Aarons 2007 Annual Report Download - page 22

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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.
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.