<Page>
FINANCIAL HIGHLIGHTS
<Table>
<Caption>
YEAR ENDED YEAR ENDED
(DOLLAR AMOUNTS IN THOUSANDS, DECEMBER 31, DECEMBER 31, PERCENTAGE
EXCEPT PER SHARE) 2002 2001 CHANGE
- -------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Revenues $ 640,688 $ 546,681 17.2%
Earnings Before Taxes 43,652 19,855 119.9
Net Earnings 27,440 12,336 122.4
Earnings Per Share 1.31 0.62 111.3
Earnings Per Share
Assuming Dilution 1.29 0.61 111.5
- -------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total Assets $ 483,648 $ 397,196 21.8%
Rental Merchandise, Net 317,287 258,932 22.5
Credit Facilities 73,265 77,713 (5.7)
Shareholders' Equity 280,545 219,967 27.5
Book Value Per Share 12.92 11.01 17.3
Debt to Capitalization 20.7% 26.1%
Pre-Tax Profit Margin 6.8 3.6
Net Profit Margin 4.3 2.3
Return on Average Equity 11.0 5.8
- -------------------------------------------------------------------------------------------------------------
STORES OPEN AT YEAR END
Sales & Lease Ownership 387 364 6.3%
Sales & Lease Ownership Franchised 232 209 11.0
Sight & Sound 25
Rent-to-Rent 70 75 (6.7)
- -------------------------------------------------------------------------------------------------------------
Total Stores 714 648 10.2%
- -------------------------------------------------------------------------------------------------------------
</Table>
[CHART]
REVENUES BY YEAR
[CHART]
NET EARNINGS BY YEAR
<Page>
SELECTED FINANCIAL INFORMATION
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
(DOLLAR AMOUNTS IN THOUSANDS, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
EXCEPT PER SHARE) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------------
Systemwide Revenues(1) $ 874,709 $ 735,389 $ 656,096 $ 547,255 $ 464,175
----------------------------------------------------------------------------------
OPERATING RESULTS
Revenues:
Rentals & Fees $ 459,179 $ 403,385 $ 359,880 $ 318,154 $ 289,272
Retail Sales 72,698 60,481 62,417 62,296 62,576
Non-Retail Sales 88,969 66,212 65,498 45,394 18,985
Other 19,842 16,603 15,125 11,515 8,826
----------------------------------------------------------------------------------
640,688 546,681 502,920 437,359 379,659
----------------------------------------------------------------------------------
Costs & Expenses:
Retail Cost of Sales 53,856 43,987 44,156 45,254 44,386
Non-Retail Cost of Sales 82,407 61,999 60,996 42,451 17,631
Operating Expenses 293,346 276,682 227,587 201,923 189,719
Depreciation of Rental Merchandise 162,660 137,900 120,650 102,324 89,171
Interest 4,767 6,258 5,625 4,105 3,561
----------------------------------------------------------------------------------
597,036 526,826 459,014 396,057 344,468
----------------------------------------------------------------------------------
Earnings Before Income Taxes 43,652 19,855 43,906 41,302 35,191
Income Taxes 16,212 7,519 16,645 15,700 13,707
----------------------------------------------------------------------------------
Net Earnings $ 27,440 $ 12,336 $ 27,261 $ 25,602 $ 21,484
----------------------------------------------------------------------------------
Earnings Per Share $ 1.31 $ .62 $ 1.38 $ 1.28 $ 1.06
Earnings Per Share Assuming Dilution 1.29 .61 1.37 1.26 1.04
----------------------------------------------------------------------------------
Dividends Per Share:
Common $ .04 $ .04 $ .04 $ .04 $ .04
Class A .04 .04 .04 .04 .04
- --------------------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Rental Merchandise, Net $ 317,287 $ 258,932 $ 267,713 $ 219,831 $ 194,163
Property, Plant & Equipment, Net 87,094 77,282 63,174 55,918 50,113
Total Assets 483,648 397,196 380,379 318,408 272,174
Interest-Bearing Debt 73,265 77,713 104,769 72,760 51,727
Shareholders' Equity 280,545 219,967 208,538 183,718 168,871
- --------------------------------------------------------------------------------------------------------------------------------
AT YEAR END
Stores Open:
Company-Operated 482 439 361 320 291
Franchised 232 209 193 155 136
Rental Agreements in Effect 369,000 314,600 281,000 254,000 227,400
Number of Employees 4,800 4,200 3,900 3,600 3,400
- --------------------------------------------------------------------------------------------------------------------------------
</Table>
(1) SYSTEMWIDE REVENUES INCLUDE REVENUES OF FRANCHISED AARON'S SALES & LEASE
OWNERSHIP STORES. FRANCHISED STORE REVENUES ARE NOT REVENUES OF AARON RENTS.
The Company adopted Statement of Financial Accounting Standards No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS on January 1, 2002. If the Company had
applied the non-amortization provisions of Statement 142 for all periods
presented, net income and diluted income per share would have increased by
approximately $688,000 ($.03 per share), $431,000 ($.02 per share), $323,000
($.02 per share), and $173,000 ($.01 per share) for the years ended December 31,
2001, 2000, 1999, and 1998, respectively.
<Page>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 VERSUS YEAR ENDED DECEMBER 31, 2001
REVENUES
Total revenues for the year ended 2002 increased $94 million to $640.7
million compared to $546.7 million in 2001, a 17.2% increase. The increase was
due mainly to a $55.8 million, or 13.8%, increase in rentals and fees revenues,
plus a $22.8 million, or 34.4%, increase in non-retail sales. Our rentals and
fees revenues include all revenues derived from rental agreements from our sales
and lease ownership and rent-to-rent stores, including agreements that result in
our customers acquiring ownership at the end of the term of the rental
agreements. The increase in rentals and fees revenues was attributable to a
$77.3 million increase from our sales and lease ownership division, which had an
average increase of 13% in same store revenues for the year ended 2002 and
added 149 Company-operated stores since the beginning of 2001. The growth in our
sales and lease ownership division was offset by a $21.5 million decrease in
rental revenues in our rent-to-rent division. The decrease in rent-to-rent
division revenues is primarily the result of our decision to close, merge, or
sell 29 under-performing stores since the beginning of 2001, as well as a
decline of same store revenues.
Revenues from retail sales increased $12.2 million to $72.7 million in 2002
from $60.5 million in 2001 due to an increase of $20.8 million in the sales and
lease ownership division offset by a decrease of $8.6 million in our
rent-to-rent division. Retail sales represent sales of both new and rental
return merchandise. Non-retail sales, which primarily represent merchandise sold
to our franchisees, increased 34.4% to $89 million in 2002 from $66.2 million
in 2001. The increased sales reflect the growth of our franchise operations.
Other revenues, which include franchise fee and royalty income and other
miscellaneous revenues, for the year ended December 31, 2002 increased $3.2
million to $19.8 million compared with $16.6 million in 2001, a 19.5% increase.
This increase was attributable to franchise fee and royalty income increasing
$3 million, or 21.8%, to $16.6 million compared with $13.6 million last year,
reflecting the net addition of 23 franchised stores in 2002 and improved
operating revenues at older franchised stores.
With respect to our major operating units, revenues for our sales and lease
ownership division increased $121 million to $501.4 million in 2002 compared
with $380.4 million last year, a 31.8% increase. This increase was attributable
to the store additions and same store revenue growth described above. Rent-to-
rent division revenues for 2002 decreased 20% to $119.9 million from $150
million in 2001, due primarily to the closing or other disposition of
under-performing stores and same store revenue decline previously described.
COST OF SALES
Cost of sales from retail sales increased $9.9 million or 22.4%, to $53.9
million in 2002 compared to $44 million in 2001, and as a percentage of
sales, increased to 74.1% from 72.7%. The increase in retail cost of sales as
a percentage of sales was primarily due to a slight decrease in margins in
both the rent-to-rent and sales and lease ownership divisions in 2002 along
with lower margins on retail sales from our newly acquired Sight & Sound
stores. Cost of sales from non-retail sales increased $20.4 million to $82.4
million in the 2002 from $62 million in 2001, and as a percentage of sales,
decreased to 92.6% from 93.6%. The increased margins on non-retail sales were
primarily the result of higher margins on certain products sold to
franchisees.
EXPENSES
Operating expenses in 2002 increased $16.7 million to $293.3 million from
$276.7 million in 2001, a 6% increase. As a percentage of total revenues,
operating expenses were 45.8% in 2002 and 50.6% in 2001. Operating expenses
decreased in 2002 as a percentage of total revenues primarily due to higher
costs in 2001 associated with the acquisition of sales and lease ownership store
locations formerly operated by one of the nation's largest furniture retailers
along with other new store openings coupled with non-cash charges of $5.6
million related to the rent-to-rent division. In addition, we discontinued
amortizing goodwill in 2002 in connection with the adoption of a new accounting
standard. This adoption had the effect of eliminating amortization expense of
$1.1 million in 2002 compared with 2001.
Depreciation of rental merchandise increased $24.8 million to $162.7 million
in 2002 from $137.9 million during 2001, an 18% increase. As a percentage of
total rentals and fees, depreciation of rental merchandise increased to 35.4%
from 34.2% in 2001. The increase as a percentage of rentals and fees reflects 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 rent-to-rent division.
On January 1, 2002, we began depreciating sales and lease ownership
merchandise upon the earlier to occur of its initial lease to a customer or
twelve months after it is acquired from the vendor. Previously, we began
depreciating sales and lease ownership merchandise as soon as it was delivered
to our stores from our distribution centers. This change in accounting method
increased net earnings by approximately $3 million, or $.14 per diluted common
share in 2002.
