aaron's initiation 3-3-09

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. (RJA) as of the date stated above and are subject to change. Information has been obtained from third-party sources we consider reliable, but we do not guarantee that the facts cited in the foregoing report are accurate or complete. Other departments of RJA may have information that is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report that may not be consistent with the report's conclusions. 2009 Raymond James & Associates, Inc. All Rights Reserved The Raymond James Financial Center, 880 Carillon Parkway, St. Petersburg, FL 33716

Institutional clients may call for additional information:Research 800-237-5643 Trading 800-237-8426

Aaron Rents (RNT:NYSE) Outperform 2 Budd Bugatch, CFA (727) 567-2527 [email protected] TJ McConville Research Associate (727) 567-5761 Chad Bolen Senior Research Associate (727) 567-2546

EQUITY RESEARCH

March 3, 2009

Home Retailers Initiation of Coverage

Raymond James & Associates, Inc.

Aaron Rents 2

Table of Contents

Executive Summary ............................................................................................................ 4 Investment Thesis............................................................................................................... 4

Positive Industry Characteristics: Profitability, Growth, and Barriers....................... 5 Expanding Customer Base...................................................................................... 5 Focused Business Approach................................................................................... 5 High Quality, Experienced Leadership .................................................................... 6 Valuation.................................................................................................................. 6 Stock Drivers ......................................................................................................... 10

Investment Risks............................................................................................................... 11 Aaron Rents: A Detailed Examination.............................................................................. 14

Company History: Lease Ownership Begins ........................................................ 14 Company History: Public Trading of RNT and RNT.A.......................................... 16 Revenue and Earnings Growth ............................................................................. 17 "Gross Margins"..................................................................................................... 27 Operating Expenses .............................................................................................. 28 Competition ........................................................................................................... 35 Senior Management .............................................................................................. 37 Recent Results ...................................................................................................... 38 Model and Estimates ............................................................................................. 39

Technical Analysis............................................................................................................. 41 Summary and Recommendation....................................................................................... 42

Appendices Income Statement Model .................................................................................................. 43 Common Size Income Statement Model .......................................................................... 44 Balance Sheet Model........................................................................................................ 45 Cash Flow Statement Model ............................................................................................. 46 Operating Expense Model ................................................................................................ 47 Economic Value Added Worksheet (EVA) ........................................................................ 48 Free Cash Flow Intrinsic Value Calculation ...................................................................... 49 Operating Assumptions Sensitivity Analysis ..................................................................... 50 Sample Aarons Customer Information and Order Form................................................... 51 Sample Aarons Lease Agreement & Federal Consumer Leasing Act Disclosures.......... 53 Rent-to-Own Industry Overview........................................................................................ 56

Please read disclosure/risk information on page 64 and Analyst Certification on page 68.


Aaron Rents 3

Aaron Rents (RNT:NYSE) Outperform 2 Headquartered in Atlanta, Georgia, Aaron Rents is the second largest participant in the sales and lease ownership, or rent-to-own, industry. Through its network of more than 1,000 company-owned and 500 franchised stores, Aaron Rents serves cash- or credit-constrained customers who want important quality-of-life enhancing merchandise. Aaron Rents manufactures a significant amount of the upholstered furniture and bedding it leases through its MacTavish division.

RNT: Initiating Coverage with an Outperform Rating

We initiate coverage of Aaron Rents with an Outperform rating and $28.00, twelve-month target price. Our target represents about 16x and 14x our 2009 and 2010 EPS estimates, respectively, in-line with historical averages and just above our ~13% three-year projected EPS growth rate. The target is also supported by our free cash flow and economic profit calculation of intrinsic value, detailed in the Appendix of this report.

Aaron Rents is one of two leaders in the rental purchase industry, a growing sub-segment of the retail sector. Over the past decade, as consumers have continued to adopt the rent-to-own or lease ownership transaction, industry sales have outpaced the overall economy. Furthermore, the tenets of a lease ownership transaction to be discussed later in this report become increasingly attractive during periods of tight credit and economic uncertainty.

Although Aaron Rents has been recently modified its strategy from aggressive unit growth to increased operating profitability, abundant opportunity for incremental store expansion remains. Sales growth will be driven internally and by additions of company-owned and franchised stores. Additionally, as management focuses on store profitability, there is the prospect for reaccelerating earnings growth.

Aarons management team is one of the most respected in the industry. The companys founder and current chairman of the board is a pioneer within rent-to-own and his knowledge and experience have been passed along to his son, the current CEO. Aaron Rents has a reputation for exceeding earnings expectations and delivering solidly positive comparable-store sales growth.

Despite its historically elevated valuation, the stock currently trades at a discount to historical medians. Currently, shares are priced at ~13.5x our 2009 EPS estimate, below the ~16x ten-year median. Versus its peers, the stocks valuation premium well below peak levels. We are introducing a 2009 EPS estimate of $1.80, within managements $1.72-1.87 guidance. For 2010 our EPS estimate is $2.07. Non-GAAP

EPS Q1 Q2 Q3 Q4 Full GAAP EPS

Full FY=Dec Mar Jun Sep Dec Year Year

2008A $0.42 $0.39 $0.39 $0.39 $1.55 $1.66 2009E 0.49 0.45 0.43 0.42 1.80 1.80 2010E 0.56 0.51 0.49 0.51 2.07 2.07 2011E UR UR UR UR 2.26 2.26 Rows may not add due to rounding. UR: Under Review. Non-GAAP EPS exclude earnings from discontinued operations and one-time items.

March 3, 2009

Home Retailers Initiation of Coverage

Budd Bugatch, CFA (727) 567-2527 [email protected] TJ McConville Research Associate (727) 567-5761 Chad Bolen Senior Research Associate (727) 567-2546 Current Price (3/2/2009 ) $24.32 Projected 12-Month Target Price: $28.00 52-Week Range $30.22-$15.11 Dividend/Yield $0.07/0.3% Book Value (12/08) $14.30 Suitability Growth Shares Out. (mil.) 53.4 Market Cap. (mil.) $1299 Avg. Daily Vol. (10 day) 1,034,011 Proj. 3-Yr EPS Growth Rate 13% ROE 11% LT Debt (mil.)/% Cap. $116/13% P/E Ratios (Non-GAAP) 2009E 13.5x 2010E 11.7x 2011E 10.8x Revenues (mil.) 2008A $1,593 2009E $1,759 2010E $1,947 2011E $2,126 Operating Margins 2008A 9.3% 2009E 9.4% 2010E 9.8% 2011E 9.7%


Aaron Rents 4

Executive Summary

Aaron Rents, based in Atlanta, Georgia, is one of the two largest players in the growing rent-to-own (RTO) industry. The company now focuses on lease ownership sales of home furnishings to customers that have little, no, or poor credit histories. Aarons owns and operates 1,053 store locations and franchises an additional 504 stores in 48 states and Canada. Plans are underway for additional expansion in Canada.

Founded in 1955 by Chairman R. Charles Loudermilk, Sr., Aarons initially focused on renting outdoor tents and chairs. It since has migrated into primarily a Sales and Lease Ownership (SALO) business that offers a wide variety of products and serves more than 1.1 million customers. Aaron Rents operates three distinct divisions: Sales and Lease Ownership, Corporate Furnishings, and Manufacturing.

The Aarons Sales & Lease Ownership (SALO) division is the companys largest and fastest growing division, serving credit-constrained consumers in need of basic home furnishings, appliances, and electronics. At year-end 2008 there were 1,037 company-owned stores, including 10 RIMCO outlets, and 504 franchised stores, including eight RIMCO outlets.

The companys Corporate Furnishings business serves both corporate customers with office furniture and residential furniture for employee relocations and the traditional residential customers. In the fourth quarter of 2008, the company sold substantially all of the assets of this division to CORT Business Services Corporation, a wholly owned subsidiary of Berkshire Hathaway for more than $75 million. As of year-end, there were 16 stores operating exclusively as Aarons Corporate Furnishings.

The MacTavish Furniture Industries division manufactures the majority of upholstered furniture and a significant portion of the mattresses and foundations leased, rented, and sold by Aarons.

Investment Thesis

Aaron Rents is on a roll. During the past several years, management has grown its store count aggressively through green field store openings, acquisition, conversion of independent rent-to-own (RTO) operators to the Aarons format, and expansion of its franchise program.

During this period, Aarons has focused its business almost exclusively on its Sales and Lease Ownership division by selling most of the assets of its Corporate Furnishings division, by closing underperforming stores, and shrinking other RTO concepts. In the movement of stores, 2008 was a particularly active year.

Contrary to other home furnishings and hard goods retailers, a challenging job/wage and consumer confidence environment benefits RTO operators. RTO transactions are popular with consumers that are cash-, credit-, and/or budget-constrained. As unemployment rates rise and consumers look to maintain and/or improve their living standards, RTO operators benefit by an increased pool of potential customers.

Aarons is an industry leader that caters to a better class of these cash- and/or credit-constrained customers. By virtue of its policies and practices, it has delivered consistent revenue and earnings comparisons for several years and quarterly results have exceeded estimates for each of the past five quarters. Moreover, management has recently increased its earnings outlook several times. In combination, these factors make Aarons an attractive equity to recommend.

Thomson-Reuters Insider Trading BOT/SL

last 6 months.....394,400/1,031,185

Float (mil.)............................... 53.5

Common Equity (mil.)/% of Cap ........... $762/87%


Aaron Rents 5

We initiate coverage of Aarons common stock, RNT, with an Outperform rating for the following specific reasons:

Even in its early days, the rent-to-own (RTO) or lease-ownership industry was highly profitable. In fact, the perceived too-large profits of the early players and calculated annual percentage rate proxies were the lightning rods that caused much of the negative attention directed towards the business.

Despite the criticisms, the industry continues to grow, primarily from market penetration and an expanding customer base and less so from new locations. Nevertheless, store growth opportunities still exist. We believe that within the realm of furnishing retailers few, if any, growth stories remain. Aaron Rents is one of them.

Since 1995, RTO industry revenues have grown at an above-average 5.0% compound annual growth rate (CAGR), driven by increased adoption by consumers. Over this period, there has yet to be a down year in revenue growth for the industry, with revenues actually increasing in 2001s recession.

In the current recession, the industrys popularity with consumers is growing as more consumers face financial pressures and the need for new furnishings particularly digital television increases. To many of the industrys customers, the home television is their chief source of entertainment, raising its status to a necessity.

From a Porter analysis view, the most attractive aspects of the rent-to-own industry are (a) the relatively high start-up costs that limit the threat of new entrants and (b) the comparative advantage of the lessor versus the lessee in determining price and terms, given the customers typical financial position.

Additionally, rivalry among competitors, while appearing fierce on the surface, is, on balance, relatively rational because the major players target different customer populations. That said, the industry leadership is tightly contested, and Aarons has found its own niche amongst the upper portion of the target customer - $50,000 in household income and below. Management sized this market at about 50% of the ~78 million family households in the U.S. today.

The recent economic meltdown seems likely to have long-term effects on the consumer landscape. In Aarons case, the collapse of many consumers FICO scores should drive more customers to its stores. The fact that the company does not conduct formal credit checks becomes an increasingly attractive value proposition to consumers who were forced to file for bankruptcy or suffered home foreclosures.

As evident recently, the reaction of many lending institutions to a downturn is to tighten credit. In most states, lease ownership transactions are not defined as outright sales, meaning that no additional debt is incurred by RTO customers. These important features no credit checks and no incurred new debt seem likely to be increasingly valuable to a larger number of households that previously might not rent-to-own.

Aaron Rents continues to focus and streamline its business by adjusting its corporate structure as well as its product offering. The result is a leaner operating structure that is attuned to its customers wants and needs. Recently, it sold the majority of its Aarons Corporate Furnishings division to the CORT Business Services Corporation division of Berkshire Hathaway. The sale signaled a heightened commitment by Aaron Rents management to the Sales and Lease Ownership business, its growth engine.

The necessary wants that Aarons offers include home furnishings such as furniture, electronics, and appliances. Although not necessary for basic survival, these products are all but essential for quality of life attainment for most Americans. In addition, given the relatively low levels of discretionary income of most Aarons customers, a comfortable and entertaining home is necessary since nights out are rare.

Positive Industry Characteristics:

Profitability, Growth, and Barriers

Expanding Customer Base

Focused Business Approach


Aaron Rents 6

Rent-to-own industry observers recognize that the Aarons model has revolutionized, and improved, the lease ownership business. The company focuses on providing the lowest possible total cost of ownership for its customers, consistent with acceptable profit potential, thereby maximizing the number of items a customer can obtain.

The result is a much higher customer count per store than the industry average. At the beginning of 2008, when available industry data exists, Aarons had roughly 583 customers per average company-owned store and 614 customers per store including franchises. This compares with the industry at 350 customers per store for operators with over 21 stores. At year end of 2008, Aarons had 696 customers per company-owned store and 702 customers per store including franchises. Customer count is a key indicator of successful execution in the RTO industry.

The favorable lease terms also lead to better relationships between the customers and store managers. Anecdotal reports suggest that the opening of an Aarons store in a market with pre-existing rent-to-own outlets can cause those operators to lose as much as 40% of their business if they fail to match Aarons pricing model.

Management talent is another of Aarons core advantages. Its senior executives have been with Aarons for over 75 years combined. Board Chairman R. Charles Charlie Loudermilk, Sr. (81) remains the majority holder of the companys Class-A voting stock.

Current Chief Executive Officer Robert C. Robin Loudermilk, Jr. (49) is Charlie Loudermilks son and served as the companys chief operating officer from 1997 to June 2008. Robin has been a member of the board of directors since 1982.

Gilbert Gil Danielson (62) has been Aaron Rents chief financial officer since 1990. In 1994, after the early 1990s creation to two classes of stock, he guided the initial offering of the Aarons common stock. Mr. Danielson also serves on the board of directors and has been on the board at Servidyne Inc., an office building optimization consulting firm, since 2000.

Chief Operating Officer William Ken Butler joined Aaron Rents in 1974, starting as an assistant store manager. In 1987, he was tasked to spearhead the development of Aarons rent-to-own business that led to the transition of Aarons from a rent-to-rent business. Following Robin Loudermilks promotion to CEO in June 2008, Mr. Butler was promoted to COO. Prior to that, he was president of the companys Sales and Lease Ownership division, a title that he still holds today.

The common shares of Aaron Rents have enjoyed a significant valuation premium to Rent-A-Center, its closest peer. Historically, the valuation gap between the two has ranged from 11.8 multiple turns in RCIIs favor (in 1999) to 11.5 multiple turns in RNTs favor (in 2004) on a forward P/E basis. Recently, however, RNTs premium has eroded following an upward move in RCIIs stock price. Currently, RNT trades at 4.9 multiple turns higher than RCII.

From a growth perspective, Aarons is poised to significantly outpace the RTO industry, its main competitor, and retailers in general. With just over 1,500 stores currently, Aarons management is confident that the market will support a near doubling of its base. Through the use of its franchise program, the company should be able to expand its footprint more quickly than it would on its own.

We currently project that revenues will grow at a 10% CAGR over the next three years. This will be driven primarily through continued growth at the company-owned stores as well as from franchise royalties and fees.

High Quality, Experienced Leadership

Valuation


Aaron Rents 7

Furthermore, our EPS estimates imply a 13%, three-year CAGR as the company focuses on improving store profitability.

This page and the following three delve deeply into the valuation metrics for RNT. For interested readers, the data shows 10-year historical averages for a number of metrics. For those inclined to skip the section, the main thesis is that although RNT trades at somewhat elevated valuations versus its peer, it currently is below its historical medians.

The ending figures presented are as of February 24, 2009.

We see that based on consensus estimates, RNT currently trades at 13.4x forward EPS. This compares with the approximate 10-year median multiple of 15.5x. In the lower portion of the below chart, we see that RNT typically trades at about 1.5x the RCII forward earnings multiple. Currently, shares trade at about 1.8x.

RNT Forward P/E - Compared with RCII

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On the following page, we present a similarly constructed chart that compares the forward P/E multiple of RNT to that implied by consensus estimates for the S&P 500 Index. Noting that RNT has a 10-year median of 1.0x the S&P 500 multiple, the stock currently trades at 1.2x the multiple. This is mainly a function of the overall market pullback throughout 2008 and the relative resiliency of the Aaron Rents business model and stock performance.


Aaron Rents 8

RNT Forward P/E - Compared with S&P 500

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On an absolute price-to-sales (P/S) basis, shown by the solid line in the chart below, RNT now trades at a discount to its historical median multiple. Shares trade at 0.8x trailing four quarter sales compared with the 10-year median 0.9x multiple. Relative to RCII, however, RNT trades at a premium: 1.9x, compared with its historical 10-year median premium of 1.4x.

