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Executives

Gilbert L. Danielson – Executive Vice President & Chief Financial Officer

Leigh Wilder – Investor Relations

Robin C. Loudermilk, Jr. – President & Chief Executive Officer

William K. Butler, Jr. – Chief Operating Officer

R. Charles Loudermilk, Sr. – Chairman of the Board

Analysts

David Burtzlaff – Stephens Inc.

Arvind Bhatia – Sterne, Agee & Leach

David Magee – Suntrust Robinson Humphrey

Laura Champine – Cullen & Company

Laura Richardson – BB&T Capital Markets

Jordan Hymowitz – Philadelphia Financial

John Harlowe – Barrow Hanley

Joel K. Havard – Hilliard Lyons

Michael Smith – Kansas City Capital

Aaron Rents Inc. (RNT) Q4 2008 Earnings Call February 17, 2009 10:30 AM ET

Operator

Good morning ladies and gentlemen and welcome to the Aaron Rents fourth quarter earnings release conference call. (Operator Instructions). I will now turn the call over to Mr. Gilbert Danielson. Mr. Danielson you may begin.

Gilbert Danielson

Well, thank you for joining us this morning. I’m going to turn the call over briefly to Leigh Wilder, who works with us in investor relations, and she’s going to make the introductions and read our Safe Harbor Statement and then we’ll have a few prepared remarks and then we’ll certainly answer any questions.

Leigh Wilder

Good morning. My name is Leigh Wilder and I assist in investor relations for Aaron Rents. The company’s earnings release issued yesterday, and the related Form 8-K, are available on our website www.aaronrents.com in the investor relations section, and this webcast will be archived for replay there as well.

With us today are Robin Loudermilk, Chief Executive Officer, Ken Butler, Chief Operating Officer and Gil Danielson, Chief Financial Officer. Before we discuss the results, I would like to read the company's Safe Harbor Statement.

Except for the historical information, the matters discussed today are forward-looking statements of the company. As such, they will involve a number of risks and uncertainties, including factors such as changes in general economic conditions, competition, pricing, customer demand and the other issues that could cause actual results to differ materially from such statements, including the risks and uncertainties discussed under risk factors in the company’s 2007 Annual Report on form 10-K, including, without limitations, the company’s projected revenues, earnings, and store openings for future periods.

Robin, Gil and Ken will have a few remarks and then we will open the floor up for Q&A. Robert?

Robin C. Loudermilk, Jr.

We’re quite pleased with the fourth quarter and fiscal year 2008 results were very strong. Even in these difficult times, our customers continue to come to our stores to get basic home furnishings products. With the credit continuing to tighten and uncertainty in the air, I believe over time we will continue to see an increase in our business, as more and more individuals see the value of Aarons’ programs.

These strong financial results continue to be negatively impacted by the new store start-up expenses related to a large number of stores that we opened during the last year or so, but as we've slowed the growth this year, this new store drag has decreased, as expected, and is returning to more normal levels.

We finalized during the quarter, the sale of our Aaron’s Corporate Furnishings division, which allowed us to pay down some debt, which proved to prudent in this time of uncertainty. This sale will allow us to focus on our faster growing, large market Aaron’s Sales and Lease ownership concept.

To maximize our success in this concept, we must remain focused on servicing and collecting, or as we call it, renting and renewing, from our approximately 1.1 million and growing customer base.

Our plans for the next several years are to grow, on average, our store base in the range of 5 to 9%. The store growth was less than that in 2008 as we consolidated some stores, sold a few stores and had not been achieving our profit goals and taking our breath a little in this tough economic environment, and strengthening our store management team.

The slower growth made in previous years, will let us grow over time at a more consistent, predictable and efficient manner, and it should improve future profit margins as we’ve done here in the last year, and overall financial performance.

Thank you for your support of the company. I’ll turn it over to Ken for a few comments and talk about the results of the Aarons Sales and Lease ownership division.

William K. Butler, Jr.

Well, thank you Robin and good morning and thank you for your continued interest in Aarons. Once again, I want to thank all of our associates, franchisees, partners and vendors in all teaming together for the most eventful quarter in our history.

The highlights were numerous and I’ll start off by mentioning the sale of our corporate furnishings division to CORT. CORT elected not to purchase approximately $18 million worth of inventory at original cost, and consequently our people have been busy emptying warehouses and shipping inventory all over the country into Aarons Sales and Lease ownership stores.

Most of the products have been leased, sold or are now sitting in our stores ready and available for lease or for sale. Shortly after this deal, we acquired the assets and stores of Rosey Rentals, our second largest franchisee, with stores throughout the southeast.

So really the net effect of these two transactions is that we swapped corporate furnishing stores for what we do best, Aarons Sales and Lease ownership stores. Additionally, during the quarter we converted Tiger John Cleek stores in Missouri, the big University of Missouri fan, to the Aarons program.

This is the sixth such transaction like this we have done over the last year and a half, and this one I make mention as Tiger is the resigning president of APRO, which is our industry’s trade organization. We are continuing to work on more of these types of conversions with outstanding operators throughout the country.

We’ve also consolidated 20 of our RENCO stores into Aarons stores and now we’re operating with only ten stand-alone RENCO operations, and this small group remaining should be profitable and the 20 consolidations should enhance the profit in the respective Aarons stores.

Not to get sidetracked from our biggest event during the quarter, is our continued growth of new customers. That is our number one metric that we look at to determine the overall health of our business, and I’m proud to report that our business is indeed healthy.

During the quarter we gained 68,000 new customers. That’s a net gain of our deliveries, returns, charge-offs and customer pay-outs. Last years’ net gain was a respectable 50,000, so our store has gained a whopping 36% more customers than a year ago in the same quarter.

Our business climate, as you can imagine, is upbeat and we look forward to continue delivering positive results throughout 2009.

Gilbert L. Danielson

Thanks, Ken. I’ll go over some of the financial results for the quarter that were in the press release. As noted in the earliest release and we’ve talked about it, certainly the sale of the Aaron’s Corporate Furnishing division was consummated in November. We received just a little bit over $75 million in cash relating to that sale.

The company revenues for the quarter, which are now basically from tending the operations, are the Aaron’s Sales and Lease ownership revenues, increased 11% for the quarter and 14% for the year. Annual revenue is almost $1.6 billion.

In addition, our franchisees collectively and increased their revenues $171.8 million in the fourth quarter and $665 million for the year. They were up 19% in both period and revenues. Although it’s not a GAAP number, if you add the revenues from our company stores and the revenues from our franchise stores that they’re generating at their store fronts, we did over $2.3 billion in total system-wide revenues for the year of ’08.

We mentioned that the same store revenue growth in the fourth quarter for the Aarons Sales and Lease ownership company operated stores was 6.2%. Those were stores that were open over 15 months, for stores that were open over two years it was 3.2%. The same store revenue growth for franchise stores was up 13.8%.

Quite pleased that we certainly had an increase in net gain in customers and the customer count on a same store basis for our company stores for the quarter was up 12% in this quarter compared to the quarter last year.

Net earnings for the fourth quarter were $21.1 million or $0.39 per diluted share, compared to $0.28 per diluted share last year's increase of 39%. Diluted earnings per share for the year were $1.56 compared to $1.46 last year, up 14%.

If you just look at the continuing operations, taking out the discontinued operations of the Aarons Corporate Furnishings division, our continuing operations EPS increased 50% for the quarter and 19% for the year.

Talked about new store drag for the quarter is becoming more normalized. It was approximately 5% per share in the fourth quarter, compared to $0.11 per share in the fourth quarter last year.

Talked about the opening of the stores during the fourth quarter, we opened 26 new company operated stores and 30 franchise stores. Also acquired 18 stores from several competitors, as well as buying one store and selling 11 stores. We had a lot of activity in the fourth quarter with realigning stores, and also as we mentioned we acquired 35 franchise stores near the very end of the fourth quarter.

For the 2008 year, we opened 49 new company stores and 58 new franchise stores. After numerous acquisition sales, other realignments, mergers, consolidations and taking out the Aarons Corporate Furnishing stores that we sold, our net store count increase from continuing operations increased 2.9% for the year.

Area development agreements on the franchise side were awarded in the quarter to open another 24 franchise stores and for the 2008 year we’ve sold 149 new stores, and the pipeline of stores that are expected to open in various future years at the end of December was 282 stores.

Our guidance for the first quarter of ’09 is expect revenues in excess of $445 million and earnings per share in the range of $0.49 to $0.54 per share, and again for 2009 we expect our company revenues to approximate $1.75 billion in revenues.

As you noted we raised our guidance slightly for '09 to $1.72 to $1.87 per share. We continue to anticipate our new store growth in '09, new store front, will increase approximately 5% to 9%, kind of a equal mix between franchise and company stores. That will be a net store growth. We anticipate we will still have some consolidation and some maybe some sales of stores in '09, which it will happen. So we're looking at a net store growth of 5% to 9%.

We will also plan in '09 to continue to acquire franchise stores compared to independent operators as we've already mentioned or sell company operated stores as warranted to franchisees and perhaps others.

These are all done to expand the Aaron's offering, to improve our profitability that makes sense. To swap stores, change stores to franchisees, we'll certainly pursue that activity as we have done in the last several years. Those are basically our comments; we would like to throw it out for questions and answers now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from David Burtzlaff – Stephens Inc., please go ahead.

David Burtzlaff – Stephens Inc.

I just have a few questions here. First the $1.2 million gain, Gil where does that show up in the income statement.

Gilbert L. Danielson

That's [indiscontent], that's a pre-tax gain and it is in that discontinued net earnings line on the income statement. We don’t show the revenues or the expenses of the Aaron's Corporate Furnishings on the face of our income statement.

We just show the net earnings of the division on that one line item. Transaction is pretty well gone now, so if we move forward in future periods that line will either be zero or practically zero, or if there's anything in that line.

David Burtzlaff – Stephens Inc.

Okay and then revenues came in lower than original guidance after the third quarter. Was there anything to that?

Gilbert L. Danielson

I don’t think so; I looked at it a little bit. Obviously, rentals and fees were up 11%, a little bit lighter than it had been in previous quarters. As we talked about it, we've been doing a lot of realignment of stores here in the last 18 months and we have been selling some company stores to our franchisees and vice versa, but when we sell a company store to the franchisee we lose quite a bit of revenue.

We get royalty fees coming back and it's not a profitability issue; it's just a revenue. I was just looking we sold some stores back that were in our numbers in the fourth quarter of '07 that were in our company revenues numbers that are now franchisee stores, if you pro forma those out, the rentals and fees would have been up 13% for the fourth quarter compared to the reported 11%.

So, yes a little bit less, but we just have had a lot of realignments of moving stores around and that has affected the revenue line a little bit this year, but it certainly has not had any effect other than positive on the bottom line.

David Burtzlaff – Stephens Inc.

And then on the same store sales traffic was up 12%. So I mean am I reading that right that pricing is down about 6%?

Gilbert L. Danielson

Well what the average customer's paying is down. The average customer's paying about $143 a month. If you look at the quarter verses quarter, fourth quarter of this year verses fourth quarter of '07, on an average basis for the whole quarter, this quarter the average customer is paying about $143 a month. Last year they were paying about $149 a month. So that's a 5% decline in what they are paying on a monthly basis on average.

There are several reasons for that. I mean certainly the price of electronics has come down, so even though we have maintained margins on electronics you're getting a little bit less from the customer on the price of electronics and we've also lengthened terms on the front of our product lines, primarily furniture.

We lengthened the terms of those awhile back from 18 to 24 months, which brought the monthly payment down a little bit. Where actually that's positive though, because we'll end up getting a little bit more money on the rental of the agreements as they go the term, because it will just be a little it longer period of time.

So our customers are up more than our same store revenues. I feel that's positive. Even thought the average customer's paying a bit more, we're getting more customers. We're spreading the portfolio around to have more customers that are paying a little bit less, and I just see that as a positive strength in the portfolio.

David Burtzlaff – Stephens Inc.

And then lastly, operating expenses seem to be down a lot more than what I was looking for. I mean even on a percent of revenue basis. Is that just less store drag, or is there something else?

Gilbert L. Danielson

Yes, quarter to quarter, fourth quarter to fourth quarter, that's certainly a big part of it, just the swing in the new store drag, but we've been working very hard on improving margins. We've talked about this for a long period of time. I think you're seeing some of that come to fruition in our operating expenses.

We – certainly, our fuel cost is down from where it had been a year ago, just running the trucks. We're getting, we're leveraging off our advertising better, so our advertising costs are a little bit down. So and just some other areas, so this is a leverage business and if you tweak the operating expenses a little bit it, it can really have a pretty positive effect on your bottom line.

Operator

Our next question comes from analyst Arvind Bhatia – Sterne, Agee & Leach, please go ahead.

Arvind Bhatia – Sterne, Agee & Leach

I was wondering if you could comment on the stimulus bill. I know before when we talked about you guys were feeling like there was some provisions that could help cash flow by deferring taxes. Number one, I wanted to just get some updates there.

Second, just wondering are you seeing or starting to see any savings on lease negotiations and as you do your 2009, 2010 leases what's your expectation verses what it was, say three or six months ago? And then write offs I wondered if you, I don’t know if I missed it, but did you comment on what the write offs were this quarter?

Gilbert L. Danielson

I talked a little bit about the income taxes, I guess. We all know that in '08 the government gave bonus depreciation to help from a tax standpoint for people to spur investments and that benefited us into '08. We paid very little federal income taxes in '08 and it probably saved us $55 to $65 million in tax in '08.

Now that's just a deferral, you eventually have to pay it back, in theory anyway. As I understand it and I haven’t read the bill – not much different I guess than our congressmen, but on the '09 stimulus package it's going to be similar to the '08.

So it is similar bonus depreciation. Again, I don’t think we'll pay hardly anything in federal income taxes in '09 and that again will probably save us $55 $65 million in tax. That's just a cash flow situation. Eventually they will stop doing that, I would assume and then you'll have further cash taxes due down in future periods.

Arvind Bhatia – Sterne, Agee & Leach

You have to pay all of that back next year or does that get deferred over a number of years?

Gilbert L. Danielson

No, it will be deferred next year in '09, and then unless they extend it and you'll have some pretty good tax payments coming up in '10 and '11. The tax rate for the quarter was 38.4%. I would say looking at '09 our tax rate, which is our tax provision, which has nothing to do with paying the tax, or with cash paying taxes, I'd use 38.5% as the guideline for the provision next year.

William K. Butler, Jr.

Arvind, on the real estate lease issue that you brought up and I would definitely say 90% of the leases coming up we're getting a more favorable rate, due to what's happening in the market place. So we're pretty lean and mean in that area too.

Arvind Bhatia – Sterne, Agee & Leach

Can you quantify that at all, what percentage savings you're starting to see?

Gilbert L. Danielson

Not really, we've got 1,000 stores. So maybe 200 are coming up each year, $175 per renewal and we're just seeing more favorable rates.

Robert C. Loudermilk, Jr.

You really can't quantify, but what we're doing is going to landlords and if we have a renewal we're certainly negotiating a lower rate on our renewal, but we're also looking at leases that have term left on them with maybe a renewal a couple years out. We would be willing to go ahead and exercise the renewal for a reduced rate for a longer period of time.

Also, you're looking at TI improvements in the showrooms, in the stores. There's a lot of different ways that you can cut that melon as far as your oxy costs, rent, TI, concessions. Going forward, a lot of these landlords are looking for a longer term to go get financing at banks, and so being a credit tenant that we are, we're using that leverage and we're being fare, but I think as Ken said, we're definitely seeing our oxy costs come down.

I think at the end of this year that we'll be able to put a pencil to it a little bit better, but it's really just kind of starting but we're working on it hard. We're very aware of it.

Arvind Bhatia – Sterne, Agee & Leach

And, Gil, did you have the write off number?

Gilbert L. Danielson

Yes, the write off at the store level, write off that's a percentage of gross revenues were 3.2% in the fourth quarter. I mean it's comparable what it has been this year.

Arvind Bhatia – Sterne, Agee & Leach

Okay and I guess final question is just again a big picture, obviously you're seeing a lot more customers. You are now able to say kind of where it's coming from, higher income, lower income, just any general comments that would maybe explain this more in terms of where you're seeing the traffic trends?

William K. Butler, Jr.

Yes, I think the market alone has made more people – credit is tight and I think it's made more people our customers and so we're the store that's getting approval. We're not having to worry about someone's credit or whether it's been tarnished or not and so our market is open and free and when you have that you have retail competitors and it's tough to get credit. I think it's definitely expanded our market, too, to a better customer base.

Gilbert L. Danielson

Arvind, I talked to one our franchisees last week and he was telling me that just – that he was seeing customers and I am sure we're seeing the company stores too, customers with higher, much higher income, $70,000, $80,000 of annual income where as we've always said that our customer base is $50,000 household income and below.

So it tells you the trade down, voluntary or involuntary and I think what it really tells you is we're seeing a lot of customers that just want the flexibility that the program offers. That they don’t know what's going to happen three months, six months, down the road, they need a bed or a refrigerator so let's go and lease that thing and we can turn it in.

They have cash, actually we're seeing more credit cards, we're also seeing a lot more frankly online payments come through and so we're seeing a more creditworthy customer come to our showroom with this tightening in this trade down going on.

Arvind Bhatia – Sterne, Agee & Leach

Great, thank you guys, and congratulations.

Gilbert L. Danielson

Thank you.

Operator

Thank you our next question comes from David Magee – Suntrust Robinson. Please go ahead.

David Magee – Suntrust Robinson Humphrey

Yes, hi guys, good morning. Could you all talk just a little bit about the categories and the margins that you saw in say electronics versus the furniture and just what the sales experience and I guess as an add on to that, as you're seeing new kinds of customers enter your stores, are the buying the same type of things as their, are there any kind of mix implications there?

Robin C. Loudermilk, Jr.

Well there's not question that laptops and the LCD televisions have gone up, but I think the one area that we really have worked hard on over the last two years is furniture and we kind of recognize, we thought our price points were a little bit high and we've, as Gil mentioned to you earlier, we've stretched the term out and we've hit kind of that sweet price point.

If we can put something in our stores around $99 a month it's just a sweet, kind of a sweet spot and by doing what we've done we're hitting those numbers and our furniture business has really made a healthy, healthy comeback.

Every product category we have is up. LCDs obviously are leading the pack with laptops but we're really proud that we've worked on the furniture and the other items.

David Magee – Suntrust Robinson Humphrey

And what are you seeing in areas that have had a more rapid rise in unemployment in the past 12 months? How are your stores performing in those areas?

Gilbert L. Danielson

Yes, actually we were looking at that the other day and we looked at unemployment rates in various parts of the country that the government puts out. We looked at the state of Michigan and I guess it was as of the fourth quarter.

State of Michigan was the only state that had over 10% unemployment in the state. Of course, the average unemployment is 7.5% or whatever, but in the state of Michigan our stores in the state of Michigan in the fourth quarter were comping at just about the same rate that overall stores comped at the 6%.

So that's a bad state. Not every state's at 10%, certainly there's pockets of this country that are higher than 10% but we get the question all the time about unemployment, unemployment going up, and how bad could it get and where's the break point on when unemployment gets so bad that everything kind of crumbles down.

Well, if we're doing that well in Michigan I think there's certainly opportunities for us to keep going in the other states and a lot of the other states certainly aren't even close to that unemployment rate.

David Magee – Suntrust Robinson Humphrey

Thanks, Gill and just last question. Gil how did the cash flow turn out last year for the entire year?

Gilbert L. Danielson

We're still – it's going to be positive. Through the nine months it was positive cash flow of about $51 million. I am going to defer that a little bit. We're moving some numbers down around – between continuing operations and discontinued operations in our cash flow statement.

So we'll be filing the 10-K in a few days and it will be definitive there. I expect '09 certainly will be a positive, a good positive cash flow year for us as the growth slows down somewhat and as we continue to grow it at a little lesser rate.

David Magee – Suntrust Robinson Humphrey

Great, fair enough, thanks a lot.

Operator

Thank you our next question comes from John Baugh – Stifel Nicolaus, please go ahead.

John Baugh – Stifel Nicolaus

Thank you and congratulations. Ken, maybe a question for you first. Are we seeing more new customers, you give us the net number, are we seeing a material increase in new customers but also at the same time an increase of people struggling at the lower end or are the numbers fairly consistent?

William K. Butler, Jr.

I think the numbers are consistent. Our deliveries per store per unit are up and have been really since the stimulus checks came out this past summer. I think that definitely gave us somewhat of a summer boost but it's been pretty consistent across the board.

Our returns are running at historical levels. Our non-renewables and our percent of money we collect running at historical levels maybe even a little bit better, so.

John Baugh – Stifel Nicolaus

Okay so do you – you're not seeing a material change in I don’t know you don’t want to call them past dues but non-renewables or late payments or it's not a – in the last six months, two quarters, you haven't seen a material change in that figure?

William K. Butler, Jr.

Absolutely not.

John Baugh – Stifel Nicolaus

Oh, okay. Gil, a question on depreciation, it dropped to 40 basis points from the third quarter and I think it was down 60 basis points year-over-year, is there anything going on there and how do we think about modeling that in '09?

Gilbert L. Danielson

Oh, I think – there certainly has been a drop in a little bit of the percentage rentals and fees but I just think we're doing a good job and we have lots of opportunities on our buying side. Obviously, we've got – a retailer growing like we are you have a lot of good positive buying opportunities to bring costs down on everything you buy.

But I wouldn't expect it to go much lower than it has been, John if you're modeling out for '09. I'd say it's probably hanging in around where it's at now.

John Baugh – Stifel Nicolaus

At the fourth quarter level or where the year ended?

Gilbert L. Danielson

I would model somewhere between 36.25 and 36.50 as a percentage of rentals and fees each quarter.

John Baugh – Stifel Nicolaus

Okay, and then on the inventory number I guess, I mean it was up a little bit 21% or something 22%, I guess part of that is what? