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EX-32.2 - EXHIBIT 32.2 2Q2017 - AARON'S INCexhibit3222q2017.htm
EX-32.1 - EXHIBIT 32.1 2Q2017 - AARON'S INCexhibit3212q2017.htm
EX-31.2 - EXHIBIT 31.2 2Q2017 - AARON'S INCexhibit3122q2017.htm
EX-31.1 - EXHIBIT 31.1 2Q2017 - AARON'S INCexhibit3112q2017.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ________________________________
 FORM 10-Q
________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2017
OR
o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                      TO                     
COMMISSION FILE NUMBER 1-13941
 ________________________________
 AARON’S, INC.
(Exact name of registrant as specified in its charter)
 _________________________________
Georgia
 
58-0687630
(State or other jurisdiction of
incorporation or organization)
 
(I. R. S. Employer
Identification No.)
 
 
 
400 Galleria Parkway SE, Suite 300
Atlanta, Georgia
 
30339-3182
(Address of principal executive offices)
 
(Zip Code)
(678) 402-3000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 ___________________________________

Indicate by check mark whether registrant (l) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of l934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
 
ý
 
 
Accelerated Filer
 
o
 
 
 
 
 
 
 
 
Non-Accelerated Filer
 
o
(Do not check if a smaller reporting company)
 
Smaller Reporting Company
 
o
 
 
 
 
 
 
 
 
Emerging Growth Company
 
o
 
 
 
 
 
 
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of Each Class
 
Shares Outstanding as of
July 28, 2017
Common Stock, $0.50 Par Value
 
70,726,804



1


AARON’S, INC.
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3. Defaults Upon Senior Securities
 
 
Item 4. Mine Safety Disclosures
 
 
Item 5. Other Information
 
 
 
 

2


PART I – FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
AARON’S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
(Unaudited)
 
 
 
June 30,
2017
 
December 31,
2016
 
(In Thousands, Except Share Data)
ASSETS:
 
 
 
Cash and Cash Equivalents
$
260,335

 
$
308,561

Investments
22,252

 
20,519

Accounts Receivable (net of allowances of $36,589 in 2017 and $35,690 in 2016)
84,822

 
95,777

Lease Merchandise (net of accumulated depreciation and allowances of $744,077 in 2017 and $743,222 in 2016)
994,236

 
999,381

Loans Receivable (net of allowances and unamortized fees of $16,572 in 2017 and $13,830 in 2016)
83,737

 
84,804

Property, Plant and Equipment at Cost (net of accumulated depreciation of $235,828 in 2017 and $231,062 in 2016)
200,842

 
211,271

Goodwill
527,924

 
526,723

Other Intangibles (net of accumulated amortization of $88,122 in 2017 and $75,459 in 2016)
235,041

 
247,672

Prepaid Expenses and Other Assets
138,941

 
121,028

Total Assets
$
2,548,130

 
$
2,615,736

LIABILITIES & SHAREHOLDERS’ EQUITY:
 
 
 
Accounts Payable and Accrued Expenses
$
281,920

 
$
297,766

Deferred Income Taxes Payable
260,032

 
276,116

Customer Deposits and Advance Payments
62,992

 
62,427

Debt
401,113

 
497,829

Total Liabilities
1,006,057

 
1,134,138

Commitments and Contingencies (Note 4)


 


SHAREHOLDERS' EQUITY:
 
 
 
Common Stock, Par Value $0.50 Per Share: Authorized: 225,000,000 Shares at June 30, 2017 and December 31, 2016; Shares Issued: 90,752,123 at June 30, 2017 and December 31, 2016
45,376

 
45,376

Additional Paid-in Capital
256,032

 
254,512

Retained Earnings
1,620,699

 
1,534,983

Accumulated Other Comprehensive Income (Loss)
118

 
(531
)
 
1,922,225

 
1,834,340

Less: Treasury Shares at Cost
 
 
 
Common Stock: 20,029,149 Shares at June 30, 2017 and 19,303,578 at December 31, 2016
(380,152
)
 
(352,742
)
Total Shareholders’ Equity
1,542,073

 
1,481,598

Total Liabilities & Shareholders’ Equity
$
2,548,130

 
$
2,615,736

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

3


AARON’S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(In Thousands, Except Per Share Data)
REVENUES:
 
 
 
 
 
 
 
Lease Revenues and Fees
$
718,089

 
$
688,677

 
$
1,461,711

 
$
1,430,288

Retail Sales
6,106

 
6,460

 
14,884

 
17,415

Non-Retail Sales
69,602

 
72,610

 
138,929

 
151,915

Franchise Royalties and Fees
12,824

 
14,772

 
27,025

 
31,067

Interest and Fees on Loans Receivable
8,532

 
5,302

 
16,733

 
10,065

Other
491

 
1,532

 
916

 
3,030

 
815,644

 
789,353

 
1,660,198

 
1,643,780

COSTS AND EXPENSES:
 
 
 
 
 
 
 
Depreciation of Lease Merchandise
345,398

 
321,969

 
707,396

 
670,271

Retail Cost of Sales
3,940

 
3,892

 
9,331

 
10,957

Non-Retail Cost of Sales
61,818

 
63,984

 
123,903

 
135,369

Operating Expenses
330,548

 
330,601

 
659,373

 
679,025

Restructuring Expenses
13,445

 

 
13,772

 

Other Operating (Income) Expense, Net
(511
)
 
755

 
(1,072
)
 
(5,974
)
 
754,638

 
721,201

 
1,512,703

 
1,489,648

OPERATING PROFIT
61,006

 
68,152

 
147,495

 
154,132

Interest Income
378

 
507

 
1,352

 
928

Interest Expense
(5,552
)
 
(5,904
)
 
(11,367
)
 
(12,216
)
Other Non-Operating Income (Expense), Net
1,163

 
(1,631
)
 
2,138

 
(1,992
)
EARNINGS BEFORE INCOME TAXES
56,995

 
61,124

 
139,618

 
140,852

INCOME TAXES
20,660

 
22,623

 
49,983

 
52,664

NET EARNINGS
$
36,335

 
$
38,501

 
$
89,635

 
$
88,188

EARNINGS PER SHARE
 
 
 
 
 
 
 
Basic
$
0.51

 
$
0.53

 
$
1.26

 
$
1.21

Assuming Dilution
$
0.51

 
$
0.53

 
$
1.24

 
$
1.20

CASH DIVIDENDS DECLARED PER SHARE:
 
 
 
 
 
 
 
Common Stock
$
0.0275

 
$
0.025

 
$
0.055

 
$
0.050

WEIGHTED AVERAGE SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
70,686

 
72,761

 
71,001

 
72,697

Assuming Dilution
71,697

 
73,279

 
72,040

 
73,248

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

4


AARON’S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
(In Thousands)
2017
 
2016
 
2017
 
2016
Net Earnings
$
36,335

 
$
38,501

 
$
89,635

 
$
88,188

Other Comprehensive Income:
 
 
 
 
 
 
 
Foreign Currency Translation Adjustment
446

 
93

 
649

 
686

Total Other Comprehensive Income
446

 
93

 
649

 
686

Comprehensive Income
$
36,781

 
$
38,594

 
$
90,284

 
$
88,874

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.


5


AARON’S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
(In Thousands)
OPERATING ACTIVITIES:
 
 
 
Net Earnings
$
89,635

 
$
88,188

Adjustments to Reconcile Net Earnings to Cash Provided by Operating Activities:
 
 
 
Depreciation of Lease Merchandise
707,396

 
670,271

Other Depreciation and Amortization
40,302

 
40,956

Accounts Receivable Provision
82,106

 
74,968

Provision for Credit Losses on Loans Receivable
9,130

 
4,211

Stock-Based Compensation
11,705

 
10,446

Deferred Income Taxes
(16,084
)
 
(9,522
)
Other Changes, Net
(3,795
)
 
(5,640
)
Changes in Operating Assets and Liabilities, Net of Effects of Acquisitions and Dispositions:
 
 
 
Additions to Lease Merchandise
(905,693
)
 
(789,768
)
Book Value of Lease Merchandise Sold or Disposed
202,734

 
210,547

Accounts Receivable
(71,081
)
 
(45,475
)
Prepaid Expenses and Other Assets
(13,618
)
 
36,882

Income Tax Receivable
(751
)
 
164,790

Accounts Payable and Accrued Expenses
(16,940
)
 
(109,888
)
Accrued Regulatory Expense

 
(4,737
)
Customer Deposits and Advance Payments
562

 
(10,746
)
Cash Provided by Operating Activities
115,608

 
325,483

INVESTING ACTIVITIES:
 
 
 
Investments in Loans Receivable
(37,139
)
 
(36,500
)
Proceeds from Loans Receivable
31,053

 
35,236

Outflows on Purchases of Property, Plant and Equipment
(26,822
)
 
(30,955
)
Proceeds from Property, Plant and Equipment
7,256

 
18,457

Outflows on Acquisitions of Businesses
(940
)
 
(332
)
Proceeds from Dispositions of Businesses
948

 
34,968

Cash (Used in) Provided by Investing Activities
(25,644
)
 
20,874

FINANCING ACTIVITIES:
 
 
 
Proceeds from Debt
7,000

 
90,678

Repayments on Debt
(104,309
)
 
(204,512
)
Dividends Paid
(3,903
)
 
(3,636
)
Acquisition of Treasury Stock
(34,302
)
 

Issuance of Stock Under Stock Option Plans
2,982

 
248

Shares Withheld for Tax Payments
(5,715
)
 
(1,838
)
Cash Used in Financing Activities
(138,247
)
 
(119,060
)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
57

 

(Decrease) Increase in Cash and Cash Equivalents
(48,226
)
 
227,297

Cash and Cash Equivalents at Beginning of Period
308,561

 
14,942

Cash and Cash Equivalents at End of Period
$
260,335

 
$
242,239

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

6

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

AARON’S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1.
BASIS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Aaron’s, Inc. (the "Company") is a leading omnichannel provider of lease-purchase solutions. As of June 30, 2017, the Company's operating segments are Aaron's Business, Progressive Leasing and DAMI.
The Aaron's Business offers furniture, consumer electronics, home appliances and accessories to consumers primarily on a month-to-month, lease-to-own basis with no credit needed through the Company's Aaron's stores in the United States and Canada. This operating segment also awards franchises and supports franchisees of its Aaron's stores. In addition, the Aaron's Business segment also includes the operations of Woodhaven Furniture Industries, which manufactures and supplies the majority of the upholstered furniture and bedding leased and sold in Company-operated and franchised stores.
Progressive Leasing is a virtual lease-to-own company that provides lease-purchase solutions in 46 states. It does so by purchasing merchandise from third-party retailers desired by those retailers’ customers and, in turn, leasing that merchandise to the customers on a lease-to-own basis. Progressive Leasing consequently has no stores of its own, but rather offers lease-purchase solutions to the customers of traditional retailers.
DAMI partners with merchants to provide a variety of revolving credit products originated through two third-party federally insured banks to customers that may not qualify for traditional prime lending (called "second-look" financing programs).
On May 13, 2016, the Company sold the 82 Company-operated HomeSmart stores and ceased operations of that division. See the Assets Held for Sale section below for further discussion of the disposition.
The following table presents store count by ownership type for the Aaron's Business operations:
Stores as of June 30 (Unaudited)
2017
 
2016
Company-operated Aaron's Branded Stores
1,093

 
1,221

Franchised Stores
680

 
722

Systemwide Stores
1,773

 
1,943

The following table presents active doors for Progressive Leasing:
Active Doors at June 30 (Unaudited)
2017
 
2016
Progressive Leasing Active Doors1
19,148

 
13,930

1 An active door is a retail store location at which at least one virtual lease-to-own transaction has been completed during the trailing three month period.
Basis of Presentation
The preparation of the Company’s condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates. Generally, actual experience has been consistent with management’s prior estimates and assumptions. Management does not believe these estimates or assumptions will change significantly in the future absent unidentified and unforeseen events.
The accompanying unaudited condensed consolidated financial statements do not include all information required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the accompanying unaudited condensed consolidated financial statements. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission for the year ended December 31, 2016 (the "2016 Annual Report"). The results of operations for the three and six months ended June 30, 2017 are not necessarily indicative of operating results for the full year.

7

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Principles of Consolidation
The condensed consolidated financial statements include the accounts of Aaron’s, Inc. and its subsidiaries, each of which is wholly owned. Intercompany balances and transactions between consolidated entities have been eliminated.
Accounting Policies and Estimates
See Note 1 to the consolidated financial statements in the 2016 Annual Report.
Earnings Per Share
Earnings per share is computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. The computation of earnings per share assuming dilution includes the dilutive effect of stock options, restricted stock units ("RSUs"), restricted stock awards ("RSAs") and performance share units ("PSUs") (collectively, "share-based awards") as determined under the treasury stock method. The following table shows the calculation of dilutive share-based awards:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
(Shares In Thousands)
2017
 
2016
 
2017
 
2016
Weighted Average Shares Outstanding
70,686

 
72,761

 
71,001

 
72,697

Dilutive Effect of Share-Based Awards
1,011

 
518

 
1,039

 
551

Weighted Average Shares Outstanding Assuming Dilution
71,697

 
73,279

 
72,040

 
73,248

Approximately 1,000 and 265,000 weighted-average share-based awards were excluded from the computations of earnings per share assuming dilution during the three and six months ended June 30, 2017, respectively, as the awards would have been anti-dilutive for the periods presented.
Approximately 1,265,000 and 1,057,000 weighted-average share-based awards were excluded from the computations of earnings per share assuming dilution during the three and six months ended June 30, 2016, respectively, as the awards would have been anti-dilutive for the periods presented.
Investments
At June 30, 2017 and December 31, 2016, investments classified as held-to-maturity securities consisted of British pound-denominated notes issued by Perfect Home Holdings Limited ("Perfect Home"). Perfect Home is based in the U.K. and operates 35 retail stores as of June 30, 2017. The Perfect Home Notes ("Notes") consisted of outstanding principal and accrued interest of £17.1 million ($22.3 million) and £16.6 million ($20.5 million) at June 30, 2017 and December 31, 2016, respectively. The Notes are classified as held-to-maturity securities as the Company held the investment to the maturity date of June 30, 2017. As a result of Perfect Home's constrained liquidity during the second quarter, the Company ceased accruing additional interest income of the annualized 12% stated interest rate on the Notes effective April 1, 2017.
The Company has not received payment of the outstanding Notes that were due June 30, 2017. While Perfect Home is currently in negotiations to obtain alternative sources of financing, the Company is also in negotiations with Perfect Home to: (i) receive full payment of the outstanding Notes; (ii) receive partial repayment of the Notes and refinance the remaining outstanding balance; (iii) refinance the outstanding Notes; (iv) extend the maturity date of the existing Note agreement; or (v) a combination thereof. The Company has a subordinated security interest in substantially all the assets of Perfect Home, which consists primarily of outstanding loans receivable, merchandise inventory and cash. As of June 30, 2017, the Company believes the present value of the estimated future net cash inflows of the secured assets is sufficient to recover the outstanding balance of the Notes. Therefore, no impairment has been considered to have occurred as of June 30, 2017. If Perfect Home is unable to access additional capital and fails to execute on its business strategy, there could be a change in the valuation of the Notes that may result in an impairment loss in future periods.
Accounts Receivable
Accounts receivable consist primarily of receivables due from customers of Company-operated stores and Progressive Leasing, corporate receivables incurred during the normal course of business (primarily for in-transit credit card transactions, real estate leasing activities and vendor consideration) and franchisee obligations.

8

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Accounts receivable, net of allowances, consist of the following: 
(In Thousands)
June 30, 2017

December 31, 2016
Customers
$
36,782

 
$
36,227

Corporate
21,397

 
26,375

Franchisee
26,643

 
33,175

Accounts Receivable
$
84,822

 
$
95,777

The following table shows the amounts recognized for bad debt expense and provision for returns and uncollected payments:
 
Six Months Ended June 30,
(In Thousands)
2017
 
2016
Bad Debt Expense
$
68,044

 
$
56,210

Provision for Returns and Uncollected Renewal Payments
14,062

 
18,758

Accounts Receivable Provision
$
82,106

 
$
74,968

Refer to Note 1 to the consolidated financial statements in the 2016 Annual Report for information on the Company's accounting policy for the accounts receivable provision.
Lease Merchandise
The Company’s lease merchandise consists primarily of furniture, consumer electronics, home appliances and accessories and is recorded at the lower of cost or net realizable value. The cost of merchandise manufactured by our Woodhaven Furniture Industries operations is determined using standard cost and includes overhead from production facilities, shipping costs and warehousing costs. The Company-operated stores depreciate merchandise to a 0% salvage value over the lease agreement period when on lease, generally 12 to 24 months, and generally 36 months when not on lease. The Company’s Progressive Leasing segment, at which substantially all merchandise is on lease, depreciates merchandise generally over 12 months. Depreciation is accelerated upon early payout.
The following is a summary of lease merchandise, net of accumulated depreciation and allowances:
(In Thousands)
June 30, 2017
 
December 31, 2016
Merchandise on Lease
$
790,505

 
$
786,936

Merchandise Not on Lease
203,731

 
212,445

Lease Merchandise, net of Accumulated Depreciation and Allowances
$
994,236

 
$
999,381

The Company’s policies require weekly lease merchandise counts at its store-based operations, which include write-offs for unsalable, damaged, or missing merchandise inventories. In addition to daily cycle counting, full physical inventories are generally taken at the fulfillment and manufacturing facilities annually and appropriate provisions are made for missing, damaged and unsalable merchandise. In addition, the Company monitors lease merchandise levels and mix by division, store, and fulfillment center, as well as the average age of merchandise on hand. If unsalable lease merchandise cannot be returned to vendors, its carrying amount is adjusted to its net realizable value or written off.
All lease merchandise is available for lease or sale. On a monthly basis, all damaged, lost or unsalable merchandise identified is written off. The Company records a provision for write-offs on the allowance method, which estimates the merchandise losses incurred but not yet identified by management as of the end of the accounting period based on historical write-off experience. The provision for write-offs is included in operating expenses in the accompanying condensed consolidated statements of earnings.

9

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table shows the components of the allowance for lease merchandise write-offs:
 
Six Months Ended June 30,
(In Thousands)
2017
 
2016
Beginning Balance
$
33,399

 
$
33,405

Merchandise Written off, net of Recoveries
(61,034
)
 
(63,312
)
Provision for Write-offs
63,938

 
62,031

Ending Balance
$
36,303

 
$
32,124

Loans Receivable, Net
Gross loans receivable represents the principal balances of credit card charges at DAMI's participating merchants that remain outstanding to cardholders, plus unpaid interest and fees due from cardholders. The allowances and unamortized fees represents an allowance for uncollectible amounts; merchant fee discounts, net of capitalized origination costs; promotional fee discounts; and deferred annual card fees.
Loans acquired in the October 15, 2015 DAMI acquisition (the "Acquired Loans") were recorded at their estimated fair value at the acquisition date. The projected net cash flows from expected payments of principal, interest, fees and servicing costs and anticipated charge-offs were included in the determination of fair value; therefore, an allowance for loan losses and an amount for unamortized fees were not recognized for the Acquired Loans. The difference, or discount, between the expected cash flows to be received and the fair value of the Acquired Loans is accreted to interest and fees on loans receivable based on the effective interest method. At each period end, the Company evaluates the appropriateness of the accretable discount on the Acquired Loans based on actual and revised projected future cash receipts.
Losses on loans receivable are recognized when they are incurred, which requires the Company to make its best estimate of probable losses inherent in the portfolio. The Company evaluates loans receivable collectively for impairment. The method for calculating the best estimate of probable losses takes into account the Company’s historical experience, adjusted for current conditions and the Company's judgment concerning the probable effects of relevant observable data, trends and market factors. Economic conditions and loan performance trends are closely monitored to manage and evaluate exposure to credit risk. Trends in delinquency ratios are an indicator of credit risk within the loans receivable portfolio, including the migration of loans between delinquency categories over time (roll rates). Charge-off rates represent another indicator of the potential for future credit losses. The risk in the loans receivable portfolio is correlated with broad economic trends, such as unemployment rates, gross domestic product growth and gas prices, which can have a material effect on credit performance. To the extent that actual results differ from estimates of uncollectible loans receivable, the Company’s results of operations and liquidity could be materially affected.
The Company calculates the allowance for loan losses based on actual delinquency balances and historical average loss experience on loans receivable by aging category for the prior eight quarters. The allowance for loan losses is maintained at a level considered adequate to cover probable losses of principal, interest and fees on active loans in the loans receivable portfolio. The adequacy of the allowance is evaluated at each period end.
Delinquent loans receivable are those that are 30 days or more past due based on their contractual billing dates. The Company places loans receivable on nonaccrual status when they are greater than 90 days past due or upon notification of cardholder bankruptcy, death or fraud. The Company discontinues accruing interest and fees and amortizing deferred merchant fees (net of origination costs) and promotional fees for loans receivable in nonaccrual status. Loans receivable are removed from nonaccrual status when cardholder payments resume, the loan becomes less than 90 days past due and collection of the remaining amounts outstanding is deemed probable. Payments received on nonaccrual loans are allocated according to the same payment hierarchy methodology applied to loans that are accruing interest. Loans receivable are charged off at the end of the month following the billing cycle in which the loans receivable become 120 days past due.

