Aaron's Company
Annual Report 2007

Plain-text annual report

s Come ms Come Making Dreams Come True one customer at a time one cuusstomuuss Ann Annual Report 2007 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 in over 1,560 Company-operated and franchised stores in the United States and Canada. The Company’s major operations are the Aaron’s Sales & Lease Ownership division, the Aaron’s Corporate Furnishings division and MacTavish Furniture Industries. Aaron Rents is the industry leader in serving 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 . . . . . . . . 2–3 The Aaron’s Story . . . . . . . . . 4–18 Financial Information . . . . . . 19–45 Common Stock Market Prices and Dividends . . . . . . . . . 46 Store Locations . . . . . . . . . . . . . 47 Board of Directors and Officers . 48 Corporate and Shareholder Information . . . . . . . . . . . . . . . . 49 2 Financial Highlights (Dollar Amounts in Thousands, Except Per Share) OPERATING RESULTS Revenues Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution FINANCIAL POSITION 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 STORES OPEN AT YEAR END Sales and Lease Ownership Sales and Lease Ownership Franchised* Corporate Furnishings Total Stores Year Ended December 31, 2007 Year Ended December 31, 2006 Percentage Change $1,494,911 128,845 80,275 1.48 1.46 $1,326,592 124,710 78,635 1.50 1.47 $1,113,176 623,452 185,832 673,380 12.56 $ 979,606 612,149 129,974 607,015 11.21 21.6% 8.6 5.4 12.5 1,014 484 62 1,560 17.6% 9.4 5.9 15.1 845 441 59 1,345 12.7% 3.3 2.1 (1.3) (0.7) 13.6% 1.8 43.0 10.9 12.0 20.0% 9.8 5.1 16.0% * Sales and Lease Ownership franchised stores are not owned or operated by Aaron Rents, Inc. Net Earnings By Year R e v e n u e s B y Y e a r $1,500,000 ) s d n a s u o h t n i $ ( 1,200,000 900,000 600,000 300,000 0 2 0 0 3 2 0 0 4 2 0 0 6 2 0 0 7 2 0 0 5 ) s d n a s u o h t n i $ ( $100,000 80,000 60,000 40,000 20,000 0 2003 2004 2005 2006 2007 11 To Our Shareholders As always, we experienced another exciting and challenging year. We take particular note of the people who enable our Company to keep setting records year after year — our customers. This annual report communicates the foundation of Aaron’s long-term success in the words of our customers. In the following pages, our customers tell it like it is — and we are extremely proud of what they say about our way of doing business. During the past year, we reached new milestones in several key categories. • For the first time, we exceeded the $2 billion mark in combined Company and franchised store revenues. Company revenues were a record $1.495 billion, an increase of 13% over last year, while franchised store revenues, which are not included in the Company figures, reached $559 million, a 15% gain. Net earnings were $80.3 million with fully diluted earnings per share of $1.46 impacted by expansion costs and other factors. • Our total store count reached 1,560 by year end, an increase of 16% for the year. • The number of customers being served at our Company-operated and franchised Aaron’s Sales & Lease Ownership stores increased 15% during the year to over 925,000, also a record. • We awarded area development agreements to open a record 182 new franchised stores, resulting in a total of 284 stores in the pipeline to open over the next several years. • For the fourth consecutive year, we increased our quarterly dividend to the current rate of $.016 per share, a 6.7% increase over last year. Our Directors authorized the repurchase of an addi- tional 2,329,498 shares of common stock, almost doubling the previously approved repurchase authorization and bringing to 5,000,000 the total number of Aaron Rents common shares authorized for repurchase. In the fourth quarter of 2007, the Company repurchased 692,042 shares of common stock, which we view as a judicious use of capital and an investment in supporting shareholder value. 2 These achievements were accomplished in the face of several challenges. Expenses associated with our rapid expansion were substantial, and there were also unforeseen store construction delays and, in some areas, less than expected growth in revenues. Our ambitious goal to add 250 stores in 2007 was a significant challenge, and we ended the year adding 215 stores. That was still a major accomplishment and a very strong growth rate. Same store revenues for Company-operated Aaron’s Sales & Lease Ownership stores increased 2.1% for stores open over two years at the end of 2007. We are now following a more attainable expansion plan and concentrating on improving overall profit- ability and revenue growth in existing stores. Our priority in 2008 is to achieve a higher level of perfor- mance in all areas of our operations. Over the next several years, our plan is to increase overall store count in the range of 10-13% annually. Our objective is to achieve consistent growth in revenues, earnings, stores and shareholder value. Our optimism in achieving these goals is based on several factors. • First, we have a tremendous existing and potential customer base — our largest market is households with less than $50,000 annual income, which represents roughly half of the U.S. population. • Second, Aaron’s has established market leadership in serving our customers. We have moved consumer rental, sales and lease ownership products to Main Street America over the past two decades with our attractive and spacious stores and a wide range of high-quality brand-name furniture, appliances and electronics. • Third, our dedicated and highly capable associates are committed to providing the highest level of service and achieving record performance measures every day. Reflecting this, several of our key asso- ciates were advanced during 2007 to positions of greater responsibility in the Aaron’s Sales & Lease Ownership division. John T. Trainor was promoted to Vice President, Information Technology, and Paul A. Doize to Vice President, Real Estate. In addition, due to the division’s growth, we added two new operating regions during the year and promoted Michael H. Pokorny to Vice President, Northeast Operations, and John A. Allevato to Vice President, RIMCO Operations, of these new regions. We look forward with enthusiasm to the year ahead, confident that we can take advantage of the oppor- tunities to achieve continuing strong and consistent growth to the benefit of our customers, our associ- ates, our business partners and our shareholders. Sincerely, R. Charles Loudermilk, Sr. Chairman and Chief Executive Officer Robert C. Loudermilk, Jr. President and Chief Operating Officer 3 For over 50 years, Aaron’s has been making customers’ “dreams come true.” From our first rental of folding chairs, our Company’s product line has expanded to include flat- screen televisions; laptop computers; high-efficiency washers and dryers; stainless steel refrigerators; bedroom, living room and dining room furniture; and much, much more. Our Aaron’s Sales & Lease Ownership Company-operated and franchised stores serve over 925,000 customers in 48 states and Canada. Our growth and success represent the hard work and dedication of our associates, fran chisees, management team and the loyalty of our customers. 4 “ I have been a customer of Aaron’s for about 10 years. I had been a customer of a rental store but turned the merchandise back to them because the product and pricing were better at Aaron’s. I have been a customer of Aaron’s many, many times. Over the years, I have leased a computer, mattresses, camera, and I just got a flat-screen television for my son. I do shop around, but I have found that when I make a large purchase on a credit card, it takes me longer to pay off, and I end up paying more than I would getting the product from Aaron’s. Plus, with leasing, I have the added benefit of warranties and service.” Weathe “ Weatherford is a suburban community about 20 miles west of Fort Worth, Texas. The town has grown fairly rapidly as the Fort Worth metropolitan area has expanded, and our population is now close to 25,000. Some people commute to work in Fort Worth, others work in the oil fields. We also have a small college in town, so we have a large computer business. Our average customer pays $150 a month and often has several items under agreement. This store is about four years old and is going really well. I have been the general manager for 18 months, and it is my second store as general manager. Most of our customers are families and most are renters. Many live on the outskirts of Weatherford, often in rural areas. Most come in for electronics, and many of our customers have multiple contracts. Rent-to- own stores are the primary competition here, and our customers see that it is cheaper in the long run to shop with Aaron’s. We have an awesome selection of merchandise, which is a big advantage. Our merchandise selec- tion seems to get better every year, and we open up new categories on a regular basis. Big screen televisions are hot right now. ” — Brandi Cienega, General Manager, Store CO296 Brandi Cienega 5 Columbu GA “ Columbus, Georgia, and Phenix City, Alabama, are virtually one market. There are a number of large employers in the region, including AFLAC, Total Systems and Pratt & Whitney. Fort Benning is the single largest employer, and we have quite a few customers who are stationed there or who work there. We have quite a few computers on lease to deployed military personnel. They want to be able to stay in touch with their families. Most customers come to us first for sofas and chairs or electronics. The customers in this store tend to be younger families — most are 25-30 years old. I grew up in Columbus and have lived here most of my life except for college and opening a store for Aaron’s in Albany, Georgia. I know my customers and know this market.” — John Alexander, General Manager, Store F009 r “ I have been in the military about a year and a half and have been a customer of Aaron’s for six months. I needed some furniture and found bedroom and living room furniture I liked at Aaron’s. They have been good to work with. Recently, payroll in my company was messed up, and Aaron’s worked with me until my paycheck arrived.” 6 C o m p a n y R e v e n u e s F r o m F r a n c h i s i n g $40,000 ) s d n a s u o h t n i $ ( 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 2 0 0 3 2 0 0 4 2 0 0 6 2 0 0 7 2 0 0 5 Company Pretax Profit From Franchising $30,000 25,000 20,000 15,000 ) s d n a s u o h t n i $ ( 10,000 5,000 0 2003 2004 2005 2006 2007 Aaron’s Sales & Lease Ownership The Aaron’s Sales & Lease Ownership division is the Company’s largest and the primary engine of growth. Stores offer credit-constrained consumers a broad array of quality home furnishings and elec- tronics. The sales and lease ownership model offers consumers unique benefits compared to retailers that offer financing vehicles. The Aaron’s business model is based on 12-, 18-, or 24-month lease pay- ment options with a “cash and carry” price and a “90 Day Same as Cash” option. The stores are typically freestanding and attractively displayed, offering a broad selection of electronics, furniture, appliances and accessories. Key features of the Aaron’s Sales & Lease Ownership model include: • Same or next-day delivery, free of charge • Flexible payment options (cash, check, credit and debit cards) • No application fees, no balloon payments, no credit reports • Monthly or semimonthly payments • Quality brand-name products with repair or replacement guarantees • No long-term obligation • Lower total cost than rent-to-own competitors With a lease arrangement, a customer can return product at any time. Accordingly, customer service is critical to our success. We utilize in-house training and employee development programs through Aaron’s E-University to enhance customer relations skills, promote uniform customer service standards and distribute timely information about new products and promotions. Key features of our customer service include free delivery of our products and free service on products under lease. Our best customers have multiyear relationships with the Company and, importantly, over 45% of our customers complete the lease term and obtain ownership of their merchandise, a significantly higher percentage than the rent-to-own industry pag kee the I th the rig 7 “ Mattoon is roughly 50 miles from Champaign, Illinois. Our town of 25,000 has a significant agricultural base and a number of factories nearby. Eastern Illinois University is about 15 minutes away. This store is around three years old and doing well. This is a stable community. Most of our employees live in Mattoon, and many grew up here. That gives us a sense of being a local store. This is a relationship business, and we close each contract with a handshake. Some of our older farmers just don’t like credit so our 90 Day Same as Cash program is popular with them. We have several ways to get our customers to product ownership. We really are trying to provide the highest level of service. Many of our customers are young families 25-27 years old. Often, they acquire a big-screen television or appliances first and then come back for additional merchandise. We do a great business in lawn tractors here. As a manager, I try to get involved in the community, and my store sponsors charity events that are meaningful to our customers. I am part of this community too.” — Steve Davis, General Manager, Store F0567 Company-Operated Sales & Lease Ownership Lease Revenues Other 4% Computers 17% Electronics 31% Furniture 33% Appliances 15% Store Growth 2,000 1,500 1,000 500 0 2003 2004 2005 2006 2007 8 “ I live in Mattoon and grew up in a nearby town. Before Aaron’s opened a store here, I shopped at a rent-to-own store. I did not like it at all. It seems as though my weekly payment was always due a day before my payday. I would call the store to let them know, but I still got phone calls hounding me to pay that day. I know I paid a whole lot more money there than I would have at an Aaron’s store. When the Aaron’s store opened in Mattoon, I leased a sectional sofa. Since then, I have bought a computer, a laptop computer, bedroom furniture and a television set. There is no comparison with the competitor’s store. The customer service at Aaron’s is so much better, and the merchandise selection is better too. I also think the quality of products is better. It is just a completely different experience at Aaron’s.” 9 The Aaron’s Dream Weekend at Talladega Superspeedway is our premier event partnership featuring the Aaron’s 499 NASCAR Sprint Cup Series Race and the Aaron’s 312 NASCAR Nationwide Series Race, both nationally televised races. average of approximately 25%. At the end of 2007, we had over 610,000 customers of Company-operated stores, and an additional 318,000 customers were being served by franchised stores. Over the past five years, we have developed a standard freestanding store, approximately 9,000 square feet with an attractively merchandised sales floor and uniform color palette and signage, which is substantially larger than the stores of competitors. We offer room packages that combine furniture and accessories, all available at affordable monthly lease payments. Electronics have been an excellent product category for quite a few years, and exciting new products have been driving demand. The phase- out of analog television signals should continue to spur demand for large-screen digital televisions. Our computer leasing business continues to grow with laptops becoming a popular product. Computers now represent 17% of our product mix. Our national brands are an additional assurance of quality. Our stores are open six days a week and can be operated with less than 10 employees. Sixteen regional fulfillment centers enable the Company to minimize inventory at the store level while making possible same or next-day delivery service. A typical urban store will draw customers from up to a 10-mile radius, while rural stores often draw from up to 60 miles. Customers of rural stores represent approximately 40% of Company customers and sub- urban customers another 40%, with urban customers the remainder. Urban customers tend to be renters in densely populated metropolitan areas and are younger 10 Customer Proximity to Store 20+ miles 3% 15 – 20 miles 8% 5 miles or less 10% 10 –15 miles 29% 8 – 10 miles 19% 5 – 8 miles 31% Cus tome r G roups Rural 40% Urban 20% Suburban 40% Veronica T “ I have only been a customer since last September. I wanted to replace my computer and decided to lease a computer from Aaron’s. To be honest, my experience was quite good. The salesman was really knowledgeable about the computer. I had some problems loading software, and this salesman went above and beyond to get it right. I’m really happy.” Eastman “ Eastman is a small town, roughly 30 minutes from Dublin, Georgia. Eastman is mostly agricultural, and the population is less than 6,000 people. My store opened in 2007, and business is going well. The competition in this market is rent-to-own as well as some traditional furniture stores. We have a big competitive advantage in that a customer does not need to make a large deposit in order to get the merchandise they want. All of our customers are on tight budgets. Most people come in first for electronics. I think people see us as fair, treating those with credit and without credit the same. I have been with Aaron’s two years, and this has been a good career opportunity for me.” — Keair Harris, General Manager, Store CO967 11 than the average Aaron’s customer. These customers tend to have lower household incomes than the average. Suburban customers typically are married and new homeowners in the suburbs of larger cities. The Company’s rural customers tend to be older than the suburban and urban customers, with limited income, and often have lived in their homes for a number of years. A majority of all Aaron’s customers have lived in their current residence less than one year. The average annual income for all Company customers is $35,800, with urban customers having the lowest average income ($29,800) and suburban customers the high- est ($44,000). Approximately 80% of the Company’s customers have household income of less than $50,000. Nearly half of Aaron’s customers have children under 18 living at home, with the urban H o m e O w n e r s h i p H o m e O w n e r s h i p 100% 80 60 40 ) t n e c r e p ( 20 0 Urban Suburban Rural Rural ■ Renter ■ Homeowner Percentage of Customers 18–44 80% 70 60 50 40 30 ) t n e c r e p p ( ( 20 10 0 Urban Suburban Rural C h i l d r e n L i v i n g a t H o m e 100% 80 60 40 ) t n e c r e p ( 20 0 Rural Suburban Urban ■ No Children at home ■ Children at home “ Alice is about 45 minutes west of Corpus Christi, Texas, and has been growing fairly steadily. My store opened in April of 2006, and the next closest Aaron’s store is 35 minutes away. There is a Super Wal-Mart in this region, which draws traffic. I have been in this market for over 10 years and opened this store as general manager. Even before the store opened, I went door to door with my staff, introducing Aaron’s and the sales and lease ownership program. Word of mouth is definitely the best way to bring in new business. We opened 113 accounts in our first two weeks of business and now have over 1,000. Our customers are oil rig workers, refinery workers, schoolteachers and bankers. I live in this community too, and I try to get to know as many people as possible in Alice. Many of our customers have enough credit-worthiness to shop other places, but we sell them on service and price. We can compete with furniture stores that offer 12 months of no interest. We are also one of the 20 top Aaron’s stores in computer leases. We just are a big player in this market.” — Robert Valls, General Manager, Store CO570 12 “ I have been a customer for about a year. I was shopping for a laptop computer, and a friend recommended Aaron’s. Since then, I have added a bedroom set and a television. I shopped around for both, but Aaron’s had a better selection and a better deal. I didn’t see what I had in mind on the showroom floor, but the salesman showed me a catalog and ordered exactly what I wanted.” 13 14 n, G Jo Iap “ Stone Mountain was probably a distinct community when this store was opened over 15 years ago, but the Atlanta metropolitan area has really grown and the boundaries between the city and suburban areas have blurred. I would guess that there are 100,000 people within a five- mile radius of this store and at least 20 apart- ment communities. Our customers range from 18-year-old college students and service industry workers to retirees. Direct mail has been effective in reaching our customers, and we often have people walking in the door with a monthly circular in hand. There are quite a few rental stores close by, and we often pick up customers based on price and service. In addition, we have some customers who have been with us for well over 10 years. We have a staff of eight in this store, and one of the keys to growth is for us to get out in the community and meet our customers.” — Joseph Iapichino, General Manager, Store C0009 Eula Lewis “ I am an educator, and my husband is with the Georgia Department of Transportation, and we have five children. I have been a customer since around 1992. Over the years, I have bought electronics, sofas, lamps, a refrigerator, washer/dryers and a computer. I like Aaron’s because I can go into the store and select the products I want. I am able to buy products without using my credit. I don’t shop other stores. I just prefer Aaron’s — maybe it is just the friendliness of the company.” , GA group the highest (75%) and the rural group the lowest (37%). The typical Aaron’s customer is a high school graduate who has attended college. Urban customers tend to have lower levels of educational achievement, while over 80% of suburban and rural customers have completed some college work. The Company’s customer base is ethnically diverse, as is the employee base. Over 80% of our customers pay by the month with the remainder paying semimonthly. The Company’s centralized market- ing produces a consistent message and brand image executed by an in-house advertising agency and delivered through national and local television advertising, direct mail, direct delivery of promotional materials and a variety of sports sponsorships. “Aaron’s Makes Dreams Come True” is a consistent Company message, promoted through our “Dream Products” merchandise, our “Drive Dreams Home” NASCAR championship racing sponsorship and the over 25 million flyers distributed every month to households in our markets. We believe the high-profile NASCAR sponsorship has been extremely effective in expanding the Compa- ny’s brand awareness, establishing Aaron’s as a national market leader. The Company’s franchise program, launched in 1992, has been an important engine of store growth. A typical franchisee owns and operates three or four stores, but several of the over 100 franchisee groups operate over 10 stores. Franchise royalties and fees contribute over 20% of the Company’s earnings. 15 Since the inception of the franchise program, Aaron’s has acquired over 200 franchised stores, providing the Company with additional high-performing stores. At year end 2007, there were 484 franchised stores open and another 284 stores under area development agreements to open over the next few years. Custom wheels and high-performance tires have been a rapidly emerging category in the rent-to-own industry with several corporate participants. At the end of 2007, we operated 27 Company-operated RIMCO stores and four franchised RIMCO stores. These stores lease automobile tires and rims to cus- tomers under sales and lease ownership agreements. At present, the Company still considers the RIMCO stores a development-stage concept. The Company intends to continue to expand the sales and lease ownership concept through new store openings, selective acquisitions and franchise awards. New stores typically break-even during the second year of operation, and a large number of stores opened over the past three years are now beginning to leverage their fixed costs and investment in rental inventory. In addition, operational efficiencies continue to be an important avenue for improved profitability and a current management focus. Aaron’s Corporate Furnishings Division The Aaron’s Corporate Furnishings division rents and sells new and rental return merchandise to businesses and individuals out of 46 stores in 16 states. In addi- tion, the division operates 16 stores that specialize in office furnishings. The division, currently represent- ing approximately 8% of Company revenues, offers both residential and office furniture and is thought to be the second largest corporate furnishings rental company in the United States. A growing part of the business has been the rental of residential furniture to business customers for use by relocated employees or those on temporary assignment. A national accounts program has developed strategic partnerships to fulfill nationwide needs of clients. As an example, Aaron’s furnishes all of the trailers used by broadcasters at NASCAR races and selected other special events. This “ My husband, Wayne, and I have been customers for about eight years. First, we bought a tele- vision through Aaron’s. When it was paid off, we gave it to one of our grown daughters. When we paid off the second TV, we gave it to the other daughter. Now, it is time to keep one for ourselves. Honestly, I really don’t look at competitors because Aaron’s payment plan is so convenient and the selection is good.” 16 “ The population of Farmington is about 45,000, and we are the biggest town within a two-hour drive in any direction. Farmington is in the Four Corners region — about 45 minutes from where Utah, Arizona, New Mexico and Colorado meet. It is really a rural market, and we draw our customers from quite a distance — up to an hour and a half away. It is an hour to the Arizona border, for example, and we still can offer next-day or two-day delivery. The energy business is big here. There is a fair amount of oil and gas interests, coal mining and power plants. Most of the big energy companies have operations in this region. The economy is in good shape, and this store is still growing in its sixth year. I became general manager of this store about five years ago when the store had 1,056 customers. Now the customer count is over 2,275. Our customer base is 60% Native American. The largest Navaho reservation is about 30 miles away, but many of our Native American customers do not live on a reservation. Interestingly, many Native Americans operate on a cash basis and do not use the banking system. We do quite a bit of business under our 90 Day Same as Cash program. We compete with Rent-a-Center and several locally owned rental stores, but there are also two Wal-Mart stores in our region. We have been very successful in converting rent-to-own customers to our sales and lease ownership program by showing the price advantage. We actually compete with Wal-Mart, and our customers choose Aaron’s because they can spread out their product cost over three months with our 90 Day Same as Cash program.” — Kevin Woods, General Manager, Store FO284 17 Financial Contents Selected Financial Information . . 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations . . 20–28 Consolidated Balance Sheets . . . 29 Consolidated Statements of Earnings . . . . . . . . . . . . . . . . 30 Consolidated Statements of Shareholders’ Equity . . . . . . . . . 30 Consolidated Statements of Cash Flows . . . . . . . . . . . . . . 31 Notes to Consolidated Financial Statements . . . . . . 32–43 Management Report on Internal Control Over Financial Reporting . . . . . . . . . . 44 Reports of Independent Registered Public Accounting Firm . . . . . . . . . 44–45 is a mature industry with some cyclical characteristics but remains a solid generator of profits and cash flow. MacTavish Furniture Industries The Company operates seven furniture plants and five bedding facilities that manufacture custom-designed residential and office furniture. The ability to control quality, durability, styling and cost through our own manufacturing facilities is a competitive advantage. The MacTavish division supplies the majority of the Company’s upholstered furniture (such as sofas, sofa beds, chairs and modular sofa collections) and bedding needs. Aaron’s Community Outreach Program Aaron’s strives to be a good corporate citizen in our customers’ communities through sponsorships, volunteer efforts and charitable contributions. The Aaron’s Community Outreach Program (ACORP) empowers each store, based on achievement of performance goals, to earn money to donate to local charities selected by the associates of the store. Over the years, ACORP has supported a wide range of organizations including Boys and Girls Clubs, Toys for Tots, the Make-A-Wish Foundation and various hurricane relief efforts. Since 1999, ACORP has donated over $2.5 million to worthy causes in the communities served by Aaron’s stores, a tangible expression of the spirit of giving of Aaron’s associates. 18 Selected Financial Information (Dollar Amounts in Thousands, Except Per Share) OPERATING RESULTS Revenues: Rentals and Fees Retail Sales Non-Retail Sales Franchise Royalties and Fees 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 Earnings Per Share Year Ended December 31, 2007 Year Ended December 31, 2006 Year Ended December 31, 2005 Year Ended December 31, 2004 Year Ended December 31, 2003 $1,126,812 $ 992,791 $ 845,162 $694,293 $553,773 54,518 261,584 38,803 13,194 62,319 224,489 33,626 13,367 58,366 185,622 29,781 6,574 56,259 160,774 25,253 9,901 68,786 120,355 19,347 4,536 1,494,911 1,326,592 1,125,505 946,480 766,797 36,099 239,755 674,412 407,321 8,479 41,262 207,217 579,565 364,109 9,729 39,054 172,807 507,158 305,630 8,519 39,380 149,207 414,518 253,456 5,413 1,366,066 1,201,882 1,033,168 861,974 128,845 48,570 124,710 46,075 92,337 34,344 84,506 31,890 50,913 111,714 344,884 195,661 5,782 708,954 57,843 21,417 $ 80,275 $ 78,635 $ 57,993 $ 52,616 $ 36,426 $ 1.48 $ 1.50 $ 1.16 $ 1.06 $ .74 Earnings Per Share Assuming Dilution 1.46 1.47 1.14 1.04 .73 Dividends Per Share: Common Class A FINANCIAL POSITION Rental Merchandise, Net Property, Plant and Equipment, Net Total Assets Interest-Bearing Debt Shareholders’ Equity AT YEAR END Stores Open: Company-Operated Franchised $ .061 $ .057 $ .054 $ .039 $ .022 .061 .057 .054 .039 .022 $ 623,452 $ 612,149 $ 550,932 $425,567 $343,013 247,038 1,113,176 185,832 673,380 170,294 979,606 129,974 607,015 133,759 111,118 858,515 211,873 434,471 700,288 116,655 375,178 1,076 484 904 441 806 392 674 357 Rental Agreements in Effect 965,000 773,000 697,000 582,000 Number of Employees 9,600 8,400 7,600 6,400 99,584 559,884 79,570 320,186 560 287 464,800 5,400 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW Aaron Rents, Inc. is a leading specialty retailer of consumer electronics, computers, residential and office furniture, household appliances and accessories. Our major operating divisions are the Aaron’s Sales & Lease Ownership Division, the Aaron’s Office Furnishings Division, the Aaron’s Corporate Furnishings Division, and the MacTavish Furniture Industries Division, which manufactures and supplies the majority of the upholstered furniture and bedding leased and sold in our stores. Our sales and lease ownership division represents the fastest growing segment of our business, accounting for 91%, 90%, and 89% of our total revenues in 2007, 2006, and 2005 respectively. Aaron Rents has demonstrated strong revenue growth over the last three years. Total revenues have increased from $1.126 billion in 2005 to $1.495 billion in 2007, represent- ing a compound annual growth rate of 15.2%. Total revenues for the year ended December 31, 2007 were $1.495 billion, an increase of $168.3 million, or 12.7%, over the prior year. Most of our growth comes from the opening of new sales and lease ownership stores and increases in same store revenues from previously opened stores. We added 169 com- pany-operated sales and lease ownership stores in 2007. We spend on average approximately $600,000 in the first year of operation of a new store, which includes purchases of rental merchandise, investments in leasehold improvements and financing first year start-up costs. Our new sales and lease ownership stores typically achieve revenues of approximately $1.1 million in their third year of operation. Our comparable stores open more than three years normally achieve approxi- mately $1.4 million in unit revenues, which we believe represents a higher unit revenue volume than the typical rent-to-own store. Most of our stores are cash flow positive in the second year of operations following their opening. We 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 added a net 43 stores in 2007. We purchased 39 franchised stores during 2007. Franchise royalties and other related fees represent a growing source of high margin revenue for us, accounting for approximately $38.8 million of revenues in 2007, up from $29.8 million in 2005, representing a compounded annual growth rate of 14.1%. KEY COMPONENTS OF INCOME In this management’s discussion and analysis section, we review the Company’s consolidated results including the five components of our revenues (rentals and fees, retail sales, non-retail sales, franchise royalties and fees, and other rev- enues), costs of sales and expenses (of which depreciation of rental merchandise is a significant part). We also review the results of our sales and lease ownership and corporate furnishings divisions. 