in prepaid expenses and other assets to $50.1 million from $26.2 million at December 31, 2004 and 2003, respectively, is primarily the result of recording an income tax receivable of $20.0 million, in connection with calculating the Company’s 2004 provision for income taxes. Goodwill and Other Intangibles. The increase of $19.4 million to $74.9 million from $55.5 million on December 31, 2004 and 2003, respectively, is the result of a series of acqui- sitions of sales and lease ownership businesses, net of amortization of certain finite-life intangible assets. The aggregate purchase price for these asset acquisitions in 2004 totaled approximately $38.5 million, and the principal tangible assets acquired consisted of rental merchandise and certain fixtures and equipment. Deferred Income Taxes Payable. The increase of $39.9 million in deferred income taxes payable at December 31, 2004 from December 31, 2003 is primarily the result of March 2002 tax law changes, effective September 2001, that allowed additional accelerated depreciation of rental merchandise for tax purposes. Additional tax law changes effective May 2003 increased the allowable acceleration and extended the life of the March 2002 changes to December 31, 2004. Credit Facilities. The $37.1 million increase in the amounts we owe under our credit facilities to $116.7 million from $79.6 million on December 31, 2004 and 2003, respectively, reflects net borrowings under our revolving credit facility during 2004, primarily to fund purchases of rental merchandise, acquisitions, and working capital. Also contributing to the increase is a new capital lease with a related party with an outstanding balance of $6.7 million as of December 31, 2004. Liquidity and Capital Resources General Cash flows from operating activities for the years ended December 31, 2004 and 2003 were $34.7 million and $68.5 million, respectively. Our cash flows include profits on the sale of rental return merchandise. Our primary capital requirements consist of buying rental merchandise for both Company-operated sales and lease ownership and rent-to- rent stores. In 2005, we anticipate that we will make cash payments for income taxes approximating $58 million. As Aaron Rents continues to grow, the need for additional rental merchandise will continue to be our major capital require- ment. These capital requirements historically have been financed through: • cash flow from operations • bank credit • trade credit with vendors 17 • proceeds from the sale of rental return merchandise • private debt • stock offerings At December 31, 2004, $45.5 million was outstanding under our revolving credit agreement. The increase in borrowings is primarily attributable to cash invested in new store growth throughout 2004. Our revolving credit agreement provides for maximum borrowings of $87 million and expires on May 28, 2007. We also have $50 million in aggregate principal amount of 6.88% senior unsecured notes due August 2009 currently outstanding, principal repayments for which are first required in 2005. From time to time, we use interest rate swap agreements as part of our overall long-term financing program. Our revolving credit agreement and senior unsecured notes, as well as the construction and lease facility and franchisee loan program discussed below, contain financial covenants which, among other things, forbid us from exceeding certain debt-to-equity levels and require us to maintain minimum fixed charge coverage ratios. If we fail to comply with these covenants, we will be in default under these commitments, and all amounts would become due immediately. We were in compliance with all of these covenants at December 31, 2004. We purchase our common shares in the market from time to time as authorized by our Board of Directors. As of December 31, 2004, our Board of Directors has authorized us to purchase up to an additional 2,670,502 common shares. At our annual shareholders meeting in May 2003, our shareholders authorized an increase in the authorized number of shares of Common Stock by 25 million shares for a total of 50 million shares. The purpose of increasing the number of shares of authorized Common Stock was to give the Company greater flexibility in connection with its capital structure, possible future financing requirements, potential acquisitions, employee compensation, and other corporate matters, including stock splits like the 3-for-2 splits described below. We have a consistent history of paying dividends, having paid dividends for 18 consecutive years. A $.013 per share dividend on Common Stock and Class A Common Stock was paid in January 2004 and July 2004. In addition, in July 2004 our Board of Directors declared a 3-for-2 stock split, effected in the form of a 50% stock dividend, which was distributed to shareholders in August 2004. In August 2004 the Board of Directors also announced an increase in the frequency of cash dividends from semi-annual to quarterly basis. The first quarterly payment of $.013 per share on both Common Stock and Class A Common Stock was distributed in October 2004 for a total fiscal year cash outlay of $2,042,000. A $.009 per share dividend on Common Stock and Class A Common Stock was paid in January 2003 and July 2003 for a total fiscal year cash outlay of $924,000 after giving effect to a 3-for-2 stock split, effected in the form of a 50% stock dividend distributed to shareholders in August 2003. Subject to sufficient operating profits, future capital needs, and other contingencies, we currently expect to continue our policy of paying dividends. We believe that our expected cash flows from operations, existing credit facilities, vendor credit, and proceeds from the sale of rental return merchandise will be sufficient to fund our capital and liquidity needs for at least the next 24 months. 18 Commitments Construction and Lease Facility. On October 31, 2001, we renewed our $25 million construction and lease facility. From 1996 to 1999, we arranged for a bank holding company to purchase or construct properties identified by us pursuant to this facility, and we subsequently leased these properties from the bank holding company under operating lease agreements. The total amount advanced and outstanding under this facility at December 31, 2004 was approximately $24.9 million. Since the resulting leases are accounted for as operating leases, we do not record any debt obligation on our balance sheet. This construction and lease facility expires in 2006. Lease payments fluctuate based upon current interest rates and are generally based upon LIBOR plus 1.1%. The lease facility contains residual value guarantee and default guarantee provisions that would require us to make payments to the lessor if the underlying properties are worth less at termination of the facility than agreed upon values in the agreement. Although we believe the likelihood of funding to be remote, the maximum guarantee obligation under the residual value and default guarantee provisions upon termination are approximately $21.1 million and $24.9 million, respectively, at December 31, 2004. Leases. We lease warehouse and retail store space for substantially all of its operations under operating leases expiring at various times through 2019. Most of the leases contain renewal options for additional periods ranging from one to 15 years or provide for options to purchase the related property at predetermined purchase prices that do not represent bargain purchase options. We also lease transporta- tion and computer equipment under operating leases expiring during the next five years. We expect that most leases will be renewed or replaced by other leases in the normal course of business. Approximate future minimum rental payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as of December 31, 2004, including leases under our construction and lease facility described above, are as follows: $50,676,000 in 2005; $40,605,000 in 2006; $29,878,000 in 2007; $19,479,000 in 2008; $11,590,000 in 2009; and $23,549,000 thereafter. We have 24 capital leases, 23 of which are with limited liability companies (“LLCs”) whose owners include certain Aaron Rents’ executive officers and controlling shareholder. Eleven of these related party leases relate to properties purchased from Aaron Rents in October and November 2004 by one of the LLCs for a total purchase price of approximately $6.8 million. This LLC is leasing back these properties to Aaron Rents for a 15-year term, with a five-year renewal at the Company’s option, at an aggregate annual rental of approximately $883,000. Another 11 of these related party leases relate to properties purchased from Aaron Rents in December 2002 by one of the LLCs for a total purchase price of approximately $5 million. This LLC is leasing back these properties to Aaron Rents for a 15-year term at an aggregate annual rental of approximately $702,000. The other related party capital lease relates to a property sold by Aaron Rents to a second LLC for $6.3 million in April 2002 and leased back to Aaron Rents for a 15-year term at an annual rental of approximately $681,000. See Note D to the Consolidated Financial Statements. None of the sale transactions resulted in any gain or loss in our financial statements, and we did not change the basis of the assets subject to the leases. These transactions were accounted for as financings. Franchise Guaranty. We have guaranteed the borrowings of certain independent franchisees under a franchise loan program with several banks. In the event these franchisees are unable to meet their debt service payments or otherwise experience an event of default, we would be unconditionally liable for a portion of the outstanding balance of the fran- chisee’s debt obligations, which would be due in full within 90 days of the event of default. At December 31, 2004, the portion that we might be obligated to repay in the event our franchisees defaulted was approximately $99.7 million. However, due to franchisee borrowing limits, we believe any