10

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

DAMI extends or declines credit to an applicant through its bank partners based upon the applicant’s credit rating. Below is a summary of the credit quality of the Company’s loan portfolio as of June 30, 2017 and December 31, 2016 by Fair Issac and Company (FICO) score as determined at the time of loan origination:
FICO Score Category
June 30, 2017
 
December 31, 2016
600 or Less
1.7
%
 
1.8
%
Between 600 and 700
77.2
%
 
78.1
%
700 or Greater
21.1
%
 
20.1
%
Prepaid Expenses and Other Assets
Prepaid expenses and other assets consist of the following:
(In Thousands)
June 30, 2017
 
December 31, 2016
Prepaid Expenses
$
85,844

 
$
75,485

Assets Held for Sale
12,054

 
8,866

Deferred Tax Asset
5,912

 
5,912

Income Tax Receivable
12,635

 
11,884

Other Assets
22,496

 
18,881

Prepaid Expenses and Other Assets
$
138,941

 
$
121,028

Assets Held for Sale
Certain properties, consisting of parcels of land and commercial buildings, met the held for sale classification criteria as of June 30, 2017 and December 31, 2016. Assets held for sale are recorded at the lower of their carrying value or fair value less estimated cost to sell and are classified within prepaid expenses and other assets in the condensed consolidated balance sheets. Depreciation is suspended on assets upon classification to held for sale. The carrying amount of the properties held for sale as of June 30, 2017 and December 31, 2016 is $12.1 million and $8.9 million, respectively. The Company estimated the fair values of real estate properties using the market values for similar properties.
On May 13, 2016, the Company sold its 82 remaining Company-operated HomeSmart stores for $35.0 million and ceased operations of that division. The sale did not represent a strategic shift that would have a major effect on the Company’s operations and financial results and therefore the HomeSmart segment was not classified as discontinued operations. During the six months ended June 30, 2016, the Company recognized an impairment loss of $4.2 million on the disposition and recorded additional charges of $1.4 million related to exiting the HomeSmart business, primarily consisting of impairment charges on certain assets related to the division that were not included in the May 2016 disposition. The impairment loss and additional charges were recorded in other operating (income) expense, net in the condensed consolidated statements of earnings.
On January 29, 2016, the Company sold its corporate headquarters building for cash of $13.6 million, resulting in a gain of $11.1 million for the six months ended June 30, 2016. The cash proceeds were recorded in proceeds from sales of property, plant and equipment in the condensed consolidated statements of cash flows and the gain was recorded in other operating (income) expense, net in the condensed consolidated statements of earnings.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following:
(In Thousands)
June 30, 2017
 
December 31, 2016
Accounts Payable
$
54,663

 
$
71,941

Accrued Insurance Costs
44,120

 
47,649

Accrued Salaries and Benefits
40,628

 
41,612

Accrued Real Estate and Sales Taxes
29,521

 
32,986

Deferred Rent
31,193

 
31,859

Other Accrued Expenses and Liabilities
81,795

 
71,719

Accounts Payable and Accrued Expenses
$
281,920

 
$
297,766


11

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Debt
At June 30, 2017, the Company was in compliance with all covenants related to its outstanding debt. See Note 7 to the consolidated financial statements in the 2016 Annual Report for further information regarding the Company's indebtedness.
Accumulated Other Comprehensive (Loss) Income
Changes in accumulated other comprehensive (loss) income for the six months ended June 30, 2017 are as follows:
(In Thousands)
Foreign Currency
Balance at January 1, 2017
$
(531
)
Other Comprehensive Income
649

Balance at June 30, 2017
$
118

There were no reclassifications out of accumulated other comprehensive (loss) income for the six months ended June 30, 2017.
Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measures, the following hierarchy prioritizes the inputs to valuation methodologies used to measure fair value:
Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3—Valuations based on unobservable inputs reflecting the Company's own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.
The Company measures assets held for sale at fair value on a nonrecurring basis and records impairment charges when they are deemed to be impaired. The Company maintains certain financial assets and liabilities, including investments and fixed-rate long-term debt, that are not measured at fair value but for which fair value is disclosed.
The fair values of the Company’s other current financial assets and liabilities, including cash and cash equivalents, accounts receivable and accounts payable, approximate their carrying values due to their short-term nature. The fair value for the loans receivable, net of allowances, and the revolving credit borrowings also approximate their carrying amounts.
Related Party Transactions
The Company leases certain properties under capital leases from related parties that are described in Notes 7 and 14 to the consolidated financial statements in the 2016 Annual Report.
Supplemental Disclosure of Noncash Investing Transactions
During the six months ended June 30, 2017, the Company entered into exchange transactions to acquire and sell certain customer agreements and related lease merchandise with third parties which are accounted for as business combinations and business disposals. The fair value of the noncash consideration exchanged in these transactions was $3.7 million.
Recent Accounting Pronouncements
Adopted
Share-Based Payments. In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09, Improvements to Employee Share-Based Payment Accounting. The objective of the update is to simplify the accounting for employee share-based awards, including the income tax effects of awards and the classification on the statement of cash flows. The Company adopted this ASU in the first quarter of 2017.

12

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The ASU requires excess tax benefits and deficiencies that result from the difference between what is deductible for tax purposes and the compensation cost recognized for financial reporting purposes to be recognized prospectively as income tax benefit or expense in the statement of earnings in the reporting period in which they occur. Previously, the excess tax benefits and deficiencies were recognized in additional paid-in capital. During the six months ended June 30, 2017, the recognition of tax benefits on exercised options and vested restricted stock reduced our income tax provision by $0.7 million.
The ASU also requires excess tax benefits and deficiencies to be classified as an operating activity on the statement of cash flows. Prior to the update, excess tax benefits and deficiencies were classified as a financing activity. This amendment has been adopted by the Company on a retrospective basis and as a result we have reclassified $0.7 million of excess tax deficiencies previously disclosed as a financing activity in the statement of cash flows to operating activities for the six months ended June 30, 2016.
The ASU requires cash paid by the Company when directly withholding shares for tax-withholding purposes to be classified retrospectively as a financing activity on the statement of cash flows. As a result, cash outflows of $1.8 million representing cash payments to tax authorities for shares withheld during the six months ended June 30, 2016 were reclassified from operating activities to financing activities.
The Company has elected to continue to estimate forfeitures in determining the amount of stock compensation expense.
Pending Adoption
Revenue Recognition. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 replaces substantially all existing revenue recognition guidance with a single, comprehensive revenue recognition model that requires a company to recognize revenue to depict the transfer of promised goods and services to customers at the amount to which it expects to be entitled in exchange for transferring those goods or services. Companies may use either a full retrospective or a modified retrospective approach to adopt ASU 2014-09, and, as a result of a subsequent update, it will be effective in annual reporting periods, and interim periods within that period, beginning after December 15, 2017. While the majority of the Company's revenues are related to leasing activities and not within the scope of ASU 2014-09, certain of the Company's revenue streams related to its franchise business will likely result in changes to the timing of revenue recognition as well as the presentation of certain revenues.
The Company believes the standard will change the timing of recognition of pre-opening revenue from franchisees. The Company's current accounting policy is to recognize initial franchise pre-opening revenue when earned, which is generally when a new store opens. Under the new standard, the initial franchise pre-opening services are not distinct from the continuing franchise services as they would not transfer a benefit to the franchisee directly without use of the franchise license and should be bundled with the franchise license as a single performance obligation. As a result, the pre-opening revenues will likely be recognized over the life of the franchise license term.
The Company also believes the standard will change the presentation of advertisement fees charged to franchisees. Advertising fees charged to franchisees are currently recorded as a reduction to operating expenses within the consolidated statements of earnings. The new standard will result in the presentation of advertisement fees charged to franchisees to be reported on a gross basis within the consolidated statements of earnings. The Company does not currently believe these matters will result in a material impact to the consolidated statements of earnings. The Company is evaluating whether to use the full or modified retrospective approach upon adoption in the first quarter of 2018.
Leases. In February 2016, the FASB issued ASU 2016-02, Leases, which would require lessees to recognize assets and liabilities for most leases and would change certain aspects of today’s lessor accounting, among other things. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. Companies must use a modified retrospective approach to adopt ASU 2016-02. A majority of the Company's revenue generating activities will be within the scope of ASU 2016-02. The Company has preliminarily determined that the new standard will not materially impact the timing of revenue recognition. The new standard will likely result in the Company classifying bad debt expense incurred within its Progressive segment as a reduction of lease revenue and fees within the consolidated statements of earnings. The new standard will impact the Company as a lessee by requiring substantially all of its operating leases to be recognized on the balance sheet as a right-to-use asset and lease liability. The Company is currently quantifying the impacts of its operating leases to the consolidated financial statements, as well as evaluating the other impacts of adopting ASU 2016-02. The Company intends to adopt the new standard in the first quarter of 2019.

13

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Financial Instruments - Credit Losses. In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The main objective of the update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by companies at each reporting date. For trade and other receivables, held to maturity debt securities and other instruments, companies will be required to use a new forward-looking "expected losses" model that generally will result in the recognition of allowances for losses earlier than under current accounting guidance. The standard will be adopted on a prospective basis with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The Company has not yet determined the potential effects of adopting ASU 2016-13 on its consolidated financial statements.
Business Combinations. In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business. The objective of the update is to add guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. Companies must use a prospective approach to adopt ASU 2017-01, which is effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted.
The Company believes the new standard will result in certain store acquisitions (disposals), which do not transfer a substantive process, to be accounted for as asset acquisitions (disposals). The Company currently accounts for these transactions as business acquisitions (disposal). These store asset acquisitions will result in any economic goodwill to be subsumed in the definite-lived assets being acquired and subsequently recorded as depreciation and amortization expense through the consolidated statements of earnings. Transactions that will now be accounted for as asset disposals, instead of business disposals, will not result in the write-off of goodwill as part of the disposal. The Company will adopt the new standard in the first quarter of 2018.
NOTE 2. FAIR VALUE MEASUREMENT
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table summarizes financial liabilities measured at fair value on a recurring basis:
(In Thousands)
June 30, 2017
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Deferred Compensation Liability
$

 
$
(12,869
)
 
$

 
$

 
$
(11,978
)
 
$

The Company maintains the Aaron’s, Inc. Deferred Compensation Plan, which is an unfunded, nonqualified deferred compensation plan for a select group of management, highly compensated employees and non-employee directors. The liability is recorded in accounts payable and accrued expenses in the condensed consolidated balance sheets. The liability representing benefits accrued for plan participants is valued at the quoted market prices of the participants’ investment elections, which consist of equity and debt "mirror" funds. As such, the Company has classified the deferred compensation liability as a Level 2 liability.
Non-Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The following table summarizes non-financial assets measured at fair value on a nonrecurring basis:
(In Thousands)
June 30, 2017
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Assets Held for Sale
$

 
$
12,054

 
$

 
$

 
$
8,866

 
$

Assets classified as held for sale are recorded at the lower of carrying value or fair value less estimated costs to sell, and any adjustment is recorded in other operating (income) expense, net or restructuring expenses in the condensed consolidated statements of earnings. The highest and best use of the assets held for sale is as real estate land parcels for development or real estate properties for use or lease; however, the Company has chosen not to develop or use these properties.