20 REVENUES. We separate our total revenues into five compo- nents: rentals and fees, retail sales, non-retail sales, franchise royalties and fees, and other revenues. Rentals and fees includes all revenues derived from rental agreements from our sales and lease ownership and corporate furnishings stores, including agreements that result in our customers acquiring ownership at the end of the term. Retail sales represent sales of both new and rental return merchandise from our sales and lease ownership and corporate furnish- ings stores. Non-retail sales mainly represent merchandise sales to our sales and lease ownership division franchisees. Franchise royalties and fees represent fees from the sale of franchise rights and royalty payments from franchisees, as well as other related income from our franchised stores. Other revenues include, at times, income from the sale of equity investments held in third parties, gains on asset dispositions and other miscellaneous revenues. COST OF SALES. We separate our cost of sales into two components: retail and non-retail. Retail cost of sales repre- sents 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 cus- tomers by our company-operated sales and lease ownership and corporate furnishings 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, 2007 and 2006, we had a revenue deferral representing cash collected in advance of being due or otherwise earned totaling $27.1 million and $24.1 million, respectively, and an accrued revenue receivable, net of allowance for doubtful accounts, based on historical collection rates of $5.3 million and $5.0 million, respectively. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt of the merchandise 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 merchan- dise over the agreement period, generally 12 to 24 months when rented, and 36 months when not rented, to 0% salvage value. Our corporate furnishings division depreciates mer- chandise 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 corporate furnishings 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. We record 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. The 2005 rental merchandise adjustments include write-offs of merchandise in the third quarter that resulted from losses associated with Hurricanes Katrina and Rita. These hurricane-related write-offs were $2.8 million, net of insurance proceeds. Rental merchandise adjustments totaled $30.0 million, $20.8 million, and $21.8 million for the years ended December 31, 2007, 2006, and 2005, 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 of lease incentives or allowances from landlords. The total amount of incentives and allowances received in 2007, 2006, and 2005 totaled $1.4 million, $1.5 million, and $1.5 million, respectively. Such amounts are recognized ratably over the lease term. From time to time, we close or consolidate stores. Our primary cost associated with closing or consolidating stores is the future lease payments and related commitments. We record an estimate of the future obligation related to closed or consolidated 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. For the years ended December 31, 2007 and 2006, our reserve for closed or consolidated stores was $1.3 million and $693,000, respectively. 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, 2006. 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 work- ers 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. Our workers compensation insurance claims and group health insurance balance was a prepaid expense of $5.6 million and $656,000 at December 31, 2007 and 2006, 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, 2007. 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, 2007. 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 different conditions occur in future periods. Same Store Revenues We believe the changes in same store revenues are a key performance indicator. The change in same store revenues is calculated by comparing revenues for the year to revenues for the prior year for all stores open for the entire 24-month period, excluding stores that received rental agreements from other acquired, closed, or merged stores. 21 RESULTS OF OPERATIONS Year Ended December 31, 2007 Versus Year Ended December 31, 2006 The following table shows key selected financial data for the years ended December 31, 2007 and 2006, and the changes in dollars and as a percentage to 2007 from 2006. (In Thousands) REVENUES: Rentals and Fees Retail Sales Non-Retail Sales Franchise Royalties and Fees 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 Year Ended December 31, 2007 Year Ended December 31, 2006 Increase/(Decrease) in Dollars to 2007 from 2006 % Increase/ (Decrease) to 2007 from 2006 $1,126,812 54,518 261,584 38,803 13,194 1,494,911 36,099 239,755 674,412 407,321 8,479 1,366,066 128,845 48,570 $ 80,275 $ 992,791 62,319 224,489 33,626 13,367 1,326,592 41,262 207,217 579,565 364,109 9,729 1,201,882 124,710 46,075 $ 78,635 $134,021 (7,801) 37,095 5,177 (173) 168,319 (5,163) 32,583 94,847 43,212 (1,250) 164,184 4,135 2,495 $ 1,640 13.5% (12.5) 16.5 15.4 (1.3) 12.7 (12.5) 15.7 16.4 11.9 (12.8) 13.7 3.3 5.4 2.1% Revenues The 12.7% increase in total revenues, to $1.495 billion in 2007 from $1.327 billion in 2006, was due mainly to a $134.0 million, or 13.5%, increase in rentals and fees rev- enues, plus a $37.1 million increase in non-retail sales. The $134.0 million increase in rentals and fees revenues was attributable to a $131.2 million increase from our sales and lease ownership division, which had a 3.8% increase in same store revenues during the 24 month period ended December 31, 2007 and added 266 company-operated stores since the beginning of 2006. Additionally, included in other revenues in 2007 was a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters and included in other revenues in 2006 was a $7.2 million gain from the sale of the assets of our 12 stores located in Puerto Rico and three additional stores located in the continental United States. The 12.5% decrease in revenues from retail sales, to $54.5 million in 2007 from $62.3 million in 2006, was due to a decrease of $4.1 million in the sales and lease ownership division and a decrease of $3.7 million in the corporate furnishings division. The decline in retail sales was primarily driven by a strategic decision to increase retail sales prices effective in the fourth quarter of 2006. Retail sales represent sales of both new and returned rental merchandise. The 16.5% increase in non-retail sales (which mainly repre- sents merchandise sold to our franchisees), to $261.6 million in 2007 from $224.5 million in 2006, was due to the growth of our franchise operations and our distribution network. The total number of franchised sales and lease ownership stores at December 31, 2007 was 484, reflecting a net addition of 92 stores since the beginning of 2006. The 15.4% increase in franchise royalties and fees, to $38.8 million in 2007 from $33.6 million in 2006, primarily reflects an increase in royalty income from franchisees, increasing 17.3% to $29.8 million in 2007 compared to $25.4 million in 2006. The increase is due primarily to the growth in the number of franchisees. The 1.3% decrease in other revenues, to $13.2 million in 2007 from $13.4 million in 2006, is primarily due to a decline in investment and interest income during the period. With respect to our major operating unit, revenues for our sales and lease ownership division increased 13.7%, to $1.366 billion for 2007 from $1.201 billion for 2006. This increase was attributable to the addition of stores and same store revenue growth described above. Cost of Sales Cost of sales from retail sales decreased 12.5% to $36.1 million in 2007 compared to $41.3 million in 2006, with 22 retail cost of sales as a percentage of retail sales remaining stable at 66.2% for both periods. Retail cost of sales as a percentage of retail sales in our sales and lease ownership division decreased to 54.0% in 2007 from 58.7% in 2006 as a result of the increase in retail sales prices mentioned above. This decrease in the sales and lease ownership division was offset by an increase in retail cost of sales as a percentage of retail sales in our corporate furnishings division, to 75.5% in 2007 from 72.2% in 2006. Cost of sales from non-retail sales increased 15.7%, to $239.8 million in 2007 from $207.2 million in 2006, and as a percentage of non-retail sales, decreased slightly to 91.7% from 92.3%. Expenses Operating expenses in 2007 increased $94.8 million to $674.4 million from $579.6 million in 2006, a 16.4% increase. As a percentage of total revenues, operating expenses were 45.1% in 2007 and 43.7% in 2006. Operating expenses increased as a percentage of total revenues in 2007 mainly due to the adding of 266 company-operated stores since the beginning of 2006. Depreciation of rental merchandise increased $43.2 million to $407.3 million in 2007 from $364.1 million during the comparable period in 2006, an 11.9% increase. As a percentage of total rentals and fees, depreciation of rental merchandise decreased slightly to 36.1% from 36.7% a year ago. Interest expense decreased to $8.5 million in 2007 compared with $9.7 million in 2006, a 12.8% decrease. The decrease in interest expense was primarily due to lower debt levels during the first half of 2007. Debt levels during the first half of 2007 were lower as a result of debt payments made with cash from operations. Income tax expense increased $2.5 million to $48.6 million in 2007 compared with $46.1 million in 2006, representing a 5.4% increase. Aaron Rents’ effective tax rate was 37.7% in 2007 compared with 36.9% in 2006. Net Earnings Net earnings increased $1.6 million to $80.3 million in 2007 compared with $78.6 million in 2006, representing a 2.1% increase. As a percentage of total revenues, net earnings were 5.4% and 5.9% in 2007 and 2006, respectively. The increase in net earnings was primarily the result of the maturing of new company-operated sales and lease owner- ship stores added over the past several years, contributing to a 3.8% increase in same store revenues, and a 15.4% increase in franchise royalties and fees. Additionally, included in other revenues in 2007 was a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters and included in other revenues in 2006 was a $7.2 million gain from the sale of the assets of our 12 stores located in Puerto Rico and three additional stores located in the continental United States. Year Ended December 31, 2006 Versus Year Ended December 31, 2005 The following table shows key selected financial data for the years ended December 31, 2006 and 2005, and the changes in dollars and as a percentage to 2006 from 2005. (In Thousands) REVENUES: Rentals and Fees Retail Sales Non-Retail Sales Franchise Royalties and Fees 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 Year Ended December 31, 2006 Year Ended December 31, 2005 Increase in Dollars to 2006 from 2005 % Increase to 2006 from 2005 $ 992,791 62,319 224,489 33,626 13,367 1,326,592 41,262 207,217 579,565 364,109 9,729 1,201,882 124,710 46,075 $ 78,635 $ 845,162 58,366 185,622 29,781 6,574 1,125,505 39,054 172,807 507,158 305,630 8,519 1,033,168 92,337 34,344 $ 57,993 $147,629 3,953 38,867 3,845 6,793 201,087 2,208 34,410 72,407 58,479 1,210 168,714 32,373 11,731 $ 20,642 17.5% 6.8 20.9 12.9 103.3 17.9 5.7 19.9 14.3 19.1 14.2 16.3 35.1 34.2 35.6% 23 Revenues The 17.9% increase in total revenues, to $1.327 billion in 2006 from $1.126 billion in 2005, was due mainly to a $147.6 million, or 17.5%, increase in rentals and fees rev- enues, plus a $38.9 million increase in non-retail sales. The $147.6 million increase in rentals and fees revenues was attributable to a $142.4 million increase from our sales and lease ownership division, which had a 7.2% increase in same store revenues during the 24 month period ended December 31, 2006 and added 229 company-operated stores since the beginning of 2005. The growth in our sales and lease owner- ship division was augmented by a $5.5 million increase in revenues in our corporate furnishings division. Additionally, included in other revenues in 2006 was a $7.2 million gain from the sale of the assets of our 12 stores located in Puerto Rico and three additional stores located in the continental United States. We received $16.0 million in cash proceeds and disposed of goodwill of $1.0 million in conjunction with these sales. The 6.8% increase in revenues from retail sales, to $62.3 million in 2006 from $58.4 million in 2005, was primarily due to an increase of $3.7 million in the sales and lease ownership division as a result of the increased demand and growing store base described above. Retail sales represent sales of both new and returned rental merchandise. The 20.9% increase in non-retail sales (which mainly repre- sents merchandise sold to our franchisees), to $224.5 million in 2006 from $185.6 million in 2005, was due to the growth of our franchise operations and our distribution network. The total number of franchised sales and lease ownership stores at December 31, 2006 was 441, reflecting a net addition of 84 stores since the beginning of 2005. The 12.9% increase in franchise royalties and fees, to $33.6 million in 2006 from $29.8 million in 2005, primarily reflects an increase in royalty income from franchisees, increasing 17.6% to $25.4 million in 2006 compared to $21.6 million in 2005. The increase in royalty income from franchisees was partially offset by decreased franchise and financing fee revenues. Revenues increased in this area pri- marily due to the previously mentioned growth of franchised stores and an increase in certain royalty rates. The 103.3% increase in other revenues, to $13.4 million in 2006 from $6.6 million in 2005, is primarily attributable to a $7.2 million gain from the sale of the assets of our 12 stores located in Puerto Rico and three additional stores in the continental United States. In addition, included in other income in 2005 is $934,000 of proceeds from business interruption insurance associated with the operations of hurricane-affected areas and a $565,000 gain on the sale of our holdings of Rent-Way, Inc. common stock. With respect to our major operating units, revenues for our sales and lease ownership division increased 19.5%, to $1.201 billion for 2006 from $1.005 billion for 2005. This increase was attributable to the addition of stores and same store revenue growth described above. The 4.7% increase in 24 corporate furnishings division revenues, to $123.0 million for 2006 from $117.5 million for 2005, is primarily the result of improving economic and business conditions. Cost of Sales Cost of sales from retail sales increased 5.7% to $41.3 million in 2006 compared to $39.1 million in 2005, with retail cost of sales as a percentage of retail sales remaining comparable between the periods. Cost of sales from non-retail sales increased 19.9%, to $207.2 million in 2006 from $172.8 million in 2005, and as a percentage of non-retail sales, decreased slightly to 92.3% from 93.1%. Expenses Operating expenses in 2006 increased $72.4 million to $579.6 million from $507.2 million in 2005, a 14.3% increase. As a percentage of total revenues, operating expenses were 43.7% in 2006 and 45.1% in 2005. Operating expenses decreased as a percentage of total revenues in 2006 mainly due to the maturing of new company-operated sales and lease ownership stores and the 7.2% increase in same store revenues previously mentioned. Additionally, operating expenses in 2005 included $2.5 million in expenses, net of $1.9 million of insurance recoveries, related to losses due to Hurricanes Katrina and Rita. Depreciation of rental merchandise increased $58.5 million to $364.1 million in 2006 from $305.6 million during the comparable period in 2005, a 19.1% increase. As a percentage of total rentals and fees, depreciation of rental merchandise increased to 36.7% from 36.2% from a year ago. The increase as a percentage of rentals and fees was primar- ily due to increased depreciation expense associated with an increase in 90 day same as cash sales and the early payout of lease ownership agreements in our sales and lease ownership division and, to a lesser extent, a greater percentage of our rentals and fees revenues coming from our sales and lease ownership division, which depreciates its rental merchandise at a faster rate than our corporate furnishings division. Interest expense increased to $9.7 million in 2006 compared with $8.5 million in 2005, a 14.2% increase. The increase in interest expense was primarily due to higher debt levels during part of 2006 and, to a lesser extent, higher interest rates in 2006. Debt levels at December 31, 2006 decreased significantly as a result of debt payments made with the proceeds of the Company’s 2006 stock offering. Income tax expense increased $11.7 million to $46.1 million in 2006 compared with $34.3 million in 2005, representing a 34.2% increase. Aaron Rents’ effective tax rate was 36.9% in 2006 compared with 37.2% in 2005. Net Earnings Net earnings increased $20.6 million to $78.6 million in 2006 compared with $58.0 million in 2005, representing a 35.6% increase. As a percentage of total revenues, net earnings were 5.9% and 5.2% in 2006 and 2005, respectively. The increase in net earnings was primarily the result of the maturing of new company-operated sales and lease owner- ship stores added over the past several years, contributing to a 7.2% increase in same store revenues, and a 12.9% increase in franchise royalties and fees. Additionally, included in other revenues in 2006 was a $7.2 million gain from the sale of the assets of our 12 stores located in Puerto Rico and three additional stores in the continental United States. Also included in the 2005 results are increased expenses and losses due to Hurricanes Katrina and Rita. Balance Sheet CASH. The Company’s cash balance decreased to $5.2 mil- lion at December 31, 2007 from $8.8 million at December 31, 2006. Fluctuations in our cash balances are the result of timing differences between when our stores deposit cash and when that cash is available for application against borrowings outstanding under our revolving credit facility. For additional information, refer to the “Liquidity and Capital Resources” section below. RENTAL MERCHANDISE. The increase of $11.3 million in rental merchandise, net of accumulated depreciation, to $623.5 million at December 31, 2007 from $612.1 million at December 31, 2006, is primarily the result of a net increase of 169 company-operated stores since December 31, 2006 and the continued revenue growth of existing company- operated stores. PROPERTY, PLANT AND EQUIPMENT. The increase of $76.7 million in property, plant and equipment, net of accumulated depreciation, to $247.0 million at December 31, 2007 from $170.3 million at December 31, 2006, is primarily the result of a net increase of 169 company-operated stores since December 31, 2006. GOODWILL. The $31.2 million increase in goodwill, to $143.3 million on December 31, 2007 from $112.0 million on December 31, 2006, is the result of a series of acquisi- tions of sales and lease ownership businesses. During 2007, the Company acquired a net of 51 stores. The aggregate purchase price for these asset acquisitions totaled $57.3 million, with the principal tangible assets acquired consisting of rental merchandise and certain fixtures and equipment. OTHER INTANGIBLES. The $1.4 million increase in other intangibles, to $4.8 million on December 31, 2007 from $3.4 million on December 31, 2006, is the result of acquisitions of sales and lease ownership businesses mentioned above, net of amortization of certain finite-life intangible assets. PREPAID EXPENSES AND OTHER ASSETS. Prepaid expenses and other assets increased $7.9 million to $37.3 million at December 31, 2007 from $29.4 million at December 31, 2006, primarily as a result of an increase in prepaid workers compensation insurance. ACCOUNTS PAYABLE AND ACCRUED EXPENSES. The increase of $20.0 million in accounts payable and accrued expenses, to $141.0 million at December 31, 2007 from $121.0 million at December 31, 2006, is primarily the result of an increase in current income taxes payable. DEFERRED INCOME TAXES PAYABLE. The decrease of $11.4 million in deferred income taxes payable to $82.3 mil- lion at December 31, 2007 from $93.7 million at December 31, 2006 is primarily the result of the slow down of rental merchandise inventory growth during 2007. CREDIT FACILITIES AND SENIOR NOTES. The $55.9 million increase in the amounts we owe under our credit facilities to $185.8 million on December 31, 2007 from $130.0 million on December 31, 2006, reflects net borrowings under our revolving credit facility during 2007 primarily to fund purchases of rental merchandise, acquisitions, and working capital. Additionally, we made a $10.0 million repayment on our senior unsecured notes in the third quarter of 2007. LIQUIDITY AND CAPITAL RESOURCES General Cash flows generated from operating activities for the years ended December 31, 2007 and 2006 were $109.2 million and $75.0 million, respectively. Our primary capital requirements consist of buying rental merchandise for both sales and lease ownership and corporate furnishings stores. As Aaron Rents continues to grow, the need for additional rental merchandise will continue to be our major capital requirement. Other capital requirements include purchases of property, plant and equipment and expenditures for acquisitions. These capital requirements historically have been financed through: • cash flow from operations; • bank credit; • trade credit with vendors; • proceeds from the sale of rental return merchandise; • private debt offerings; and • stock offerings. In May 2006, we completed an underwritten public offer- ing of 3.45 million newly-issued shares of our common stock for net proceeds, after the underwriting discount and expenses, of approximately $84.0 million. We used the pro- ceeds to repay borrowings under our revolving credit facility. The Company’s Chairman, Chief Executive Officer and con- trolling shareholder sold an additional 1,150,000 shares in the offering. At December 31, 2007, $82.9 million was outstanding under our revolving credit agreement. The credit facilities balance increased by $67.3 million in 2007 primarily as a result of net borrowings made under our credit facility during the period. We renegotiated our revolving credit agreement 25 on February 27, 2006, extending the life of the agreement until May 28, 2008 and increasing the total available credit to $140.0 million. We have $20.0 million currently outstanding in aggregate principal amount of 6.88% senior unsecured notes due August 2009, the first principal repayments of which were due and paid in 2005 in the aggregate amount of $10.0 million, with annual $10.0 million repayments due until August 2009. Additionally, we have $60.0 million cur- rently outstanding in aggregate principal amount of 5.03% senior unsecured notes due July 2012, principal repayments of which are first required in 2008. Our revolving credit agreement and senior unsecured notes, and our franchisee loan program discussed below, contain certain financial covenants. These covenants include requirements that we maintain ratios of: (1) EBITDA plus lease expense to fixed charges of no less than 2:1; (2) total debt to EBITDA of no greater than 3:1; and (3) total debt to total capitalization of no greater than 0.6:1. EBITDA in each case, means consolidated net income before interest and tax expense, depreciation (other than rental merchandise depreciation) and amortization expense, and other non- cash charges. The Company is also required to maintain a minimum amount of shareholder’s equity. See the full text of the covenants themselves in our credit and guarantee agreements, which we have previously filed as exhibits to our Securities and Exchange Commission reports, for the details of these covenants and other terms. If we fail to comply with these covenants, we will be in default under these agreements, and all amounts would become due immediately. We were in compliance with all of these covenants at December 31, 2007 and believe that we will continue to be in compliance in the future. On February 27, 2007, we amended the franchise loan facility and guaranty to increase the maximum commitment amount from $115.0 million to $125.0 million. Purchases of sales and lease ownership stores had a posi- tive impact on operating cash flows in each period presented. The positive impact on operating cash flows from purchasing stores occurs as the result of rental merchandise acquired in these purchases being treated as an investing cash outflow rather than as an operating cash flow as occurs with our normal rental merchandise purchases. As such, the operating cash flows attributable to the newly purchased stores usually have an initial positive effect on operating cash flows that may not be indicative of the extent of their contributions in future periods. The amount of rental merchandise purchased in these acquisitions and shown under investing activities was $20.4 million in 2007, $13.3 million in 2006 and $16.8 million in 2005. We purchase our common shares in the market from time to time as authorized by our board of directors. As of December 31, 2007, Aaron Rents was authorized by its board of directors to purchase up to 4,307,958 common shares under approved resolutions. We repurchased 692,042 shares during the fourth quarter of 2007. 26 We have a consistent history of paying dividends, having paid dividends for 20 consecutive years. A $.014 per share dividend on Common Stock and Class A Common Stock was paid in January 2006, April 2006, and July 2006. Our board of directors increased the dividend for the third quarter of 2006 to $.015 per share from the previous quarterly dividend of $.014 per share. The payment for the third quarter of 2006 was distributed in October 2006 for a total fiscal year cash outlay of $2.9 million. A $.015 per share dividend on Common Stock and Class A Common Stock was paid in January 2007, April 2007, July 2007, and October 2007 for a total cash outlay of $3.2 million in 2007. Our board of directors increased the dividend 6.7% for the fourth quarter of 2007 on November 15, 2007 to $.016 per share from the previous quarterly dividend of $.015 per share. The payment for the fourth quarter was paid in January 2008. Subject to sufficient operating profits, any future capital needs and other contingencies, we currently expect to continue our policy of paying dividends. If we achieve our expected level of growth in our opera- tions, we anticipate we will supplement our expected cash flows from operations, existing credit facilities, vendor credit, and proceeds from the sale of rental return merchan- dise by expanding our existing credit facilities, by securing additional debt financing, or by seeking other sources of capital to ensure we will be able to fund our capital and liquidity needs for at least the next 24 months. We believe we can secure these additional sources of capital in the ordinary course of business. COMMITMENTS INCOME TAXES. During 2007, we made $50.9 million in income tax payments. During 2008, we anticipate that we will make cash payments for income taxes approximating $19 million. The Company has benefited in the past from the additional first-year or “bonus” depreciation allowance under U.S. federal income tax law related to its operations in the Gulf Opportunities Zone. The Company will also benefit from the Economic Stimulus Act of 2008 as bonus depreciation will be available on its assets nationwide and tax payments will be reduced for one year. In future years we anticipate having to make increased tax payments on our income as a result of expected profitability and the reversal of the accelerated depreciation deductions that were taken in prior periods. LEASES. We lease warehouse and retail store space for substantially all of our operations under operating leases expiring at various times through 2027. 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 trans- portation 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. We have 22 capital leases, 21 of which are with a limited liability company (“LLC”) whose managers and owners are 13 Aaron Rents’ executive officers and its controlling shareholder, with no individual, including the controlling shareholder, owning more than 11.76% of the LLC. Eleven of these related party leases relate to properties purchased from Aaron Rents in October and November 2004 by the LLC for a total purchase price of $6.8 million. This LLC is leasing back these properties to Aaron Rents for a 15-year term, with a five-year renewal at Aaron Rents’ option, at an aggregate annual rental of $883,000. Another ten of these related party leases relate to properties purchased from Aaron Rents in December 2002 by the LLC for a total purchase price of approximately $5.0 million. This LLC is leasing back these properties to Aaron Rents for a 15-year term at an aggregate annual rental of $572,000. During 2006, a property sold by Aaron Rents to a second LLC controlled by the Company’s major shareholder for $6.3 million in April 2002 and leased back to Aaron Rents for a 15-year term at an annual rental of $681,000 was sold to an unrelated third party. We entered into a new capital lease with the unrelated third party. No gain or loss was recog- nized on this transaction. We finance a portion of our store expansion through sale-leaseback transactions. The properties are generally sold at net book value and the resulting leases qualify and are accounted for as operating leases. We do not have any retained or contingent interests in the stores nor do we pro- vide any guarantees, other than a corporate level guarantee of lease payments, in connection with the sale-leasebacks. The operating leases that resulted from these transactions are included in the table below. FRANCHISE LOAN GUARANTY. We have guaranteed the borrowings of certain independent franchisees under a fran- chise loan program with several banks and we also guarantee franchisee borrowings under certain other debt facilities. At December 31, 2007, the portion that the Company might be obligated to repay in the event franchisees defaulted was $108.6 million. Of this amount, approximately $77.4 million represents franchisee borrowings outstanding under the franchisee loan program and approximately $31.2 million represents franchisee borrowings that we guarantee under other debt facilities. 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 in 1994, we have had no significant losses associated with the franchisee loan and guaranty program. The Company believes the likelihood of any significant amounts being funded in connection with these commitments to be remote. We have no long-term commitments to purchase mer chandise. See Note F to the Consolidated Financial Statements for further information. The following table shows our approximate contractual obligations, including interest, and commitments to make future payments as of December 31, 2007: (In Thousands) Total Period Less Than 1 Year Period 2–3 Years Period 4–5 Years Period Over 5 Years Credit Facilities, Excluding Capital Leases $166,926 $105,610 $ 34,012 $24,003 $ 3,301 Capital Leases Operating Leases 18,906 337,955 1,091 83,831 2,421 111,505 2,786 48,305 12,608 94,314 Total Contractual Cash Obligations $523,787 $190,532 $147,938 $75,094 $110,223 The following table shows the Company’s approximate commercial commitments as of December 31, 2007: (In Thousands) Total Period Less Than 1 Year Period 2–3 Years Period 4–5 Years Period Over 5 Years Guaranteed Borrowings of Franchisees $108,632 $108,632 $ — $ — $ — 27 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 aggre- gate 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. MARKET RISK From time-to-time, we manage our exposure to changes in short-term interest rates, particularly to reduce the impact on floating-rate borrowings, by entering into interest rate swap agreements. 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 minimize the risk of counterparty default. At December 31, 2007 and 2006 we did not have any swap agreements. We do not use any market risk sensitive instruments to hedge commodity, foreign currency, or risks other than inter- est rate risk, and hold no market risk sensitive instruments for trading or speculative purposes. RECENT ACCOUNTING PRONOUNCEMENTS In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 establishes a frame- work for measuring the fair value of assets and liabilities which is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards which permit, or in some cases require, estimates of fair value market value. SFAS 157 also expands financial statement disclosure requirements about the use of fair value measurements, including the effect of such measures on earnings. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. However, on December 14, 2007, the FASB issued FASB Staff Position FAS 157-b, which deferred the effective date of SFAS 157 for one year, as it relates to nonfinancial assets and liabilities. We will adopt SFAS 157 as it relates to financial assets and liabilities beginning in the first quarter of fiscal 2008. We are currently evaluating the impact of this Statement on our financial statements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of SFAS No. 115 (“SFAS 159”). SFAS 159 permits an entity to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of this Statement on our financial statements. In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141R will change the accounting treatment for certain specific acquisition related items including: expensing acquisition related costs as incurred, valuing noncontrolling interests at fair value at the acquisition date and expensing restructuring costs associated with an acquired business. SFAS 141R also includes a substantial number of new disclosure require- ments. SFAS 141R is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We are currently evaluating the impact of this Statement on our financial statements. 28 Consolidated Balance Sheets (In Thousands, Except Share Data) ASSETS Cash Accounts Receivable (net of allowances of $4,014 in 2007 and $3,037 in 2006) Rental Merchandise Less: Accumulated Depreciation Property, Plant and Equipment, Net Goodwill, Net Other Intangibles, Net Prepaid Expenses and Other Assets Total Assets LIABILITIES AND SHAREHOLDERS’ EQUITY Accounts Payable and Accrued Expenses Dividends Payable Deferred Income Taxes Payable Customer Deposits and Advance Payments Credit Facilities Total Liabilities Commitments and Contingencies Shareholders’ Equity: Common Stock, Par Value $.50 Per Share; Authorized: 100,000,000 Shares; Shares Issued: 48,439,602 at December 31, 2007 and 2006 Class A Common Stock, Par Value $.50 Per Share; Authorized: 25,000,000 Shares; Shares Issued: 12,063,856 at December 31, 2007 and 2006 Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Less: Treasury Shares at Cost, Common Stock, 3,147,360 and 2,696,781 Shares at December 31, 2007 and 2006, respectively Class A Common Stock, 3,748,860 and 3,667,623 Shares at December 31, 2007 and 2006, respectively Total Shareholders’ Equity Total Liabilities and Shareholders’ Equity The accompanying notes are an integral part of the Consolidated Financial Statements. December 31, 2007 December 31, 2006 $ 5,249 $ 8,807 52,025 993,423 (369,971) 623,452 247,038 143,282 4,814 37,316 43,495 925,534 (313,385) 612,149 170,294 112,047 3,389 29,425 $1,113,176 $979,606 $ 141,030 $121,018 869 82,293 29,772 185,832 439,796 811 93,687 27,101 129,974 372,591 24,220 24,220 6,032 188,575 499,109 (82) 717,854 6,032 183,966 424,991 — 639,209 (26,946) (16,290) (17,528) 673,380 (15,904) 607,015 $1,113,176 $979,606 29 Consolidated Statements of Earnings (In Thousands, Except Per Share) REVENUES Rentals and Fees Retail Sales Non-Retail Sales Franchise Royalties and Fees 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 Earnings Per Share Earnings Per Share Assuming Dilution Year Ended December 31, 2007 Year Ended December 31, 2006 Year Ended December 31, 2005 $1,126,812 54,518 261,584 38,803 13,194 1,494,911 36,099 239,755 674,412 407,321 8,479 1,366,066 128,845 48,570 $ 80,275 $ 1.48 1.46 $ 992,791 62,319 224,489 33,626 13,367 1,326,592 41,262 207,217 579,565 364,109 9,729 1,201,882 124,710 46,075 $ 78,635 $ 1.50 1.47 $ 845,162 58,366 185,622 29,781 6,574 1,125,505 39,054 172,807 507,158 305,630 8,519 1,033,168 92,337 34,344 $ 57,993 $ 1.16 1.14 The accompanying notes are an integral part of the Consolidated Financial Statements. Consolidated Statements of Shareholders’ Equity (In Thousands, Except Per Share) Treasury Stock Common Stock Shares Amount Common Class A Additional Paid-In Capital Accumulated Other Comprehensive (Loss) Income Derivatives Retained Comprehensive Designated Marketable As Hedges Securities Earnings Income BALANCE, JANUARY 1, 2005 Dividends, $.054 per share Reissued Shares Net Earnings Change in Fair Value of Financial Instruments, Net of Income Taxes of $284 Comprehensive Income (7,293) 267 (7,026) ($37,919) $22,495 $6,032 $ 91,032 $294,077 $ — ($279) ($260) 1,648 1,820 (2,693) 57,993 57,993 (36,271) 22,495 6,032 92,852 349,377 (3,021) 525 58,518 279 246 — (14) BALANCE, DECEMBER 31, 2005 Dividends, $.057 per share Stock-Based Compensation Reissued Shares Stock Offering Net Earnings Change in Fair Value of Financial Instruments, Net of Income Taxes of $8 Comprehensive Income BALANCE, DECEMBER 31, 2006 Reacquired Shares Dividends, $.061 per share Stock-Based Compensation Reissued Shares Net Earnings FIN 48 Adjustment Foreign Currency Translation Adjustment, Net of Income Taxes of $2 Change in Fair Value of Financial Instruments, Net of Income Taxes of $46 Comprehensive Income 662 4,077 1,725 3,671 5,169 82,274 78,635 78,635 14 78,649 (32,194) 24,220 (13,401) 6,032 183,966 424,991 — (6,364) (692) 160 1,121 (3,307) 3,067 1,542 80,275 (2,850) 80,275 6 (88) $80,193 14 — (88) BALANCE, DECEMBER 31, 2007 (6,896) ($44,474) $24,220 $6,032 $188,575 $499,109 $ — ($ 88) The accompanying notes are an integral part of the Consolidated Financial Statements. 30 Consolidated Statements of Cash Flows Cash Provided by (Used by) Operating Activities 109,165 74,961 (In Thousands) OPERATING ACTIVITIES: Net Earnings Depreciation of Rental Merchandise Other Depreciation and Amortization Additions to Rental Merchandise Book Value of Rental Merchandise Sold or Disposed Change in Deferred Income Taxes Gain on Marketable Securities (Gain) Loss on Sale of Property, Plant and Equipment Gain on Asset Dispositions Change in Income Tax Receivable, Prepaid Expenses and Other Assets Change in Accounts Payable and Accrued Expenses Change in Accounts Receivable Excess Tax Benefits from Stock-Based Compensation Change in Other Assets Change in Customer Deposits Stock-Based Compensation Other Changes, Net INVESTING ACTIVITIES: Additions to Property, Plant and Equipment Contracts and Other Assets Acquired Proceeds from Sale of Marketable Securities Proceeds from Asset Dispositions Proceeds from Sale of Property, Plant and Equipment Cash Used by Investing Activities FINANCING ACTIVITIES: Proceeds from Sale of Senior Notes Proceeds from Credit Facilities Repayments on Credit Facilities Proceeds from Stock Offering Dividends Paid Excess Tax Benefits from Stock-Based Compensation Acquisition of Treasury Stock Issuance of Stock Under Stock Option Plans Cash Provided by Financing Activities (Decrease) Increase in Cash Cash at Beginning of Year Cash at End of Year Cash Paid During the Year: Interest Income Taxes The accompanying notes are an integral part of the Consolidated Financial Statements. Year Ended December 31, 2007 Year Ended December 31, 2006 Year Ended December 31, 2005 $ 80,275 $ 78,635 $ 57,993 407,321 37,553 (706,674) 304,994 (11,394) — (4,685) (2,919) — 19,904 (8,530) (789) (8,430) 2,671 2,800 (2,932) 364,109 31,472 (681,716) 263,092 18,490 — 128 (7,246) (805) 8,381 (683) (3,855) (6,617) 3,643 3,671 4,262 (141,518) (57,323) — 6,851 36,340 (155,650) — 513,838 (457,980) — (3,249) 789 (13,401) 2,930 42,927 (3,558) 8,807 (92,293) (32,397) — 16,005 28,092 (80,593) — 302,587 (384,814) 83,999 (2,909) 3,855 — 4,748 7,466 1,834 6,973 305,630 27,501 (647,657) 233,861 (20,261) (579) 148 — 18,553 17,025 (10,076) — 5,864 4,388 — 1,123 (6,487) (60,453) (47,907) 6,993 1,182 13,004 (87,181) 60,000 450,854 (415,636) — (2,641) — — 2,199 94,776 1,108 5,865 $ 5,249 $ 8,807 $ 6,973 $ 8,548 $ 10,000 $ 8,395 50,931 14,273 51,228 31 Notes to Consolidated Financial Statements NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES As of December 31, 2007 and 2006, and for the Years Ended December 31, 2007, 2006 and 2005. BASIS OF PRESENTATION — The consolidated financial statements include the accounts of Aaron Rents, Inc. and its wholly owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated. The preparation of the Company’s consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make esti- mates 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. In May 2006, the Company completed an underwritten public offering of 3.45 million newly-issued shares of com- mon stock for net proceeds, after the underwriting discount and expenses, of approximately $84.0 million. The Company used the proceeds to repay borrowings under the revolving credit facility. The Company’s Chairman, Chief Executive Officer and controlling shareholder sold an additional 1,150,000 shares in the offering. Certain reclassifications have been made to the prior periods to conform to the current period presentation. In 2006 and 2005 cash flow presentations, $3.2 million and $996,000, respectively, of construction in progress has been reclassified to additions of property, plant and equipment from proceeds from sale of property, plant and equipment. LINE OF BUSINESS — The Company is engaged in the busi- ness of renting and selling residential and office furniture, consumer electronics, appliances, computers, and other merchandise throughout the U.S. and Canada. The Company manufactures furniture principally for its sales and lease ownership and corporate furnishings operations. RENTAL MERCHANDISE — The Company’s rental merchan- dise consists primarily of residential and office furniture, consumer electronics, appliances, computers, and other mer- chandise and is recorded at cost, which includes overhead from production facilities, shipping costs and warehousing costs. 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 corporate furnishings division depreciates merchandise over its estimated useful life, which ranges from six months to 60 months, net of its salvage value, which ranges from 0% to 60% of historical cost. The Company’s policies require weekly rental merchan- dise counts by store managers, which include write-offs for 32 unsalable, damaged, or missing merchandise inventories. Full physical inventories are generally taken at the fulfillment and manufacturing facilities on a quarterly basis, and appropriate provisions are made for missing, damaged and unsalable merchandise. In addition, the Company monitors 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, all damaged, lost or unsalable merchandise identified is written off. The Company records rental merchandise adjustments on the allowance method. The 2005 rental merchandise adjustments include write-offs of merchandise in the third quarter that resulted from losses associated with Hurricanes Katrina and Rita. These hurricane- related write-offs were $2.8 million, net of insurance pro- ceeds. Rental merchandise write-offs totaled $30.0 million, $20.8 million, and $21.8 million during the years ended December 31, 2007, 2006, and 2005, respectively, and are included in operating expenses in the accompanying consolidated statements of earnings. PROPERTY, PLANT AND EQUIPMENT — The Company records property, plant and equipment at cost. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the respective assets, which are from eight to 40 years for buildings and improvements and from one to five 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 accompanying consolidated statements of earnings, for property, plant and equipment was $35.1 million, $29.1 million, and $25.6 million during the years ended December 31, 2007, 2006, and 2005, respectively. GOODWILL AND OTHER INTANGIBLES — Goodwill represents the excess of the purchase price paid over the fair value of the net tangible and identifiable intangible assets acquired in connection with business acquisitions. The Company has elected to perform its annual impairment evaluation as of September 30. Based on the evaluation, there was no impairment. More frequent evaluations are completed if indicators of impairment become evident. Other intangibles represent the value of customer relationships acquired in connection with business acquisitions as well as acquired franchise development rights, recorded at fair value as determined by the Company. As of December 31, 2007 and 2006, the net intangibles other than goodwill were $4.8 million and $3.4 million, respectively. The customer relationship intangible is amortized on a straight-line basis over a two-year useful life while acquired franchise develop- ment rights are amortized over the unexpired life of the franchisee’s ten year area development agreement. Amortization expense on intangibles, included in operating expenses in the accompanying consolidated statements of earnings, was $2.5 million, $2.4 million, and $2.0 million during the years ended December 31, 2007, 2006, and 2005, respectively. 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 remaining 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 corresponding charge to earnings. Impairment losses, if any, are measured based upon the difference between the carrying amount and the fair value of the assets. There were no impairments of long-lived assets for the year ended December 31, 2007. DEFERRED INCOME TAXES — These represent primarily 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 — At December 31, 2007 and 2006, the fair market value of fixed rate long- term debt was $80.4 million and $88.9 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 revenue. Until all payments are received under sales and lease ownership agreements, the Company maintains ownership of the rental merchandise. Revenues from the sale of merchandise to franchisees are recognized at the time of receipt of the merchandise by the franchisee, and 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. Refer to Note I for discus- sion of recognition of other franchise-related revenues. The Company presents sales net of sales taxes. COST OF SALES — Included in cost of sales is 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 corporate furnishings division. It is not practicable to allocate operating expenses between selling and rental operations. SHIPPING AND HANDLING COSTS — The Company classifies shipping and handling costs as operating expenses in the accompanying consolidated statements of earnings and these costs totaled $53.1 million in 2007, $45.0 million in 2006, and $40.5 million in 2005. ADVERTISING — The Company expenses advertising costs as incurred. Advertising costs are recorded as expenses the first time an advertisement appears. Such costs aggregated to $32.2 million in 2007, $28.3 million in 2006, and $27.1 million in 2005. These advertising expenses are shown net of cooperative advertising considerations received from vendors, substantially all of which represents reimbursement of specific, identifiable, and incremental costs incurred in selling those vendors’ products. The amounts of cooperative advertising consideration netted against advertising expense were $20.1 million in 2007, $18.3 million in 2006 and $16.9 million in 2005. The prepaid advertising asset was $2.4 million and $2.0 million at December 31, 2007 and 2006, respectively. STOCK-BASED COMPENSATION — The Company has stock- based employee compensation plans, which are more fully described in Note H below. Prior to January 1, 2006, the Company accounted for awards granted under those plans following the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB SFAS No. 123(R), Share-Based Payments (“SFAS 123R”), using the modified prospective application method. Under this transition method, compensation expense recognized in the year ended December 31, 2006 includes the applicable amounts of compensation expense of all stock-based payments granted prior to, but not yet vested, as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock- Based Compensation (“SFAS 123”), and previously presented in the pro forma footnote disclosures. The Company has in the past granted 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, recognized no compensation expense for these stock option grants. The Company also has granted 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 $1.5 million, $5.2 million, and $1.9 million in 2007, 2006, and 2005, respectively. The Company amended the Key Executive grants in 2006 and raised the exercise price of each of the stock options to the fair market value of the common stock on the original grant date, adjusted for a 3-for-2 stock dividend that occurred on August 2, 2004 in the case of those stock options with an original grant date that preceded the stock dividend date. The amendment also provides that, in order to compensate the grantees for the increase in the exercise price of the stock options, the full original discounted amount will be paid in cash on the applicable 2007 vesting date. Under the modified prospective application method, results for prior periods have not been restated to reflect the effects of implementing SFAS 123R. For purposes of pro forma disclosures under SFAS 123 as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement 123, the 33 Notes to Consolidated Financial Statements estimated fair value of the options is amortized to expense over the options’ vesting period. The following table illus- trates the effect on net earnings and earnings per share if the fair value based method had been applied to all outstanding and unvested awards for the following period: (In Thousands, Except Per Share) Net Earnings before effect of Key Executive grants Expense effect of Key Executive grants recognized Net earnings as reported Stock-based Employee Compensation Cost, Net of Tax — Pro Forma Pro forma net earnings Earnings per share: Basic — as reported Basic — pro forma Diluted — as reported Diluted — pro forma Year Ended December 31, 2005 $58,522 (529) 57,993 (1,996) $55,997 $ 1.16 $ 1.12 $ 1.14 $ 1.10 INSURANCE RESERVES — Estimated insurance reserves are accrued primarily for group health and workers com- pensation 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. COMPREHENSIVE INCOME — For the years ended December 31, 2007, 2006 and 2005, comprehensive income totaled $80.2 million, $78.6 million, and $58.5 million, respectively. FOREIGN CURRENCY TRANSLATION — Assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the current rate of exchange on the last day of the reporting period. Revenues and expenses are generally trans- lated at a daily exchange rate and equity transactions are translated using the actual rate on the day of the transaction. NEW ACCOUNTING PRONOUNCEMENTS — In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 establishes a frame- work for measuring the fair value of assets and liabilities which is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards which permit, or in some cases require, estimates of fair value market value. SFAS 157 also expands financial statement disclosure requirements about the use of fair value measurements, including the effect of such measures on earnings. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 34 15, 2007, and interim periods within those years. However, on December 14, 2007, the FASB issued FASB Staff Position FAS 157-b, which deferred the effective date of SFAS 157 for one year, as it relates to nonfinancial assets and liabilities. The Company will adopt SFAS 157 as it relates to financial assets and liabilities beginning in the first quarter of fiscal 2008. The Company is currently evaluating the impact of this Statement on its financial statements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of SFAS No. 115 (“SFAS 159”). SFAS 159 permits an entity to choose to measure many financial instruments and certain other items at fair value. SFAS is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this Statement on its financial statements. In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141R will change the accounting treatment for certain specific acquisition related items including expensing acquisition related costs as incurred, valuing noncontrolling interests at fair value at the acquisition date and expensing restructuring costs associated with an acquired business. SFAS 141R also includes a substantial number of new disclosure require- ments. SFAS 141R is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The Company is currently evaluating the impact of this Statement on its financial statements. NOTE B: EARNINGS PER SHARE Earnings per share is computed by dividing net income by the weighted average number of Common Stock and Class A Common Stock outstanding during the year, which were approximately 54,163,000 shares in 2007, 52,545,000 shares in 2006, and 49,846,000 shares in 2005. 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 809,000 in 2007, 832,000 in 2006 and 959,000 in 2005. The Company has a restricted share plan in which shares are issuable upon satisfaction of certain performance conditions. As of December 31, 2007, only a portion of the performance conditions have been met and therefore only a portion of these shares have been included in the computa- tion of diluted earnings per share. The effect of restricted stock increased weighted average shares outstanding by 110,000 in 2007. NOTE C: PROPERTY, PLANT AND EQUIPMENT Following is a summary of the Company’s property, plant, and equipment at December 31: (In Thousands) Land 2007 2006 $ 50,176 $ 26,195 Buildings and Improvements Leasehold Improvements and Signs Fixtures and Equipment Assets Under Capital Lease: with Related Parties with Unrelated Parties Construction in Progress 96,804 89,476 66,311 9,332 10,564 19,042 57,373 79,543 54,148 9,534 10,564 10,719 Less: Accumulated Depreciation and Amortization 341,705 248,076 (94,667) (77,782) $247,038 $170,294 NOTE D: CREDIT FACILITIES Following is a summary of the Company’s credit facilities at December 31: (In Thousands) Bank Debt 2007 2006 $ 82,884 $ 15,612 Senior Unsecured Notes 80,000 90,000 Capital Lease Obligation: with Related Parties with Unrelated Parties Other Debt 9,542 9,364 4,042 10,095 10,022 4,245 $185,832 $129,974 BANK DEBT — The Company has a revolving credit agree- ment with several banks providing for unsecured borrowings up to $140.0 million. Amounts borrowed bear interest at the lower of the lender’s prime rate or LIBOR plus 87.5 basis points. The pricing under a working capital line is based upon overnight bank borrowing rates. At December 31, 2007 and 2006, respectively, an aggregate of $82.9 million (bearing interest at 5.83%) and $15.6 million (bearing interest at 6.22%) 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 was 5.99% in 2007, 5.97% in 2006, and 4.42% in 2005. The revolving credit agreement expires May 28, 2008. The revolving credit agreement contains financial covenants which, among other things, forbid the Company from exceeding certain debt to equity levels and require the maintenance of minimum fixed charge coverage ratios. If the Company fails to comply with these covenants, the Company will be in default under these agreements, and all amounts would become due immediately. At December 31, 2007, $122.7 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 in a private placement to a con- sortium of insurance companies. The unsecured notes bear interest at a rate of 6.88% per year and 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. The notes were amended in July 2005 as a result of entry into a note purchase agreement for an additional $60.0 million in senior unsecured notes to the purchasers in a private placement. The agreement was amended for the purpose of permitting the new issuance of the notes and amending the negative covenants in the revolving credit agreement. On July 27, 2005, the Company entered into a note purchase agreement with a consortium of insurance companies. Pursuant to this agreement, the Company and its two subsidiaries as co-obligors issued $60.0 million in senior unsecured notes to the purchasers in a private place- ment. The notes bear interest at a rate of 5.03% per year and mature on July 27, 2012. Interest only payments are due quarterly for the first two years, followed by annual $12 million principal repayments plus interest for the five years thereafter. The $50.0 million note purchase agreement, of which $20.0 million is outstanding as of December 31, 2007, contains financial maintenance covenants, negative covenants regarding the Company’s other indebtedness, its guarantees and investments, and other customary covenants substantially similar to the covenants in the Company’s, revolving credit facility, other note purchase agreement, and its former construction and lease facility, as modified by the amendments described herein. CAPITAL LEASES WITH RELATED PARTIES — In October and November 2004, the Company sold eleven properties, including leasehold improvements, to a limited liability com- pany (“LLC”) controlled by a group of Company executives, including the Company’s Chairman, Chief Executive Officer, and controlling shareholder. The LLC obtained borrowings collateralized by the land and buildings totaling $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 $883,000. 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 9.7%. Accordingly, the land and buildings, associated depreciation expense, and lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction. 35 Notes to Consolidated Financial Statements In December 2002, the Company sold ten properties, including leasehold improvements, to the LLC. The LLC obtained borrowings collateralized by the land and buildings totaling $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 approximately $572,000. The transaction has been accounted for as a financing in the accompanying consolidated financial state- ments. The rate of interest implicit in the leases is approxi- mately 11.1%. Accordingly, the land and buildings, associated depreciation expense, and lease obligations are recorded in the Company’s consolidated financial statements. No gain or loss was recognized in this transaction. During 2006, a property sold by Aaron Rents to a second LLC controlled by the Company’s major shareholder for $6.3 million in April 2002 and leased back to Aaron Rents for a 15-year term at an annual rental of $681,000 was sold to an unrelated third party. The Company entered into a new capital lease with the unrelated third party. No gain or loss was recognized on this transaction. LEASES — The Company finances a portion of store expan- sion through sale-leaseback transactions. The properties are generally sold at net book value and the resulting leases qualify and are accounted for as operating leases. The Company does not have any retained or contingent interests in the stores nor does the Company provide any guarantees, other than a corporate level guarantee of lease payments, in connection with the sale-leasebacks. OTHER DEBT — Other debt at December 31, 2007 and 2006 includes $3.3 million of industrial development corporation revenue bonds. The average weighted borrowing rate on these bonds in 2007 was 3.79%. No principal payments are due on the bonds until maturity in 2015. Future maturities under the Company’s Credit Facilities $106,701 23,170 13,263 13,419 13,370 15,909 are as follows: (In Thousands) 2008 2009 2010 2011 2012 Thereafter 36 NOTE E: INCOME TAXES Following is a summary of the Company’s income tax expense for the years ended December 31: (In Thousands) 2007 2006 2005 Current Income Tax Expense (Benefit): Federal State Deferred Income Tax (Benefit) Expense: Federal State $53,582 $25,453 $50,064 6,382 2,132 4,541 59,964 27,585 54,605 (10,214) 16,524 (17,751) (1,180) 1,966 (2,510) (11,394) 18,490 (20,261) $48,570 $46,075 $34,344 Significant components of the Company’s deferred income tax liabilities and assets at December 31 are as follows: (In Thousands) 2007 2006 Deferred Tax Liabilities: Rental Merchandise and Property, Plant and Equipment $ 91,823 $ 99,813 Other, Net Total Deferred Tax Liabilities 11,625 103,448 10,273 110,086 Deferred Tax Assets: Accrued Liabilities Advance Payments Other, Net Total Deferred Tax Assets 6,586 10,615 3,954 21,155 5,053 8,959 2,387 16,399 Net Deferred Tax Liabilities $ 82,293 $ 93,687 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 35.0% 35.0% 35.0% 2007 2006 2005 Increases in U.S. Federal Taxes Resulting From: State Income Taxes, Net of Federal Income Tax Benefit Other, Net Effective Tax Rate 2.6 .1 2.1 (.2) 2.2 — 37.7% 36.9% 37.2% The Company files a federal consolidated income tax return in the United States and the separate legal entities file in various states and foreign jurisdictions. With few excep- tions, the Company is no longer subject to federal, state and local tax examinations by tax authorities for years before 2004 or subject to non-United States income tax examina- tions for the years ended prior to 2002. The Company does not anticipate total uncertain tax benefits will significantly change during the year due to settlement of audits and the expiration of statutes of limitations. The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, the Company recog- nized a $2.9 million increase in the liability for uncertain tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. $83.8 million in 2008; $66.2 million in 2009; $45.3 million in 2010; $28.8 million in 2011; $19.5 million in 2012; and $94.3 million thereafter. The Company has guaranteed certain debt obligations of some of the franchisees amounting to $108.6 million and $111.6 million at December 31, 2007 and 2006, respectively. Of this amount, approximately $77.4 million represents franchise borrowings outstanding under the franchise loan program and approximately $31.2 million represents fran- chise borrowings under other debt facilities at December 31, 2007. 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 $83.7 million in 2007, $72.0 million The following table summarizes the activity related to our in 2006, and $59.9 million in 2005. uncertain tax positions: (In Thousands) Balance at January 1, 2007 $3,159 Additions based on tax positions related to the current year Additions for tax positions of prior years Statute expirations Settlements 178 343 (61) (137) Balance at December 31, 2007 $3,482 As of December 31, 2007, the amount of uncertain tax benefits that, if recognized, would affect the effective tax rate is $3.5 million, including interest and penalties. During the year ended December 31, 2007, the Company recog- nized interest and penalties of $530,000. The Company had $735,000 and $550,000 of accrued interest and penalties at December 31, 2007 and January 1, 2007, respectively. The Company recognizes potential interest and penalties related to uncertain tax benefits as a component of income tax expense. 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 2021. 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. 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, 2007, are as follows: 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 $806,000 in 2007, $791,000 in 2006, and $676,000 in 2005. NOTE G: SHAREHOLDERS’ EQUITY The Company held 6,896,220 common shares in its treasury and was authorized to purchase an additional 4,307,958 shares at December 31, 2007. 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. The Company repurchased 692,042 shares of Common Stock in 2007. 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 con- verts 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 likelihood 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 estimates the fair value for the options granted on the grant date using a Black-Scholes option-pricing model. The expected volatility is based on the historical vola- tility of the Company’s Common Stock over the most recent period generally commensurate with the expected estimated life of each respective grant. The expected lives 37 Notes to Consolidated Financial Statements of options are based on the Company’s historical share option exercise experience. Forfeiture assumptions are based on the Company’s historical forfeiture experience. The Company believes that the historical experience method is the best estimate of future exercise and forfeiture patterns currently available. The risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options. The expected dividend yields are based on the approved annual dividend rate in effect and current market price of the underlying Common Stock at the time of grant. No assumption for a future dividend rate increase has been included unless there is an approved plan to increase the dividend in the near term. For the pro forma information regarding net income and earnings per share, the Company recognizes compensation expense over the explicit service period up to the date of actual retirement. Upon adoption of SFAS 123R, the Company is required to recognize compensation expense over a period to the date the employee first becomes eligible for retirement for awards granted or modified after the adoption of SFAS 123R. The results of operations for the year ended December 31, 2007 and 2006 include $1.9 million and $3.5 million, respec- tively, in compensation expense related to unvested grants as of January 1, 2006. At December 31, 2007, there was $3.1 million of total unrecognized compensation expense related to non-vested stock options which is expected to be recognized over a period of 2.9 years. SFAS 123R requires that the benefits of tax deductions in excess of recognized compensation expense be reported as financing cash flows, rather than as operating cash flow as required under prior guidance. Excess tax benefits of $789,000 were accordingly included in cash provided by financing activities for the year ended December 31, 2007. The related net tax benefit from the exercise of stock options in the year ended December 31, 2007 was $1.1 million. weighted average assumptions for 2007 and 2005, respec- tively: risk-free interest rates of 5.11% and 3.86%; a dividend yield of .24% and .25%; a volatility factor of the expected market price of the Company’s Common Stock of .39 and .43; weighted average assumptions of forfeiture rates of 6.82% and 5.85%; and weighted average expected lives of the option of eight and five years. The aggregate intrinsic value of options exercised was $2.9 million, $12.7 million, and $3.7 million in 2007, 2006, and 2005, respectively. The total fair value of options vested was $6.6 million, $4.9 million, and $1.2 million in 2007, 2006, and 2005, respectively. The Company granted 337,500 in stock options during the fourth quarter of 2007. The Company amended the Key Executive grants in 2006 and raised the exercise price of each of the stock options to the fair market value of the common stock on the original grant date, adjusted for a 3-for-2 stock dividend that occurred on August 2, 2004 in the case of those stock options with an original grant date that preceded the stock dividend date. The amendment also provides that, in order to compensate the grantees for the increase in the exercise price of the stock options, the full original discounted amount will be paid in cash on the applicable 2007 vesting date. Shares of restricted stock may be granted to employees and directors and typically vest over approximately three years. Restricted stock grants may be subject to one or more objective employment, performance or other forfeiture conditions as established at the time of grant. Any shares of restricted stock that are forfeited will again become avail- able for issuance. Compensation cost for restricted stock is equal to the fair market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Total compensation expense related to restricted stock was $1.7 million and $277,000 in 2007 and 2006, respectively. The following table summarizes information about Under the Company’s stock option plans, options granted restricted stock activity: to date 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, 374,500 of the Company’s shares are reserved for future grants at December 31, 2007. The Company did not grant any stock options in 2006. The weighted average fair value of options granted was $10.79 and $8.09 in 2007 and 2005, respectively. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following Restricted Weighted Average (In Thousands) Outstanding at January 1, 2007 Granted Vested Forfeited Stock 242 — — (17) Outstanding at December 31, 2007 225 Grant Price $25.40 — — 25.40 $25.40 38 The following table summarizes information about stock options outstanding at December 31, 2007: Range of Exercise Prices $ 4.38 – 10.00 10.01 – 15.00 15.01 – 20.00 20.01 – 24.94 $ 4.38 – 24.94 Options Outstanding Options Exercisable Number Outstanding December 31, 2007 Weighted Average Remaining Contractual Life (in years) Weighted Average Exercise price Number Exercisable December 31, 2007 Weighted Average Exercise Price 874,199 352,650 199,450 994,396 2,420,695 2.88 5.81 5.95 7.87 5.61 $ 6.79 14.43 17.41 21.87 874,199 352,650 199,450 554,888 $ 6.79 14.43 17.41 22.08 $14.98 1,981,187 $13.50 The table below summarizes option activity for the periods indicated in the Company’s stock option plans: Outstanding at January 1, 2007 Granted Exercised Forfeited Outstanding at December 31, 2007 Exercisable at December 31, 2007 Options (In Thousands) 2,320 338 (185) (52) 2,421 1,981 Weighted Average $13.67 21.14 8.57 19.62 14.97 $13.50 Weighted Average Remaining Contractual Term Aggregate Intrinsic Value (In Thousands) $15,013 — (2,891) (97) 12,941 $12,941 5.61 years 4.79 years Weighted Average Fair Value $ 6.57 10.79 4.43 8.20 7.29 $ 6.57 The weighted average fair value of unvested options was $9.66 as of December 31, 2006 and $10.53 as of December 31, 2007. The weighted average fair value of options that vested during 2007 was $6.57. NOTE I: FRANCHISING OF AARON’S SALES AND LEASE OWNERSHIP STORES The Company franchises Aaron’s Sales and Lease Ownership stores. As of December 31, 2007 and 2006, 768 and 674 franchises had been granted, respectively. Franchisees typi- cally pay a non-refundable initial franchise fee from $15,000 to $50,000 depending upon market size 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 and 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 before the substantial completion of the Company’s obligations are deferred. 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 was $3.4 million, $3.1 million, and $3.0 million and royalty revenue was $29.8 million, $25.4 million, and $21.6 million for the years ended December 31, 2007, 2006 and 2005, respectively. Deferred franchise and area development agreement fees, included in customer deposits and advance payments in the accompany- ing consolidated balance sheets, was $5.7 million and $4.3 million as of December 31, 2007 and 2006, respectively. 39 Notes to Consolidated Financial Statements Franchised Aaron’s Sales and Lease Ownership store activity is summarized as follows: Franchised stores open at January 1, Opened Added through acquisition Purchased from the Company Purchased by the Company Closed Franchised stores open at December 31, 2007 2006 2005 441 65 9 11 (39) (3) 392 75 0 3 (28) (1) 357 71 0 0 (35) (1) 484 441 392 Company-operated Aaron’s Sales and Lease Ownership store activity is summarized as follows: Company-operated stores open at January 1, Opened Added through acquisition Closed, sold or merged Company-operated stores open at December 31, 2007 2006 2005 845 145 39 (15) 748 616 78 40 (21) 82 56 (6) 1,014 845 748 In 2007, the Company acquired the rental contracts, merchandise, and other related assets of 77 stores, including 39 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 51 stores. In 2006, the Company acquired the rental contracts, merchan- dise, and other related assets of 40 stores, including 28 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 37 stores. In 2005, the Company acquired the rental contracts, merchandise, and other related assets of 96 stores, including 35 franchised stores, and merged certain acquired stores into existing stores, resulting in a net gain of 56 stores. NOTE J: ACQUISITIONS AND DISPOSITIONS During 2007, the Company acquired the rental contracts, merchandise, and other related assets of a net 39 sales and lease ownership stores for an aggregate purchase price of $57.3 million. Fair value of acquired tangible assets included $20.4 million for rental merchandise, $2.2 million for fixed assets, and $241,000 for other assets. Fair value of liabilities assumed approximated $499,000. The excess cost over the fair value of the assets and liabilities acquired in 2007, representing goodwill, was $31.3 million. The fair value of acquired separately identifiable intangible assets included $2.7 million for customer lists and $1.1 million for acquired franchise development rights. The estimated amortization of these customer lists and acquired franchise development rights in future years approximates $1.6 million, $1.1 million, $178,000, $168,000, and $141,000 for 2008, 2009, 2010, 2011, and 2012, respectively. The purchase price allocations for certain acquisitions during December 2007 are preliminary pending finalization of the Company’s assessment of the fair values of tangible assets acquired. During 2006, the Company acquired the rental contracts, merchandise, and other related assets of a net 40 sales and lease ownership stores for an aggregate purchase price of $32.4 million. Fair value of acquired tangible assets included $13.3 million for rental merchandise, $1.5 million for fixed assets, and $154,000 for other assets. Fair value of liabilities assumed approximated $65,000. The excess cost over the fair value of the assets and liabilities acquired in 2006, representing goodwill, was $15.5 million. The fair value of acquired separately identifiable intangible assets included $1.4 million for customer lists and $885,000 for acquired franchise development rights. The estimated amortization of these customer lists and acquired franchise development rights in future years approximates $857,000, $582,000, $115,000, $112,000, and $106,000 for 2007, 2008, 2009, 2010, and 2011, respectively. 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 2007, 2006 and 2005 consolidated financial statements was not significant. The Company sold eleven, three, and five of its sales and lease ownership locations to franchisees in 2007, 2006, and 2005, respectively. The effect of these sales on the consolidated financial statements was not significant. The Company also sold the assets of 12 of its sales and lease ownership locations in Puerto Rico to an unrelated third party in the second quarter of 2006. The Company received $16.0 million in cash proceeds, recognized a $7.2 million gain, and disposed of goodwill of $1.0 million in conjunction with the 2006 sales. 