Interest expense decreased $1.5 million to $4.8 million in 2002 compared
with $6.3 million in 2001, a 23.8% decline. As a percentage of total revenues,
interest expense decreased to 0.7% in 2002 from 1.1% in 2001. The decrease in
interest expense as a percentage of total revenues was primarily due to lower
debt levels in 2002.
Income tax expense increased $8.7 million to $16.2 million in 2002 compared
with $7.5 million in 2001, representing an 115.6% increase due to the higher
pre-tax earnings. Aaron Rents' effective tax rate was 37.1% in 2002 compared
with 37.9% in 2001, primarily due to lower non-deductible expenses.
NET EARNINGS
As a result, net earnings increased $15.1 to $27.4 million in 2002
compared with $12.3 million last year representing a 122.4% increase. As a
percentage of total revenues, net earnings were 4.3% in 2002 and 2.3% in
2001. The increase in net earnings was primarily due to the non-cash charges
of $5.6 million incurred in the third quarter of 2001 along with the maturing
101 Company-operated sales and lease ownership stores added in 2001, and a
13% increase in same store revenue growth, coupled with the change in our
rental merchandise depreciation method and the non-amortization of goodwill.
In addition, the Company experienced higher than usual operating expenses in
2001 associated with the addition of 101 Company-operated stores.
<Page>
YEAR ENDED DECEMBER 31, 2001 VERSUS YEAR ENDED DECEMBER 31, 2000
REVENUES
Total revenues for 2001 increased $43.8 million to $546.7 million compared
with $502.9 million in 2000, an 8.7% increase. The increase was due mainly to a
$43.5 million, or 12.1%, increase in rentals and fees revenues, plus a $714,000
increase in non-retail sales. The increase in rentals and fees revenues was
attributable to a $62.7 million increase from our sales and lease ownership
division, which added 101 Company-operated stores in 2001, offset by a $19.2
million decrease in our rent-to-rent division.
Revenues from retail sales decreased $1.9 million to $60.5 million in 2001
from $62.4 million for the prior year, a 3.1% decrease. Non-retail sales, which
primarily represent merchandise sold to our franchisees, increased 1.1% to $66.2
million compared with $65.5 million for 2000. The increased sales were due to
the growth of our franchise operations.
Other revenues for 2001 increased $1.5 million to $16.6 million compared
with $15.1 million in 2000, a 9.8% increase. This increase was attributable to
franchise fee and royalty income increasing $1.2 million, or 10%, to $13.6
million compared with $12.4 million in 2000, reflecting the net addition of 16
new franchised stores in 2001 and improved operating revenues at mature
franchised stores.
With respect to our major operating units, revenues for our sales and lease
ownership division increased $67.5 million to $380.4 million in 2001 compared
with $312.9 million in 2000, a 21.6% increase. This increase was attributable to
the sales and lease ownership division adding 101 stores in 2001 combined with
same store revenue growth of 7.7% in 2001. Rent-to-rent division revenues in
2001 decreased 14.2% to $150 million from $174.9 million in 2000. The decrease
in rent-to-rent division revenues is primarily the result of our decision to
close, merge, or sell 23 under-performing stores in 2001.
COST OF SALES
Cost of sales from retail sales decreased $169,000 to $44 million in 2001
compared with $44.2 million in 2000, and as a percentage of sales, increased
to 72.7% from 70.7% primarily due to product mix. Cost of sales from
non-retail sales increased $1 million to $62 million in 2001 from $61 million
in 2000, and as a percentage of sales, increased to 93.6% from 93.1%. The
decreased margins on non-retail sales were primarily the result of slightly
lower margins on certain products sold to franchisees.
EXPENSES
Operating expenses in 2001 increased $49.1 million to $276.7 million from
$227.6 million in 2000, a 21.6% increase. As a percentage of total revenues,
operating expenses were 50.6% in 2001 and 45.3% in 2000. Operating expenses
increased as a percentage of total revenues primarily due to the costs
associated with the acquisition and accelerated start-up costs of sales and
lease ownership locations formerly operated by one of the nation's largest
furniture retailers along with other new store openings. In addition, we
recorded non-cash charges of $5.6 million related to the future real estate
lease obligations of closed rent-to-rent stores and the write down of inventory
and other assets within our rent-to-rent division.
Depreciation of rental merchandise increased $17.2 million to $137.9 million
in 2001 from $120.7 million in 2000, a 14.3% increase. As a percentage of total
rentals and fees, rental merchandise depreciation increased to 34.2% from 33.5%.
This increase as a percentage of rentals and fees was mainly because a greater
percentage of our rentals and fees revenues are coming from our sales and lease
ownership division, which depreciates its rental merchandise at a faster rate
than our rent-to-rent division.
Interest expense increased 11.3% to $6.3 million in 2001 compared with $5.6
million in 2000. As a percentage of total revenues, interest expense was 1.1% in
both years.
Income tax expense decreased $9.1 million to $7.5 million in 2001 compared
with $16.6 million in 2000, a 54.8% decline. Aaron Rents' effective tax rate was
37.9% in both 2001 and 2000.
NET EARNINGS
Net earnings decreased $14.9 million to $12.3 million for 2001 compared with
$27.3 million for 2000, a 54.8% decrease. As a percentage of total revenues, net
earnings were 2.3% in 2001 and 5.4% in 2000. The decrease in net earnings was
mainly the result of start-up expenses associated with the 101 new store
openings, as compared with 32 stores opened in the prior year, and non-cash
charges associated with our rent-to-rent division.
BALANCE SHEET
Cash. The Company's cash balance remained virtually unchanged with a balance
of $96,000 and $93,000 at December 31, 2002 and 2001, respectively. The
consistency of the cash balance is the result of the Company being a net
borrower with all excess cash being used to pay down debt balances.
Deferred Income Taxes. The increase of $29.6 million in deferred income
taxes from December 31, 2001 to December 31, 2002 is primarily the result of
March 2002 tax law changes, effective September 2001, that allow accelerated
depreciation of rental merchandise for tax purposes.
Bank Debt. The reduction in bank debt of $65.1 million from December 31,
2001 to December 31, 2002 is primarily the result of the Company's private
placement of $50 million of senior unsecured notes in August 2002 coupled with a
June 2002 public offering of 1.725 million newly-issued shares of Common Stock
for net proceeds of $34.1 million.
Other Debt. The increase of $60.6 million in other debt from December 31,
2001 to December 31, 2002 is primarily the result of the Company's private
placement of $50 million of senior unsecured notes in August 2002 and $11.7
million of debt related to capital leases associated with the sale and lease
back of real estate.
Additional Paid-In Capital. The increase of $33.7 million in additional paid
in capital from December 31, 2001 to December 31, 2002 is primarily the result
of the Company's June 2002 public offering of 1.725 million newly-issued shares
of Common Stock.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
Cash flows from operations for the year ended December 31, 2002 and 2001
were $221.7 and $189.4 million, respectively. Our cash flows include profits on
the sale of rental return merchandise. Our primary capital requirements consist
of buying rental merchandise for both Company-operated sales and lease ownership
and rent-to-rent stores. As Aaron Rents continues to grow, the need for
additional rental merchandise will continue to be our
<Page>
major capital requirement. These capital requirements historically have been
financed through:
- - bank credit
- - trade credit with vendors
- - private debt
- - stock offerings
- - cash flow from operations
- - proceeds from the sale of rental return merchandise
In August 2002, we sold $50 million in aggregate principal amount of our
6.88% senior unsecured notes due August 2009 in a private placement. Quarterly
interest payments are due for the first two years followed by annual $10 million
principal repayments plus interest for the next five years. We used some of the
net proceeds of the sale to repay borrowings under our existing revolving credit
facility, and intend to use a portion to finance future expansion. Information
regarding our obligations to make future payments under our senior unsecured
notes appears under "Commitments" below.
In June 2002, we completed an underwritten public offering of 1.725 million
newly-issued shares of our common stock (including shares issued pursuant to the
underwriters' over-allotment option) for net proceeds, after the underwriting
discount and expenses, of approximately $34.1 million. We used the proceeds to
repay borrowings under our revolving credit facility. A selling shareholder sold
an additional 575,000 shares in the offering.
Aaron Rents has financed its growth through a revolving credit agreement
with several banks, collateralized real estate borrowings, trade credit with
vendors, and internally generated funds. Our revolving credit agreement dated
March 30, 2001 provides for unsecured borrowings up to $110 million, including
an $8 million credit line to fund daily working capital requirements. The
interest rate under our revolving credit agreement is currently the lower of the
lender's prime rate or LIBOR plus 1.25%. The agreement expires on March 30,
2004.
At December 31, 2002, an aggregate of $7.3 million was outstanding under the
revolving credit agreement, bearing interest at a weighted average variable rate
of 3.1%. The Company's long-term debt decreased by approximately $4.4 million in
2002. The decline in borrowings is primarily attributable to cash generated from
operating activities of $221.7 million along with the $34.1 million in net
proceeds from a public offering of 1.725 million shares of our Common Stock.
Information regarding our obligations to make future payments under our credit
facility appears under "Commitments" below. We use interest rate swap agreements
as part of our overall long-term financing program, as described below under
"Market Risk."
Aaron Rents' revolving credit agreement, senior unsecured notes, the
construction and lease facility, and the franchise loan program discussed below,
contain financial covenants which, among other things, forbid us from exceeding
certain debt to equity levels and require us to maintain minimum fixed charge
coverage ratios. If we fail to comply with these covenants, then we will be in
default under these commitments, and all amounts would become due immediately.
Aaron Rents was complying with all these covenants at December 31, 2002.
As of December 31, 2002, Aaron Rents was authorized by itsboard of directors
to purchase up to an additional 1,186,890 common shares.
Aaron Rents has paid dividends for 16 consecutive years. A $.02 per share
dividend on our common stock and Class A stock was paid in January 2002 and
July 2002, for a total fiscal year cash outlay of $798,000. Subject to
sufficient operating profits, to any future capital needs and to other
contingencies, we currently expect to continue our policy of paying dividends.
We believe that the proceeds from our public stock offering, our senior note
offering, our expected cash flows from operations, proceeds from the sale of
rental return merchandise, bank and other borrowings, and vendor credit will be
sufficient to fund our capital and liquidity needs for at least the next 24
months.
COMMITMENTS
Construction and Lease Facility. On October 31, 2001, we renewed our $25
million construction and lease facility. From 1996 to 1999, we arranged for a
bank holding company to purchase or construct properties identified by us
pursuant to this facility, and we subsequently leased these properties from
the bank holding company under operating lease agreements. The total amount
advanced and outstanding under this facility at December 31, 2002 was
approximately $24.7 million. Since the resulting leases are accounted for as
operating leases, we do not record any debt obligation on our balance sheet.
This construction and lease facility expires in 2006. Lease payments
fluctuate based upon current interest rates and are generally based upon
LIBOR plus 1.35%. The lease facility contains residual value guarantee and
default guarantee provisions. Although we believe the likelihood of funding
to be remote, the maximum guarantee obligation under the residual value and
default guarantee provisions upon termination are approximately $20.9 million
and $24.7 million, respectively, at December 31, 2002.
Leases. Aaron Rents leases warehouse and retail store space for
substantially all of its operations under operating leases expiring at
various times through 2015. 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 which do not
represent bargain purchase options. We also lease transportation and computer
equipment under operating leases expiring during the next three years. We
expect that most leases will be renewed or replaced by other leases in the
normal course of business. Approximate future minimum rental payments
required under operating leases that have initial or remaining non-cancelable
terms in excess of one year as of December 31, 2002 including leases under
our construction and lease facility described above are as follows: $33.3
million in 2003; $27.8 million in 2004; $19.8 million in 2005; $12.6 million
in 2006; $6.8 million in 2007; and $7.1 million thereafter.
The Company has 13 capital leases, 12 of which are with limited liability
companies (LLCs) whose owners include Aaron Rents' executive officers, and
majority shareholder. Eleven of these related party leases relate to
properties purchased from Aaron Rents in December 2002 by one of the LLCs for
a total purchase price of approximately $5 million. The LLC is leasing back
these properties to Aaron Rents for 15-year terms at an aggregate annual
rental of approximately $635,000. The twelfth related party capital lease
relates to a property sold by Aaron Rents to a second LLC for $6.3 million in
April 2002 and leased back to Aaron Rents for a 15-year term at an annual
rental of approximately $617,000. See Note E to the Consolidated Financial
Statements.
Franchise Guaranty. Aaron Rents has guaranteed the borrowings of certain
independent franchisees under a franchise loan program with a bank. In the event
these franchisees are unable to meet their debt service payments or otherwise
experience an event
<Page>
of default, we would be unconditionally liable for a portion of the outstanding
balance of the franchisee's debt obligations, which would be due in full within
90 days of the event of default. At December 31, 2002, the portion which we
might be obligated to repay in the event our franchisees defaulted was
approximately $63.7 million. However, due to franchisee borrowing limits, we
believe any losses associated with any defaults would be mitigated through
recovery of rental merchandise and other assets. Since its inception, Aaron
Rents has had no losses associated with the franchisee loan and guaranty
program.
We have no long-term commitments to purchase merchandise. See Note G to the
Consolidated Financial Statements for further information.
The following table shows the Company's approximate obligations and
commitments to make future payments under contractual obligations as of December
31, 2002:
<Table>
<Caption>
PERIOD PERIOD PERIOD PERIOD
LESS THAN 1-3 4-5 OVER
(IN THOUSANDS) TOTAL 1 YEAR YEARS YEARS 5 YEARS
- --------------------------------------------------------------------------------------------------------------------------------
Credit facilities, including capital leases $ 73,265 $ 277 $ 18,138 $ 21,020 $ 33,830
Operating leases 107,530 33,326 47,678 19,426 7,100
----------------------------------------------------------------------------------
Total Contractual Cash Obligations $ 180,795 $ 33,603 $ 65,816 $ 40,446 $ 40,930
================================================================================================================================
</Table>
The Company has certain commercial commitments related to franchisee
borrowing guarantees and residual values under operating leases. The Company
believes the likelihood of any significant amounts being funded in connection
with these commitments to be remote. The following table shows the Company's
approximate commercial commitments as of December 31, 2002:
<Table>
<Caption>
TOTAL PERIOD PERIOD PERIOD PERIOD
AMOUNTS LESS THAN 1-3 4-5 OVER
(IN THOUSANDS) COMMITTED 1 YEAR YEARS YEARS 5 YEARS
- --------------------------------------------------------------------------------------------------------------------------------
Guaranteed borrowings of franchisees $ 63,700 $ 63,700
Residual value guarantee under
operating leases 20,900 20,900
----------------------------------------------------------------------------------
Total Contractual Cash Obligations $ 84,600 $ 63,700 $ 20,900
================================================================================================================================
</Table>
MARKET RISK
Aaron Rents manages its exposure to changes in short-term interest rates,
particularly to reduce the impact on our variable payment construction and lease
facility and floating-rate borrowings, by entering into interest rate swap
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 minimizes the risk of counterparty
default to a large extent.
At December 31, 2002, we had swap agreements with total notional principal
amounts of $60 million which effectively fixed the interest rates on obligations
in the notional amount of $28 million of debt under our revolving credit
agreement, variable payment construction and lease facility, and other debt at
an average rate of 5.9%, as follows: $20 million at an average rate of 6.15%
until May 2003; $10 million at an average rate of 7.96% until November 2003; $10
million at an average rate of 7.75% until November 2003; and an additional $20
million at an average rate of 7.6% until June 2005. In 2002, we reassigned
approximately $24 million of notional amount of swaps to the variable payment
obligations under our construction and lease facility described above. Since
August 2002, fixed rate swap agreements in the notional amount of $32 million
were not being utilized as a hedge of variable obligations, and accordingly,
changes in the valuation of such swap agreements are recorded directly to
earnings. The fair value of interest rate swap agreements was a liability of
approximately $3.3 million at December 31, 2002. A 1% adverse change in interest
rates on variable rate obligations would not have a material adverse impact on
the future earnings and cash flows of the Company.
We do not use any market risk sensitive instruments to hedge commodity,
foreign currency, or risks other than interest rate risk, and hold no market
risk sensitive instruments of any kind for trading or speculative purposes.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 (SFAS 141), BUSINESS COMBINATIONS. This
statement eliminates the pooling of interests method of accounting for all
business combinations initiated after June 30, 2001, and addresses the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. We have had no significant business combinations after
June 30, 2001.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142 (SFAS 142), GOODWILL AND OTHER INTANGIBLE ASSETS. We performed
Step 1 of the required transitional impairment test under SFAS 142 using a
combination of the market value and comparable transaction approaches to
business enterprise valuation. We concluded that the enterprise fair values of
our reporting units were greater than the carrying value, and accordingly, no
further impairment analysis was considered necessary. We also adopted the
non-amortization provisions of SFAS 142, which resulted in an increase in net
earnings of $688,000 or $.03 diluted earnings per share for 2002.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144 (SFAS 144), ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS. This statement supercedes Statement of
Financial
<Page>
Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. We adopted SFAS 144 as of January
1, 2002, and the statement had no material effect on our consolidated financial
statements.
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, 2002 and 2001, Aaron Rents had a net revenue
deferral representing cash collected in advance of being due or otherwise earned
totaling approximately $7.5 million and $5.7 million, respectively. Revenues
from the sale of residential and office furniture and other merchandise are
recognized at the time of shipment.
RENTAL MERCHANDISE DEPRECIATION
Our sales and lease ownership division depreciates merchandise over the
agreement period, generally 12 to 24 months when rented, and 36 months when
not rented, to 0% salvage value. Prior to 2002, we depreciated sales and
lease ownership merchandise as soon as it was delivered to our stores from
our distribution centers. In the first quarter of 2002, we began depreciating
this merchandise upon the earlier to occur of its initial lease to a customer
or 12 months after it is acquired from the vendor. See Note B to the
Consolidated Financial Statements. Nevertheless, sales and lease ownership
merchandise is generally depreciated at a faster rate than our rent-to-rent
merchandise. As sales and lease ownership revenues continue to comprise an
increasing percentage of total revenues, we expect rental merchandise
depreciation to increase at a correspondingly faster rate. Our rent-to-rent
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%.
Our policies require weekly rental merchandise counts by store managers,
which includes a write-off for unsalable, damaged, or missing merchandise
inventories. Full physical inventories are generally taken at our distribution
and manufacturing facilities on a quarterly basis, and appropriate provisions
are made for missing, damaged and unsalable merchandise. In addition, we monitor
rental merchandise levels and mix by division, store and distribution center, as
well as the average age of merchandise on hand. If unsalable rental merchandise
cannot be returned to vendors, it's adjusted to its net realizable value or
written off.
All rental merchandise is available for rental and sale. On a monthly basis,
we write off damaged, lost or unsalable merchandise as identified. These
write-offs totaled approximately $10.1 million, $10 million and $8.9 million
during the years ended December 31, 2002, 2001, and 2000, respectively.
CLOSED STORE RESERVES
From time to time, Aaron Rents closes or consolidates retail stores. We
record an estimate of the future obligation related to closed stores based upon
the present value of the future lease payments and related commitments, net of
estimated sublease income which we base upon historical experience. At the years
ended December 31, 2002 and 2001, our reserve for closed stores was $1.5 million
and $3.4 million, 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, 2002.
INSURANCE PROGRAMS
Aaron Rents maintains insurance contracts for paying of workers'
compensation and group health insurance claims. Using actuarial analysis and
projections, we estimate the liabilities associated with open and incurred but
not reported workers compensation claims. This analysis is based upon an
assessment of the likely outcome or historical experience, net of any stop loss
or other supplementary coverages. We also calculate the projected outstanding
plan liability for our group health insurance program.
Our liability for workers compensation insurance claims and group health
insurance was approximately $3.1 million and $3.3 million, respectively, at the
years ended December 31, 2002 and 2001.
If we resolve existing workers compensation claims for amounts which 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, 2002.
Additionally, if the actual group health insurance liability exceeds our
projection, we will be required to pay additional amounts beyond those accrued
at December 31, 2002.
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.
FORWARD LOOKING STATEMENTS
Certain written and oral statements made by our Company may constitute
"forward-looking statements" as defined under the Private Securities Litigation
Reform Act of 1995, including statements made in this report and other filings
with the Securities and Exchange Commission. All statements which address
operating performance, events, or developments that we expect or anticipate will
occur in the future--including growth in store openings and franchises awarded,
market share, and statements expressing general optimism about future operating
results-- are forward-looking statements. Forward-looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially. The Company undertakes no obligation to publicly update or revise
any forward-looking statements. For a discussion of such risks and uncertainties
see "Certain Factors Affecting Forward-Looking Statements" in the Company's
Annual Report on Form 10-K for fiscal 2002, filed with the Securities and
Exchange Commission, which discussion is incorporated herein by this reference.
<Page>
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA) 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash $ 96 $ 93
Accounts Receivable 26,973 25,411
Rental Merchandise 470,225 392,532
Less: Accumulated Depreciation (152,938) (133,600)
-------------------------------
317,287 258,932
Property, Plant & Equipment, Net 87,094 77,282
Goodwill, Net 25,985 22,096
Prepaid Expenses & Other Assets 26,213 13,382
-------------------------------
Total Assets $ 483,648 $ 397,196
================================================================================================================================
LIABILITIES & SHAREHOLDERS' EQUITY
Accounts Payable & Accrued Expenses $ 64,131 $ 65,344
Dividends Payable 434 399
Deferred Income Taxes Payable 50,517 20,963
Customer Deposits & Advance Payments 14,756 12,810
Credit Facilities 73,265 77,713
-------------------------------
Total Liabilities 203,103 177,229
Commitments & Contingencies
Shareholders' Equity
Preferred Stock, Par Value $1 Per Share;
Authorized: 1,000,000 Shares; None Issued
Common Stock, Non-Voting, Par Value $.50 Per Share;
Authorized: 25,000,000 Shares;
Shares Issued: 19,995,987 at December 31, 2002
and 18,270,987 at December 31, 2001 9,998 9,135
Class A Common Stock, Voting, Par Value $.50 Per Share;
Authorized: 25,000,000 Shares;
Shares Issued: 5,361,761 2,681 2,681
Additional Paid-In Capital 87,502 53,846
Retained Earnings 223,928 197,321
Accumulated Other Comprehensive Loss (1,868) (1,954)
-------------------------------
322,241 261,029
Less: Treasury Shares at Cost,
Common Stock, 2,012,470 Shares at December 31, 2002
and 2,130,421 Shares at December 31, 2001 (25,792) (26,826)
Class A Common Stock, 1,630,055 Shares at December 31, 2002
and 1,532,255 Shares at December 31, 2001 (15,904) (14,236)
-------------------------------
Total Shareholders' Equity 280,545 219,967
-------------------------------
Total Liabilities & Shareholders' Equity $ 483,648 $ 397,196
================================================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
<Page>
CONSOLIDATED STATEMENTS OF EARNINGS
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------------
REVENUES
Rentals & Fees $ 459,179 $ 403,385 $ 359,880
Retail Sales 72,698 60,481 62,417
Non-Retail Sales 88,969 66,212 65,498
Other 19,842 16,603 15,125
------------------------------------------------
640,688 546,681 502,920
================================================================================================================================
COSTS & EXPENSES
Retail Cost of Sales 53,856 43,987 44,156
Non-Retail Cost of Sales 82,407 61,999 60,996
Operating Expenses 293,346 276,682 227,587
Depreciation of Rental Merchandise 162,660 137,900 120,650
Interest 4,767 6,258 5,625
------------------------------------------------
597,036 526,826 459,014
------------------------------------------------
Earnings Before Income Taxes 43,652 19,855 43,906
Income Taxes 16,212 7,519 16,645
------------------------------------------------
Net Earnings $ 27,440 $ 12,336 $ 27,261
------------------------------------------------
Earnings Per Share $ 1.31 $ .62 $ 1.38
------------------------------------------------
Earnings Per Share Assuming Dilution 1.29 .61 1.37
================================================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<Table>
<Caption>
ACCUMULATED OTHER
COMPREHENSIVE INCOME (LOSS)
ADDITIONAL DERIVATIVES
TREASURY STOCK COMMON STOCK PAID-IN RETAINED DESIGNATED MARKETABLE
(IN THOUSANDS, EXCEPT PER SHARE) SHARES AMOUNT COMMON CLASS A CAPITAL EARNINGS AS HEDGES SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 (3,710) $ (41,592) $ 9,135 $ 2,681 $ 54,181 $ 159,313
Reacquired Shares (328) (4,625)
Dividends, $.04 per share (792)
Reissued Shares 275 3,495 (519)
Net Earnings 27,261
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 (3,763) (42,722) 9,135 2,681 53,662 185,782
Dividends, $.04 per share (797)
Reissued Shares 100 1,660 184
Net Earnings 12,336
Change in Fair Value of Financial
Instruments, Net of Income Taxes
of $1,191 $ (1,954)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 (3,663) (41,062) 9,135 2,681 53,846 197,321 (1,954)
Reacquired Shares (98) (1,667)
Stock Offering 863 33,215
Dividends, $.04 per share (833)
Reissued Shares 118 1,033 441
Net Earnings 27,440
Change in Fair Value of Financial
Instruments, Net of Income Taxes
of $51 (18) $ 104
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 (3,643) $ (41,696) $ 9,998 $ 2,681 $ 87,502 $ 223,928 $ (1,972) $ 104
===================================================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
<Page>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Earnings $ 27,440 $ 12,336 $ 27,261
Depreciation & Amortization 179,040 153,548 133,109
Deferred Income Taxes 29,554 1,168 6,576
Change in Accounts Payable &
Accrued Expenses (3,725) 27,320 (2,248)
Change in Accounts Receivable (488) (1,657) (2,607)
Other Changes, Net (10,152) (3,357) 4,074
------------------------------------------------
Cash Provided by Operating Activities 221,669 189,358 166,165
================================================================================================================================
INVESTING ACTIVITIES
Additions to Property, Plant & Equipment (42,913) (34,785) (23,761)
Book Value of Property Retired or Sold 17,723 6,605 7,326
Additions to Rental Merchandise (351,389) (237,912) (279,580)
Book Value of Rental Merchandise Sold 140,435 115,527 115,601
Contracts & Other Assets Acquired (14,033) (12,125) (14,273)
------------------------------------------------
Cash Used by Investing Activities (250,177) (162,690) (194,687)
================================================================================================================================
FINANCING ACTIVITIES
Proceeds from Credit Facilities 139,542 162,219 202,637
Repayments on Credit Facilities (143,990) (189,275) (170,628)
Dividends Paid (798) (797) (792)
Common Stock Offering 34,078
Acquisition of Treasury Stock (1,667) (4,625)
Issuance of Stock under Stock Option Plans 1,346 1,183 1,926
------------------------------------------------
Cash Provided (Used) by Financing Activities 28,511 (26,670) 28,518
------------------------------------------------
Increase (Decrease) in Cash 3 (2) (4)
Cash at Beginning of Year 93 95 99
------------------------------------------------
Cash at End of Year $ 96 $ 93 $ 95
------------------------------------------------
Cash Paid (Received) During the Year:
Interest $ 4,361 $ 6,183 $ 5,674
Income Taxes (2,151) 3,544 5,762
================================================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AS OF DECEMBER 31, 2002 AND 2001, AND FOR THE YEARS ENDED DECEMBER 31, 2002,
2001 AND 2000.
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 generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in these financial
statements and accompanying notes. Actual results could differ from those
estimates.
Line of Business -- The Company is engaged in the business of renting and
selling residential and office furniture, consumer electronics, appliances, and
other merchandise throughout the U.S. and Puerto Rico. The Company manufactures
furniture for its sales and lease ownership and rent-to-rent operations.
Rental Merchandise consists primarily of residential and office furniture,
consumer electronics, appliances, and other merchandise and is recorded at cost.
The sales and lease ownership division depreciates merchandise over the
agreement period, generally 12 to 24 months, when on rent, and 36 months, when
not on rent, to a 0% salvage value. The rent-to-rent division depreciates
merchandise over its estimated useful life which ranges from six months to 60
months, net of its salvage value which ranges from 0% to 60%. Our policies
require weekly rental merchandise counts by store managers, which includes a
write-off for unsalable, damaged, or missing merchandise inventories. Full
physical inventories are generally taken at our distribution and manufacturing
facilities on a quarterly basis, and appropriate provisions are made for
missing, damaged and unsalable merchandise. In addition, we monitor rental
merchandise levels and mix by division, store, and distribution 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 and sale. On a monthly basis,
we write off damaged, lost or unsalable merchandise as identified. These
write-offs, recorded as a component of operating expenses, totaled approximately
$10.1 million, $10 million and $8.9 million during the years ended December
31, 2002, 2001, and 2000, respectively. See Note B.
Property, Plant, and Equipment are recorded at cost. Depreciation and
amortization are computed on a straight-line basis over the estimated useful
lives of the respective assets, which are from 8 to 40 years for buildings and
improvements and from 1 to 5 years for other depreciable property and equipment.
Gains and losses related to dispositions and retirements are expensed as
incurred. Maintenance and repairs are also expensed as incurred; renewals and
betterments are capitalized.
Deferred Income Taxes are provided for temporary differences between the
amounts of assets and liabilities for financial and tax reporting purposes. Such
temporary differences arise principally from the use of accelerated depreciation
methods on rental merchandise for tax purposes.
Cost of Sales includes the net book value of merchandise sold, primarily
using specific identification in the sales and lease ownership division and
first-in, first-out in the rent-to-rent division. It is not practicable to
allocate operating expenses between selling and rental operations.
Shipping and Handling Costs -- Shipping and handling costs are classified as
operating expenses in the accompanying consolidated statements of earnings and
totaled approximately $20,554,000 in 2002, $18,965,000 in 2001, and $17,397,000
in 2000.
Advertising -- The Company expenses advertising costs as incurred. Such
costs aggregated $15,406,000 in 2002, $14,204,000 in 2001, and $11,937,000 in
2000.
Stock Based Compensation -- The Company has elected to follow Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES and
related Interpretations in accounting for its employee stock options and adopted
the disclosure-only provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION (SFAS No. 123). The
Company grants stock options for a fixed number of shares to employees with an
exercise price equal to the fair value of the shares at the date of grant and,
accordingly, recognizes no compensation expense for the stock option grants.
Income tax benefits resulting from stock option exercises credited to additional
paid-in capital totaled approximately $341,000, $288,000, and $540,000, in 2002,
2001, and 2000, respectively.
Goodwill -- Goodwill primarily represents the excess of the purchase price
paid over the fair value of the net assets acquired in connection with business
acquisitions. Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS
(SFAS No. 142). SFAS No. 142 requires that entities assess the fair value of the
net assets underlying all acquisition-related goodwill on a reporting unit basis
effective beginning in 2002. When the fair value is less than the related
carrying value, entities are required to reduce the amount of goodwill (see Note
B). The approach to evaluating the recoverability of goodwill as outlined in
SFAS No. 142 requires the use of valuation techniques utilizing estimates and
assumptions about projected future operating results and other variables. The
impairment only approach required by SFAS No. 142 may have the effect of
increasing the volatility of the Company's earnings if goodwill impairment
occurs at a future date.
Long-Lived Assets Other Than Goodwill -- 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 are 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.
Fair Value of Financial Instruments -- The carrying amounts reflected in the
consolidated balance sheets for cash, accounts receivable, bank, and other debt
approximate their respective fair values. The fair value of the liability for
interest rate swap agreements, included in accounts payable and accrued expenses
in the consolidated balance sheet, was approximately $3,321,000 and $3,145,000
at December 31, 2002 and 2001, respectively, based upon quotes from financial
institutions. At December 31, 2002 and 2001, the carrying amount for variable
rate debt approximates fair market value since the interest rates on these
instruments are reset periodically to current market rates.
At December 31, 2002, the fair market value of fixed rate long-term debt was
approximately $51,074,000, based primarily
<Page>
on quoted prices for these or similar instruments. The fair value of fixed rate
long-term debt was estimated by calculating the present value of anticipated
cash flows. The discount rate used was an estimated borrowing rate for similar
debt instruments with like maturities.
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. The Company maintains ownership of the rental
merchandise until all payments are received under sales and lease ownership
agreements. Revenues from the sale of residential and office furniture and other
merchandise are recognized at the time of shipment which is when title and risk
of ownership are transferred to the customer.
Franchisees pay a non-refundable initial franchise fee of $35,000 for each
store opened and an ongoing royalty of 5% of cash receipts. Franchise fees and
area development franchise fees are generated from the sale of rights to
develop, own, and operate Aaron's Sales & Lease Ownership stores. These fees are
recognized when substantially all of the Company's obligations per location are
satisfied (generally at the date of the store opening). Prior to opening, the
franchisees are provided support in creating a business plan, site selection
services, marketing analysis, and training, and are provided necessary computer
software and assistance in advertising and publicity to reach the market area of
each store. Franchise fees and area development fees received prior to the
substantial completion of the Company's obligations are deferred. The ongoing
royalties are recognized in the period earned. In addition, on a monthly basis,
the Company recognizes servicing and guarantee fees as earned associated with
the Company-sponsored franchise loan program. The Company includes this income
in Other Revenues in the Consolidated Statements of Earnings.
Allowance for Uncollectible Accounts Receivable -- The Company had an
allowance for uncollectible accounts receivable of $1,300,000 as of December 31,
2002.
Closed Store Reserves -- From time to time the Company closes
under-performing stores. The charges related to the closing of these stores
primarily consist of reserving the net present value of future minimum payments
under the store's real estate leases.
Insurance Reserves -- Estimated insurance reserves are accrued primarily for
group health and workers compensation benefits provided to the Company's
employees. Estimates for these insurance reserves are made based on actual
reported but unpaid claims and actuarial analysis of the projected claims run
off for both reported and unreported but incurred claims.
Derivative Instruments and Hedging Activities -- From time to time, the
Company uses interest rate swap agreements to synthetically manage the interest
rate characteristics of a portion of its outstanding debt and to limit the
Company's exposure to rising interest rates. The Company designates at inception
that interest rate swap agreements hedge risks associated with future variable
interest payments and monitors each swap agreement to determine if it remains an
effective hedge. The effectiveness of the derivative as a hedge is based on a
high correlation between changes in the value of the underlying hedged item. The
ineffectiveness related to the Company's derivative transactions is not
material. The Company records amounts to be received or paid as a result of
interest rate swap agreements as an adjustment to interest expense, or in the
case of variable payment lease obligations, as an adjustment to net expenses. At
December 31, 2002, the notional amount of approximately $28,000,000 of the
Company's interest rate swaps were designated as effective cash flow hedges, and
approximately $32,000,000 were not being utilized as a hedge of variable
obligations. In the event of early termination or redesignation of interest rate
swap agreements, any resulting gain or loss would be deferred and amortized as
an adjustment to interest expense of the related debt instrument over the
remaining term of the original contract life of the agreement. In the event of
early extinguishment of a designated debt obligation, any realized or unrealized
gain or loss from the associated swap would be recognized in income at the time
of extinguishment. The Company does not enter into derivatives for speculative
or trading purposes.
Comprehensive Income -- Comprehensive income totaled $27,526,000,
$10,382,000, and $27,261,000, for the years ended December 31, 2002, 2001, and
2000, respectively.
New Accounting Pronouncements -- Effective January 1, 2002, the Company
adopted SFAS No. 141, BUSINESS COMBINATIONS (SFAS No. 141), and SFAS No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS (SFAS No. 142). SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. SFAS No. 142 requires that entities assess the
fair value of the net assets underlying all acquisition-related goodwill on a
reporting unit basis. See Note B.
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES (SFAS
No. 146) which addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING) (EITF 94-3). SFAS No. 146 requires that a liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred as opposed to the date of an entity's commitment to an exit plan. SFAS
No. 146 also establishes fair value as the objective for initial measurement of
the liability. SFAS No. 146 is effective for exit or disposal activities that
are initiated after December 31, 2002. The Company does not expect SFAS No. 146
to have a significant impact on the Company's financial statements.
In December, 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION -- TRANSITION AND DISCLOSURE (SFAS No. 148). SFAS No. 148 amends
SFAS No. 123 to provide alternative methods of transition to SFAS No. 123's fair
value method of accounting for stock-based employee compensation. SFAS No. 148
also amends the disclosure provisions of SFAS No. 123 and Accounting Principles
Board Opinion No. 28, INTERIM FINANCIAL REPORTING, to require disclosure in the
summary of significant accounting policies of the effects of an entity's
accounting policy with respect to stock-based employee compensation on reported
net income and earnings per share in annual and interim financial statements.
The disclosure provisions of SFAS No. 148 are applicable to all companies with
stock-based employee compensation, regardless of whether they account for that
compensation using the fair value method of SFAS No. 123 or the intrinsic value
method of APB Opinion No. 25. SFAS No. 148's amendment of the transition and
annual disclosure requirements of SFAS No. 123 are effective for fiscal years
ending after December 15, 2002. The additional disclosures required under SFAS
No. 148 have been included in Note I.
In November, 2002, the FASB issued Interpretation Number 45, GUARANTOR'S
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS (FIN 45). FIN
<Page>
45 requires an entity to disclose in its interim and annual financial
statements information with respect to its obligations under certain guarantees
that it has issued. It also requires an entity to recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements of FIN 45 are effective for
interim and annual periods ending after December 15, 2002. These disclosures are
presented in Note G. The initial recognition and measurement requirements of FIN
45 are effective prospectively for guarantees issued or modified after December
31, 2002. The Company is currently assessing the initial measurement
requirements of FIN 45. However, management does not believe that the
recognition requirements will have a material impact on the Company's financial
position or results of operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB No. 51.
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN46 must be applied for the first interim
or annual period beginning after June 15, 2003. The adoption is not expected to
have a material effect on the Company's financial statements.
In January 2003, the Emerging Issues Task Force (EITF) of the FASB issued
EITF Issue No. 02-16, ACCOUNTING BY A CUSTOMER (INCLUDING A RESELLER) FOR
CERTAIN CONSIDERATION RECEIVED FROM A VENDOR (EITF 02-16). EITF 02-16 addresses
accounting and reporting issues related to how a reseller should account for
cash consideration received from vendors. Generally, cash consideration received
from vendors is presumed to be a reduction of the prices of the vendor's
products or services and should, therefore, be characterized as a reduction of
cost of sales when recognized in the customer's income statement. However, under
certain circumstances this presumption may be overcome and recognition as
revenue or as a reduction of other costs in the income statement may be
appropriate. While the Company does receive cash consideration from vendors
subject to the provisions of EITF 02-16, the Company has not yet completed its
evaluation of the potential impact on its financial statements. EITF 02-16 is
effective for fiscal periods beginning after December 15, 2002.
NOTE B: ACCOUNTING CHANGES
Effective January 1, 2002, the Company prospectively changed its method
of depreciation for sales and lease ownership rental merchandise. Previously,
all sales and lease ownership rental merchandise began being depreciated when
received at the store over a period of the shorter of 36 months or the length
of the rental period(s), to a salvage value of zero. Due to changes in
business, the Company changed the depreciation method such that sales and
lease ownership rental merchandise received into a store begins being
depreciated at the earlier of the expiration of 12 months from the date of
acquisition, or upon being subject to a sales and lease ownership agreement.
Under the previous and the new depreciation method, rental merchandise in
distribution centers does not begin being depreciated until 12 months from
the date of acquisition. The Company believes the new depreciation method
results in a better matching of the costs of rental merchandise with the
corresponding revenue. The change in method of depreciation had the effect of
increasing net income by approximately $3,038,000, or approximately $.14
diluted earnings per share, for the year ended December 31, 2002.
Effective January 1, 2002, the Company adopted SFAS No. 141 and SFAS No.
142. SFAS No. 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. SFAS No. 142 requires
that entities assess the fair value of the net assets underlying all
acquisition-related goodwill on a reporting unit basis effective beginning in
2002. When fair value is less than the related carrying value, entities are
required to reduce the amount of goodwill. The Company performed Step 1 of the
required transitional impairment test under SFAS No. 142 using a combination of
the market value and comparable transaction approaches to business enterprise
valuation. The Company concluded that the enterprise fair value of the Company's
reporting units was greater than the carrying value and, accordingly, no further
impairment analysis was considered necessary.
Prior to the adoption of SFAS No. 142, the Company amortized goodwill over
estimated useful lives up to a maximum of 20 years. Had the Company accounted
for goodwill consistent with the provisions of SFAS No. 142 in prior years, the
Company's earnings would have been affected as follows:
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
(IN THOUSANDS, DECEMBER 31, DECEMBER 31, DECEMBER 31,
EXCEPT PER SHARE) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Net earnings, as reported $ 27,440 $ 12,336 $ 27,261
Add back: Goodwill amortization, net of tax 688 431
------------------------------------------------
Net earnings, as adjusted $ 27,440 $ 13,024 $ 27,692
========================================================================================================
Basic earnings per common share:
As reported $ 1.31 $ .62 $ 1.38
Add back: Goodwill amortization .03 .02
------------------------------------------------
As adjusted $ 1.31 $ .65 $ 1.40
------------------------------------------------
Diluted earnings per common share:
As reported $ 1.29 $ .61 $ 1.37
Add back: Goodwill amortization .03 .02
------------------------------------------------
As adjusted $ 1.29 $ .64 $ 1.39
========================================================================================================
</Table>
NOTE C: EARNINGS PER SHARE
Earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding during the year, which were
20,909,000 shares in 2002, 19,928,000 shares in 2001, and 19,825,000 shares in
2000. 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 324,000 in 2002, 214,000 in 2001, and 142,000 in 2000, respectively.
<Page>
NOTE D: PROPERTY, PLANT & EQUIPMENT
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001
- ----------------------------------------------------------------------------------------
Land $ 9,077 $ 10,504
Buildings & Improvements 32,943 37,570
Leasehold Improvements & Signs 44,587 38,214
Fixtures & Equipment 29,768 28,357
Assets Under Capital Lease:
With Related Parties 10,308
With Unrelated Parties 1,432
Construction in Progress 4,318 1,788
-------------------------------
132,433 116,433
Less: Accumulated Depreciation & Amortization (45,339) (39,151)
-------------------------------
$ 87,094 $ 77,282
========================================================================================
</Table>
NOTE E: CREDIT FACILITIES
Following is a summary of the Company's credit facilities at December 31:
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001
- ----------------------------------------------------------------------------------------
Bank Debt $ 7,325 $ 72,397
Private Placement 50,000
Capital Lease Obligation:
With Related Parties 10,308
With Unrelated Parties 1,432
Other Debt 4,200 5,316
-------------------------------
$ 73,265 $ 77,713
========================================================================================
</Table>
Bank Debt -- The Company has a revolving credit agreement dated
March 30, 2001 with several banks providing for unsecured borrowings up to
$110,000,000, which includes an $8,000,000 credit line to fund daily working
capital requirements. Amounts borrowed bear interest at the lower of the
lender's prime rate or LIBOR plus 1.25%. The pricing under the working capital
line is based upon overnight bank borrowing rates. At December 31, 2002 and
2001, an aggregate of $7,325,000 (bearing interest at 2.65%) and $72,397,000
(bearing interest at 3.21%) was outstanding under the current and prior
revolving credit agreements, respectively. The Company pays a .25% commitment
fee on unused balances. The weighted average interest rate on borrowings under
the revolving credit agreement (before giving effect to interest rate swaps) was
3.86% in 2002, 5.77% in 2001, and 7.07% in 2000. The revolving credit agreement
expires March 30, 2004.
The revolving credit agreement contains certain covenants which require that
the Company not permit its consolidated net worth as of the last day of any
fiscal quarter to be less than the sum of (a) $187,675,000 plus (b) 50% of the
Company's consolidated net income (but not loss) for the period beginning
January 1, 2001 and ending on the last day of such fiscal quarter plus (c) 100%
of the net proceeds of $34,078,000 from an underwritten public offering of
1,725,000 newly-issued shares of its common stock in June 2002. It also places
other restrictions on additional borrowings and requires the maintenance of
certain financial ratios. At December 31, 2002, $37,901,000 of retained earnings
were available for dividend payments and stock repurchases under the debt
restrictions, and the Company was in compliance with all covenants.
Private Placement -- On August 14, 2002 the Company sold $50,000,000 in
aggregate principal amount of senior unsecured notes (the Notes) in a private
placement to a consortium of insurance companies. The Notes mature August 13,
2009. Quarterly interest only payments at 6.88% are due for the first two years
followed by annual $10,000,000 principal repayments plus interest for the five
years thereafter.
Capital Leases with Related Parties -- In April 2002, the Company sold land
and buildings with a carrying value of approximately $6,258,000 to a limited
liability company (LLC) controlled by the Company's majority shareholder.
Simultaneously, the Company and the LLC entered into a fifteen-year lease for
the building and a portion of the land, with two five-year renewal options at
the discretion of the Company. The LLC obtained borrowings collateralized by the
land and building totalling approximately $6,401,000. The land and building
associated with the lease collateralizing the obligation are occupied by the
Company. The transaction has been accounted for as a financing in the
accompanying consolidated financial statements. The rate of interest implicit in
the lease financing is approximately 8.7%. Accordingly, the land and building
and the lease obligation are recorded in the Company's consolidated financial
statements. No gain or loss was recognized associated with this transaction.
In December 2002, the Company sold 11 properties, including leasehold
improvements, to a separate limited liability company (LLC) controlled by a
group of Company executives and managers, including the Company's majority
shareholder. The LLC obtained borrowings collateralized by land and buildings
totalling approximately $5 million. Simultaneously, the Company and the LLC
entered into 11 separate fifteen-year leases for the land and buildings, each
lease containing one five-year renewal option at the discretion of the
Company. The land and buildings associated with the lease collateralizing the
obligation are occupied by the Company. The transactions have been accounted
for as capital leases in the accompanying consolidated financial statements.
The rate of interest implicit in the leases is approximately 11.1%.
Accordingly, the land and buildings and the lease obligations are recorded in
the Company's consolidated financial statements. No gain or loss was
recognized associated with this transaction.
Other Debt -- Other debt at December 31, 2002 is comprised of $4,200,000 of
industrial development corporation revenue bonds. The average weighted borrowing
rate on these bonds in 2002 was 1.60%. No principal payments are due on the
bonds until maturity in 2015.
<Page>
Future principal maturities under the Company's credit facilities are as
follows:
<Table>
2003 $ 277
2004 7,713
2005 10,425
2006 10,464
2007 10,556
Thereafter 33,830
=======================================================================
</Table>
NOTE F: INCOME TAXES
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Current Income Tax (Benefit) Expense:
Federal $ (11,431) $ 6,239 $ 9,461
State (1,911) 112 608
------------------------------------------------
(13,342) 6,351 10,069
Deferred Income Tax Expense:
Federal 26,209 953 5,520
State 3,345 215 1,056
------------------------------------------------
29,554 1,168 6,576
------------------------------------------------
$ 16,212 $ 7,519 $ 16,645
=========================================================================================================
</Table>
Significant components of the Company's deferred income tax liabilities and
assets are as follows:
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001
- ----------------------------------------------------------------------------------------
Deferred Tax Liabilities:
Rental Merchandise and
Property, Plant & Equipment $ 59,432 $ 28,852
Other, Net 3,486 1,376
-------------------------------
Total Deferred Tax Liabilities 62,918 30,228
Deferred Tax Assets:
Accrued Liabilities 1,211 2,702
Advance Payments 5,371 3,512
Other, Net 5,819 3,051
-------------------------------
Total Deferred Tax Assets 12,401 9,265
-------------------------------
Net Deferred Tax Liabilities $ 50,517 $ 20,963
========================================================================================
</Table>
<Page>
The Company's effective tax rate differs from the federal income tax
statutory rate as follows:
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Statutory Rate 35.0% 35.0% 35.0%
Increases in Taxes
Resulting From:
State Income Taxes,
Net of Federal Income Tax Benefit 2.1 1.1 2.5
Other, Net 1.8 0.4
------------------------------------------------
Effective Tax Rate 37.1% 37.9% 37.9%
=========================================================================================================
</Table>
NOTE G: COMMITMENTS
The Company leases warehouse and retail store space for substantially all of
its operations under operating leases expiring at various times through 2015.
The Company also leases certain properties under capital leases which are more
fully described in Note E. Most of the operating 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 which do not
represent bargain purchase options. In addition, certain properties occupied
under operating leases contain normal purchase options. The Company also has a
$25,000,000 construction and lease facility. Properties acquired by the lessor
are purchased or constructed and then leased to the Company under operating
lease agreements. The total amount advanced and outstanding under this facility
at December 31, 2002 was approximately $24,700,000. Since the resulting leases
are operating leases, no debt obligation is recorded on the Company's balance
sheet. The Company also leases transportation and computer equipment under
operating leases expiring during the next three to 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, 2002, are as follows: $33,325,000 in 2003; $27,847,000 in 2004; $19,831,000
in 2005; $12,596,000 in 2006; $6,829,000 in 2007; and $7,100,000 thereafter.
Certain operating leases expiring in 2006 contain residual value guarantee
provisions and other guarantees in the event of a default. Although the
likelihood of funding under these guarantees is considered by the Company to be
remote, the maximum amount the Company may be liable for under such guarantees
is approximately $24,700,000.
Rental expense was $38,970,000 in 2002, $36,506,000 in 2001, and $30,659,000
in 2000.
The Company leases one building from a partnership of which an officer of
the Company is a partner under an operating lease expiring in 2008 for annual
rentals aggregating $212,700.
<Page>
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 $453,000 in 2002, $436,000 in
2001; and $427,000 in 2000.
NOTE H: SHAREHOLDERS' EQUITY
In February 1999, the Company's Board of Directors authorized the repurchase
of up to 2,000,000 shares of the Company's Common Stock and/or Class A Common
Stock. During 2002, 97,800 shares of the Company's Class A Common Stock were
purchased at an aggregate cost of $1,667,490 and 9,884 shares of the Company's
Common Stock were transferred back into treasury at an aggregate cost of
$218,000. The Company was authorized to purchase an additional 1,186,890 shares
and held a total of 3,642,525 common shares in its treasury at December 31,
2002. The Company's 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.
The Company has 1,000,000 shares of Preferred Stock authorized. The shares
were issuable in series with terms for each series fixed by the Board and such
issuance is subject to approval by the Board of Directors. No preferred shares
have been issued.
NOTE I: STOCK OPTIONS
The Company has stock option plans under which options to purchase shares of
the Company's Common Stock are granted to certain key employees. Under the
plans, options granted become exercisable after a period of two or three years
and unexercised options lapse five or ten years after the date of the grant.
Options are subject to forfeiture upon termination of service. Under the plans,
1,817,000 of the Company shares were reserved for issuance at December 31, 2002.
The weighted average fair value of options granted was $9.84 in 2002, $9.68 in
2001, and $8.11 in 2000.
Pro forma information regarding net earnings and earnings per share is
required by FAS 123, and has been determined as if the Company had accounted for
its employee stock options granted in 2002, 2001, and 2000 under the fair value
method. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted average
assumptions for 2002, 2001, and 2000, respectively: risk-free interest rates of
5.78%, 6.05%, and 6.47%, a dividend yield of .18%, .24%, and .28%; a volatility
factor of the expected market price of the Company's Common Stock of .46, .45,
and .45; and a weighted average expected life of the option of 5 years in 2002,
and eight years for all other years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures under SFAS No. 123 as amended by SFAS
No. 148, the estimated fair value of the options is amortized to expense over
the options' vesting period. The following table illustrates the effect on net
earnings and earnings per share as if the fair value based method had been
applied to all outstanding and unvested awards in each period:
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
(IN THOUSANDS, DECEMBER 31, DECEMBER 31, DECEMBER 31,
EXCEPT PER SHARE) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Net earnings as reported $ 27,440 $ 12,336 $ 27,261
Deduct: total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,165) (1,262) (1,351)
------------------------------------------------
Pro forma net earnings $ 26,275 $ 11,074 $ 25,910
------------------------------------------------
Earnings per share:
Basic -- as reported $ 1.31 $ .62 $ 1.38
------------------------------------------------
Basic -- pro forma $ 1.26 $ .56 $ 1.31
------------------------------------------------
Diluted -- as reported $ 1.29 $ .61 $ 1.37
------------------------------------------------
Diluted -- pro forma $ 1.24 $ .55 $ 1.30
=========================================================================================================
</Table>
The table below summarizes option activity for the periods indicated in the
Company's stock option plans.
<Table>
<Caption>
WEIGHTED
AVERAGE
(IN THOUSANDS, EXERCISE
EXCEPT PER SHARE) OPTIONS PRICE
- ----------------------------------------------------------------------------------------
Outstanding at December 31, 1999 1,302 $ 12.17
Granted 405 13.73
Exercised (235) 8.22
Forfeited (95) 16.18
- ----------------------------------------------------------------------------------------
Outstanding at December 31, 2000 1,377 13.02
Granted 133 16.30
Exercised (110) 10.77
Forfeited (99) 16.44
- ----------------------------------------------------------------------------------------
Outstanding at December 31, 2001 1,301 13.29
Granted 205 20.86
Exercised (98) 13.77
Forfeited (70) 17.34
- ----------------------------------------------------------------------------------------
Outstanding at December 31, 2002 1,338 14.21
- ----------------------------------------------------------------------------------------
Exercisable at December 31, 2002 714 $ 12.47
========================================================================================
</Table>
<Page>
The following table summarizes information about stock options outstanding
at December 31, 2002.
<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE
NUMBER OUTSTANDING REMAINING WEIGHTED AVERAGE NUMBER EXERCISABLE WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES DECEMBER 31, 2002 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2002 EXERCISE PRICE
- ---------------------------------------------------------------------------------------------------------------------------------
$ 9.87 - $ 10.00 411,800 3.27 years $ 9.88 411,800 $ 9.88
10.01 - 15.00 408,000 7.42 years 13.38 90,500 13.13
15.01 - 20.86 517,850 6.92 years 16.87 211,350 17.26
- ---------------------------------------------------------------------------------------------------------------------------------
$ 9.87 - $ 20.86 1,337,650 6.23 years $ 14.21 713,650 $ 12.47
=================================================================================================================================
</Table>
NOTE J: FRANCHISING OF AARON'S SALES & LEASE OWNERSHIP STORES
The Company franchises Aaron's Sales & Lease Ownership stores. As of
December 31, 2002 and 2001, 445 and 299 franchises had been awarded,
respectively. Franchisees pay a non-refundable initial franchise fee of $35,000
and an ongoing royalty of 5% of cash receipts. Franchise fees and area
development franchise fees are generated from the sale of rights to develop,
own, and operate Aaron's Sales & Lease Ownership stores. These fees are
recognized when substantially all of the Company's obligations per location are
satisfied, generally at the date of the store opening. Franchise fees and area
development fees received prior to the substantial completion of the Company's
obligations are deferred. The Company includes this income in Other Revenues in
the Consolidated Statement of Earnings.
The Company has guaranteed certain debt obligations of some of the
franchisees amounting to $63,704,000 at December 31, 2002. The Company receives
a guarantee and servicing fee based on such franchisees' outstanding debt
obligations which is recognized as income is earned. The Company has recourse
rights to the assets securing the debt obligations. As a result, the Company
does not expect to incur any significant losses under these guarantees.
NOTE K: ACQUISITIONS AND DISPOSITIONS
In 2000, the Company acquired 20 sales and lease ownership stores including
nine stores purchased from franchisees and 10 stores located in Puerto Rico. The
aggregate purchase price of these 2000 acquisitions was $14,273,000 and the
excess cost over the fair market value of tangible assets acquired was
approximately $7,150,000. During 2001, the Company acquired 23 sales and lease
ownership stores including 13 stores purchased from franchisees. The aggregate
purchase price of these 2001 acquisitions was $10,423,000 and the excess cost
over the fair market value of tangible assets acquired was approximately
$4,553,000. Also, in 2001 the Company acquired two rent-to-rent stores. The
aggregate purchase price of these 2001 rent-to-rent acquisitions was not
significant. During 2002, the Company acquired 10 sales and lease ownership
stores and 25 credit retail stores with an aggregate purchase price of
$14,033,000. The excess cost over the fair market value of tangible assets
acquired, representing goodwill, was approximately $3,889,000.
These acquisitions were accounted for under the purchase method and,
accordingly, the results of operations of the acquired businesses are included
in the Company's results of operations from their dates of acquisition. The
effect of these acquisitions on the 2002, 2001, and 2000 consolidated financial
statements was not significant.
In 2002, the Company sold four of its sales and lease ownership stores to an
existing franchisee. In 2001, the Company sold three of its sales and lease
ownership stores to existing franchisees and sold five of its rent-to-rent
stores. In 2000, the Company sold four of its rent-to-rent stores. The effect of
these sales on the consolidated financial statements was not significant.
NOTE L: SEGMENTS
DESCRIPTION OF PRODUCTS AND SERVICES OF REPORTABLE SEGMENTS
Aaron Rents, Inc. has four reportable segments: sales and lease ownership,
rent-to-rent, franchise, and manufacturing. The sales and lease ownership
division offers electronics, residential furniture, and appliances to consumers
primarily on a monthly payment basis with no credit requirements. The
rent-to-rent division rents and sells residential and office furniture to
businesses and consumers who meet certain minimum credit requirements. The
Company's franchise operation sells and supports franchises of its sales and
lease ownership concept. The manufacturing division manufactures upholstery,
office furniture, lamps, and accessories, and bedding predominantly for use by
the other divisions.
MEASUREMENT OF SEGMENT PROFIT OR LOSS AND SEGMENT ASSETS
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 segments are the same as those described in the summary of
significant accounting policies except that the sales and lease ownership
division revenues and certain other items are presented on a cash basis.
Intersegment sales are completed at internally negotiated amounts ensuring
competitiveness with outside vendors. Since the intersegment
<Page>
profit and loss affects 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.
Revenues in the "Other" category are primarily from leasing space to
unrelated, third parties in our corporate headquarters building and revenues
from several minor unrelated activities. The pretax losses in the "Other"
category are the net result of the profit and losses from leasing a portion of
the corporate headquarters and several minor unrelated activities, and the
portion of corporate overhead not allocated to the reportable segments for
management purposes. The significant increase in "Other" losses before income
taxes in 2001 and 2002 as compared to 2000 relates to the under allocation of
corporate expenses to the reportable segments in the periods of rising corporate
expenses.
"Other Allocations and Adjustments" are primarily comprised of the
capitalization and amortization of manufacturing variances not allocated to
the segment which holds the related rental merchandise, adjustments to the
closed store reserve, and other non-recurring adjustments not allocated to
the operating segments. The reason for the change in the "Other Allocations
and Adjustments" from 2000 to 2001 was primarily the recording of a $5.6
million charge for future lease obligations and impaired assets which were
not charged to the corresponding operating segment for management reporting
purposes.
Earnings before income taxes for each reportable segment are generally
determined in accordance with generally accepted accounting principles with the
following adjustments:
- A predetermined amount of approximately 2.2% of each reportable segments'
revenues is charged from corporate as an allocation of corporate overhead.
- Non-recurring or unusual adjustments related to store closures and rent
payments related to closed stores are not recorded on the reportable
segments financial statements, but rather maintained and controlled by
corporate headquarters.
- The capitalization and amortization of manufacturing variances is recorded
on the corporate financial statements as part of "Other Allocations and
Adjustments" and is not allocated to the segment which holds the related
rental merchandise.
- Interest on borrowings is estimated at the beginning of each year.
Interest is then allocated from corporate to operating segments on the
basis of relative total assets.
- Sales and lease ownership revenues are reported on the cash basis for
management reporting purposes.
Information on segments and a reconciliation to earnings before income taxes
are as follows:
<Table>
<Caption>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Revenues From
External Customers:
Sales & Lease Ownership $ 501,390 $ 380,404 $ 312,921
Rent-to-Rent 119,885 150,002 174,918
Franchise 16,663 13,913 12,621
Other 4,746 4,243 4,057
Manufacturing 56,002 47,035 54,340
Elimination of Intersegment Revenues (56,141) (47,801) (54,807)
Cash to Accrual Adjustments (1,857) (1,115) (1,130)
------------------------------------------------
Total Revenues From External Customers $ 640,688 $ 546,681 $ 502,920
------------------------------------------------
Earnings Before Income Taxes:
Sales & Lease Ownership $ 31,220 $ 11,314 $ 19,527
Rent-to-Rent 9,057 9,152 16,346
Franchise 10,919 9,212 7,484
Other (5,544) (3,244) (943)
Manufacturing 989 (587) 728
------------------------------------------------
Earnings Before Income
Taxes For Reportable Segments 46,641 25,847 43,142
Elimination of Intersegment Loss (760) (1,449) (441)
Cash to Accrual Adjustments (3,259) (1,151) (804)
Other Allocations & Adjustments 1,030 (3,392) 2,009
------------------------------------------------
Total Earnings Before Income Taxes $ 43,652 $ 19,855 $ 43,906
------------------------------------------------
Assets:
Sales & Lease Ownership $ 327,845 $ 241,245 $ 205,043
Rent-to-Rent 89,133 107,882 128,163
Franchise 12,627 13,991 12,961
Other 35,488 17,533 17,485
Manufacturing 18,555 16,545 16,727
------------------------------------------------
Total Assets $ 483,648 $ 397,196 $ 380,379
------------------------------------------------
Depreciation & Amortization:
Sales & Lease Ownership $ 154,310 $ 121,953 $ 97,139
Rent-to-Rent 22,901 29,736 34,557
Franchise 486 444 412
Other 541 690 354
Manufacturing 802 725 647
------------------------------------------------
Total Depreciation & Amortization $ 179,040 $ 153,548 $ 133,109
------------------------------------------------
Interest Expense:
Sales & Lease Ownership $ 4,768 $ 4,620 $ 2,750
Rent-to-Rent 2,493 3,010 2,496
Franchise 83 119 144
Other (2,577) (1,491) 235
------------------------------------------------
Total Interest Expense $ 4,767 $ 6,258 $ 5,625
=========================================================================================================
</Table>
<Page>
NOTE M: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<Table>
<Caption>
FIRST SECOND THIRD FOURTH
(IN THOUSANDS, EXCEPT PER SHARE) QUARTER QUARTER QUARTER QUARTER
- -----------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002
Revenues $ 156,663 $ 151,162 $ 157,838 $ 175,025
Gross Profit 79,074 78,822 79,948 84,079
Earnings Before Taxes 9,457 10,666 10,669 12,860
Net Earnings 5,921 6,696 6,721 8,102
Earnings Per Share .30 .33 .31 .37
Earnings Per Share Assuming Dilution .29 .32 .31 .37
- -----------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001
Revenues $ 141,417 $ 132,763 $ 132,516 $ 139,985
Gross Profit 75,857 71,442 70,034 68,859
Earnings Before Taxes 11,802 7,998 (3,158) 3,213
Net Earnings 7,329 4,967 (1,961) 2,001
Earnings Per Share .37 .25 (.10) .10
Earnings Per Share Assuming Dilution .37 .25 (.10) .10
- -----------------------------------------------------------------------------------------------------
</Table>
In the third quarter of 2001, the Company recorded non-cash charges totaling
approximately $5.6 million, before income taxes, related to certain store
closings and related exit costs.
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF AARON RENTS, INC.:
We have audited the accompanying consolidated balance sheets of Aaron Rents,
Inc. and Subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of earnings, shareholders' equity, and cash flows for
the years ended December 31, 2002, 2001, and 2000. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Aaron Rents,
Inc. and Subsidiaries as of December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note B, on January 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS,
and changed its method of depreciating sales and lease ownership rental
merchandise.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 21, 2003
<Page>
COMMON STOCK MARKET PRICES & DIVIDENDS
The following table shows, for the periods indicated, the range of high and
low prices per share for the Common Stock and Class A Common Stock and the cash
dividends declared per share.
The Company's Common Stock and Class A Common Stock are listed on the New
York Stock Exchange under the symbols "RNT" and "RNT.A," respectively.
The approximate number of shareholders of the Company's Common Stock and
Class A Common Stock at March 14, 2003, was 2,600. The closing price for the
Common Stock and Class A Common Stock on March 14, 2003 was $18.51 and $19.55,
respectively.
Subject to our continuing to earn sufficient income, to any future capital
needs and to other contingencies, we currently expect to continue our policy of
paying dividends. Our articles of incorporation provide that no cash dividends
may be paid on our Class A 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 dividends
actually paid in the prior year. Cash
<Table>
<Caption>
CASH
DIVIDENDS
COMMON STOCK HIGH LOW PER SHARE
- ------------------------------------------------------------------
DECEMBER 31, 2002
First Quarter $ 23.15 $ 14.45
Second Quarter 28.49 20.15 .02
Third Quarter 23.60 18.50
Fourth Quarter 23.20 20.10 .02
- ------------------------------------------------------------------
DECEMBER 31, 2001
First Quarter $ 17.50 $ 13.55
Second Quarter 19.50 15.10 .02
Third Quarter 18.97 14.90
Fourth Quarter 18.20 15.00 .02
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
CASH
DIVIDENDS
CLASS A COMMON STOCK HIGH LOW PER SHARE
- ------------------------------------------------------------------
DECEMBER 31, 2002
First Quarter $ 22.25 $ 10.50
Second Quarter 27.50 21.40 .02
Third Quarter 24.60 20.60
Fourth Quarter 23.75 21.15 .02
- ------------------------------------------------------------------
DECEMBER 31, 2001
First Quarter $ 15.90 $ 12.13
Second Quarter 16.50 15.72 .02
Third Quarter 16.35 13.75
Fourth Quarter 15.25 12.50 .02
- ------------------------------------------------------------------
</Table>
STORE LOCATIONS IN THE UNITED STATES AND PUERTO RICO
[GRAPHIC]
AT DECEMBER 31, 2002
<Table>
- - COMPANY-OPERATED SALES & LEASE OWNERSHIP 387
- - FRANCHISED SALES & LEASE OWNERSHIP 232
- - RENT-TO-RENT 70
- - SIGHT & SOUND 25
----
TOTAL STORES 714
=====================================================
MANUFACTURING & DISTRIBUTION CENTERS 21
</Table>