14

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Certain Financial Assets and Liabilities Not Measured at Fair Value
The following table summarizes the fair value of assets (liabilities) that are not measured at fair value in the condensed consolidated balance sheets, but for which the fair value is disclosed: 
(In Thousands)
June 30, 2017
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Perfect Home Notes1
$

 
$

 
$
22,252

 
$

 
$

 
$
20,519

Fixed-Rate Long-Term Debt2

 
(279,418
)
 

 

 
(368,408
)
 

1 
The Perfect Home Notes are carried at cost, which approximates fair value. The Company periodically reviews the carrying amount utilizing company-specific transactions or changes in Perfect Home’s financial performance to determine if the Notes are impaired. As of June 30, 2017, the Company considered the fair value of the Note's secured assets in determining if the Notes are impaired. The fair value of the secured assets is determined based on the present value of the estimated future net cash inflows of the Perfect Home assets that are pledged as security interest on the Notes. If Perfect Home is unable to access additional capital and fails to execute on its business strategy, there could be a change in the valuation of the Notes that may result in an impairment loss in future periods.
2 
The fair value of fixed-rate long-term debt is estimated using the present value of underlying cash flows discounted at a current market yield for similar instruments. The carrying amount of fixed-rate long-term debt was $265.0 million and $350.0 million at June 30, 2017 and December 31, 2016, respectively.
NOTE 3. LOANS RECEIVABLE
The following is a summary of the Company’s loans receivable, net:
(In Thousands)
 
June 30, 2017
 
December 31, 2016
Credit Card Loans
 
$
77,280

 
$
64,794

Acquired Loans
 
23,029

 
33,840

Loans Receivable, Gross
 
100,309

 
98,634

 
 
 
 
 
Allowance for Loan Losses
 
(9,013
)
 
(6,624
)
Unamortized Fees
 
(7,559
)
 
(7,206
)
Loans Receivable, Net
 
$
83,737

 
$
84,804

Included in the table below is an aging of the loans receivable, gross balance:
(Dollar Amounts in Thousands)
 
 
 
 
Aging Category1
 
June 30, 2017
 
December 31, 2016
30-59 days past due
 
7.1
%
 
6.8
%
60-89 days past due
 
3.6
%
 
3.2
%
90 or more days past due
 
4.2
%
 
4.3
%
Past due loans receivable
 
14.9
%
 
14.3
%
Current loans receivable
 
85.1
%
 
85.7
%
Balance of Credit Card Loans on Nonaccrual Status
 
$
1,219

 
$
1,072

Balance of Loans Receivable 90 or More Days Past Due and Still Accruing Interest and Fees
 
$

 
$

1 
This aging is based on the contractual amounts outstanding for each loan as of period end, and does not reflect the fair value adjustments for the Acquired Loans.

15

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The table below presents the components of the allowance for loan losses:
 
Six Months Ended June 30,
(In Thousands)
2017
 
2016
Beginning Balance1
$
6,624

 
$
937

Provision for Loan Losses
9,130

 
4,211

Charge-offs
(6,985
)
 
(1,056
)
Recoveries
244

 
4

Ending Balance
$
9,013

 
$
4,096

1 
The Company acquired DAMI on October 15, 2015 and recorded $89.1 million of loans receivable as of the acquisition date. No corresponding allowance for loan losses was recorded as the loans receivable were established at fair value in acquisition accounting. The January 1, 2016 balance represents the provision for loan losses incurred from October 15, 2015 to December 31, 2015.
NOTE 4. COMMITMENTS AND CONTINGENCIES
Guarantees
The Company has guaranteed certain debt obligations of some of the franchisees under a franchise loan program with several banks. In the event these franchisees are unable to meet their debt service payments or otherwise experience an event of default, the Company would be unconditionally liable for the outstanding balance of the franchisees’ debt obligations under the franchisee loan program, which would be due in full within 90 days of the event of default. At June 30, 2017, the maximum amount that the Company would be obligated to repay in the event franchisees defaulted was $52.6 million. The Company has recourse rights to franchisee assets securing the debt obligations, which consist primarily of lease merchandise and fixed assets. Since the inception of the franchise loan program in 1994, the Company has had no significant associated losses. The Company believes the likelihood of any significant amounts being funded by the Company in connection with these guarantees to be remote. The carrying amount of the franchisee-related borrowings guarantee, which is included in accounts payable and accrued expenses in the condensed consolidated balance sheets, is approximately $0.9 million as of June 30, 2017.
The maximum facility commitment amount under the franchisee loan program is $125.0 million, including a Canadian subfacility commitment amount for loans to franchisees that operate stores in Canada (other than the province of Quebec) of CAD $25.0 million. The Company remains subject to the financial covenants under the franchisee loan facility. We are in compliance with the covenants at June 30, 2017 and believe that we will continue to be in compliance in the future.
Legal Proceedings
From time to time, the Company is party to various legal and regulatory proceedings arising in the ordinary course of business.
Some of the proceedings to which the Company is currently a party are described below. The Company believes it has meritorious defenses to all of the claims described below, and intends to vigorously defend against the claims. However, these proceedings are still developing and due to the inherent uncertainty in litigation, regulatory and similar adversarial proceedings, there can be no guarantee that the Company will ultimately be successful in these proceedings, or in others to which it is currently a party. Substantial losses from these proceedings or the costs of defending them could have a material adverse impact upon the Company's business, financial position and results of operations.
The Company establishes an accrued liability for legal and regulatory proceedings when it determines that a loss is both probable and the amount of the loss can be reasonably estimated. The Company continually monitors its litigation and regulatory exposure and reviews the adequacy of its legal and regulatory reserves on a quarterly basis. The amount of any loss ultimately incurred in relation to matters for which an accrual has been established may be higher or lower than the amounts accrued for such matters.
At June 30, 2017, the Company had accrued $6.3 million for pending legal and regulatory matters for which it believes losses are probable and is the Company's best estimate of its exposure to loss. The Company records these liabilities in accounts payable and accrued expenses in the condensed consolidated balance sheets. The Company estimates that the aggregate range of reasonably possible loss in excess of accrued liabilities for such probable loss contingencies is between $0 and $1 million.

16

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

At June 30, 2017, the Company estimated that the aggregate range of loss for all material pending legal and regulatory proceedings for which a loss is reasonably possible, but less likely than probable (i.e., excluding the contingencies described in the preceding paragraph), is between $1 million and $4 million. Those matters for which a reasonable estimate is not possible are not included within estimated ranges and, therefore, the estimated ranges do not represent the Company's maximum loss exposure. The Company’s estimates for legal and regulatory accruals, aggregate probable loss amounts and reasonably possible loss amounts are all subject to the uncertainties and variables described above.
Consumer
In Margaret Korrow, et al. v. Aaron's, Inc., originally filed in the Superior Court of New Jersey, Middlesex County, Law Division on October 26, 2010, plaintiff filed suit on behalf of herself and others similarly situated alleging that the Company is liable in damages to plaintiff and each class member because the Company's lease agreements issued after March 16, 2006 purportedly violated certain New Jersey state consumer statutes. Plaintiff's complaint seeks equitable relief, treble damages under the New Jersey Consumer Fraud Act, and statutory penalty damages of $100 per violation of all contracts issued in New Jersey, and also claims that there are multiple violations per contract. The complaint also seeks pre-and-post judgment interest and attorneys' fees. On July 31, 2013, the Court certified a class comprising all persons who entered into a rent-to-own contract with the Company in New Jersey from March 16, 2006 through March 31, 2011. On February 23, 2016, the Court granted in part and denied in part the Company’s motion for partial summary judgment filed August 14, 2015, dismissing plaintiff’s claims that a pro-rate feature of the lease agreements violated the New Jersey Consumer Fraud Act, but denying summary judgment on the claim that Aaron’s Service Plus violated the same act. In December 2016, a class notice was mailed to certain individuals who were customers of Company-operated stores in New Jersey from March 16, 2006 to March 31, 2011. The parties participated in a settlement conference and reached tentative settlement terms in March 2017. The parties continue to work on a final comprehensive settlement agreement and final court approval.
Privacy and Related Matters
In Crystal and Brian Byrd v. Aaron's, Inc., Aspen Way Enterprises, Inc., John Does (1-100) Aaron's Franchisees and Designerware, LLC, filed on May 16, 2011, in the United States District Court, Western District of Pennsylvania, plaintiffs allege the Company and its independently owned and operated franchisee Aspen Way Enterprises ("Aspen Way") knowingly violated plaintiffs' privacy in violation of the Electronic Communications Privacy Act ("ECPA") and the Computer Fraud Abuse Act and sought certification of a putative nationwide class. Plaintiffs based these claims on Aspen Way's use of a software program called "PC Rental Agent." Plaintiffs have filed an amended complaint, which asserts claims under the ECPA, common law invasion of privacy, seeks an injunction, and names additional independently owned and operated Company franchisees as defendants. Plaintiffs seek monetary damages as well as injunctive relief.
In March 2014, the United States District Court dismissed all claims against all franchisees other than Aspen Way Enterprises, LLC, dismissed claims for invasion of privacy, aiding and abetting, and conspiracy against all defendants, and denied plaintiffs’ motion to certify a class action, but denied the Company’s motion to dismiss the claims alleging ECPA violations. In April 2015, the United States Court of Appeals for the Third Circuit reversed the denial of class certification on the grounds stated by the District Court, and remanded the case back to the District Court for further consideration of that and the other elements necessary for class certification. On January 24, 2017, final briefs were submitted on the remand of plaintiffs’ motion for class certification with the District Court, and oral arguments were held on March 30, 2017. The Court's decision is pending.
In Michael Winslow and Fonda Winslow v. Sultan Financial Corporation, Aaron's, Inc., John Does (1-10), Aaron's Franchisees and Designerware, LLC, filed on March 5, 2013 in the Los Angeles Superior Court, plaintiffs assert claims against the Company and its independently owned and operated franchisee, Sultan Financial Corporation (as well as certain John Doe franchisees), for unauthorized wiretapping, eavesdropping, electronic stalking, and violation of California's Comprehensive Computer Data Access and Fraud Act and its Unfair Competition Law. Each of these claims arises out of the alleged use of PC Rental Agent software. The plaintiffs are seeking injunctive relief and damages as well as certification of a putative California class. In April 2013, the Company removed this matter to federal court. In May 2013, the Company filed a motion to stay this litigation pending resolution of the Byrd litigation, a motion to dismiss for failure to state a claim, and a motion to strike certain allegations in the complaint. The Court subsequently stayed the case. The Company's motions to dismiss and strike certain allegations remain pending. In June 2015, the plaintiffs filed a motion to lift the stay, which was denied in July 2015.
In Lomi Price v. Aaron's, Inc. and NW Freedom Corporation, filed on February 27, 2013, in the State Court of Fulton County, Georgia, an individual plaintiff asserts claims against the Company and its independently owned and operated franchisee, NW Freedom Corporation, for invasion of privacy/intrusion on seclusion, computer invasion of privacy and infliction of emotional distress. Each of these claims arises out of the alleged use of PC Rental Agent software.  The plaintiff is seeking compensatory and punitive damages. This case has been stayed pending resolution of the Byrd litigation.