losses associated with any defaults would be mitigated through recovery of rental merchandise and other assets. Since its inception, we have had no losses associated with the franchisee loan and guaranty program We have no long-term commitments to purchase merchan- dise. See Note F to the Consolidated Financial Statements for further information. The following table shows our approxi- mate contractual obligations and commitments to make future payments as of December 31, 2004: (In Thousands) Total Credit Facilities, Period Less Than 1 Year Period 2–3 Years Period 4–5 Years Period Over 5 Years Excluding Capital Leases $ 98,862 $ 10,004 $ 65,537 $20,011 $ 3,310 Capital Leases 17,793 587 1,397 1,908 13,901 Operating Leases 175,777 50,676 70,483 31,069 23,549 Total Contractual Cash Obligations $292,432$ 61,267 $137,417 $52,988 $40,760 The following table shows the Company’s approximate commercial commitments as of December 31, 2004: (In Thousands) Total Period Less Than 1 Year Period 2–3 Years Period 4–5 Years Period Over 5 Years Guaranteed Borrowings of Franchisees Residual Value $ 99,706 $99,706 $ — $ — $ — Guarantee Under Operating Leases 21,149 Total Commercial 21,149 Commitments $120,855 $99,706 $21,149 $ — $ — Purchase orders or contracts for the purchase of rental merchandise and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. We do not have significant agreements for the purchase of rental merchandise or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months. Income Taxes. Within the next 12 months, we anticipate that we will make cash payments for income taxes approxi- mating $58 million. Market Risk We manage our exposure to changes in short-term interest rates, particularly to reduce the impact on our variable payment construction and lease facility and floating- rate borrowings, by entering into interest rate swap agree- ments. These swap agreements involve the receipt of amounts by us when floating rates exceed the fixed rates and the payment of amounts by us to the counterparties when fixed rates exceed the floating rates in the agreements over their term. We accrue the differential we may pay or receive as interest rates change, and recognize it as an adjustment to the floating-rate interest expense related to our debt. The counterparties to these contracts are high credit quality commercial banks, which we believe largely minimizes the risk of counterparty default. At December 31, 2004 we had swap agreements with total notional principal amounts of $20 million that effectively fixed the interest rates on obligations in the notional amount of $20 million of debt under our variable payment construc- tion and lease facility at an average rate of 7.5% until June 2005. Since August 2002 fixed rate swap agreements in the notional amount of $32 million were not being utilized as a hedge of variable obligations, and accordingly, changes in the valuation of such swap agreements were recorded directly to earnings. These swaps expired during 2003. The fair value of interest rate swap agreements was a liability of approximately $0.3 million at December 31, 2004. A 1% adverse change in interest rates on variable rate obligations would not have a material adverse impact on the future earnings and cash flows of the Company. We do not use any market-risk-sensitive instruments to hedge commodity, foreign currency, or risks other than interest rate risk, and hold no market risk sensitive instruments for trading or speculative purposes. Recent Accounting Pronouncements In June 2002 the Financial Accounting Standards Board (FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146) which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred as opposed to the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes fair value as the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Adoption of SFAS No. 146 did not have a material effect on the Company’s consolidated financial statements. 19 In November 2002 the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires an entity to disclose in its interim and annual financial statements information with respect to its obligations under certain guarantees that it has issued. It also requires an entity to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure require- ments of FIN 45 are effective for interim and annual periods ending after December 15, 2002. These disclosures are pre- sented in Note F to the Consolidated Financial Statements. The initial recognition and measurement requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The adoption of the recognition provisions of FIN 45 had no significant effect on the consolidated financial statements. In January 2003 the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. The Company has not entered into transactions with, created, or acquired significant potential variable interest entities subsequent to that date. For interests in variable interest entities arising prior to February 1, 2003, the Company must apply the provisions of FIN 46 as of December 31, 2003. The Company has concluded that certain independent franchisees, as discussed in Note I to the Consolidated Financial Statements, are not subject to the interpretation and are therefore not included in the Company’s consolidated financial statements. In addition, as discussed in Note D to the Consolidated Financial Statements, the Company has certain capital leases with partnerships controlled by related parties of the Company. The Company has concluded that these partnerships are not variable interest entities. The Company has concluded that the accounting and reporting of its construction and lease facility (see Note F to the Consolidated Financial Statements) are not subject to the provisions of FIN 46 since the lessor is not a variable interest entity as defined by FIN 46. In January 2003 the Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor (EITF 02-16). EITF 02-16 addresses accounting and reporting issues related to how a reseller should account for cash consideration received from vendors. Generally, cash consideration received from vendors is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, under certain circumstances this presumption may be overcome, and recognition as revenue or as a reduction of other costs in the income statement may be appropriate. The Company does receive cash consideration from vendors subject to the provisions of EITF 02-16. EITF 02-16 is effective for fiscal periods beginning after December 15, 2002. The Company adopted EITF 02-16 as of January 1, 2003. Such adoption did not have a material effect on the Company’s consolidated financial statements since substantially all cooperative advertising consideration received from vendors represents a reimbursement of specific, identifiable, and incremental costs incurred in selling those vendors’ products. In November 2004 the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs — An Amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current- period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of con- version be based on the normal capacity of the production facilities. SFAS 151 is effective for the Company beginning January 1, 2006, though early application is permitted. Management is currently assessing the impact of SFAS 151, but does not expect the impact to be material. In December 2004 the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-based Payment (SFAS 123R). SFAS 123R amends SFAS 123 to require adoption of the fair-value method of accounting for employee stock options effective June 30, 2005. The transition guidance in SFAS 123R specifies that compen- sation expense for options granted prior to the effective date be recognized over the remaining vesting period of those options, and that compensation expense for options granted subsequent to the effective date be recognized over the vesting period of those options. We anticipate recognizing compensation expense of $1.7 million, $2.6 million, and $1.0 million for the years ended December 31, 2005, 2006, and 2007, respectively, in connection with stock option grants made prior to December 31, 2004. Forward-Looking Statements Certain written and oral statements made by our Company may constitute “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including statements made in this report and other filings with the Securities and Exchange Commission. All statements which address operating performance, events, or developments that we expect or anticipate will occur in the future — including growth in store openings, franchises awarded, and market share, and statements expressing general optimism about future operating results’ — are forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially. The Company undertakes no obligation to publicly update or revise any forward- looking statements. For a discussion of such risks and uncertainties, see “Certain Factors Affecting Forward- Looking Statements” in Item I of the Company’s Annual Report on Form 10-K filed with the SEC. 20 Consolidated Balance Sheets (In Thousands, Except Share Data) ASSETS Cash Accounts Receivable (net of allowances of $1,963 in 2004 and $1,718 in 2003) Rental Merchandise Less: Accumulated Depreciation Property, Plant & Equipment, Net Goodwill and Other Intangibles, Net Prepaid Expenses & Other Assets Total Assets LIABILITIES & SHAREHOLDERS’ EQUITY Accounts Payable & Accrued Expenses Dividends Payable Deferred Income Taxes Payable Customer Deposits & Advance Payments Credit Facilities Total Liabilities Commitments & Contingencies Shareholders’ Equity Common Stock, Par Value $.50 Per Share; Authorized: 50,000,000 Shares; Shares Issued: 44,989,602 and 44,990,212 at December 31, 2004 and 2003, respectively Class A Common Stock, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 12,063,856 and 12,063,903 at December 31, 2004 and 2003, respectively Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Less: Treasury Shares at Cost, Common Stock, 3,625,230 and 4,223,625 Shares at December 31, 2004 and 2003, respectively Class A Common Stock, 3,667,623 Shares at December 31, 2004 and 2003 Total Shareholders’ Equity Total Liabilities & Shareholders’ Equity The accompanying notes are an integral part of the Consolidated Financial Statements. December 31, 2004 December 31, 2003 $ 5,865 $ 4,687 32,736 639,192 (213,625) 425,567 111,118 74,874 50,128 30,878 518,741 (175,728) 343,013 99,584 55,485 26,237 $700,288 $559,884 $ 93,565 $ 88,446 647 95,173 19,070 116,655 325,110 655 55,290 15,737 79,570 239,698 22,495 22,495 6,032 91,032 294,077 (539) 6,032 88,305 243,415 413,097 360,247 (22,015) (24,157) (15,904) 375,178 (15,904) 320,186 $700,288 $559,884 21 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, 2004 Year Ended December 31, 2003 Year Ended December 31, 2002 $694,293 56,259 160,774 35,154 946,480 39,380 149,207 414,518 253,456 5,413 861,974 84,506 31,890 $ 52,616 1.06 $ 1.04 $ $553,773 68,786 120,355 23,883 766,797 50,913 111,714 344,884 195,661 5,782 708,954 57,843 21,417 $ 36,426 0.74 $ 0.73 $ $459,179 72,698 88,969 19,842 640,688 53,856 82,407 293,346 162,660 4,767 597,036 43,652 16,212 $ 27,440 0.58 $ 0.57 $ The accompanying notes are an integral part of the Consolidated Financial Statements. Consolidated Statements of Shareholders’ Equity (In Thousands, Except Per Share) BALANCE, DECEMBER 31, 2001 Reacquired Shares Stock Offering Dividends, $.018 per share Reissued Shares Net Earnings Change in Fair Value of Financial Instruments, Net of Income Taxes of $51 BALANCE, DECEMBER 31, 2002 Dividends, $.022 per share Stock Dividend Reissued Shares Net Earnings Change in Fair Value of Financial Instruments, Net of Income Taxes of $1,209 BALANCE, DECEMBER 31, 2003 Dividends, $.039 per share Stock Dividend Reissued Shares Net Earnings Change in Fair Value of Financial Instruments, Net of Income Taxes of $119 Treasury Stock Common Stock Shares Amount Common Class A Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Derivatives Designated Marketable Securities As Hedges ($41,062) $ 9,135 $2,681 $53,846 $197,321 ($1,954) $ 111 (8,242) (220) (1,667) 863 265 1,033 33,215 441 (833) 27,440 (8,197) (41,696) 9,998 2,681 87,502 306 1,635 4,999 1,340 (54) 857 (7,891) (40,061) 14,997 4,021 88,305 598 2,142 7,498 2,011 (80) 2,807 223,928 (1,090) (6,340) 36,426 252,924 (1,954) (9,509) 52,616 (18) (1,972) 104 104 1,031 (941) 837 941 662 (1,201) BALANCE, DECEMBER 31, 2004 (7,293) ($37,919) $22,495 $6,032 $91,032 $294,077 ($ 279) ($ 260) The accompanying notes are an integral part of the Consolidated Financial Statements. 22 Consolidated Statements of Cash Flows (In Thousands) OPERATING ACTIVITIES Net Earnings Depreciation & Amortization Additions to Rental Merchandise Book Value of Rental Merchandise Sold or Disposed Deferred Income Taxes Gain on Marketable Securities Loss (Gain) on Sale of Property, Plant & Equipment Change in Income Taxes Receivable, Included in Prepaid Expenses and Other Assets Change in Accounts Payable & Accrued Expenses Change in Accounts Receivable Other Changes, Net Cash Provided by Operating Activities INVESTING ACTIVITIES Additions to Property, Plant & Equipment Contracts & Other Assets Acquired Proceeds from Sale of Marketable Securities Investment in Marketable Securities Proceeds from Sale of Property, Plant & Equipment Cash Used by Investing Activities FINANCING ACTIVITIES Proceeds from Credit Facilities Repayments on Credit Facilities Proceeds from Stock Offering Dividends Paid Acquisition of Treasury Stock Issuance of Stock Under Stock Option Plans Cash Provided by Financing Activities Increase (Decrease) in Cash Cash at Beginning of Year Cash at End of Year Cash Paid (Received) During the Year: Interest Income Taxes The accompanying notes are an integral part of the Consolidated Financial Statements. Year Ended December 31, 2004 Year Ended December 31, 2003 Year Ended December 31, 2002 $ 52,616 277,187 (528,255) 206,589 39,919 (5,481) 84 (20,023) 4,118 (1,858) 9,842 34,738 (37,723) (38,497) 7,592 (6,436) 4,760 $ 36,426 215,397 (384,429) 178,460 3,496 $ 27,440 179,040 (361,180) 150,226 29,554 (814) (573) 17,275 (3,905) 6,630 68,536 (37,898) (44,347) (715) 8,025 (6,590) (488) (8,757) 8,672 (42,913) (14,033) (1,395) 18,296 (40,045) (70,304) (74,935) 287,307 (250,222) 86,424 (80,119) 139,542 (143,990) (2,042) (924) 1,701 36,744 1,178 4,687 1,789 7,170 771 3,916 34,078 (798) (1,667) 1,346 28,511 (2,862) 6,778 $ 5,865 $ 4,687 $ 3,916 $ 5,361 $ 16,783 $ 6,759 $ 4,987 $ 4,361 $ (2,151) 23 Notes to Consolidated Financial Statements Note A: Summary of Significant Accounting Policies As of December 31, 2004 and 2003, and for the Years Ended December 31, 2004, 2003 and 2002. Basis of Presentation — The consolidated financial state- ments include the accounts of Aaron Rents, Inc. and its wholly owned subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminat- ed. The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates. Generally, actual experience has been consistent with management’s prior estimates and assumptions. Management does not believe these estimates or assumptions will change significantly in the future absent unsurfaced or unforeseen events. On July 12, 2004, the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend on both Common Stock and Class A Common Stock. New shares were distributed on August 16, 2004 to shareholders of record as of the close of business on August 2, 2004. All share and per share information has been restated for all periods presented to reflect this stock dividend. On July 21, 2003, the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend on both Common Stock and Class A Common Stock. New shares were distributed on August 15, 2003 to shareholders of record as of the close of business on August 1, 2003. All share and per share information has been restated for all periods presented to reflect this stock dividend. Certain amounts presented for prior years have been reclassified to conform to the current year presentation. Line of Business — The Company is engaged in the business of renting and selling residential and office furniture, consumer electronics, appliances, computers, and other merchandise throughout the U.S., Puerto Rico, and Canada. The Company manufactures furniture principally for its rent-to-rent and sales and lease ownership operations. Cash — In prior balance sheet and statement of cash flow presentations, checks outstanding were classified as a reduction to cash. Since the financial institutions with checks outstanding and those with deposits on hand did not and do not have legal right of offset, we have reclassified checks out- standing in certain zero balance bank accounts to accounts payable at December 31, 2004 and for all consolidated balance sheets and consolidated statements of cash flows presented. This reclassification has the effect of increasing both cash and accounts payable and accrued expenses by $4.6 million, $3.8 million, and $6.7 million for the years ended December 31, 2003, 2002, and 2001, respectively. Certain transactions previously reflected as a reduction of book value of rental merchandise sold or disposed in the accompanying consolidated statements of cash flows for the years ended December 31, 2003 and 2002 are reflected as an addition to rental merchandise for the year ended December 24 31, 2004. These transactions have been reclassified in the accompanying consolidated statements of cash flows to conform with the current period presentation, resulting in increases in both additions to rental merchandise and book value of rental merchandise sold or disposed of $10.6 million and $9.8 million for the years ended December 31, 2003 and 2002, respectively. Rental Merchandise consists primarily of residential and office furniture, consumer electronics, appliances, computers, and other merchandise and is recorded at cost. The sales and lease ownership division depreciates merchandise over the rental agreement period, generally 12 to 24 months when on rent and 36 months when not on rent, to a 0% salvage value. 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% of historical cost. Our policies require weekly rental merchandise counts by store managers, which include write- offs for unsalable, damaged, or missing merchandise inven- tories. Full physical inventories are generally taken at our distribution and manufacturing facilities on a quarterly basis, and appropriate provisions are made for missing, damaged and unsalable merchandise. In addition, we monitor rental merchandise levels and mix by division, store, and fulfillment center, as well as the average age of merchandise on hand. If unsalable rental merchandise cannot be returned to vendors, it is adjusted to its net realizable value or written off. All rental merchandise is available for rental or sale. On a monthly basis, we write off damaged, lost or unsalable merchandise as identified. Effective September 30, 2004, we began recording rental merchandise adjustments on the allowance method. In connection with the adoption of this method, we recorded a one-time adjustment of approximate- ly $2.5 million to establish a rental merchandise allowance reserve. We expect rental merchandise adjustments in the future under this new method to be materially consistent with the prior year’s adjustments under the direct-write-off method. Inventory write-offs, including the effect of the establishment of the reserve mentioned above, totaled approximately $18.0 million, $11.9 million, and $10.1 mil- lion during the years ended December 31, 2004, 2003, and 2002, respectively, and are included in operating expenses in the accompanying consolidated statements of earnings. 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 40 years for buildings and improvements and from 1 to 5 years for other depreciable property and equipment. Gains and losses related to dispositions and retirements are recognized as incurred. Maintenance and repairs are also expensed as incurred; renewals and betterments are capitalized. Depreciation expense — included in operating expenses in the accom- panying consolidated statements of earnings — for plant, property, and equipment approximated $22.2 million, $19.2 million, and $16.4 million during the years ended December 31, 2004, 2003, and 2002, respectively. Goodwill and Other Intangibles — Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in connection with business acquisitions. Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). SFAS No. 142 requires that entities assess the fair value of the net assets underlying all acquisition-related goodwill on a reporting- unit basis effective beginning in 2002. When the fair value is less than the related carrying value, entities are required to reduce the carrying value of goodwill. The approach to eval- uating the recoverability of goodwill as outlined in SFAS No. 142 requires the use of valuation techniques using estimates and assumptions about projected future operating results and other variables. The Company has elected to perform this annual evaluation on September 30. More frequent evalua- tions will be completed if indicators of impairment become evident. The impairment only approach required by SFAS No. 142 may have the effect of increasing the volatility of the Company’s earnings if goodwill impairment occurs at a future date. Other Intangibles represent the value of customer relationships acquired in connection with business acquisi- tions, recorded at fair value as determined by the Company. As of December 31, 2004 and 2003, the net intangibles other than goodwill was $1.9 and $2.2 million, respectively. These intangibles are amortized on a straight-line basis over a two-year useful life. Amortization expense on intangibles, included in operating expenses in the accompanying consoli- dated statements of earnings, was $1.6 million and $0.5 million during the years ended December 31, 2004 and 2003, respectively. No amortization expense on intangibles was recognized in the year ended December 31, 2002. Substantially all of the Company’s goodwill and other intangibles relate to the Sales and Lease Ownership segment and are expected to be fully deductible for U.S. federal income tax purposes. Impairment — The Company assesses its long-lived assets other than goodwill for impairment whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. To analyze recoverability, the Company projects undiscounted net future cash flows over the remain- ing life of such assets. If these projected cash flows were less than the carrying amount, an impairment would be recognized, resulting in a write-down of assets with a corre- sponding charge to earnings. Impairment losses, if any, are measured based upon the difference between the carrying amount and the fair value of the assets. Investments in Marketable Securities — The Company holds certain marketable equity securities and has designated these securities as available-for-sale. The fair value of these securities was approximately $6.0 million and $3.6 million as of December 31, 2004 and 2003, respectively. These amounts are included in prepaid expenses and other assets in the accompanying consolidated balance sheets. The Company did not sell any of its investments in marketable securities during the two-year period ended December 31, 2003. In May of 2004 the Company sold its holdings in Rainbow Rentals, Inc. with a cost basis of approximately $2.1 million for cash proceeds of approximately $7.6 million in connection with Rent-A-Center’s acquisition of Rainbow Rentals. The Company recognized an after-tax gain of $3.4 million on this transaction. In connection with this gain recognition, $3.4 million was transferred from unrealized gains within accumulated other comprehensive income to net income on the accompanying Consolidated Statement of Earnings for the year ended December 31, 2004. 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 depreciation methods on rental merchandise for tax purposes. 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. The fair value of the liability for inter- est rate swap agreements, included in accounts payable and accrued expenses in the accompanying consolidated balance sheets, was approximately $346,000 and $1,369,000 at December 31, 2004 and 2003, respectively, based upon quotes from financial institutions. At December 31, 2004 and 2003, the carrying amount for variable rate debt approx- imates fair market value since the interest rates on these instruments are reset periodically to current market rates. At December 31, 2004 and 2003 the fair market value of fixed rate long-term debt was approximately $51.4 million and $52.9 million, respectively, based on quoted prices for similar instruments. 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 rev- enue. Until all payments are received under sales and lease ownership agreements, the Company maintains ownership of the rental merchandise. Revenues from the sale of merchan- dise to franchisees are recognized at the time of receipt by the franchisee; revenues from such sales to other customers are recognized at the time of shipment, at which time title and risk of ownership are transferred to the customer. Please refer to Note I for discussion of recognition of other franchise- related revenues. Cost of Sales includes the net book value of merchandise sold, primarily using specific identification in the sales and lease ownership 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. Shipping and Handling Costs are classified as operating expenses in the accompanying consolidated statements of earnings and totaled approximately $31.1 million in 2004, $24.9 million in 2003, and $20.6 million in 2002. Advertising — The Company expenses advertising costs as incurred. Such costs aggregated approximately $22.4 million in 2004, $18.7 million in 2003, and $15.4 million in 2002. Stock Based Compensation — The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees 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 (SFAS 123). The Company grants stock options for a fixed number of shares to employees primarily with an exercise price equal to the fair value of the shares at the date of grant and, accordingly, recognizes no compensation expense for these stock option grants. The Company also grants stock options for a fixed number of shares to certain key executives with an exercise price below the fair value of the shares at the date of grant (“Key Executive grants”). Compensation expense for Key Executive grants is recognized over the three-year vesting period of the options for the difference between the exercise price and the fair value of a share of Common Stock on the date of grant times the number of options granted. Income tax benefits resulting from stock option exercises credited to additional paid-in capital totaled approximately $3,248,000, $703,000, and $341,000 in 2004, 2003, and 2002, respectively. 25 For purposes of pro forma disclosures under SFAS No. 123 as amended by SFAS No. 148, the estimated fair value of the options is amortized to expense over the options’ vesting period. The following table illustrates the effect on net earn- ings and earnings per share if the fair-value-based method had been applied to all outstanding and unvested awards in each period: (In Thousands) Net Earnings before effect of Key Executive grants Expense effect of Key Executive grants recognized Net earnings as reported Deduct: total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects Pro forma net earnings Earnings per share: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2004 2002 $52,854 $36,426 $27,440 (238) 52,616 36,426 27,440 (1,687) $50,929 (1,345) $35,081 (1,165) $26,275 Basic — as reported Basic — pro forma Diluted — as reported Diluted — pro forma $ 1.06 $ 1.03 $ 1.04 $ 1.01 $ $ $ $ .74 .71 .73 .70 $ $ $ $ .58 .56 .57 .55 Closed Store Reserves — From time to time, the Company closes under-performing stores. The charges related to the closing of these stores primarily consist of reserving the net present value of future minimum payments under the stores’ real estate leases. As of both December 31, 2004 and 2003, accounts payable and accrued expenses in the accompanying Consolidated Balance Sheets included approximately $2.2 million for closed store expenses. Insurance Reserves — Estimated insurance reserves are accrued primarily for group health and workers compen- sation benefits provided to the Company’s employees. Estimates for these insurance reserves are made based on actual reported but unpaid claims and actuarial analyses of the projected claims run off for both reported and incurred but not reported claims. Effective on September 30, 2004, we revised certain estimates related to our accrual for group health self-insurance based on our experience that the time periods between our liability for a claim being incurred and the claim being reported had declined and favorable claims experience which resulted in a reduction in expenses of $1.4 million in 2004. The group health self-insurance liability and expense are included in accounts payable and accrued expenses and in operating expenses in the accompanying consolidated balance sheets and statements of earnings, respectively. Derivative Instruments and Hedging Activities — From time to time, the Company uses interest rate swap agree- ments to synthetically manage the interest rate characteristics of a portion of its outstanding debt and to limit the Company’s exposure to rising interest rates. The Company designates at inception that interest rate swap agreements hedge risks associated with future variable interest payments and monitors each swap agreement to determine if it remains 26 an effective hedge. The effectiveness of the derivative as a hedge is based on a high correlation between changes in the value of the underlying hedged item and the derivative instru- ment. The Company records amounts to be received or paid as a result of interest swap agreements as an adjustment to interest expense. Generally, the Company’s interest rate swaps are designated as cash flow hedges. In the event of early termination or redesignation of interest rate swap agreements, any resulting gain or loss would be deferred and amortized as an adjustment to interest expense of the related debt instrument over the remaining term of the original contract life of the agreement. In the event of early extinguishment of a designated debt obligation, any realized or unrealized gain or loss from the associated swap would be recognized in income or expense at the time of extinguish- ment. There was no net income effect related to swap ineffec- tiveness in 2004. For the year ended December 31, 2003, the Company’s net income included an after-tax benefit of approximately $170,000 related to swap ineffectiveness. The Company does not enter into derivatives for speculative or trading purposes. The fair value of the swaps as of December 31, 2004 and 2003 of $0.3 million and $1.4 million, respec- tively, is included in accounts payable and accrued expenses in the accompanying consolidated balance sheets. Comprehensive Income totaled approximately $52.1 million, $38.3 million, and $27.5 million, for the years ended December 31, 2004, 2003 and 2002, respectively. New Accounting Pronouncements — In November 2002 the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires an entity to disclose in its interim and annual financial statements information with respect to its obligations under certain guarantees that it has issued. It also requires an entity to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure require- ments of FIN 45 are effective for interim and annual periods ending after December 15, 2002. These disclosures are pre- sented in Note F. The initial recognition and measurement requirements of FIN 45 are effective prospectively for guar- antees issued or modified after December 31, 2002. The adoption of the recognition provisions of FIN 45 had no significant effect on the consolidated financial statements. In January 2003 the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. The Company has not entered into trans- actions with, created, or acquired significant potential vari- able interest entities subsequent to that date. For interests in variable interest entities arising prior to February 1, 2003, the Company must apply the provisions of FIN 46 as of December 31, 2003. The Company has concluded that cer- tain independent franchisees, as discussed in Note I, are not subject to the interpretation, and are therefore not included in the Company’s consolidated financial statements. In addi- tion, as discussed in Note D, the Company has certain capital leases with partnerships controlled by related parties of the Company. The Company has concluded that these partner- ships are not variable interest entities. The Company has concluded that the accounting and reporting of its con- struction and lease facility (see Note F) are not subject to the provisions of FIN 46 since the lessor is not a variable interest entity, as defined by FIN 46. In January 2003 the Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor (EITF 02-16). EITF 02-16 addresses accounting and reporting issues related to how a reseller should account for cash consideration received from vendors. Generally, cash consideration received from vendors is pre- sumed to be a reduction of the prices of the vendor’s prod- ucts or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, under certain circumstances this presumption may be overcome, and recognition as revenue or as a reduction of other costs in the income statement may be appropriate. The Company does receive cash consideration from vendors subject to the provisions of EITF 02-16. EITF 02-16 is effective for fiscal periods beginning after December 15, 2002. The Company adopted EITF 02-16 as of January 1, 2003. Such adoption did not have a material effect on the Company’s financial statements since substantially all cooper- ative advertising consideration received from vendors repre- sents a reimbursement of specific, identifiable, and incremen- tal costs incurred in selling those vendors’ products. In November 2004 the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs — An Amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current- period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of con- version be based on the normal capacity of the production facilities. SFAS 151 is effective for the Company beginning January 1, 2006, though early application is permitted. Management is currently assessing the impact of SFAS 151, but does not expect the impact to be material. In December 2004 the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-based Payment (SFAS 123R). SFAS 123R amends SFAS 123 to require adoption of the fair-value method of accounting for employee stock options effective June 30, 2005. The transi- tion guidance in SFAS 123R specifies that compensation expense for options granted prior to the effective date be recognized over the remaining vesting period of those options, and that compensation expense for options granted subsequent to the effective date be recognized over the vesting period of those options. We anticipate recognizing compensation expense of approximately $1.7 million, $2.6 million, and $1.0 million for the years ended December 31, 2005, 2006, and 2007, respectively, in connection with stock option grants made prior to December 31, 2004. 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 approximately 49,602,000 shares in 2004, 48,964,000 shares in 2003, and 47,046,000 shares in 2002. The computation of earnings per share assuming dilution includes the dilutive effect of stock options and awards. Such stock options and awards had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 973,000 in 2004, 819,000 in 2003, and 729,000 in 2002. Note C: Property, Plant & Equipment Following is a summary of the Company’s property, plant, and equipment at December 31: (In Thousands) 2004 2003 Land Buildings & Improvements Leasehold Improvements & Signs Fixtures & Equipment Assets Under Capital Lease: With Related Parties With Unrelated Parties Construction in Progress Less: Accumulated Depreciation & Amortization $ 11,687 39,305 63,291 36,518 15,734 1,475 4,339 $172,349 $ 10,370 39,772 54,348 32,135 10,308 1,432 3,647 $152,012 (61,231) $111,118 (52,428) $ 99,584 Note D: Credit Facilities Following is a summary of the Company’s credit facilities at December 31: (In Thousands) Bank Debt Senior Unsecured Notes Capital Lease Obligations: With Related Parties With Unrelated Parties Other Debt 2004 2003 $ 45,528 50,000 $13,870 50,000 16,596 1,197 3,334 $116,655 10,144 1,319 4,237 $79,570 Bank Debt — The Company has a revolving credit agree- ment dated May 28, 2004 with several banks providing for unsecured borrowings up to $87.0 million, which includes a $12.0 million credit line to fund daily working capital requirements. Amounts borrowed bear interest at the lower of the lender’s prime rate or LIBOR plus 1.00%. The pricing under the working capital line is based upon overnight bank borrowing rates. At December 31, 2004 and 2003, respec- tively, an aggregate of approximately $45.5 million (bearing interest at 3.41%) and $13.9 million (bearing interest at 2.24%) was outstanding under the revolving credit agree- ment. The Company pays a .20% commitment fee on unused balances. The weighted average interest rate on borrowings under the revolving credit agreement (before giving effect to interest rate swaps in 2003 and 2002) was 2.72% in 2004, 2.53% in 2003, and 3.86% in 2002. The revolving credit agreement expires May 28, 2007. The revolving credit agreement contains certain covenants which require 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) $338,340,000 plus (b) 50% of the Company’s consolidated net income (but not loss) for the period beginning April 1, 2004 and ending on the last day 27 of such fiscal quarter. It also places other restrictions on additional borrowings and requires the maintenance of certain financial ratios. At December 31, 2004, $16.9 million of retained earnings was available for dividend payments and stock repurchases under the debt restrictions, and the Company was in compliance with all covenants. Senior Unsecured Notes — On August 14, 2002 the Company sold $50.0 million in aggregate principal amount of senior unsecured notes (the Notes) in a private placement to a consortium of insurance companies. The Notes mature August 13, 2009. Quarterly interest only payments at an annual rate of 6.88% are due for the first two years followed by annual $10,000,000 principal repayments plus interest for the five years thereafter. Capital Leases with Related Parties — In October and November 2004 the Company sold 11 properties, including leasehold improvements, to a separate limited liability corpo- ration (“LLC”) controlled by a group of Company executives and managers, including the Company’s chairman, chief executive officer, and controlling shareholder. The LLC obtained borrowings collateralized by the land and buildings totaling approximately $6.8 million. The Company occupies the land and buildings collateralizing the borrowings under a 15-year term lease, with a five-year renewal at the Company’s option, at an aggregate annual rental of approximately $883,000. The transaction has been accounted for as a financing in the accompanying consoli- dated financial statements. The rate of interest implicit in the leases is approximately 9.7%. Accordingly, the land and buildings and the lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction. In December 2002 the Company sold 11 properties, including leasehold improvements, to a separate limited lia- bility corporation (LLC) controlled by a group of Company executives and managers, including the Company’s chairman, chief executive officer, and controlling shareholder. The LLC obtained borrowings collateralized by the land and buildings totaling approximately $5.0 million. The Company occupies the land and buildings collateralizing the borrowings under a 15-year term lease at an aggregate annual rental of approx- imately $702,000. The transaction has been accounted for as a financing in the accompanying consolidated financial statements. The rate of interest implicit in the leases is approximately 11.1%. Accordingly, the land and buildings and the lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction. In April 2002 the Company sold land and buildings with a carrying value of approximately $6.3 million to a limited liability corporation (LLC) controlled by the Company’s major shareholder. Simultaneously, the Company and the LLC entered into a 15-year lease for the building and a por- tion of the land, with two five-year renewal options at the discretion of the Company. The LLC obtained borrowings collateralized by the land and building totaling approximate- ly $6.4 million. The Company occupies the land and building collateralizing the borrowings under a 15-year term lease at an aggregate annual rental of approximately $681,000. The transaction has been accounted for as a financing in the accompanying consolidated financial statements. The rate of interest implicit in the lease financing is approximately 8.7%. Accordingly, the land and building and the debt obligation 28 are recorded in the Company’s consolidated financial state- ments. No gain or loss was recognized in this transaction. Other Debt — Other debt at December 31, 2004 and 2003 includes $3.3 million of industrial development corporation revenue bonds. The average weighted borrowing rate on these bonds in 2004 was 1.41%. No principal payments are due on the bonds until maturity in 2015. At December 31, 2004, other debt also includes a note payable for approxi- mately $33,000 assumed by the Company in connection with a store acquisition. Future maturities under the Company’s Credit Facilities are as follows: (In Thousands) 2005 2006 2007 2008 2009 Thereafter $10,591 10,648 56,286 10,914 11,005 17,211 Note E: Income Taxes Following is a summary of the Company’s income tax expense for the years ended December 31: (In Thousands) 2004 2003 2002 Current Income Tax Expense (Benefit): Federal State Deferred Income Tax Expense: Federal State ($7,720) (309) (8,029) $16,506 1,415 17,921 ($11,431) (1,911) (13,342) 35,967 3,952 39,919 $31,890 3,220 276 3,496 $21,417 26,209 3,345 29,554 $16,212 Significant components of the Company’s deferred income tax liabilities and assets at December 31 are as follows: (In Thousands) 2004 2003 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 $101,577 4,054 105,631 4,948 5,510 10,458 $95,173 $62,795 3,035 65,830 4,250 5,770 520 10,540 $55,290 The Company’s effective tax rate differs from the statutory U.S. federal income tax rate for the years ended December 31 as follows: Statutory Rate Increases in U.S. Federal Taxes Resulting From: State Income Taxes, Net of Federal Income Tax Benefit Other, Net Effective Tax Rate 2004 2003 2002 35.0% 35.0% 35.0% 2.8 (0.1) 37.7% 2.0 2.1 37.0% 37.1% 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 2019. The Company also leases certain properties under capital leases that are more fully described in Note D. Most of the leases contain renewal options for additional periods ranging from one to 15 years or provide for options to purchase the related property at predetermined purchase prices that do not represent bargain purchase options. In addition, certain properties occupied under operating leases contain normal purchase options. The Company also leases transportation and computer equipment under operating leases expiring during the next five years. Management expects that most leases will be renewed or replaced by other leases in the normal course of business. The Company also has a $25.0 million construction and lease facility. Properties acquired by the lessor are pur- chased or constructed and then leased to the Company under operating lease agreements. The total amount advanced and outstanding under this facility at December 31, 2004 was approximately $24.9 million. Since the resulting leases are operating leases, no debt obligation is recorded on the Company’s balance sheet. Future minimum rental payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as of December 31, 2004, are as follows: $50.7 million in 2005, $40.6 million in 2006, $29.9 million in 2007, $19.5 million in 2008, $11.6 million in 2009, and $23.5 million thereafter. Certain operating leases expiring in 2006 contain residual value guarantee provisions and other guarantees in the event of a default. Although the likelihood of funding under these guarantees is considered by the Company to be remote, the maximum amount the Company may be liable for under such guarantees is approximately $24.9 million. The Company has guaranteed certain debt obligations of some of the franchisees amounting to approximately $99.7 million at December 31, 2004. The Company receives guarantee fees based on such franchisees’ outstanding debt obligations, which it recognizes as the guarantee obligation is satisfied. The Company has recourse rights to the assets securing the debt obligations. As a result, the Company has never incurred any, nor does Management expect to incur any, significant losses under these guarantees. Rental expense was $50.1 million in 2004, $44.1 million in 2003, and $39.0 million in 2002. 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 $506,000 in 2004, $512,000 in 2003, and $453,000 in 2002. Note G: Shareholders’ Equity The Company held 7,292,853 common shares in its treas- ury and was authorized to purchase an additional 2,670,502 shares at December 31, 2004. During 2002 the Company purchased approximately 221,000 shares of the Company’s Class A Common Stock at an aggregate cost of $1,667,490. The Company also transferred 22,239 shares of the Company’s Common Stock at an aggregate cost of approxi- mately $218,000 back into treasury, reflected net against reissued shares in the consolidated statement of shareholders’ equity. The Company’s articles of incorporation provide that no cash dividends may be paid on the Class A Common Stock unless equal or higher dividends are paid on the Common Stock. If the number of the Class A Common Stock (voting) falls below 10% of the total number of outstanding shares of the Company, the Common Stock (non-voting) automatically converts into Class A Common Stock. The Common Stock may convert to Class A Common Stock in certain other limited situations whereby a national securities exchange rule might cause the Board of Directors to issue a resolution requiring such conversion. Management considers the likeli- hood of any conversion to be remote at the present time. 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 three years and unexercised options lapse ten years after the date of the grant. Options are subject to forfeiture upon termination of service. Under the plans, approximately 922,000 of the Company’s shares are reserved for future grants at December 31, 2004. The weighted average fair value of options granted was $5.18 in 2004, $5.48 in 2003, and $4.37 in 2002. Pro forma information regarding net earnings and earn- ings per share, presented in Note A, is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options granted in 2004, 2003 and 2002 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 2004, 2003, and 2002, respectively: risk-free interest rates of 3.16%, 3.41%, and 5.78%; a dividend yield of .28%, .23%, and .18%; a volatility factor of the expected market price of the Company’s Common Stock of .43, .52, and .46; and weighted average expected lives of the option of four, six, and five years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that 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. 29 The following table summarizes information about stock options outstanding at December 31, 2004: Range of Exercise Prices Number Outstanding December 31,2004 Options Outstanding Weighted Average Remaining Contractual Life (in years) Options Exercisable Weighted Average Exercise Price Number Exercisable December 31,2004 Weighted Average Exercise Price $ 4.38 – 10.00 10.01 – 15.00 15.01 – 20.00 20.01 – 24.86 $ 4.38 – 24.86 1,910,486 711,750 112,500 588,138 3,322,874 5.02 9.03 8.79 9.79 6.85 $6.75 14.01 15.64 22.26 $11.35 1,455,986 $6.00 1,455,986 $ 6.00 The table below summarizes option activity for the periods indicated in the Company’s stock option plans: Outstanding at December 31, 2001 Granted Exercised Forfeited Outstanding at December 31, 2002 Granted Exercised Forfeited Outstanding at December 31, 2003 Granted Exercised Forfeited Outstanding at December 31, 2004 Exercisable at December 31, 2004 Options (In Thousands) Weighted Average Exercise Price 2,928 460 (220) (158) 3,010 738 (321) (142) 3,285 865 (738) (89) 3,323 1,456 $ 5.91 9.27 6.12 7.71 6.31 13.29 6.18 8.08 7.82 19.79 5.30 13.27 $11.35 $ 6.00 Note I: Franchising of Aaron’s Sales & Lease Ownership Stores The Company franchises Aaron’s Sales & Lease Ownership stores. As of December 31, 2004 and 2003, 658 and 528 franchises had been awarded, respectively. Franchisees typically pay a non-refundable initial franchise fee of $50,000 and an ongoing royalty of either 5% or 6% of gross revenues. Franchise fees and area development fees are generated from the sale of rights to develop, own and operate Aaron’s Sales & Lease Ownership stores. These fees are recognized as income 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. Substantially all of the amounts reported as non-retail sales and non-retail cost of sales in the accompanying consolidated statements of earnings relate to the sale of rental merchandise to franchisees. Franchise agreement fee revenue approximated $3.3 million, $2.2 million, and $1.6 million and royalty revenues approximated $17.8 million, $14.0 million, and $12.