40 NOTE K: SEGMENTS Description of Products and Services of Reportable Segments Aaron Rents, Inc. has four reportable segments: sales and lease ownership, corporate furnishings (formerly known as 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 requirements. The corporate furnishings division rents and sells residential and office furniture to businesses and consumers who meet certain minimum credit requirements. The Company’s fran- chise operation sells and supports franchisees of its sales and lease ownership concept. The manufacturing division manufactures upholstered furniture, office furniture, 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: • Sales and lease ownership rental merchandise write-offs are recorded using the direct write-off method for management reporting purposes and 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. • Interest on borrowings is estimated at the beginning of each year. Interest is then allocated to operating segments based on relative total assets. Revenues in the “Other” category are primarily from leasing space to unrelated third parties in the corporate headquarters building and revenues from several minor unrelated activities. The pre-tax 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 the $565,000 gain recognized on the sale of marketable securities in 2005. Additionally, included in the “Other” category is a $4.9 million gain from the sale of a parking deck at the Company’s corporate headquarters in the first quarter of 2007. • Sales and lease ownership revenues are reported on the cash basis for management reporting purposes. Measurement of Segment Profit or Loss and Segment Assets • 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 2007, 2006, and 2005. • 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 state- ments 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 the sales and lease ownership division is estimated at the beginning of each year and then allocated to the division ratably over time for manage- ment reporting purposes. For financial reporting purposes, advertising expense is recognized when the related adver- tising activities occur. The difference between these two methods is reflected as part of the Cash to Accrual and Other Adjustments line below. The Company evaluates performance and allocates resources based on revenue growth and pre-tax profit or loss from operations. The accounting policies of the reportable seg- ments are the same as those described in the summary of significant accounting policies except that the 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. 41 Notes to Consolidated Financial Statements Information on segments and a reconciliation to earnings before income taxes are as follows: (In Thousands) REVENUES FROM EXTERNAL CUSTOMERS: Sales and Lease Ownership Corporate Furnishings Franchise Other Manufacturing Elimination of Intersegment Revenues Cash to Accrual Adjustments Year Ended December 31, 2007 Year Ended December 31, 2006 Year Ended December 31, 2005 $1,325,064 $1,167,073 $ 975,026 120,683 122,965 117,476 38,803 11,687 73,017 (73,173) (1,170) 33,626 5,791 78,458 (78,221) (3,100) 29,781 5,411 83,803 (83,509) (2,483) Total Revenues from External Customers $1,494,911 $1,326,592 $1,125,505 EARNINGS BEFORE INCOME TAXES: Sales and Lease Ownership Corporate Furnishings Franchise Other Manufacturing Earnings Before Income Taxes for Reportable Segments Elimination of Intersegment Loss (Profit) Cash to Accrual and Other Adjustments Total Earnings Before Income Taxes ASSETS: Sales and Lease Ownership Corporate Furnishings Franchise Other Manufacturing Total Assets DEPRECIATION AND AMORTIZATION: Sales and Lease Ownership Corporate Furnishings Franchise Other Manufacturing $ 90,224 $ 97,611 $ 63,317 9,410 28,651 4,527 (368) 12,824 23,949 (5,808) (1,740) 132,444 126,836 497 (4,096) 1,777 (3,903) 10,802 22,143 (585) 1,280 96,957 (1,103) (3,517) $ 128,845 $ 124,710 $ 92,337 $ 916,536 $ 779,278 $ 669,376 114,455 111,134 31,754 24,419 26,012 25,619 30,999 32,576 91,536 26,902 46,355 24,346 $1,113,176 $ 979,606 $ 858,515 $ 418,768 $ 370,004 $ 309,022 23,532 162 1,566 846 22,229 561 1,454 1,333 20,376 924 1,373 1,436 Total Depreciation and Amortization $ 444,874 $ 395,581 $ 333,131 INTEREST EXPENSE: Sales and Lease Ownership Corporate Furnishings Franchise Other Manufacturing Total Interest Expense Revenues from Canadian Operations (included in totals above): Sales and Lease Ownership Assets from Canadian Operations (included in totals above): Sales and Lease Ownership 42 $ 7,386 $ 8,234 $ 7,326 1,068 1,400 — 21 4 47 44 4 1,382 93 (297) 15 $ 8,479 $ 9,729 $ 8,519 $ 3,746 $ — $ — $ 252 $ 7 $ — NOTE L: RELATED PARTY TRANSACTIONS The Company leases certain properties under capital leases with certain related parties that are more fully described in Note D above. As part of its extensive marketing program, the Company has sponsored professional driver Michael Waltrip’s Aaron’s Dream Machine in the NASCAR Busch Series. The sons of the president of the Company’s sales and lease ownership division were paid by Mr. Waltrip’s company as full time members of its team of drivers. In 2007 one driver raced in the USAR Hooters Pro Cup Series and one driver raced in the Craftsman Truck Series. The Company’s sponsorship cost in 2007 for the drivers was approximately $730,000. In 2006 the drivers raced Aaron’s sponsored cars full time in the USAR Hooters Pro Cup Series. The amount paid in 2006 by the Company for the sponsorship of Michael Waltrip attribut- able to the USAR Hooters Pro Cup Series was $983,000, adjusted by credits in the amount of $434,000 for changes from the 2005 racing season. Motor sports sponsorships and promotions have been an integral part of the Company’s marketing programs for a number of years. NOTE M: QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (In Thousands, Except Per Share) First Quarter Second Quarter Third Quarter Fourth Quarter YEAR ENDED DECEMBER 31, 2007 Revenues Gross Profit* Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution YEAR ENDED DECEMBER 31, 2006 Revenues Gross Profit* Earnings Before Taxes Net Earnings Earnings Per Share Earnings Per Share Assuming Dilution $387,934 $358,985 $359,381 $388,611 188,488 178,118 178,669 184,464 46,880 29,207 .54 .53 31,675 19,657 .36 .36 25,313 15,919 .29 .29 24,977 15,492 .29 .28 $347,287 $321,727 $317,709 $339,869 167,365 158,188 159,039 161,619 34,631 21,561 .43 .42 31,690 20,650 .40 .39 27,625 17,383 .32 .32 30,764 19,041 .35 .35 * 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, depreciation of rental merchandise and write-offs of rental merchandise. 43 Management Report on Internal Control Over Financial Reporting Management of Aaron Rents, Inc. (the “Company”) is respon- sible 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 judg- ment 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 report- ing as of December 31, 2007. 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 its assessment, management believes that, as of December 31, 2007, the Company’s internal control over financial reporting was effective based on those criteria. The Company’s internal control over financial reporting as of December 31, 2007 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report dated February 28, 2008, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. Report of Independent Registered Public Accounting Firm 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, 2007 and 2006, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s manage- ment. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence support- ing the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presenta- tion. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, 44 the consolidated financial position of Aaron Rents, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the infor- mation set forth therein. As discussed in Note E, in 2007 the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” Also, as discussed in Note A, in 2006 the Company adopted Statement of Financial Accounting Standards (“FASB”) No. 123 (revised), “Share-Based Payment.” We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Aaron Rents, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria estab- lished in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2008 expressed an unqualified opinion thereon. Atlanta, Georgia February 28, 2008 Report of Independent Registered Public Accounting Firm THE BOARD OF DIRECTORS AND SHAREHOLDERS OF AARON RENTS, INC. We have audited Aaron Rents, Inc.’s internal control over financial reporting as of December 31, 2007, based on cri- teria 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 included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reason- able 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 internal control over financial reporting includes those poli- cies 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; (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 com- pany are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection 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, Aaron Rents, Inc. maintained, in all mate- rial respects, effective internal control over financial reporting as of December 31, 2007, 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, 2007 and December 31, 2006, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our report dated February 28, 2008 expressed an unqualified opinion thereon. Atlanta, Georgia February 28, 2008 45 Common Stock Market Prices and Dividends MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information, Holders and Dividends The following table shows the range of high and low prices per share for the Common Stock and Class A Common Stock and the cash dividends declared per share 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 19, 2008 was 274 and 109, respectively. The closing prices for the Common Stock and Class A Common Stock at February 19, 2008 were $18.80 and $17.00, respectively. Subject to our ongoing ability to generate sufficient income, any future capital needs and 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 Cash Dividends Per Share DECEMBER 31, 2007 DECEMBER 31, 2007 First Quarter Second Quarter Third Quarter Fourth Quarter $30.56 $25.93 $.015 First Quarter $27.52 $23.40 $.015 30.72 29.70 22.85 25.72 20.16 18.23 .015 .015 .016 Second Quarter Third Quarter Fourth Quarter 26.94 26.16 21.60 23.54 19.90 16.26 .015 .015 .016 DECEMBER 31, 2006 DECEMBER 31, 2006 First Quarter Second Quarter Third Quarter Fourth Quarter $28.08 $20.82 $.014 First Quarter $25.60 $19.20 $.014 29.99 27.57 29.29 24.82 22.17 21.80 .014 .014 .015 Second Quarter Third Quarter Fourth Quarter 26.25 24.83 26.38 23.00 20.25 20.25 .014 .014 .015 The line graph to the left and the table below compare, for the last five fiscal years of the Company, the yearly percentage change in the cumulative total shareholder returns (assuming reinvestment of dividends) on the Company’s Common Stock with that of the S&P SmallCap 600 Index and a Peer Group. For 2007, the Peer Group consisted of Rent-A-Center, Inc. The stock price performance shown is not necessarily indicative of future performance. 12/02 12/03 12/04 12/05 12/06 12/07 Aaron Rents, Inc. 100.00 138.25 258.01 218.11 298.44 200.01 S&P SmallCap 600 100.00 138.79 170.22 183.30 211.00 210.38 Peer Group 100.00 150.15 132.63 94.39 147.70 72.67 46 Locations Within the United States and Canada Aaron Rents, Inc. Locations within the U.S. and Canada Store Count As Of December 31, 2006 Store Count as of December 31, 2007 Company Stores — 1,014 Company Stores - 845 Franchise Stores — 484 Franchise Stores - 441 Corporate Furnishings Stores — 62 Corporate Furnishings Stores - 59 Fulfillment Centers - 16 Fulfillment Centers — 16 Mactavish Manufacturing — 12 MacTavish Manufacturing - 12 Store Count As Of December 31, 2006 Company Stores - 845 Franchise Stores - 441 Corporate Furnishings Stores - 59 Fulfillment Centers - 16 MacTavish Manufacturing - 12 47 Board of Directors R. Charles Loudermilk, Sr. Chairman of the Board, Chief Executive Officer, Aaron Rents, Inc. Ronald W. Allen (1) Retired Chairman of the Board, President and Chief Executive Officer, Delta Air Lines, Inc. Leo Benatar (2) 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 David L. Kolb (1) Retired Chairman and Chief Executive Officer, Mohawk Industries, Inc. Robert C. Loudermilk, Jr. President, Chief Operating Officer, Aaron Rents, Inc. John C. Portman, Jr. Chairman of the Board and Chief Executive Officer, Portman Holdings, LLC; Chairman, AMC, Inc.; and Chairman, John Portman & Associates Ray M. Robinson (2) President Emeritus, East Lake Golf Club and Vice Chairman, East Lake Community Foundation John Schuerholz President, The Atlanta Braves Officers Corporate R. Charles Loudermilk, Sr.* Chairman of the Board, Chief Executive Officer Robert C. Loudermilk, Jr.* President, Chief Operating Officer Gilbert L. Danielson* Executive Vice President, Chief Financial Officer James L. Cates* Senior Group Vice President, Corporate Secretary Elizabeth L. Gibbs* Vice President, General Counsel B. Lee Landers, Jr.* Vice President, Chief Information Officer Michael W. Jarnagin Vice President, Manufacturing James C. Johnson Vice President, Internal Audit Robert P. Sinclair, Jr.* Vice President, Corporate Controller D. Chad Strickland Vice President, Employee Relations Danny Walker, Sr. Vice President, Internal Security Aaron’s Corporate Furnishings Division Eduardo Quiñones* President Christopher D. Counts Vice President, Western Region Philip J. Karl Vice President, Southeast Region Donald P. Lange Vice President, Marketing and Advertising Aaron’s Sales & Lease Ownership Division William K. Butler, Jr.* President K. Todd Evans* Vice President, Franchising Mitchell S. Paull* Senior Vice President, Merchandising and Logistics John A. Allevato Vice President, RIMCO Operations Gregory G. Bellof Vice President, Mid-Atlantic Operations David A. Boggan Vice President, Mississippi Valley Operations David L. Buck Vice President, Southwestern Operations Todd G. Coppedge Vice President, Midwest Operations Paul A. Doize Vice President, Real Estate Joseph N. Fedorchak Vice President, Eastern Operations Bert L. Hanson Vice President, Mid-American Operations Michael B. Hickey Vice President, Management Development Kevin J. Hrvatin Vice President, Western Operations Steven A. Michaels Vice President, Franchise Finance Tristan J. Montanero Vice President, Central Operations Michael H. Pokorny Vice President, Northeast Operations Mark A. Rudnick Vice President, Marketing Michael P. Ryan Vice President, Northern Operations John T. Trainor Vice President, Information Technology (1) Member of Audit Committee (2) Member of Compensation Committee * Executive Officer 48 Corporate and Shareholder Information Corporate Headquarters Annual Shareholders Meeting Stock Listing 309 E. Paces Ferry Rd., N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 http://www.aaronrents.com Subsidiaries Aaron Investment Company 4005 Kennett Pike Greenville, Delaware 19807 (302) 888-2351 Aaron Rents Canada, ULC 309 E. Paces Ferry Rd., N.E. Atlanta, Georgia 30305-2377 (404) 231-0011 The annual meeting of the share holders of Aaron Rents, Inc. will be held on Tuesday, May 6, 2008, at 10:00 a.m. EDT on the 4th Floor, SunTrust Plaza, 303 Peachtree Street, Atlanta, Georgia 30303 Transfer Agent and Registrar SunTrust Bank, Atlanta Atlanta, Georgia General Counsel Kilpatrick Stockton LLP Atlanta, Georgia Form 10-K R NT Aaron Rents, Inc.’s Common Stock and Class A Common Stock are traded on the New York Stock Exchange under the symbols “RNT” and “RNTA,” respectively. Pursuant to the requirements of the New York Stock Exchange, in 2007 our Chief Executive Officer cer tified to the NYSE that he was not aware of any violation by Aaron Rents, Inc. of the NYSE’s corporate governance listing standards. Shareholders may obtain a copy of the Forward-Looking Statements Company’s annual report on Form 10-K filed with the Securities and Exchange Commission upon written request, with- out 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 Officer required by Section 302 of the Sarbanes-Oxley Act of 2002, which address, among other things, the content of our Annual Report on Form 10-K, appear as exhibits to the Form 10-K. 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 in the Company’s 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 mar- ket share, and statements expressing general optimism about future operating results — are forward-looking state- ments. 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 uncertain- ties, see “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. 3 0 9 E . P a c e s F e r r y R d . , N . E . A t l a n t a , G e o r g i a 3 0 3 0 5 - 2 3 7 7 ( 4 0 4 ) 2 3 1 - 0 0 1 1 w w w . a a r o n r e n t s . c o m 

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