17

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In Michael Peterson v. Aaron’s, Inc. and Aspen Way Enterprises, Inc., filed on June 19, 2014, in the United States District Court for the Northern District of Georgia, plaintiffs claim that the Company and Aspen Way knowingly violated plaintiffs' privacy and the privacy of plaintiffs' law firm's clients in violation of the ECPA and the Computer Fraud Abuse Act. Plaintiffs seek certification of a putative nationwide class. Plaintiffs based these claims on Aspen Way's use of PC Rental Agent software. The Court has dismissed all claims except a claim for aiding and abetting invasion of privacy. Plaintiffs filed a motion for class certification which the Court denied on January 25, 2017. On May 5, 2017, the Company filed a motion for summary judgment on the remaining single plaintiff case. The briefing on that motion was completed in late June 2017, and it remains pending.
Securities
Employees' Retirement System of the City of Baton Rouge and Parish of East Baton Rouge v. Aaron's, Inc., John W. Robinson, III, Ryan K. Woodley, and Gilbert L. Danielson, was filed June 16, 2017, in the United States District Court for the Northern District of Georgia. The litigation relates to the temporary drop in Aaron’s stock price following the Company’s announcement of 2015 third quarter results. The Complaint alleges that during the period from February 6, 2015 through October 29, 2015, Aaron's made misleading public statements about the Company's expected financial results and business prospects. The allegations underlying the lawsuit principally relate to the loss of certain data feeds experienced by Progressive Leasing beginning in February 2015 and the alleged failure to disclose the same in a timely manner, as well as certain software issues that allegedly hindered the identification of delinquent accounts during certain limited times in 2015. The Company believes the claims are without merit and intends to vigorously defend against this lawsuit. 
Other Contingencies
The Company is a party to various claims and legal proceedings arising in the ordinary course of business. Management regularly assesses the Company’s insurance deductibles, monitors the Company's litigation and regulatory exposure with the Company's attorneys and evaluates its loss experience. The Company also enters into various contracts in the normal course of business that may subject it to risk of financial loss if counterparties fail to perform their contractual obligations.
Unfunded Lending Commitments
The Company, through its DAMI business, has unfunded lending commitments totaling $378.4 million and $366.4 million as of June 30, 2017 and December 31, 2016, respectively. These unfunded commitments arise in the ordinary course of business from credit card agreements with individual cardholders that give them the ability to borrow, against unused amounts, up to the maximum credit limit assigned to their account. While these unfunded amounts represented the total available unused lines of credit, the Company does not anticipate that all cardholders will utilize their entire available line at any given point in time. Commitments to extend unsecured credit are agreements to lend to a cardholder so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The reserve for losses on unfunded loan commitments is calculated by the Company based on historical usage patterns of cardholders after the initial charge and is approximately $0.5 million as of June 30, 2017 and December 31, 2016, respectively. The reserve for losses on unfunded loan commitments is included in accounts payable and accrued expenses in the condensed consolidated balance sheets.
See Note 9 to the consolidated financial statements in the 2016 Annual Report for further information.
NOTE 5. SEGMENTS
As of December 31, 2016, the Company had five reportable segments: Sales and Lease Ownership, Franchise, Woodhaven, Progressive Leasing and DAMI. As of June 30, 2017, the Company has three operating and reportable segments: Aaron's Business, Progressive Leasing and DAMI. During the six months ended June 30, 2017, the Company changed its composition of reportable segments by combining Sales and Lease Ownership, Franchise and Woodhaven into one reportable segment, the Aaron's Business, to align the reportable segments with the current organizational structure and the operating results that the chief operating decision maker regularly reviews to analyze performance and allocate resources. The Company has retroactively adjusted, for all periods presented, its segment disclosures to align with the current composition of reportable segments.

18

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Aaron's Business offers furniture, consumer electronics, home appliances and accessories to consumers primarily on a month-to-month, lease-to-own basis with no credit needed through the Company's Aaron's stores in the United States and Canada. This operating segment also awards franchises and supports franchisees of its Aaron's stores. In addition, the Aaron's Business segment also includes the operations of Woodhaven Furniture Industries, which manufactures and supplies the majority of the upholstered furniture and bedding leased and sold in Company-operated and franchised stores. The HomeSmart operations, prior to its disposition in May 2016, is reflected within the Aaron's Business segment and offered furniture, electronics, appliances and computers to customers primarily on a weekly payment basis with no credit needed.
Progressive Leasing is a leading virtual lease-to-own company that provides lease-purchase solutions on a variety of products, including furniture and bedding, consumer electronics, appliances and jewelry. DAMI offers a variety of second-look financing programs originated through two third-party federally insured banks to customers of participating merchants and, together with Progressive Leasing, allows the Company to provide retail partners with below-prime customers one source for financing and leasing transactions.
The Company determines earnings (loss) before income taxes for all reportable segments in accordance with U.S. GAAP. Interest expense is allocated to the Progressive Leasing and DAMI segments based on a percentage of the outstanding balances of its intercompany borrowings and of the debt incurred when it was acquired.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
(In Thousands)
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Aaron's Business
$
433,613

 
$
485,477

 
$
903,851

 
$
1,028,476

Progressive Leasing
373,499

 
298,574

 
739,614

 
605,239

DAMI
8,532

 
5,302

 
16,733

 
10,065

Total Revenues from External Customers
$
815,644

 
$
789,353

 
$
1,660,198

 
$
1,643,780

 
 
 
 
 
 
 
 
Earnings (Loss) Before Income Taxes:
 
 
 
 
 
 
 
Aaron's Business1
$
21,450

 
$
34,321

 
$
70,080

 
$
95,017

Progressive Leasing
38,240

 
29,083

 
73,998

 
50,997

DAMI
(2,695
)
 
(2,280
)
 
(4,460
)
 
(5,162
)
Total Earnings Before Income Taxes
$
56,995

 
$
61,124

 
$
139,618

 
$
140,852

1 Earnings before income taxes for the Aaron's Business during the six months ended June 30, 2017 includes restructuring charges of $13.5 million related to store contractual lease obligations, severance costs and impairment charges in connection with the Company's strategic decision to close Company-operated stores, of which $13.3 million was incurred during the three months ended June 30, 2017.
Earnings before income taxes for the Aaron's Business during the six months ended June 30, 2016 were impacted by: (1) a gain of $11.1 million on the January 29, 2016 sale of the Company's corporate office building; (2) a loss of $5.6 million related to exiting the HomeSmart business and the write-down of the HomeSmart disposal group to its fair value less cost to sell upon its classification as held for sale; and (3) charges of $3.7 million related to the retirement of the Company's Chief Financial Officer.
Corporate-related assets that benefit multiple segments are reported as other assets in the table below.
(In Thousands)
June 30,
2017
 
December 31,
2016
Assets:
 
 
 
Aaron's Business1
$
1,103,084

 
$
1,199,213

Progressive Leasing
940,300

 
919,487

DAMI
102,183

 
102,958

Other
402,563

 
394,078

Total Assets
$
2,548,130

 
$
2,615,736

1 Includes inventory (principally raw materials and work-in-process) that has been classified within lease merchandise in the condensed consolidated balance sheets of $15.6 million and $14.3 million as of June 30, 2017 and December 31, 2016, respectively.

19

AARON'S, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 6. RESTRUCTURING
2016 Restructuring Program
During the year ended December 31, 2016, the Company initiated a restructuring program that included a thorough review of the Company-operated Aaron's store portfolio and the subsequent closure or planned closure of underperforming stores. As a result of this restructuring program, the Company closed 56 underperforming Company-operated stores during 2016 and 63 stores during the first six months of 2017, and anticipates closing an additional six stores during the remainder of 2017. The Company also optimized its home office and field support staff during 2016 and 2017, which resulted in a reduction in employee headcount in those areas to more closely align with current business conditions.
Total restructuring charges of $13.4 million and $13.8 million were recorded during the three and six months ended June 30, 2017, respectively. Charges for the three months ended June 30, 2017 were comprised of $11.8 million related to Aaron's store contractual lease obligations for closed stores, $1.1 million related to workforce reductions, and $0.5 million primarily related to the write-down to fair value, less estimated selling costs, of land and buildings from stores closed under the restructuring program. These costs were included in the line item "Restructuring expenses" in the condensed consolidated statements of earnings. The Company expects to incur approximately $1.5 million of additional charges related to the previously announced store closures, but will continue to evaluate its store base for strategic growth and consolidation activities in future periods. To date, the Company has incurred charges of $34.0 million under the restructuring program that was initiated in 2016 and has continued to be implemented in 2017.
The following table summarizes the balance of the accruals, which are recorded in accounts payable and accrued expenses in the condensed consolidated balance sheets, and the activity for the six months ended June 30, 2017:
(In Thousands)
Contractual Lease Obligations
 
Severance
Balance at January 1, 2017
$
10,583

 
$
2,079

Charges
12,259

 
1,591

Adjustments1
(941
)
 

Restructuring Charges
11,318

 
1,591

Payments
(4,700
)
 
(1,330
)
Balance at June 30, 2017
$
17,201

 
$
2,340

1 Adjustments relate to early buyouts of leases, changes in sublease assumptions and interest accretion.
The following table summarizes restructuring charges by segment for the three and six months ended June 30, 2017:
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
(In Thousands)
Aaron's Business
 
DAMI1
 
Total
 
Aaron's Business
 
DAMI1
 
Total
Contractual Lease Obligations
$
11,841

 
$

 
$
11,841

 
$
11,318

 
$

 
$
11,318

Fixed Asset Impairment/Other
460

 

 
460

 
864

 

 
864

Severance
996

 
148

 
1,144

 
1,352

 
238

 
1,590

Total Restructuring Expense
$
13,297

 
$
148

 
$
13,445

 
$
13,534

 
$
238

 
$
13,772

1 Restructuring charges for DAMI relate primarily to the segment's relocation efforts. Future DAMI restructuring charges are expected to be immaterial.
NOTE 7: SUBSEQUENT EVENTS
Acquisition
On July 27, 2017, the Company acquired substantially all of the assets of the store operations of SEI/Aaron’s, Inc. ("SEI"), its largest franchisee, for approximately $140.0 million in cash, subject to working capital and other adjustments. Those store operations currently serve more than 90,000 customers through 104 Aaron's-branded stores in 11 states primarily in the Northeast. The acquisition is expected to benefit our omnichannel platform through added scale, strengthen the Company's presence in certain geographic markets, and enhance Aaron's ability to drive inventory supply-chain synergies between the Aaron's business and Progressive Leasing in markets that SEI currently serves.