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Aaron Rents 9

Likewise, relative to the S&P 500 P/S ratio, RNT now trades at a premium to the 10-year median multiple.

RNT P/S - Compared With the S&P 500

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Below, we extend the valuation comparison analysis to other home furnishings companies as well as Cash America and Advance America. We chose these latter issues because these companies target a similar customer base as Aaron Rents, as well as the comparability of the revenue streams.

Rent-to-Own and Other Home Furnishings Retailers Budd Bugatch, CFA 727-567-2527

RJ Div TTM NTM P/E to PEG EV / Avg Vol Mkt CapTicker Rating Price Yield P/E P/E SPX Ratio P/B P/CF P/S EBITDA (000)'s (Mil)

RNT Aaron Rents OP2 $23.31 0.3% 14.3 12.8 1.1 0.9 1.7 2.4 0.8 2.2 1,000 1,247RCII Rent-A-Center NR $17.22 0.0% 8.4 8.2 0.7 1.0 1.1 1.4 0.4 2.2 1,318 1,150HVT Haverty Furniture MP3 $7.85 0.0% - - NA - 0.6 9.7 0.2 8.6 141 167PIR Pier 1 Imports SB1 $0.20 0.0% - - NA - 0.2 - 0.0 13.6 461 18CPWM Cost Plus MP3 $0.70 0.0% - - NA - 0.2 - 0.0 33.9 41 15CSH Cash America Int'L NR $13.25 1.1% 4.4 4.5 0.4 0.4 0.7 3.1 0.4 4.1 395 384AEA Advance America NR $0.85 29.4% 1.3 1.4 0.1 0.1 0.3 0.9 0.1 2.4 177 52

Source: BASELINE, and Mean: 4.4% 7.1 6.7 0.6 0.6 0.7 3.5 0.27 9.6 505 433 Raymond James Research Median: 0.0% 6.4 6.4 0.6 0.7 0.6 2.4 0.24 4.1 395 167Updated 3/4/2009


Aaron Rents 10

Aaron Rents: 10-Year Stock Price History versus Forward EPS Estimates

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Source; Baseline, Raymond James Research. The above chart tracks Aaron Rents month-end closing stock price versus the consensus forward EPS estimate at the same time. For most of the period, the share price tracked closely with the slope and movement in estimates. More recently, the directional movements in each continue to track; but, as we noted earlier, RNTs forward multiple has contracted from its historical 15.5 median to about 13.5x. Given the positive environment for RTO and given managements increasing emphasis on improving in-store and overall profitability, it seems likely that near-term earnings revisions ours and probably consensus will be higher. Also, below we provide a historical chart showing RNTs share price movement versus trailing P/E bands. We observe that in recent years, when the shares have been valued at 15x or below, forward performance has usually been positive.

Stock Drivers


Aaron Rents 11

Aaron Rents: 10-Year Historical Trailing P/E Bands

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Investment Risks Despite these positive attributes, we remain cognizant of the following investment risks:

Despite the fact that the rent-to-own industry is typically resilient to, and thrives during, a normal recession, a longer and even more severe economy could negatively impact results at Aarons. While its customer typically has experience with job loss and/or limited spending capacity, a severely worse economic climate could dramatically increase the population of consumers that would not be able to afford the rent-to-own monthly payment for those perceived-necessary wants.

An even more dramatic economic downturn also heightens the risk of an explosion of previously on-lease inventory returning to the stores more rapidly than management could curtail new purchases. If more customers are forced to cut back, more merchandise could be forfeited to the stores. With less product moving out to new customers, Aarons could be caught with depreciating inventory that generates no income. The companys focus on re-renting or selling returned goods, as well as its MacTavish manufacturing division, should provide it with the flexibility to avoid such a scenario.

U.S. consumers have been learning about, and adopting, lease ownership transactions for more than three decades. That said, the industry is often the target of a number of consumer advocacy groups.

These advocates ignore, or minimize, the benefits of lease ownership for the RTO target consumer group and attack the industry for what they view as predatory pricing and terms toward the weakest consumers. Over the years, these views have generated a significant amount of negative publicity that continues today. A good deal of political attention has been paid to the industry over the years, as well.

Management remains vigilant in working to educate and comfort new customers about the transaction. While rent-to-own is common lingo in the public and other parts of the industry, Aarons always labels the transaction as lease ownership. The improvements in merchandise quality are also leading to less negative commentary surrounding the process.

Economic Risk

Consumer Acceptance Challenges


Aaron Rents 12

Nonetheless, if larger numbers of consumers are persuaded not to try lease ownership, results could suffer.

As noted, the RTO industry has attracted (arguably more than) its fair share of negative attention from consumer advocates as well as the government. The scrutiny results, in part, from the industrys pricing and, in part, from prior indiscretions in collection practices. Whether deserved, or not, the heightened notice is currently, and will remain, a risk for the foreseeable future.

Today, the chief source of regulation is state law, as there is now no federal regulation to set guidelines for the lease ownership industry. There are 47 states with regulation that allows rent-to-own stores, as we know them today, to operate.

The laws vary from one state to the next, but essentially, in exchange for full consumer disclosure about the terms and condition of the RTO transaction, the states deem the transaction a lease, thus maintaining the three fundamental principals of the transfer. That said, a few of these states are considering pricing modifications to the laws that would make lease-ownership a much less attractive business from an operators standpoint.

The Association of Progressive Rental Organizations (APRO) and certain members of Congress have proposed a version of a nationwide bill to govern the industry, but the bill has not achieved legislative success in the Congress and Senate. In opposition, a federal bill to designate all lease ownership transactions as credit sales, thus making them subject to state usury laws, has also been proposed by Senator Charles Schumer (D-NY). The industrys bill has attracted far greater support in Washington over the years as senators worry about potentially displaced constituents. Neither side has achieved its goal as of yet.

Should a federal law similar to that proposed by Senator Schumer be enacted and signed, the result would be severely detrimental to Aaron Rents and other RTO operators. In essence, the industry would cease to exist in its current form and it would be likely that most operators would not survive. If the current pricing bills in New York, New Jersey, Indiana, and Maine are passed, it is likely that Aarons operations within these states would cease to grow.

Aarons has developed alternative lease structures for the states that do not recognize the rental purchase transaction as a lease, but a significant portion of the customer offering is lost in these agreements. The company has stated that it does not believe that the current legislative proposals represent an immediate threat to the company.

Merits of either sides arguments aside, investors need to be aware of the potential threats of limiting regulation.

The premium valuation multiple that Aaron Rents enjoys is largely a function of its superior growth versus its peers. A significant portion of the future growth of the company will depend on the opening of new stores. Although Aarons has proven its prowess at selecting store sites, pre-opening operations, and other opening activities, there remains the risk that it will falter in future new store openings. According to management, nearly $600,000 in start-up capital (cash investment and first-year loss) is required to open new stores, most of which becomes permanent investment.

Historically, when Aarons has entered new markets, other RTO operators have had to convert to the Aarons pricing model or risk losing up to 40% of their business. However, should customer loyalty be extremely deep in a given market, it remains a risk that Aarons will not succeed in the area.

In addition to acquiring new customers and new business, the key success factor in RTO is cash collections. Despite the fact that Aarons customers tend to be the best of those who are cash-, credit-, and/or budget-constrained,

Regulatory Risk

Execution Risk: New Store Development

Execution Risk: Cash Collections


Aaron Rents 13

their customers often, if not always, do not have enough ready cash to pay each and every one of their monthly bills.

The leadership challenge given to each Aarons store manager is to NOT let one of those unpaid bills be that of his or her store. Accordingly, the store manager is vital to that since he or she must know each customer and, more importantly, know how to contact them. If the company becomes less effective in pursuing late payers or experiences an increase in the amount of losses associated with skips and stolen, results will suffer. Quarterly write-offs (skips and stolen), as a percentage of revenues, have historically ranged from 2% to 4%, in-line with industry averages.

Despite the local nature of collections, Aarons must maintain a high level of corporate operational integrity in its collection processes or risk being punished for abuses. The punishments could come from either the regulating authorities that could pursue charges against improper collections or from customers who file suit against the company. In either event, should Aaron Rents take part in inappropriate collection activities, the companys image would be tarnished.

Also very important to the future revenue and earnings growth at Aarons is managements franchising program. If the company were unable to attract qualified new franchisees, results would suffer. Currently, the companys franchises are held in high regard within the industry. If this esteem were lost, the company might find it more difficult to attract capable people.

The high initial investment required to open an Aarons franchise, or multiple Aarons franchises, as management prefers, could also pose a risk to future franchise growth, particularly in a credit-constrained business economy. As the difficult economic cycle persists and business credit remains tight, fewer entrepreneurs may have access to the necessary capital. The company attempts to combat this factor by having developed a $125 million, maximum commitment, bank loan that it guarantees. At year-end 2008, management had guaranteed $95.6 million under the franchisee loan program, of which $89.2 million was under the bank loan program.

In addition to attracting qualified franchisees, a portion of Aarons results are a function of its franchisees success. If industry outsiders or insiders operate their stores poorly and proliferate too many unsuccessful stores, the royalty stream to the corporation could shrink. Furthermore, if franchisees deliver poor customer experiences, it will reflect poorly across the chain, impacting both company-owned and other franchise stores.

Despite the barriers to entry and other positive characteristics discussed previously, RTO competitor action is always a risk to potential share gains. Aarons most visible and major competitor is Rent-A-Center, which operates just over 3,000 locations across the U.S. and Canada. As the first publicly traded rent-to-own corporation, Rent-A-Center typically is recognized as the pioneer of the industry (the McDonalds to Aaron Rents Burger King).

Additionally, as more entrepreneurs and investors become aware of RTOs attractive economics, more become interested in opening outlets. With mature store level operating profits in the mid 20s percentages, many would-be operators may be compelled to step off the sidelines and into the game.

Aarons combats this risk by opening its franchise program to such individuals, although an increasing number of other franchise groups are surfacing. Included in this group is Premier Rentals, a consortium of RTO operators who use the size of the operation for buying and advertising leverage. Other groups are likely to mirror this approach if the prospects for the industry remain positive, as we believe they will.

Despite our commentary in the Valuation section, Aaron Rents stock still tends to trade at somewhat lofty valuations on most metrics. The market appears comfortable with rewarding the companys growth and profitability track record

Execution Risk: Franchisee Development

Competitive Risk

Valuation Risk


Aaron Rents 14

with a premium multiple. That said, should the company fail to meet or possibly to exceed expectations, there is risk of rapid and meaningful multiple compression.

Aaron Rents: A Detailed Examination

Headquartered in Atlanta, Georgia, Aaron Rents is a leading specialty retailer of consumer electronics, computers, residential and office furniture, household appliances, and accessories. It was founded in 1955 by Board Chairman R. Charles Loudermilk, Sr.

At its founding, Aaron Rents specialized in renting chairs and tents for outdoor gatherings. Aarons rent-to-rent division continues today through the 16 store remainder of its Aarons Corporate Furnishings division.

The rent-to-rent environment began to change in the mid-1960s when another industry pioneer created a concept, known as rent-to-own or now more socially acceptable lease-ownership. Mr. Loudermilk, ever vigilant about trends in the industry, was inspired to test the concept that ultimately transformed Aaron Rents into the countrys second largest lease ownership business. Mr. Loudermilk tapped Ken Butler, now the companys chief operating officer, to begin the lease ownership effort.

In 1987, Aarons developed stores to cater to cash- and/or credit-constrained customers by allowing them to lease merchandise over 12 months by making equal monthly payments. At the end of a satisfied lease term, the customer would own the goods. Originally, Aarons dubbed the transaction Twelve-to-Own.

The principal differentiating factor between Aarons and its larger peer, Rent-A-Center, was that its typical payment terms were monthly, not weekly. The monthly payment cadence allows customers to synchronize their outlays with other bills. Also, this payment rhythm tends to attract consumers with slightly higher incomes than competitors.

Despite some negative media and consumer advocate group attention, customer adoption of lease ownership accelerated in the late 1980s and early 1990s. This likely was influenced by the high interest rates charged by banks and credit card companies for purchases during this period.

In 1971, Loudermilk began to worry about supply continuity and cost treatment by suppliers. In response, he created MacTavish Furniture Industries to manufacture upholstered and office furniture and bedding. MacTavish has now expanded from its initial Quincy, Florida, (since closed) furniture facility by adding seven furniture manufacturing facilities and five bedding manufacturing facilities, aggregating about 767,000 square feet.

The MacTavish manufacturing division operates in leased facilities to manufacture upholstered furniture and bedding. The furniture manufacturing facilities now range from 10,000 to 300,000 square feet. The company also operates five bedding facilities that average about 25,000 square feet.

Company History: Lease-Ownership Begins

Company History: Manufacturing


Aaron Rents 15

Below is a detailed list of Aarons current manufacturing facilities, by location.

Aaron Rents PropertiesLocation Square FeetCairo, Georgia 300,000Cairo, Georgia 147,000Coolidge, Georgia 81,000Coolidge, Georgia 48,000Coolidge, Georgia 41,000Coolidge, Georgia 10,000Duluth, Georgia 23,000Lewisburg, Pennsylvania 25,000Buford, Georgia 32,000Sugarland, Texas 20,000Orlando, Florida 16,000Indianapolis, Indiana 24,000Source: Company Reports and Raymond James Research

In 1992, in order to expand and capitalize on the growing market, Aaron Rents began its franchise program. Under the program, approved, independent, and seasoned entrepreneurs operate SALO stores, paying an initial franchise fee of $15,000 to $50,000 (market size dependent) and a continuing royalty stream that equates to 5% or 6% (6% for all new and/or renewed agreements) of the franchisees weekly cash collections. Franchise agreements are typically 10 years in duration with one 10-year renewal option. Today, the company has more than 500 franchised stores and plans to grow this business faster than any other.

Aarons franchisee selection process is disciplined. Before approval, a potential franchisee must demonstrate financial wherewithal and experience. Historically, management targets potential franchisees that have the ability to open and operate multiple locations. The term Aarons Six-Pack refers to a cluster of six stores which a franchisee takes on when joining the Aaron Rents team. In some cases, franchisees will have previously owned and operated locations under their own or another banner.

Through acquisition of private operators, organic unit growth, and aggressive franchising, Aarons store base has grown from 456 at the end of 2000 to 1,557 at the end of 2008, including 504 franchises.

The company has stores throughout the United States and in some parts of Canada. Currently, Aaron Rents operates in 48 U.S. states. While diversified geographically, there is a denser concentration of stores in the Southeast where the company began. Demographics in Aarons major markets also more closely align with the characteristics of a typical rent-to-own customer (FICO scores, income levels, debt capacity utilization, and population of transient workers).

In 2004, the company experimented with the RIMCO concept. RIMCO rents and leases automobile rims and tires. The company started with two separate RIMCO units and peaked at 30 company-owned and nine franchised locations. That said, in December 2008, Aaron Rents announced it rolled 20 of its 30 company-owned locations into existing Aaron Rents stores. The move was enacted in order for Aarons product offering to be focused on more necessary life merchandise.

In September 2008, Aarons also announced an agreement to sell most of its Aarons Corporate Furnishings division to CORT Business Services, a division of Berkshire Hathaway. The move signaled an almost total focus on Sales and

Company History: Franchising to Expand

Company History: Secondary Concepts


Aaron Rents 16

Lease Ownership. The Corporate Furnishings Division was the companys oldest business, renting home and office furniture to individuals and businesses.

In addition to its store base, the company also leases 16 fulfillment centers across the U.S. in order to merchandise its company-owned and franchised stores. The facilities average 86,000 square feet and bundle shipments of furniture, electronics, appliances, and other items for delivery to stores. Each fulfillment center services an area with a 250-mile radius and reaches approximately 100 stores.

Below is a listing of Aaron fulfillment centers location and size.

Aaron Rents SALO Fulfillment CentersLocation Square FeetAuburndale, Florida 77,000Baltimore, Maryland 95,000Columbus, Ohio 92,000Dallas, Texas 89,000Duluth, Georgia 97,000Sugarland, Texas 104,000Winston-Salem, North Carolina 83,000Blythewood, South Carolina 77,000Madison, Tennessee 38,000Oklahoma City, Oklahoma 90,000Phoenix, Arizona 96,000Magnolia, Mississippi 125,000Plainfield, Indiana 98,000Portland, Oregon 98,000Rancho Cucamonga, California 96,000Westfield, Massachusetts 102,000Source: Company Reports and Raymond James Research

In November, 1982, Aaron Rents entered the publicly traded equity arena through an IPO. In the early 1990s, the company created two classes of stock, the Class-A voting stock and the non-voting common shares. This action permitted the company to raise additional outside capital without diluting the founders voting control. Shortly thereafter, Aarons issued 1 million shares of the now classified Class-A stock, which was priced at $15.50 (split adjusted $3.44).

Shares of the Class-A stock trade on the New York Stock Exchange under ticker symbol RNT.A. Mr. Loudermilk owns about 64% of theses shares. Including Loudermilk, executives and board members own 67% of the Class-A shares. Institutional investors own much of the balance of the Class-A shares, with T. Rowe Price accounting for nearly 10% at year-end.

As sales and units continued to grow, Aaron Rents decided to offer additional shares of common stock (RNT) to investors in another public offering. The company completed a 1.75 million unit distribution of common, non-voting stock in May 1994, pricing the shares at $12.00 (split adjusted $2.67).

The company followed this distribution of common stock with another follow-on offering in April 1998, selling 2.5 million shares at $20.125 (split adjusted $8.94). Again in June 2002, the company sold 2 million shares to the public at a price of $21.00. Finally, in May of 2006, the company sold 3.45 million shares of common stock at $25.75. The proceeds are typically used to pay down debt and for general corporate purposes.

Aaron Rents: Support and Manufacturing Locations

Company History: Public Trading of

RNT and RNT.A


Aaron Rents 17

Currently, shares offer an annual $0.07 dividend on its Class-A and common stock. By rule, Class-A stock cannot be paid a dividend unless the common stock is paid an equal or greater amount. The companys earnings and operating cash flow amply cover the dividend.

Aaron Rents sales and earnings growth has been consistent and impressive, coinciding with its aggressive unit growth during the past eight years. Management is now transitioning its attention slightly towards store efficiency, recognizing the need to maintain control of its expanding store base. Since 2000, total revenue at Aaron Rents has grown from $503 million to $1.6 billion in 2008, representing a 16% compound annual growth rate (CAGR) over the period.

Source: Company Filings and Raymond James Research

Aaron Rents: Annual Total Revenue and Y/Y Growth

$767

$946

$1,593

$503$547 $641

$1,126

$1,327$1,395

14.2%

8.7%

17.2%

19.7%

23.4%

18.9%

17.9%

5.2%

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

0%

4%

7%

11%

14%

18%

21%

25%

28%16% CAGR 2000-2008

In addition, Sales and Lease Ownership (SALO) division revenues, which include both rental charges and fees as well as retail sales, have grown steadily. From 2000, when total SALO revenue was $422 million, to 2008, when SALO revenue reached $1.2 billion, revenue has grown at a 14% CAGR. Aarons has not weathered down year-over-year comparisons for the company in either total or SALO revenue.

Revenue and Earnings Growth


Aaron Rents 18

Source: Company Filings, First Call and Raymond James Research

Aaron Rents: Franchise Royalties and Fees and Y/Y Growth

$45

$25

$39

$34$30

$17$14$12

$15

16.0%15.4%13.2%

18.4%

67.2%

-9.6%

22.1%

9.7%

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

18% CAGR 2000-2008


Aaron Rents: Annual EPS and Y/Y Growth

$0.74

$1.55

$0.97

$1.41$1.47

$1.18

$0.57

$0.35

$0.61

10.2%

-4.1%

24.6%

21.6%

31.1%

29.8%

62.9%

-42.6%$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

$1.80

2000 2001 2002 2003 2004 2005 2006 2007 2008-45%

-30%

-15%

0%

15%

30%

45%

60%

75%

Aaron Rents now has three reportable business segments: (1) Company-owned Sales and Lease Ownership, (2) Franchise, and (3) Other. The company recently ceased reporting its Corporate Furnishings segment separately. Its revenues are now included in the SALO division. The company also discloses similar data for MacTavish industries, its manufacturing unit, with most of its revenues eliminated from net sales as intercompany sales.

By far, the largest contributors to both revenue and operating income are the Sales and Lease Ownership channels, with corporate-owned stores providing the bulk of revenues and operating income.

Revenues generated by the franchises belong to those franchisees, with Aarons collecting continuing royalty payments. We will examine each of the business segments in detail.

Reported Segments: SALO, Corporate Furnishings,

Franchises and Other


Aaron Rents 19

Source: Company Reports and Raymond James Research

Aaron Rents: 2008 Revenues by Segment

3%

1%

74%

19%

3%

Rentals and Fees Retail Sales Non-Retail Sales Franchise Royalties and Fees Other

Aarons most significant division is its company-owned Sales and Lease Ownership (SALO) business. Revenues in this segment come from monthly lease payments and fees as well as merchandise sales at retail. The bulk of the revenues are from monthly lease payments and fees.

Segment revenues grew from $422 million in 2000 to $1.2 billion in 2008 and represented 84% and 74% of total revenues during these periods, respectively. As a percentage of earnings before interest and taxes (EBIT) however, the Sales and Lease Ownership division has gone from representing 45% of EBIT in 2000 to 75% in 2008. The EBIT contribution peaked in 2006, when Sales and Lease Ownership contributed 77.0% of operating income.

Comparable store sales are reported for stores open during the entirety of the periods of measurement. For instance, on a quarterly basis, a store would have to be open, and not have acquired the accounts of another operator, for the entire 15-month period of comparison to be included in the comparable-store calculation. On a yearly basis, stores must be open for the entire 24-month period without having acquired any external accounts.

Aaron Rents Inc.Company-owned SALO Comparable Store Sales

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Q1 -0.5% 7.4% 14.1% 13.7% 8.3% 7.0% 9.3% 2.6% 5.5% 5.0%Q2 10.6% 9.9% 11.3% 14.7% 7.3% 9.1% 5.0% 4.1% 5.0% 5.0%Q3 6.9% 13.6% 9.8% 10.9% 8.4% 6.9% 4.0% 5.7% 5.0% 5.0%Q4 5.0% 20.2% 10.6% 8.0% 11.5% 7.2% 3.9% 6.2% 5.0% 5.0%

Year 7.7% 13.0% 11.4% 11.7% 8.9% 7.5% 5.6% 4.6% 5.1% 5.0%

2-Year Average 2002 2003 2004 2005 2006 2007 2008 2009 2010

Q1 3.5% 10.8% 13.9% 11.0% 7.7% 8.2% 6.0% 4.1% 5.3%Q2 10.3% 10.6% 13.0% 11.0% 8.2% 7.1% 4.6% 4.6% 5.0%Q3 10.3% 11.7% 10.4% 9.7% 7.7% 5.5% 4.9% 5.4% 5.0%Q4 12.6% 15.4% 9.3% 9.8% 9.4% 5.6% 5.1% 5.6% 5.0%

Year 10.4% 12.2% 11.6% 10.3% 8.2% 6.6% 5.1% 4.9% 5.1%Reported Figures are In BoldSource: Company Reports and Raymond James Research


Aaron Rents 20

Within the company-owned SALO segment, lease or rental payments and fees make up the bulk of revenue. In 2008, rentals and fees comprised ~96% of company-owned SALO revenue, with the remaining 4% coming from retail sales. This is due to a strategy of raising retail, or cash-and-carry, prices modestly in response to competition and in an attempt to drive behavior.


Aaron Rents: 2008 Company Owned SALO Revenue Mix

4%

96%

Rentals and Fees Retail Sales

Stores offer home products ranging from furniture to electronics and accessories. Furniture merchandising tends to be relatively basic, giving store managers the ability to interchange individual pieces within sets. This strategy allows for returned merchandise to be either re-rented or sold with other sets on the floor. Aside from its MacTavish manufactured furniture and mattresses, Aarons offers Simmons mattresses, as well. Furniture accounts for about one-third of SALO revenues.

Electronics merchandising aims to be one step behind the cutting edge of technology, but still of high quality. Brands are well-known and include JVC, Mitsubishi, Philips, RCA, Sony, Dell, and Hewlett-Packard. One of the companys fastest growing items remains flat-panel televisions, a trend which was accelerated in 2008 by the pending discontinuation of the analog television spectrum. Today, electronics and computers account for about 51% of revenues, split 35% electronics and 16% computers.