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. Deferred franchise and area development agreement fees, included in customer deposits and advance payments in the accompanying consolidated balance sheets, approximated $4.8 million and $3.8 million as of December 31, 2004 and 2003, respectively. Franchised Aaron’s Sales & Lease Ownership store activity is summarized as follows: Franchise stores open at January 1 Opened Added through acquisition Purchased by the Company Closed or liquidated Franchise stores open 2004 287 79 12 (19) (2) 2003 232 79 3 (26) (1) at December 31 357 287 2002 209 27 4 (5) (3) 232 Company-operated Aaron’s Sales & Lease Ownership store activity is summarized as follows: Company-operated stores open at January 1 Opened Added through acquisition Closed or merged Company-operated stores open at December 31 2004 2003 2002 500 68 61 (13) 412 38 59 (9) 616 500 364 27 30 (9) 412 In 2004 the Company acquired the rental contracts, merchandise, and other related assets of 85 stores, including 19 franchise stores. Many of these stores and/or their accompanying assets were merged into other stores resulting in a net gain of 61 stores. In 2003 the Company acquired the rental contracts, merchandise, and other related assets of 98 stores, including 26 franchise stores. Many of these stores and/or their accompanying assets were merged into other stores resulting in a net gain of 59 stores. The 2002 acquisi- tions were primarily additional new store locations. 30 Note J: Acquisitions and Dispositions Note K: Segments During 2004 the Company acquired the rental contracts, merchandise, and other related assets of 85 sales and lease ownership stores with an aggregate purchase price of $36.0 million. Fair value of acquired tangible assets included approximately $12.9 million for rental merchandise, $0.8 million for fixed assets, and $2.4 million for other assets. Fair value of liabilities assumed approximated $47,000. The excess cost over the net fair market value of tangible assets acquired, representing goodwill and customer lists was $19.4 million and $1.2 million respectively. The estimated amorti- zation of these customer lists in future years approximates $1,447,000 for 2005, $456,000 for 2006 and $19,000 for 2007. In addition, in 2004 the Company acquired three rent- to-rent stores. The purchase price of the 2004 rent-to-rent acquisitions was $2,226,000. Fair value of acquired tangible assets included approximately $1,476,000 for rental mer- chandise and $309,000 for other assets. The excess cost over the net fair market value of tangible assets acquired, representing goodwill and customer lists, was $399,000 and $42,000, respectively. The purchase price allocations for certain acquisitions during December 2004 are preliminary pending finalization of the Company’s assessment of the fair values of tangible assets acquired. During 2003 the Company acquired 98 sales and lease ownership stores with an aggregate purchase price of $45.0 million. Fair value of acquired tangible assets included approximately $16.1 million for rental merchandise, $1.0 million for fixed assets, and $53,000 for other assets. Fair value of liabilities assumed approximated $1.3 million. The excess cost over the net fair market value of tangible assets acquired, representing goodwill and customer lists, was $26.4 million and $2.7 million, respectively. The estimated amortization of these customer lists in future years approxi- mates $849,000 for 2005. In addition, in 2003 the Company acquired one rent-to-rent store. The purchase price of the 2003 rent-to-rent acquisition was not significant. 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 2004, 2003 and 2002 consolidated financial statements was not significant. In 2004 the Company sold two of its sales and lease ownership locations to an existing franchisee. In 2003 the Company sold three of its sales and lease ownership loca- tions to an existing franchisee and sold one of its rent-to-rent stores. In 2002 the Company sold four of its sales and lease ownership stores to an existing franchisee. The effect of these sales on the consolidated financial statements was not significant. Description of Products and Services of Reportable Segments Aaron Rents, Inc. has four reportable segments: sales and lease ownership, rent-to-rent, franchise, and manufacturing. The sales and lease ownership division offers electronics, residential furniture, appliances, and computers to consumers, primarily on a monthly payment basis with no credit require- ments. 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 sales and lease ownership concept. The manufacturing division manufactures upholstered furniture, office furniture, lamps and accessories, and bedding, predominantly for use by the other divisions. Earnings before income taxes for each reportable segment are generally determined in accordance with accounting principles generally accepted in the United States with the following adjustments: • A predetermined amount of each reportable segment’s revenues is charged to the reportable segment as an allocation of corporate overhead. This allocation was approximately 2.3% in 2004 and 2003 and 2.2% in 2002. • Accruals related to store closures are not recorded on the reportable segments’ financial statements, but are rather maintained and controlled by corporate headquarters. • The capitalization and amortization of manufacturing variances are recorded on the consolidated financial statements as part of Cash to Accrual and Other Adjustments and are not allocated to the segment that holds the related rental merchandise. • Advertising expense in our sales and lease ownership division is estimated at the beginning of each year and then allocated to the division ratably over time for management reporting purposes. For financial reporting purposes, advertising expense is recognized when the related advertising activities occur. The difference between these two methods is reflected as part of the Cash to Accrual and Other Adjustments line below. • Sales and lease ownership rental merchandise write-offs are recorded using the direct write-off method for management reporting purposes and, effective in 2004, using the allowance method for financial reporting purposes. The difference between these two methods is reflected as part of the Cash to Accrual and Other Adjustments line below for 2004. • Interest on borrowings is estimated at the beginning of each year. Interest is then allocated to operating seg- ments on the basis of relative total assets. • Sales and lease ownership revenues are reported on the cash basis for management reporting purposes. 31 Revenues in the “Other” category are primarily from Information on segments and a reconciliation to earnings before income taxes are as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2004 2002 (In Thousands) Revenues From External Customers: Sales & Lease Ownership $804,723 108,453 Rent-to-Rent 25,253 Franchise 10,185 Other Manufacturing 70,440 Elimination of $634,489 $501,390 119,885 16,663 4,746 56,002 109,083 19,347 4,206 60,608 Intersegment Revenues Cash to Accrual Adjustments Total Revenues From External Customers Earnings Before Income Taxes: Sales & Lease Ownership Rent-to-Rent Franchise Other Manufacturing Earnings Before Income Taxes For Reportable Segments Elimination of Intersegment Loss (Profit) Cash to Accrual and Other Adjustments Total Earnings Before (70,884) (1,690) (60,995) 59 (56,141) (1,857) $946,480 $766,797 $640,688 $56,578 8,842 18,374 2,118 (175) $ 43,325 $ 31,220 9,057 10,919 (5,544) 989 6,341 13,600 (2,356) 1,222 85,737 62,132 46,641 178 (2,338) (760) (1,409) (1,951) (2,229) Income Taxes $ 84,506 $ 57,843 $ 43,652 Assets: Sales & Lease Ownership Rent-to-Rent Franchise Other Manufacturing Total Assets $524,492 83,478 23,495 50,452 18,371 $700,288 $412,836 $331,665 89,133 12,627 35,488 18,555 $559,884 $487,468 79,984 19,493 29,244 18,327 Depreciation & Amortization: Sales & Lease Ownership Rent-to-Rent Franchise Other Manufacturing $255,606 19,213 722 711 935 $191,777 $154,310 22,901 486 541 802 21,266 547 839 968 Total Depreciation & Amortization Interest Expense: $277,187 $215,397 $179,040 Sales & Lease Ownership Rent-to-Rent Franchise Other Total Interest Expense $ 5,197 1,044 96 (924) $ 5,413 $ 5,215 $ 4,768 2,493 83 (2,577) $ 5,782 $ 4,767 1,583 93 (1,109) leasing space to unrelated third parties in our corporate headquarters building and revenues from several minor unrelated activities. The pretax losses in the “Other” category are the net result of the activity mentioned above, net of the portion of corporate overhead not allocated to the reportable segments for management purposes, and, in 2004, the $5.5 million pretax gain recognized on the sale of marketable securities. 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 segments are the same as those described in the summary of significant accounting policies except that the sales and lease ownership 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 The Company’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. 32 Note L: Quarterly Financial Information (Unaudited) (In Thousands, Except Per Share) YEAR ENDED DECEMBER 31, 2004 Revenues Gross Profit* Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution YEAR ENDED DECEMBER 31, 2003 Revenues Gross Profit* Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution First Quarter Second Quarter Third Quarter Fourth Quarter $242,493 116,856 20,706 12,817 .26 .26 $230,286 114,641 24,928 15,385 .31 .30 $231,648 116,320 17,551 10,647 .21 .21 $191,260 $177,741 $188,406 92,986 13,907 8,748 .18 .18 90,912 13,906 8,761 .18 .18 97,475 13,733 8,651 .18 .17 $242,053 121,466 21,321 13,767 .28 .27 $209,390 103,253 16,297 10,266 .21 .20 * Gross profit is the sum of rentals and fees, retail sales, and non-retail sales less retail cost of sales, non-retail cost of sales, and depreciation of rental merchandise. During the fourth quarter of 2004, we recorded an adjustment reducing our liability for personal property taxes and our personal property tax expense by approximately $1.3 million. These items are included in accounts payable and accrued expenses in the accompanying Consolidated Balance Sheet and operating expenses in the accompanying Consolidated Statements of Earnings, respectively. Also during the fourth quarter of 2004, we recorded an adjustment arising from our annual examination of our treatment of vendor consideration under EITF 02-16. This adjustment resulted in decreases in rental merchandise net of depreciation of approximately $579,000, rental merchandise depreciation expense of approximately $126,000, retail cost of goods sold of approximately $146,000, and non-retail cost of goods sold of approximately $202,000, offset by an increase in advertising expenses, included in operating expenses in the accompanying consolidated statements of earnings, of approximately $1.1 million. Management Report on Internal Control Over Financial Reporting Management of Aaron Rents, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore it is possible to design into the process safeguards to reduce, though not eliminate, the risk. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Based on our assessment, management believes that, as of December 31, 2004, the Company’s internal control over financial reporting is effective based on those criteria. The Company’s independent auditor has issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears on the following page. 33 Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements 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, 2004 and December 31, 2003, and the related consoli- dated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsi- bility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the finan- cial 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 sig- nificant 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 financial position of Aaron Rents, Inc. and Subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Aaron Rents, Inc.’s internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2005 expressed an unqualified opinion thereon. Atlanta, Georgia March 7, 2005 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and Shareholders of Aaron Rents, Inc. We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that Aaron Rents, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Aaron Rents, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibili- ty is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was main- tained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s inter- nal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; 34 (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detec- tion of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that Aaron Rents, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Aaron Rents, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Aaron Rents, Inc. as of December 31, 2004 and 2003, and the related consoli- dated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004 of Aaron Rents, Inc. and our report dated March 7, 2005 expressed unqualified opinion thereon. Atlanta, Georgia March 7, 2005 Common Stock Market Prices & Dividends The following table shows the range of high and low Subject to our ongoing ability to generate sufficient prices per share for the Common Stock and Class A Common Stock and the cash dividends declared per share, for the periods indicated. The Company’s Common Stock and Class A Common Stock are listed on the New York Stock Exchange under the symbols “RNT” and “RNTA,” respectively. The number of shareholders of record of the Company’s Common Stock and Class A Common Stock at February 25, 2005 was 281. The closing prices for the Common Stock and Class A Common Stock at February 25, 2005 were $20.32 and $18.50, respectively. income through operations, to any future capital needs, and to other contingencies, we expect to continue our policy of paying dividends. Our articles of incorporation provide that no cash dividends may be paid on our Class A Common Stock unless equal or higher dividends are paid on the Common Stock. Under our revolving credit agreement, we may pay cash dividends in any fiscal year only if the dividends do not exceed 50% of our consolidated net earnings for the prior fiscal year plus the excess, if any, of the cash dividend limitation applicable to the prior year over the dividend actually paid in the prior year. Common Stock High Low Cash Dividends Per Share Class A Common Stock High Low D E C E M B E R 3 1 , 2 0 0 4 D E C E M B E R 3 1 , 2 0 0 4 First Quarter Second Quarter Third Quarter Fourth Quarter D E C E M B E R 3 1 , 2 0 0 3 First Quarter Second Quarter Third Quarter Fourth Quarter $17.13 22.11 22.60 25.23 $ 9.81 11.81 15.40 15.75 $13.44 16.13 18.50 21.15 $ 7.58 9.02 11.34 13.42 $.013 .013 .013 $.009 .013 First Quarter Second Quarter Third Quarter Fourth Quarter D E C E M B E R 3 1 , 2 0 0 3 First Quarter Second Quarter Third Quarter Fourth Quarter $14.93 20.15 21.11 22.59 $10.11 11.53 14.44 14.13 $12.31 14.00 17.70 19.49 $ 8.36 8.98 10.67 12.33 Cash Dividends Per Share $.013 .013 .013 $.009 .013 35 Store Locations in the United States, Puerto Rico, and Canada AT D E C E M B E R 3 1 , 2 0 0 4 Company-Operated Sales & Lease Ownership Franchised Sales & Lease Ownership Rent-to-Rent Total Stores Manufacturing & Fulfillment Centers 616 357 58 1,031 23 36 Leo Benatar Principal, Benatar & Associates William K. Butler, Jr. President, Aaron’s Sales & Lease Ownership Division Gilbert L. Danielson Executive Vice President, Chief Financial Officer, Aaron Rents, Inc. Earl Dolive (1) Vice Chairman of the Board, Emeritus, Genuine Parts Company Ingrid Saunders Jones (2) Senior Vice President, Corporate External Affairs, The Coca-Cola Company David L. Kolb (1) Chairman of the Board, Mohawk Industries, Inc. Robert C. Loudermilk, Jr. President, Chief Operating Officer, Aaron Rents, Inc. Ray M. Robinson (2) President, East Lake Golf Club and Vice Chairman, East Lake Community Foundation (1) Member of Audit Committee (2) Member of Stock Option Committee Board of Directors R. Charles Loudermilk, Sr. Chairman of the Board, Chief Executive Officer, Aaron Rents, Inc. Ronald W. Allen (1) Retired Chairman, President and Chief Executive Officer of Delta Air Lines Officers 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, Aaron Rents, Inc. William K. Butler, Jr. President, Aaron’s Sales & Lease Ownership Division Eduardo Quiñones President, Aaron Rents’ Rent-to-Rent Division James L. Cates Senior Group Vice President and Corporate Secretary, Aaron Rents, Inc. K. Todd Evans Vice President, Franchising, Aaron’s Sales & Lease Ownership Division B. Lee Landers, Jr. Vice President, Chief Information Officer, Aaron Rents, Inc. Mitchell S. Paull Senior Vice President, Merchandising and Logistics, Aaron’s Sales & Lease Ownership Division David M. Rhodus Vice President, General Counsel, Aaron Rents, Inc. Marc S. Rogovin Vice President, Real Estate and Construction, Aaron Rents, Inc. Robert P. Sinclair, Jr. Vice President, Corporate Controller, Aaron Rents, Inc. Gregory G. Bellof Vice President, Mid-Atlantic Operations, Aaron’s Sales & Lease Ownership Division David A. Boggan Vice President, Mississippi Valley Operations, Aaron’s Sales & Lease Ownership Division Corporate and Shareholder Information Corporate Headquarters 309 E. Paces Ferry Rd., N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 http://www.aaronrents.com May 3, 2005, at 10:00 a.m. E.D.T. on the 4th Floor, SunTrust Plaza, 303 Peachtree Street, Atlanta, Georgia 30303. Subsidiaries Aaron Investment Company 4005 Kennett Pike Greenville, Delaware 19807 (302) 888-2351 Aaron Rents, Inc. Puerto Rico Avenue Barbosa #376 Hato Rey, Puerto Rico 00917 (787) 764-0420 Annual Shareholders Meeting The annual meeting of the shareholders of Aaron Rents, Inc. will be held on Tuesday, Transfer Agent and Registrar SunTrust Bank, Atlanta Atlanta, Georgia General Counsel Kilpatrick Stockton LLP Atlanta, Georgia 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 David L. Buck Vice President, Southwestern Operations, Aaron’s Sales & Lease Ownership Division Christopher D. Counts Vice President, Western Residential Region, Aaron Rents’ Rent-to-Rent Division Joseph N. Fedorchak Vice President, Eastern Operations, Aaron’s Sales & Lease Ownership Division Bert L. Hanson Vice President, Mid- American Operations, Aaron’s Sales & Lease Ownership Division Michael B. Hickey Vice President, Management Development, Aaron’s Sales & Lease Ownership Division Kevin J. Hrvatin Vice President, Western Operations, Aaron’s Sales & Lease Ownership Division Michael W. Jarnagin Vice President, Manufacturing, Aaron Rents, Inc. charge. Such requests should be sent to the attention of Gilbert L. Danielson, Execu- tive Vice President, Chief Financial Officer, Aaron Rents, Inc., 309 E. Paces Ferry Rd., N.E., Atlanta, Georgia 30305-2377. The certifications of our Chief Executive and Chief Financial Officers required by Section 302 of the Sarbanes- Oxley Act of 2002, which addresses, among other things, the content of our Annual Report on Form 10-K, appear as exhibits to the Form 10-K. James C. Johnson Vice President, Internal Audit, Aaron Rents, Inc. Philip J. Karl Vice President, Southeast Residential Region, Aaron Rents’ Rent-to-Rent Division Donald P. Lange Vice President, Marketing and Advertising, Aaron Rents’ Rent-to-Rent Division Tristan J. Montanero Vice President, Central Operations, Aaron’s Sales & Lease Ownership Division Michael P. Ryan Vice President, Northern Operations, Aaron’s Sales & Lease Ownership Division Mark A. Rudnick Vice President, Marketing, Aaron’s Sales & Lease Ownership Division Danny Walker, Sr. Vice President, Internal Security, Aaron Rents, Inc. Stock Listing Aaron Rents, Inc.’s Common RNT Stock and Class A Common Stock are traded on the New York Stock Exchange under the symbols “RNT” and “RNT.A,” respectively. Pursuant to the requirements of the New York Stock Exchange, in 2004 our Chief Executive Officer certified to the NYSE that he was not aware of any violation by Aaron Rents, Inc. of the NYSE’s corporate governance listing standards. 3737 309 E. Paces Ferry Rd., N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 www.aaronrents.com