20


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Information: Except for historical information contained herein, the matters set forth in this Form 10-Q are forward-looking statements. These statements are based on management’s current expectations and plans, which involve risks and uncertainties. Such forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will,""believe," "expect," "forecast," "guidance," "intend," "could," "project," "estimate," "anticipate," "should," and similar terminology. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the filing date of this Quarterly Report and which involve risks and uncertainties that may cause actual results to differ materially from those set forth in these statements. These risks and uncertainties include factors such as the impact of increased regulation, changes in general economic conditions, including consumer confidence and demand for certain merchandise, increased competition, pricing pressures, the impact of legal proceedings faced by the Company, costs relating to protecting customer privacy and information security more generally and a failure to realize the expected benefits of the integration, the execution and results of our operational strategies, risks related to Progressive Leasing's "virtual" lease-to-own business, deteriorations in our franchisee relationships, and the other risks and uncertainties discussed under Item 1A, "Risk Factors," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (the "2016 Annual Report"). Except as required by law, the Company undertakes no obligation to update these forward-looking statements to reflect subsequent events or circumstances after the filing date of this Quarterly Report.
The following discussion should be read in conjunction with the condensed consolidated financial statements as of and for the three and six months ended June 30, 2017 and 2016, including the notes to those statements, appearing elsewhere in this report. We also suggest that management’s discussion and analysis appearing in this report be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our 2016 Annual Report.
Business Overview
Aaron’s, Inc. ("we", "our", "us" or the "Company") is a leading omnichannel provider of lease-purchase solutions. As of June 30, 2017, the Company's operating segments are Aaron's Business, Progressive Leasing, and DAMI.
The Aaron's Business offers furniture, consumer electronics, home appliances and accessories to consumers primarily on a month-to-month, lease-to-own basis with no credit needed through the Company's Aaron's stores in the United States and Canada. This operating segment also awards franchises and supports franchisees of its Aaron's stores. In addition, the Aaron's Business segment also includes the operations of Woodhaven Furniture Industries, which manufactures and supplies the majority of the upholstered furniture and bedding leased and sold in Company-operated and franchised stores.
Progressive Leasing is a virtual lease-to-own company that provides lease-purchase solutions through approximately 24,000 retail locations in 46 states. It does so by purchasing merchandise from third-party retailers desired by those retailers’ customers and, in turn, leasing that merchandise to the customers on a lease-to-own basis. Progressive Leasing consequently has no stores of its own, but rather offers lease-purchase solutions to the customers of traditional retailers.
DAMI, which was acquired by Progressive Leasing on October 15, 2015, partners with merchants to provide a variety of revolving credit products originated through two third-party federally insured banks to customers that may not qualify for traditional prime lending (called "second-look" financing programs).
Business Environment and Company Outlook
Like many industries, the lease-to-own industry has been transformed by the internet and virtual marketplace. We believe the Progressive Leasing and DAMI acquisitions have been strategically transformational for the Company in this respect and will continue to strengthen our business, as demonstrated by Progressive Leasing’s significant revenue and profit growth thus far in 2017. We also believe the traditional lease-to-own industry has been negatively impacted in recent periods by: (i) the continuing economic challenges facing many traditional lease-to-own customers; (ii) increased competition from a wide range of competitors, including national, regional and local operators of lease-to-own stores; virtual lease-to-own companies; traditional and e-commerce retailers; and, indirectly, from various types of consumer finance companies that enable our customers to shop at traditional or online retailers; and (iii) the challenges faced by many traditional "brick-and-mortar" retailers, with respect to a decrease in the number of consumers visiting those stores, especially younger consumers. In response to these changing market conditions, we are executing a strategic plan that focuses on the following items and that we believe positions us for success over the long-term:
• Improve Aaron's store profitability;
• Accelerate our omnichannel platform;
• Strengthen relationships of Progressive Leasing and DAMI's current retail partners;

21


• Focus on converting existing pipeline into Progressive Leasing retail partners; and
• Champion compliance.
As part of executing this strategy, we sold the 82 Company-operated HomeSmart stores on May 13, 2016, which we believe is enabling us to sharpen our focus on activities that have the highest potential for return. We also took steps to further address the expense structure of our Aaron's Business by completing a thorough review of our remaining store base in order to identify opportunities for rationalization. As a result of this evaluation and other cost-reduction initiatives, the Company closed 56 underperforming Company-operated stores during 2016 and closed 63 stores in the first six months of 2017, and anticipates closing an additional six stores during the remainder of 2017. The Company also optimized its home office and field support staff in 2016 and 2017, which resulted in a reduction in employee headcount in those areas, to more closely align with current business conditions.
Highlights
The following summarizes significant highlights from the three and six months ended June 30, 2017:
The Company reported revenue of $815.6 million for the three months ended June 30, 2017 compared to $789.4 million for the comparable period in 2016. Net earnings before income taxes decreased to $57.0 million compared to $61.1 million during the second quarter of 2016, due in part to $13.4 million of restructuring expenses incurred during the current period related to the store closures described above.
The Company generated cash from operating activities of $115.6 million for the six months ended June 30, 2017 compared to $325.5 million for the comparable period in 2016. The decline in net cash from operating activities was impacted by net income tax payments of $65.8 million in 2017 compared to net income tax refunds of $115.3 million in 2016.
The Company returned excess capital of $38.2 million to our shareholders through the repurchase of 1.2 million shares and the payment of our quarterly dividends, which we have paid for 30 consecutive years.
Progressive Leasing achieved record quarterly revenues of $373.5 million for the three months ended June 30, 2017, an increase of 25.1% over the three months ended June 30, 2016. Progressive Leasing's revenue growth is due to a 37.5% increase in active doors, which contributed to a 31.6% increase in total invoice volume. Progressive Leasing increased its earnings before income taxes to $38.2 million compared to $29.1 million during the second quarter of 2016, due mainly to its revenue growth.
Aaron's Business revenues decreased to $433.6 million for the three months ended June 30, 2017, a 10.7% decrease from the comparable period in 2016. The decline is due primarily to an 8.1% decrease in same store sales and the net reduction of 212 Company-operated stores during the 15-month period ended June 30, 2017, including the sale of 82 HomeSmart stores in May 2016. Earnings before income taxes decreased to $21.5 million during the second quarter compared to $34.3 million in the prior year comparable period due primarily to $13.3 million of restructuring expenses incurred within the Aaron's Business segment during the current period related to the store closures described above.
Same Store Revenues. We believe that changes in same store revenues are a key performance indicator of Aaron's Business. For the three months ended June 30, 2017, we calculated this amount by comparing revenues for the three months ended June 30, 2017 to revenues for the comparable period in 2016 for all stores open for the entire 15-month period ended June 30, 2017, excluding stores that received lease agreements from other acquired, closed or merged stores. For the six months ended June 30, 2017, we calculated this amount by comparing revenues for the six months ended June 30, 2017 to revenues for the comparable period in 2016 for all stores open for the entire 24-month period ended June 30, 2017, excluding stores that received lease agreements from other acquired, closed or merged stores. Same store revenues declined 8.1% and 8.6% for the three and six months ended June 30, 2017, respectively.
Active Doors. We believe that active doors are a key performance indicator of our Progressive Leasing segment. Active doors represent retail store locations at which at least one virtual lease-to-own transaction has been completed during the trailing three month period. The following table presents active doors for the Progressive Leasing segment:
Active Doors at June 30 (Unaudited)
2017
 
2016
Progressive Leasing Active Doors
19,148

 
13,930


22


Invoice Volume. We also believe that invoice volume is a key performance indicator of our Progressive Leasing segment. Invoice volume is defined as the retail price of lease merchandise acquired and leased by Progressive Leasing during the period, net of returns. The following table presents total invoice volume for the Progressive Leasing segment:
For the Three Months Ended June 30 (Unaudited and In Thousands)
2017
 
2016
Progressive Leasing Invoice Volume
$
268,719

 
$
204,170

Seasonality
Our revenue mix is moderately seasonal for both the Aaron's Business and Progressive Leasing. The first quarter of each year generally has higher revenues than any other quarter. This is primarily due to realizing the full benefit of business that historically gradually increases in the fourth quarter as a result of the holiday season, as well as the receipt by our customers in the first quarter of federal and state income tax refunds. Our customers will more frequently exercise the early purchase option on their existing lease agreements or purchase merchandise off the showroom floor during the first quarter of the year. Due to the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.
Key Components of Earnings Before Income Taxes
In this management’s discussion and analysis section, we review our consolidated results. For the three and six months ended June 30, 2017 and the comparable prior year periods, some of the key revenue, cost and expense items that affected earnings before income taxes were as follows:
Revenues. We separate our total revenues into six components: (i) lease revenues and fees; (ii) retail sales; (iii) non-retail sales; (iv) franchise royalties and fees; (v) interest and fees on loans receivable; and (vi) other. Lease revenues and fees include all revenues derived from lease agreements at Company-operated stores and retail locations serviced by Progressive Leasing. Retail sales represent sales of both new and returned lease merchandise from our Company-operated stores. Non-retail sales primarily represent new merchandise sales to our franchisees. Franchise royalties and fees represent fees from the sale of franchise rights and royalty payments from franchisees, as well as other related income from our franchised stores. Interest and fees on loans receivable primarily represents merchant fees, finance charges and annual and other fees earned on loans originated since the DAMI acquisition, as well as the accretion of the discount on loans acquired in the acquisition. Other revenues primarily relate to revenues from leasing real estate properties to unrelated third parties, as well as other miscellaneous revenues.
Depreciation of Lease Merchandise. Depreciation of lease merchandise primarily reflects the expense associated with depreciating merchandise held for lease and leased to customers by our Company-operated stores and Progressive Leasing.
Retail Cost of Sales. Retail cost of sales represents the depreciated cost of merchandise sold through our Company-operated stores.
Non-Retail Cost of Sales. Non-retail cost of sales primarily represents the cost of merchandise sold to our franchisees.
Operating Expenses. Operating expenses include personnel costs, occupancy costs, provision for lease merchandise write-offs, bad debt expense, shipping and handling, advertising and the provision for loan losses, among other expenses.
Restructuring Expenses. Restructuring expenses primarily represent the cost of optimization efforts and cost reduction initiatives related to the Aaron's Business, home office and field support functions. Restructuring charges were comprised principally of closed store contractual lease obligations, impairment of store property, plant and equipment and workforce reductions.
Other Operating (Income) Expense, Net. Other operating (income) expense, net, consists of gains or losses on sales of Company-operated stores and delivery vehicles, fair value adjustments on assets held for sale and gains or losses on other transactions involving property, plant and equipment.

23


Results of Operations – Three months ended June 30, 2017 and 2016
 
Three Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
REVENUES:
 
 
 
 
 
 
 
Lease Revenues and Fees
$
718,089

 
$
688,677

 
$
29,412

 
4.3
 %
Retail Sales
6,106

 
6,460

 
(354
)
 
(5.5
)
Non-Retail Sales
69,602

 
72,610

 
(3,008
)
 
(4.1
)
Franchise Royalties and Fees
12,824

 
14,772

 
(1,948
)
 
(13.2
)
Interest and Fees on Loans Receivable
8,532

 
5,302

 
3,230

 
60.9

Other
491

 
1,532

 
(1,041
)
 
(68.0
)
 
815,644

 
789,353

 
26,291

 
3.3

COSTS AND EXPENSES:
 
 
 
 
 
 
 
Depreciation of Lease Merchandise
345,398

 
321,969

 
23,429

 
7.3

Retail Cost of Sales
3,940

 
3,892

 
48

 
1.2

Non-Retail Cost of Sales
61,818

 
63,984

 
(2,166
)
 
(3.4
)
Operating Expenses
330,548

 
330,601

 
(53
)
 

Restructuring Expenses
13,445

 

 
13,445

 
          nmf
Other Operating (Income) Expense, Net
(511
)
 
755

 
(1,266
)
 
(167.7
)
 
754,638

 
721,201

 
33,437

 
4.6

OPERATING PROFIT
61,006

 
68,152

 
(7,146
)
 
(10.5
)
Interest Income
378

 
507

 
(129
)
 
(25.4
)
Interest Expense
(5,552
)
 
(5,904
)
 
(352
)
 
(6.0
)
Other Non-Operating Income (Expense), Net
1,163

 
(1,631
)
 
2,794

 
171.3

EARNINGS BEFORE INCOME TAXES
56,995

 
61,124

 
(4,129
)
 
(6.8
)
INCOME TAXES
20,660

 
22,623

 
(1,963
)
 
(8.7
)
NET EARNINGS
$
36,335

 
$
38,501

 
$
(2,166
)
 
(5.6
)%
nmf - Calculation is not meaningful
 
 
 
 
 
 
 
Revenues
Information about our revenues by reportable segment is as follows: 
 
Three Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
REVENUES:
 
 
 
 
 
 
 
Aaron's Business1
$
433,613

 
$
485,477

 
$
(51,864
)
 
(10.7
)%
Progressive Leasing2
373,499

 
298,574

 
74,925

 
25.1

DAMI3
8,532

 
5,302

 
3,230

 
60.9

Total Revenues from External Customers
$
815,644

 
$
789,353

 
$
26,291

 
3.3
 %
1 Segment revenue principally consists of lease revenues and fees, retail sales, non-retail sales and franchise royalties and fees.
2 Segment revenue consists of lease revenues and fees.
3 Segment revenue consists of interest and fees on loans receivable, and excludes the effect of interest expense.
Aaron's Business. Aaron's Business segment revenues decreased primarily due to a $45.5 million decrease in lease revenues and fees and a $3.0 million decrease in non-retail sales. Lease revenues and fees decreased due to an 8.1% decrease in same store revenues and the net reduction of 212 Company-operated stores during the 15-month period ended June 30, 2017, including the sale of 82 HomeSmart stores in May 2016. The decrease in non-retail sales was mainly due to decreasing demand for product by franchisees as a result of the net reduction of 49 franchised stores during the 15-month period ended June 30, 2017.
Progressive Leasing. Progressive Leasing segment revenues increased primarily due to a 37.5% growth in active doors, which contributed to an increase in total invoice volume.

24


DAMI. DAMI segment revenues increased due to higher interest and fee revenue recognized as a result of the growth of DAMI's post-acquisition loan portfolio subsequent to the October 15, 2015 DAMI acquisition. The balance of loans originated since the acquisition were approximately $77.3 million as of June 30, 2017 compared to $44.8 million as of June 30, 2016.
Operating Expenses
Information about certain significant components of operating expenses is as follows:
 
Three Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
Personnel Costs
$
145,917

 
$
156,428

 
$
(10,511
)
 
(6.7
)%
Occupancy Costs
48,507

 
52,005

 
(3,498
)
 
(6.7
)
Provision for Lease Merchandise Write-Offs
33,148

 
28,125

 
5,023

 
17.9

Bad Debt Expense
36,059

 
28,271

 
7,788

 
27.5

Shipping and Handling
15,684

 
17,063

 
(1,379
)
 
(8.1
)
Advertising
10,160

 
11,968

 
(1,808
)
 
(15.1
)
Provision for Loan Losses
5,387

 
2,413

 
2,974

 
123.2

Other Operating Expenses
35,686

 
34,328

 
1,358

 
4.0

Operating Expenses
$
330,548

 
$
330,601

 
$
(53
)
 
 %
Operating expenses remained consistent during the three months ended June 30, 2017 from the comparable period in 2016. As a percentage of total revenues, operating expenses decreased to 40.5% in the three months ended June 30, 2017 from 41.9% in the same period in 2016.
Personnel costs and occupancy costs decreased primarily due to the net reduction of 212 Company-operated stores during the 15-month period ended June 30, 2017. Personnel costs also decreased due to a reduction of home office and field support staff from our Aaron's Business restructuring program, partially offset by increases in hiring to support the growth of Progressive Leasing.
The provision for lease merchandise write-offs increased during the three months ended June 30, 2017. Progressive Leasing's provision for lease merchandise write-offs as a percentage of Progressive Leasing's lease revenues increased to 5.5% in 2017 from 4.5% in 2016 due to a reduction in the allowance for lease merchandise write-offs during the three months ended June 30, 2016 as lease portfolio performance had improved compared to historical periods. The provision for lease merchandise write-offs as a percentage of lease revenues for the Aaron's Business decreased to 3.6% in 2017 from 3.7% in 2016.
Bad debt expense increased by $7.8 million during the three months ended June 30, 2017 compared to the same period in 2016 due to the increase in invoice volume from Progressive Leasing as discussed above. Progressive Leasing's bad debt expense as a percentage of Progressive Leasing's revenues increased to 9.7% in 2017 compared to 9.5% in 2016.
The provision for loan losses increased during 2017 due to the growth of DAMI's post-acquisition loan portfolio subsequent to the October 15, 2015 acquisition of DAMI.
Other Costs and Expenses
Depreciation of lease merchandise. As a percentage of total lease revenues and fees, depreciation of lease merchandise increased to 48.1% from 46.8% in the prior year period, primarily due to a shift in product mix from the Aaron's Business to Progressive Leasing, which is consistent with the increasing proportion of Progressive Leasing's revenue to total lease revenue. Progressive Leasing generally experiences higher depreciation as a percentage of lease revenues because, among other factors, its merchandise has a shorter average life on lease, a higher rate of early buyouts, and the merchandise is generally purchased at retail prices compared to the Aaron's Business, which procures merchandise at wholesale prices.
Retail cost of sales. Retail cost of sales as a percentage of retail sales increased to 64.5% from 60.2% primarily due to lower inventory purchase cost during the prior year.
Non-retail cost of sales. Non-retail cost of sales as a percentage of non-retail sales increased to 88.8% from 88.1% primarily due to lower inventory purchase cost during the prior year.
Restructuring Expenses. In connection with the announced closure and consolidation of underperforming Company-operated Aaron's stores and workforce reductions in the home office and field support operations, net charges of $13.4 million were incurred during the three months ended June 30, 2017. The charges are comprised of $11.8 million related to Aaron's store contractual lease obligations for closed stores, $1.1 million related to workforce reductions, and $0.5 million primarily related to the write-down to fair value, less estimated selling costs, of land and buildings from stores closed under the restructuring program.

25


Other Operating (Income) Expense, Net
Information about the components of other operating (income) expense, net is as follows:
 
Three Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
Gains on sales of stores
$
(21
)
 
$

 
$
(21
)
 
        nmf
Net gains on sales of delivery vehicles
(387
)
 
(241
)
 
(146
)
 
(60.6
)
Impairment charges and net (gains) losses on asset dispositions and assets held for sale
(103
)
 
996

 
(1,099
)
 
(110.3
)
Other operating (income) expense, net
$
(511
)
 
$
755

 
$
1,266

 
(91.7
)%
nmf - Calculation is not meaningful
 
 
 
 
 
 
 
During the three months ended June 30, 2016, the impairment charges and net losses on asset dispositions and assets held for sale were primarily due to the write down to fair value of certain assets related to the HomeSmart division.
Operating Profit
Interest income. Interest income decreased to $0.4 million in 2017 from $0.5 million in 2016 due primarily to lower Perfect Home interest income, partially offset by higher cash equivalent balances.
Interest expense. Interest expense decreased to $5.6 million in 2017 from $5.9 million in 2016 due primarily to a lower outstanding debt balance during the three months ended June 30, 2017.
Other non-operating income (expense), net. Other non-operating income (expense), net includes the impact of foreign currency remeasurement, as well as gains resulting from changes in the cash surrender value of Company-owned life insurance related to the Company's deferred compensation plan. Included in other non-operating income (expense), net were foreign exchange remeasurement gains of $0.8 million and losses of $1.7 million during the three months ended June 30, 2017 and 2016, respectively. These net gains and losses result from changes in the value of the U.S. dollar against the British pound and Canadian dollar. Gains related to the changes in the cash surrender value of Company-owned life insurance were $0.3 million during the three months ended June 30, 2017 and were immaterial during the three months ended June 30, 2016.
Earnings Before Income Taxes
Information about our earnings (loss) before income taxes by reportable segment is as follows: 
 
Three Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
EARNINGS (LOSS) BEFORE INCOME TAXES:
 
 
 
 
 
 
 
Aaron's Business
$
21,450

 
$
34,321

 
$
(12,871
)
 
(37.5
)%
Progressive Leasing
38,240

 
29,083

 
9,157

 
31.5

DAMI
(2,695
)
 
(2,280
)
 
(415
)
 
(18.2
)
Total Earnings Before Income Taxes
$
56,995

 
$
61,124

 
$
(4,129
)
 
(6.8
)%
Income Tax Expense
Income tax expense decreased to $20.7 million for the three months ended June 30, 2017 due to lower pre-tax income and a decrease in the effective tax rate to 36.2% in 2017 from 37.0% in 2016. During 2017, the recognition of excess tax benefits as a reduction of tax expense upon adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, and an increase in credits related to research and development resulted in a decrease in the effective tax rate.

26


Results of Operations – Six months ended June 30, 2017 and 2016
 
Six Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
REVENUES:
 
 
 
 
 
 
 
Lease Revenues and Fees
$
1,461,711

 
$
1,430,288

 
$
31,423

 
2.2
 %
Retail Sales
14,884

 
17,415

 
(2,531
)
 
(14.5
)
Non-Retail Sales
138,929

 
151,915

 
(12,986
)
 
(8.5
)
Franchise Royalties and Fees
27,025

 
31,067

 
(4,042
)
 
(13.0
)
Interest and Fees on Loans Receivable
16,733

 
10,065

 
6,668

 
66.2

Other
916

 
3,030

 
(2,114
)
 
(69.8
)
 
1,660,198

 
1,643,780

 
16,418

 
1.0

COSTS AND EXPENSES:
 
 
 
 
 
 
 
Depreciation of Lease Merchandise
707,396

 
670,271

 
37,125

 
5.5

Retail Cost of Sales
9,331

 
10,957

 
(1,626
)
 
(14.8
)
Non-Retail Cost of Sales
123,903

 
135,369

 
(11,466
)
 
(8.5
)
Operating Expenses
659,373

 
679,025

 
(19,652
)
 
(2.9
)
Restructuring Expenses
13,772

 

 
13,772

 
nmf

Other Operating Income, Net
(1,072
)
 
(5,974
)
 
(4,902
)
 
(82.1
)
 
1,512,703

 
1,489,648

 
23,055

 
1.5

OPERATING PROFIT
147,495

 
154,132

 
(6,637
)
 
(4.3
)
Interest Income
1,352

 
928

 
424

 
45.7

Interest Expense
(11,367
)
 
(12,216
)
 
(849
)
 
(6.9
)
Other Non-Operating Income (Expense), Net
2,138

 
(1,992
)
 
4,130

 
207.3

EARNINGS BEFORE INCOME TAXES
139,618

 
140,852

 
(1,234
)
 
(0.9
)
INCOME TAXES
49,983

 
52,664

 
(2,681
)
 
(5.1
)
NET EARNINGS
$
89,635

 
$
88,188

 
$
1,447

 
1.6
 %
nmf - Calculation is not meaningful
 
 
 
 
 
 
 
Revenues
Information about our revenues by reportable segment is as follows:
 
Six Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
REVENUES:
 
 
 
 
 
 
 
Aaron's Business1
$
903,851

 
$
1,028,476

 
$
(124,625
)
 
(12.1
)%
Progressive Leasing2
739,614

 
605,239

 
134,375

 
22.2

DAMI3
16,733

 
10,065

 
6,668

 
66.2

Total Revenues from External Customers
$
1,660,198

 
$
1,643,780

 
$
16,418

 
1.0
 %
1 Segment revenue principally consists of lease revenues and fees, retail sales, non-retail sales and franchise royalties and fees.
2 Segment revenue consists of lease revenues and fees.
3 Segment revenue consists of interest and fees on loans receivable, and excludes the effect of interest expense.
Aaron's Business. Aaron's Business segment revenues decreased primarily due to a $103.0 million decrease in lease revenues and fees and a $13.0 million decrease in non-retail sales. Lease revenues and fees decreased primarily due to an 8.6% decrease in same store revenues and the net reduction of 201 Company-operated stores during the 24-month period ended June 30, 2017, including the sale of 82 HomeSmart stores in May 2016. The decrease in non-retail sales was mainly due to decreasing demand for product by franchisees as a result of the net reduction of 106 franchised stores during the 24-month period ended June 30, 2017.
Progressive Leasing. Progressive Leasing segment revenues increased primarily due to increases in invoice volume at existing active doors as well as an increase in active doors during the six months ended June 30, 2017 as compared to the six months ended June 30, 2016.

27


DAMI. DAMI segment revenues increased due to higher interest and fee revenue recognized as a result of the growth of DAMI's post-acquisition loan portfolio subsequent to the October 15, 2015 DAMI acquisition. The balance of loans originated since the acquisition were approximately $77.3 million as of June 30, 2017 compared to $44.8 million as of June 30, 2016.
Operating Expenses
Information about certain significant components of operating expenses is as follows:
 
Six Months Ended June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
Personnel Costs
$
296,891

 
$
319,958

 
$
(23,067
)
 
(7.2
)%
Occupancy Costs
96,875

 
105,489

 
(8,614
)
 
(8.2
)
Provision for Lease Merchandise Write-Offs
63,938

 
62,031

 
1,907

 
3.1

Bad Debt Expense
68,044

 
56,210

 
11,834

 
21.1

Shipping and Handling
32,708

 
35,899

 
(3,191
)
 
(8.9
)
Advertising
20,317

 
21,654

 
(1,337
)
 
(6.2
)
Provision for Loan Losses
9,130

 
4,211

 
4,919

 
116.8

Other Operating Expenses
71,470

 
73,573

 
(2,103
)
 
(2.9
)
Operating Expenses
$
659,373

 
$
679,025

 
$
(19,652
)
 
(2.9
)%
Operating expenses decreased during the six months ended June 30, 2017 from the comparable period in 2016. As a percentage of total revenues, operating expenses decreased to 39.7% in the six months ended June 30, 2017 from 41.3% in the same period in 2016.
Personnel costs and occupancy costs decreased primarily due to the net reduction of 201 Company-operated stores during the 24-month period ended June 30, 2017. Personnel costs also decreased due to a reduction of home office and field support staff from our Aaron's Business restructuring program, partially offset by increases in hiring to support the growth of Progressive Leasing.
The provision for lease merchandise write-offs increased during the six months ended June 30, 2017. However, Progressive Leasing's provision for lease merchandise write-offs as a percentage of Progressive Leasing's lease revenues decreased to 5.1% in 2017 from 5.4% in 2016 due to continued operational improvements and enhancements to the lease decisioning process. The provision for lease merchandise write-offs as a percentage of lease revenues for the Aaron's Business remained consistent at 3.6% in both periods.
Bad debt expense increased by $11.8 million during the six months ended June 30, 2017 from the comparable period in 2016 primarily due to the increase in invoice volume from Progressive Leasing as discussed above, partially offset by continued operational improvements and enhancements to the lease decisioning process. Progressive Leasing's bad debt expense as a percentage of Progressive Leasing's revenues decreased to 9.2% in 2017 compared to 9.3% in 2016.
The provision for loan losses increased during 2017 due to the growth of DAMI's post-acquisition loan portfolio subsequent to the October 15, 2015 acquisition of DAMI.
Other Costs and Expenses
Depreciation of lease merchandise. As a percentage of total lease revenues and fees, depreciation of lease merchandise increased to 48.4% from 46.9% in the prior year period, primarily due to a shift in product mix from the Aaron's Business to Progressive Leasing, which is consistent with the increasing proportion of Progressive Leasing's revenue to total lease revenue. Progressive Leasing generally experiences higher depreciation as a percentage of lease revenues because, among other factors, its merchandise has a shorter average life on lease, a higher rate of early buyouts, and the merchandise is generally purchased at retail prices compared to the Aaron's Business, which procures merchandise at wholesale prices.
Retail cost of sales. Retail cost of sales as a percentage of retail sales remained consistent at approximately 63% for both periods.
Non-retail cost of sales. Non-retail cost of sales as a percentage of non-retail sales remained consistent at approximately 89% for both periods.
Restructuring Expenses. In connection with the announced closure and consolidation of underperforming Company-operated stores and workforce reductions in our home office and field support operations, charges of $13.8 million were incurred during the six months ended June 30, 2017. The charges are comprised of $11.3 million related to Aaron's store contractual lease obligations for closed stores, $1.6 million related to workforce reductions, and $0.9 million primarily related to the write-down to fair value, less estimated selling costs, of land and buildings from stores closed under the restructuring program.

28


Other Operating Income, Net
Information about the components of other operating income, net is as follows:
 
Six Months Ended 
 June 30,
 
Change
(In Thousands)
2017
 
2016
 
$
 
%
Net (gains) losses on sales of stores
$
(377
)
 
$
32

 
$
(409
)
 
nmf

Net gains on sales of delivery vehicles
(792
)
 
(704
)
 
(88
)
 
(12.5
)
Impairment charges and net losses (gains) on asset dispositions and assets held for sale
97

 
(5,302
)
 
5,399

 
101.8

Other operating income, net
$
(1,072
)
 
$
(5,974
)
 
$
4,902

 
82.1
 %
nmf - Calculation is not meaningful
 
 
 
 
 
 
 
During the six months ended June 30, 2016, impairment charges and net gains on asset dispositions and assets held for sale included a loss of $4.2 million related to the sale of HomeSmart, a $1.2 million charge primarily related to the write-down to fair value of certain assets related to the HomeSmart division that were not included in the May 2016 disposition and a gain of $11.1 million related to the sale of the Company's corporate headquarters building in January 2016.
Operating Profit
Interest income. Interest income increased to $1.4 million during the six months ended June 30, 2017 from $0.9 million for the comparable period in 2016 due to an increase in cash equivalent balances, partially offset by lower Perfect Home interest income.
Interest expense. Interest expense decreased to $11.4 million for the six months ended June 30, 2017 from $12.2 million in 2016 due primarily to a lower outstanding debt balance during the six months ended June 30, 2017.
Other non-operating income (expense), net. Other non-operating income (expense), net includes the impact of foreign currency remeasurement, as well as gains resulting from changes in the cash surrender value of Company-owned life insurance related to the Company's deferred compensation plan. Included in other non-operating income (expense), net were foreign exchange remeasurement gains of $1.2 million and losses of $2.1 million during the six months ended June 30, 2017 and 2016, respectively. These net gains and losses result from changes in the value of the U.S. dollar against the British pound and Canadian dollar. Gains related to the changes in the cash surrender value of Company-owned life insurance were $0.9 million during the six months ended June 30, 2017 and were immaterial during the six months ended June 30, 2016.
Earnings Before Income Taxes
Information about our earnings (loss) before income taxes by reportable segment is as follows:
 
Six Months Ended June 30,
 
Change
(In Thousands)
2017
 
2016
 
 
%