The companys RIMCO operation, which leases custom rims and tires for cars, was an experimental concept launched in 2004. At the end of 2008, the company operated 10 RIMCO stores, after merging 20 of the stores into existing Aarons facilities during 4Q08. The company did this in order to maintain its focus on necessity items compared with more discretionary ones.

Outside of these items, Aarons also makes available jewelry, accessories, and outdoor tractors (in some geographies) that customers may lease to own. Below is a graphical depiction of 2007 SALO merchandise rental fees and sales by category (2008 data was not yet available at time of publishing).


Aaron Rents 21


Aaron Rents: 2008 SALO Merchandise Sales

4%

35%

15%30%

16%

Electronics Appliances Furniture Computers Other

SALO operating income as a percentage of total operating income has grown significantly since 2000, though it declined slightly in 2007 as the company integrated the numerous stores it had opened in the 12 months prior. Aaron Rents continues to shift away from traditional rent-to-rent and outright retail sale revenue streams, which will continue to increase the importance of the SALO segment.

The following chart depicts total EBIT dollars segmented into Sales and Lease Ownership contribution and Other. The second chart shows the information based on a percentage of total EBIT.


Aaron Rents: EBIT Dollars, By Segment

$43

$62

$148

$123

$26

$47

$127

$86$97

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

Sales and Lease Ownership Franchise Other


Aaron Rents 22


45%

17%

37%

44%

36%

21%

67%

23%

10%

70%

22%

8%

66%

21%

13%

65%

23%

12%

77%

19%

4%

73%

23%

3%

75%

22%

2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Aaron Rents: % EBIT, By Segment

Sales and Lease Ownership Franchise Other

Customer count is a key metric within the rent-to-own industry. As discussed previously, Aarons stores generate higher customer volume than industry averages due to the companys low-cost focus and customer service reputation. Below is a chart of ending annual customer counts for both company-owned stores and franchises. The company has generated a 20% CAGR in customer growth since 2002 and franchises have generated a 16% CAGR. In total, the company serves over 1.1 million customers.

Sourc: Company Reports and Raymond James Research

Aaron Rents: Annual Ending Customer Count

243,662 314,408386,865

468,228 531,366609,519

740,278147,422

234,500273,874

317,559

166,492207,703

363,034

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

2002

2003

2004

2005

2006

2007

2008

Company Owned Stores Franchises

CAGRs 2002-2008:Company Owned: 20%Franchise: 16%Total: 19%


Aaron Rents 23

Aarons Sales and Lease Ownership division provides durable household goods to low- and middle-income customers with limited or no access to traditional credit sources. To do this, the company utilizes what is known as a lease ownership or rent-to-own transaction.

The three fundamental features of a lease ownership transaction are as follows:

1) The transaction is defined as a lease agreement and thus the customer assumes no debt when he or she enters into the agreement.

2) The customer can return the merchandise at any time and be absolved of any further lease payment obligations.

3) The customer is never required to make any future payments if the merchandise is returned.

Since the transaction is not on credit, no traditional credit check is performed on customers prior to approval. Instead, Aarons asks customers to fill out informational sheets with data such as name, contact information, employment history, and two references to verify the information. Store managers ask the applicant whether it is permissible to contact the reference if said-customer becomes delinquent on payments.

Once completed, the Aarons store manager reviews the application and determines the applicants ability to pay. A significant portion of the store managers compensation is tied to the overall profitability of the store and thus he or she is motivated to grant as much leasing power to the applicant as is practicable, but no more. The manager is also responsible for collecting late payments or repossessing property of severely delinquent accounts through the stores collections department.

Aarons offers a wide variety of payment options to make the merchandise affordable to as many customers as possible. Typically, the company offers payment terms on a monthly basis (~84% of lease agreements) for terms of 12, 18, or 24 months. Intuitively, higher ticket items tend to have longer lease terms in order to make payments affordable.

Aarons lease terms are slightly shorter than the industry average, allowing for a lower total cost of ownership at the end of the transaction. The monthly payment lease also allows for lower cost of ownership since fewer payments allows Aarons to keep administrative costs lower than the competition. These savings can be passed along to customers.

Should the customer desire to buy out the contract at anytime during the agreement, she is able to do so without penalty. In fact, the customer is credited with 50% of the rental payments made against the original retail price of the product. Presented below is a table which depicts potential scenarios. Note that during the latter months of the lease, the early buyout option loses much of its value.

Lease Ownership Transaction


Aaron Rents 24

Early Buyout ExampleData uses Aaron's pricing

Item:

Frigidaire 23 cu ft. side-by-side refrigerator

Advertised Payment $99.99Service Plus $10.00Total Outlay, before tax $109.99Term 18 monthsTotal Cost of Ownership $1,979.80Advertised C-n-C price $1,066.99Cost of Lease Services $912.81

R-T-O SchedulePayment Number Amount Remaining Balance Buyout Price Total to Aaron's % Above Retail % Savings to Lease

1 $109.99 $1,869.81 $957.00 $1,066.99 0.0% 46.1%2 $109.99 $1,759.82 $847.01 $1,066.99 0.0% 46.1%3 $109.99 $1,649.84 $737.02 $1,066.99 0.0% 46.1%4 $109.99 $1,539.85 $847.01 $1,286.97 20.6% 35.0%5 $109.99 $1,429.86 $792.02 $1,341.96 25.8% 32.2%6 $109.99 $1,319.87 $737.02 $1,396.96 30.9% 29.4%7 $109.99 $1,209.88 $682.03 $1,451.95 36.1% 26.7%8 $109.99 $1,099.89 $627.03 $1,506.95 41.2% 23.9%9 $109.99 $989.90 $572.04 $1,561.94 46.4% 21.1%

10 $109.99 $879.91 $517.05 $1,616.94 51.5% 18.3%11 $109.99 $769.92 $462.05 $1,671.93 56.7% 15.6%12 $109.99 $659.93 $407.06 $1,726.92 61.9% 12.8%13 $109.99 $549.94 $352.06 $1,781.92 67.0% 10.0%14 $109.99 $439.96 $297.07 $1,836.91 72.2% 7.2%15 $109.99 $329.97 $242.07 $1,891.91 77.3% 4.4%16 $109.99 $219.98 $187.08 $1,946.90 82.5% 1.7%17 $109.99 $109.99 $132.08 $2,001.90 87.6% -1.1%18 $109.99 ($0.00) $77.09 $2,056.89 92.8% -3.9%

Source: ShopAarons.com, Company Reports and Raymond James Research

In contrast, if a customer wishes to return the merchandise at anytime prior to lease term, she is allowed to do so without obligation for making any additional payments. Further, if a customer has returned merchandise recently (usually within six months or one year) and wishes to re-rent the same merchandise again, she can do so and re-enter the previous agreement at the point where she left off.

In addition to the monthly payment, customers at Aarons are also charged a Service Plus fee equal to 10% of the monthly rental charge. This fee is intended to cover shipping, handling, delivery, installation and lease-term maintenance and/or replacement of the merchandise. Other rent-to-own companies have made this type of charge optional in their offerings, but Aarons charges the fee on all lease agreements.

Throughout the term of the lease agreement, Aarons offers free maintenance or, if necessary, replacement of the property. This bolsters customer loyalty to the company from the consumer standpoint and maintains the merchandise should the customer decide to forfeit it from the companys perspective.

Historically, rent-to-own retailers only accepted cash and/or money orders as forms of payment. Aarons accepts these mediums as well as personal checks and credit cards for payment. The result is a more steady cash stream should the customer need to use a credit card to make the payment.

Since Aarons focuses on monthly payment terms and thus a slightly higher income demographic than other rent-to-own operators, it finds that check use is less of a problem than do some weekly-pay operators.


Aaron Rents 25

Below is an example of a typical lease agreement for a bedroom set. Prices were quoted on September 3, 2008.

Aaron's Sales and Lease Ownership

Example QuoteBedroom Set leased for 24 months

SKU Description Monthly PriceSemi-Monthly

Price Retail Price7603RE2 Dresser $25.89 $13.86 $400.417605RE2 Mirror 5.70 3.06 88.167609RE2 5/0 Queen Sleigh HB 19.16 10.27 296.867610RE2 5/0 Queen Sleigh FB 9.84 5.27 152.877615RE2 5/0 Queen Rails 4.14 2.22 64.707607RE2 Nightstand 12.95 6.94 200.607601RE3 Chest 32.95 17.66 509.607611WL7 Queen Mattress 21.92 11.75 338.927613WL7 Queen Foundation 6.33 3.39 97.87

Total $138.88 $74.42 $2,149.99

Payments

LeaseService

PlusTotal

Payment PaymentsCost of

OwnershipMonthly $138.88 $13.89 $152.77 24 $3,666.43

Semi-Monthly $74.42 $7.44 $81.86 48 $3,929.38Source: Aaron Rents and Raymond James Research

Excludes sales tax computation

As one can see below, the total cost of ownership under the lease ownership scenario is relatively expensive on a nominal basis. For instance, if one were to look at the above example as a traditional credit sale, one would find that the annual percentage rate (APR) on this transaction would be ~64% for the monthly payment and ~71% for the semi-monthly payment. We exclude sales taxes from the calculation, although these are paid by the customer as a part of each periodic payment.

While these calculations are useful analytically to understand the relative cost of these transactions versus typical credit or conditional sales, there are a series of factors that are not accounted for by the math. In particular, these analyses do not take into account the right of the customer to terminate the transaction at anytime without penalty or further obligation and the fact that no credit history is required, maintained, or reported negatively from the transactions. Although we know of no objective means of pegging a value to these rights, the sheer magnitude of the imputed rates helps to explain why RTO transactions are subjected to advocacy group and regulator scrutiny and angst.

Hypothetical Interest Rate Scenario Monthly Semi-Monthly

Retail $2,149.99 Retail $2,149.99Total Cost of Ownership $3,666.43 Total Cost of Ownership $3,929.38Monthly Payment $152.77 Semi-monthly Payment $81.86Monthly Interest % 5.3% Semi-monthly Interest% 2.9%Annual % 64.0% Annual % 70.7%Source: Aaron Rents and Raymond James Research APR calculated using Prin. & Int. Method; payment at beginning of periodAPR calculation excludes value for lessee right to terminate, taxes cost of delivery and warranty


Aaron Rents 26

Below we extend the APR calculation to two electronics items (Dell computer and a 42 Phillips LCD HD TV) and one appliance (Frigidaire refrigerator). The calculated APRs for the computer and refrigerator are even more eye-popping than the above furniture example and TV. We remind investors that these are imputed interest rates that are not disclosed to consumers because the transactions are defined as leases.

Aaron's Sales and Lease Ownership

Example Quotes

SKU Description Months to own Monthly Price Retail Price7405FWW/FWB Frigidaire 22 Cu Ft Side-by-Side 18 $99.99 $1,066.99

Lease Service Plus Total Payment Cost to ownMonthly $99.99 $10.00 $109.99 $1,979.80Cost of Lease Services $912.81Imputed Annual Percentage Rate (APR) 105%

SKU Description Months to own Monthly Price Retail Price7360C92 Dell Compt'r w/ Wide Screen Monitor 12 $99.99 $899.99

Lease Service Plus Total Payment Cost to ownMonthly $99.99 $10.00 $109.99 $1,319.87Cost of Lease Services $419.88Imputed Annual Percentage Rate (APR) 94%

SKU Description Months to own Monthly Price Retail Price7301PLC Phillips 42" LCD - Full HD 1080p 24 $99.99 $1,499.99

Lease Service Plus Total Payment Cost to own$99.99 $10.00 $109.99 $2,639.74

Cost of Lease Services $1,139.75Imputed Annual Percentage Rate (APR) 68%

Source: Aaron Rents Waltrip Dream Products, Investor Presentation, and Raymond James ResearchAPR Calculated using Principal and Interest Method; payment at beginning of periodAPR calculation excludes value for lessee right to terminate, taxes, and cost of delivery and warranty

Despite what appear to be expensive transactions from a cost-of-funds perspective, a typical RTO customer does not have access to more traditional purchase avenues. Importantly, as well, about 50% of Aarons customers, according to management, obtain ownership of their leased merchandise versus less than a 25% norm for the industry. In our comparison shopping, we found that similar items, offered with weekly payment schedules, resulted in even higher APR calculations.

Another factor that our mathematics cannot account for is the fact that the cost of servicing typical Aaron Rents customers is much higher than at other retailers. These include such services as included delivery, relocation delivery, and some payment holidays.

Reinforcing the fact of the high cost of service to RTO customers is the actual disconnect between the pricing and returns of an individual lease ownership transaction and the reported EBIT and EBIT margin of Aarons SALO segment. The following graph shows the last nine years history of the companys SALO segment EBIT and EBIT margin. With the exception of 2001 and 2006, the EBIT margin of the division averaged about 7%. This is an attractive margin when compared to other home furnishings retailers, but it is not nearly the outsized level that the above APRs for individual transactions would suggest.


Aaron Rents 27

Aaron Rents: SALO EBIT and EBIT Margin

49

119

62

98106

71

36

1622

7.1%

7.4%

9.1%

7.2%7.7%

7.7%

7.2%

4.2%

7.7%

$ 0

$ 20

$ 40

$ 60

$ 80

$ 100

$ 120

$ 140

$ 160

$ 180

$ 200

2000 2001 2002 2003 2004 2005 2006 2007 2008

$Mill

ions

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

In the final analysis, Aarons customers are typically not concerned with, and cannot relate to, interest rates. They are concerned only with affordable monthly payments. Without these transactions, it is arguable that many of Aarons customers would not be able to procure, use, and enjoy the items offered in its stores. In the Appendix, we provide the reader with a sample Aarons order form and a sample lease ownership contract.

Since, throughout the lease term, Aaron Rents still maintains official ownership of the merchandise in circulation, a true cost of goods sold is not practicable to report. The merchandise does, however, depreciate throughout its life and thus a margin is possible to derive.

Rental merchandise typically depreciates over a 24-month period when rented and 36-month period when not rented. In both cases, the salvage value is 0%. Once an item is rented for the first time, it usually remains under the 24-month depreciation schedule until 0 salvage value. If an item is unrented and remains on a store floor, it does not begin depreciating until it has remained on the floor for six months.

In examining the rental merchandise gross margins, we find that the business generates returns well in excess of the depreciation. That said, the rentals and fees gross margins have contracted modestly over the past few years as Aarons continues to use a price leadership strategy to gain market share. In 2008, as the company benefitted from lower merchandise costs from its suppliers, the metric rebounded.

"Gross Margins"


Aaron Rents 28


Aaron Rents: Rentals and Fees Gross Margins

63.5%

60.0%

61.0%

62.0%

63.0%

64.0%

65.0%

66.0%

67.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Rental Fees less Depreciation of Rental Merchandise

Retail sales in the SALO division are typical merchandise sales, which result in more traditional gross margins. In the retail sales segment, we see steadily increasing gross margins. This is the result of Aarons decision to raise price in response to competition and perceptibly to drive behavior towards the lease ownership business. It is also due to a contraction in the cost of merchandise the company sells.


Aaron Rents: Retail Sales Gross Margins

38.9%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Retail Sales GM %

At the store level, much of the operating costs at Aaron Rents are relatively fixed. Typically, there are three to four employees within the store at any given time, with two to four delivery crew members delivering merchandise. Each store maintains at least two trucks to deliver the goods to customers.

Operating Expenses


Aaron Rents 29

Other employees in the store include the manager, responsible for the overall operation of the store, the assistant manager, the collections representative, and another salesperson.

Aarons stores are typically about 9,000 square feet, the majority of which is used as a show room floor. This is a larger format than traditional rent-to-own units which tend to be roughly half the size of Aarons. The larger store format is an advantage for the company, allowing it to showcase more of the merchandise on the floor. Stores tend to be located in high-traffic strip malls in well-established working class towns, near stores of competing rent-to-own operators. Aarons also builds to suit free-standing facilities.

Source: Aarons Website.

Marketing spend is a key driver for sales at Aarons. Currently, the company utilizes national and local television advertising, direct mail, and direct delivery of promotional material. All television commercials feature name brand merchandise including HDTV flat-panel televisions, computers, stainless steel refrigerators, washers, dryers, and lawn tractors.

The company also uses various sporting events at the collegiate and professional levels. These leagues include NASCAR racing, the National Basketball Association (NBA), World Wrestling Entertainment (WWE), Arena Football League (AFL), Southeastern Conference (SEC) and Atlantic Coast Conference (ACC) football and basketball, and Major League Baseball (MLB).

Aarons premier partnership continues to be the Aarons Dream Weekend at Talladega Superspeedway. The event, a weekend in April, consists of the Aarons 499 NASCAR Sprint Cup Series Race and the Aarons 312 NASCAR Nationwide Series Race. Both races are televised live on ABC/ESPN television and are among the most watched NASCAR events.

The company also sponsors the #99 Aarons Dream Machine car year-round in the NASCAR Nationwide Series and the Aarons #00 Dream Machine car in the NASCAR Sprint Cup Series races at Daytona, Atlanta, and Bristol.

Aarons Lucky Dog mascot is another well-known tool the company uses in its marketing efforts. The concept is that Everyone is a lucky dog at Aarons, since people can afford to purchase items they typically would not be able to otherwise.


Aaron Rents 30

Source: Aaron Rents Website.

Other expenses, including rent, utilities, common-area maintenance, other occupancy, and delivery costs are presented on the following page in our estimate of a store-level operating profit scenario. We see that store level operating profits are attractive, reaching over 25% on a four-wall, pre-advertising basis at maturity. When allocating about 3.0% of sales to advertising, the direct store profit before corporate overhead is about 23%.

On an economic basis, once we account for corporate overhead, taxes, and the present value of leases, we come to net operating profit after taxes (NOPAT) returns on sales of 15.6% at maturity and on beginning capital of 23.2%.


Aaron Rents 31

Below is our estimate for a typical Aarons store during the first five years of operation.

Aaron RentsAverage SALO Store Model$000s, except per square foot YR1 YR2 YR3 YR4 YR5Store Square Footage 9,000

Monthly Rental Fees $31 $51 $88 $106 $117Retail Sales 14 22 39 45 49

Revenues: Rentals, Fees, and Mdse. Sales $386 $628 $1,100 $1,276 $1,400Comp Store Sales 63% 75% 16% 10%Store Revenue per SF $42.85 $69.80 $122.22 $141.78 $155.56

Merchandise Margin 222 378 689 800 877Operating Expenses:

Rent 65 66 67 67 68Utilities 28 29 29 29 29Other Occupancy 20 20 20 20 20Leasehold Depreciation 20 17 14 12 18Delivery Expense 15 24 42 48 53Store Payroll 167 169 183 227 231Payroll Benefits 47 47 48 60 60Write offs - (skip, stolen, damaged) 11 18 32 37 41

Total Direct Operating Expenses $373 $389 $434 $500 $519Four Wall Profit ($150) ($11) $256 $300 $358

Four Wall Profit Margin -39.0% -1.7% 23.2% 23.5% 25.6%Allocated Share of Net Advertising 12 19 33 38 42Direct Store Profit Before Overhead ($162) ($30) $223 $262 $316

% of Sales -42.0% -4.7% 20.2% 20.5% 22.6%Add back Imputed Int. Exp.Comp. of Rent 39 40 40 40 41

Adjusted Pre-Tax Direct Store Profit ($123) $10 $263 $302 $356Estimated Cash Taxes (47) 4 101 116 137

Net Operating Profit After Tax (NOPAT) ($75) $6 $161 $186 $219% of Sales -19.5% 1.0% 14.7% 14.5% 15.6%

Store InvestmentFixtures, Leasehold, Net 100 83 69 58 90Pre-Opening 90 0 0 0 0Continuing Cap Expenditures 0 0 0 0 50In-Store Inventory 322 356 395 437 484Less: Payables (87.0) (87.0) (87.0) (87.0) (87.0)

Est'd Cash Investment per average store 425 352 377 408 537Capitalized Value of Rental Payments 522 527 532 538 543Total Economic Investment per avg Store $947 $880 $909 $946 $1,080Change in Capital $947 ($67) $30 $36 $134Net Cash Flow ($1,022) $73 $132 $149 $85

NOPAT ($75) $6 $161 $186 $219Ending Capital $947 $880 $909 $946 $1,080R (Beginning Capital) 0.6% 18.3% 20.4% 23.2% Source: Company Reports and Raymond James Research.

Aaron Rents franchise initiative has been an effective avenue for expanding Aarons brand and geographical footprint with a lower initial investment by the company. Through its meticulous scrutiny of a franchise applicants background and financial solvency, Aarons has become known within the industry as one of the toughest franchises to gain access to.

That said, the company has grown its franchise store count from 193 stores in 2000 to 504 stores at the end of 2008. The company has also struck area development agreements with franchisees for an additional ~280 stores in the future. Management has stated that of the roughly 10% annual square footage growth it hopes to achieve over the next few years (5% to 9% in 2009), it would like at least half to come from franchises.

Traditionally, Aarons looks for franchisees with the ability to operate more than one facility, though a small number of franchisees operate only one store. Ideally, an applicant would enter an agreement for the Aarons Six-Pack, or six stores to operate. The companys franchising team carefully selects areas

Franchise Program


Aaron Rents 32

in which it will allow franchises to open that do not compete with Aarons existing corporate-owned store base.

Currently, Aarons largest franchisee, SEI/Aarons, operates 68 stores throughout the U.S. and is among the top ten lease ownership operators in regard to size in the U.S.

When a franchisee is approved to operate an Aarons store, he or she pays the company an initial fee of $15,000 to $50,000 depending on the location of the franchise(s). The fee is non-refundable and holds the franchisees spot as a new store owner.

Franchise agreements are for a term of 10 years and carry one 10-year renewal option. While operating, franchises are required to remit royalty payments to Aaron Rents equal to 5% or 6% of the franchises weekly cash collections. Franchise royalties increased from 5% to 6% for agreements entered into or renewed after December 31, 2002.

In exchange for the initial fee and royalties, franchisees receive assistance in selecting proper store sites, floor plan design, and pre-opening planning. Aarons will also lease exterior signage to the franchisee. The company will also use its existing bank relationships to assist the franchisees in acquiring financing for operations.

Franchisees are required to complete extensive training and adhere to strict operational standards. Dcor, rental agreement terms, hours of operation, pricing, merchandise, and collection practices all must be compliant with Aarons strict code. Although franchises are not required to purchase merchandise from Aaron Rents fulfillment centers, many do in order to take advantage of company-offered financing and favorable shipping terms.

Many franchisees enjoy the benefits of Aarons heavy marketing campaigns and industry reputation. The owners also enjoy the fact that one of the unspoken agreements most Aarons franchises have with the company is that the corporation will typically repurchase the franchised store from the franchisee if he or she desires to sell it. Usually, as with most acquisition in the rent-to-own industry, acquisitions are priced at 9-12x monthly rental fees.

From Aaron Rents perspective, franchises allow the company to grow more quickly than it would organically. In addition, the increased brand exposure brings more sales to the company as a whole and the larger scale enables the company to achieve economies of scale in purchasing, distribution, advertising, and manufacturing.

Franchise royalties and fees have grown from $12.4 million in 2000 to $45 million in 2008. This represents an annual CAGR of ~18%. The chart below depicts total annual franchise royalties and fees as well as year-over-year growth from 2000 to 2008.


Aaron Rents 33


Aaron Rents: Franchise Royalties and Fees and Y/Y Growth

$45

$25

$39

$34$30

$17$14$12

$15

16.0%15.4%13.2%

18.4%

67.2%

-9.6%

22.1%

9.7%

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

18% CAGR 2000-2008

Since franchises require little to no capital investment from Aaron Rents, the operating margins for this revenue are very high. In 2008, EBIT in the franchise segment reached $33 million, representing an EBIT margin of 73.1%.

Source: Company Filings and Raymond James Research

Aaron Rents: Franchise Royalties and Fees EBIT

$7 $9$11

$14$18

$22

$33$29

$24

73.1%73.8%

71.2%

74.6%

73.2%

90.6%

65.8%

67.7%

60.4%

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

$30.0

$35.0

$40.0

$45.0

$50.0

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Franchise EBIT Margins

In addition to growing its franchise program through solicited applications, Aaron Rents also approaches well-known and successful independent RTO operators with franchise propositions. Over the years, the company has been able to secure numerous agreements using this process.


Aaron Rents 34

MacTavish Furniture Industries was founded in 1971 and provides Aaron Rents with the majority of the furniture and mattresses leased and sold in its stores. Currently, the division operates seven furniture manufacturing plants which range from 10,000 to 300,000

aaron's initiation 3-3-09

Documents

equity research

aaron rents rnt

raymond james financial

public trading of rnt

company history

additional information

foregoing report

departments of rja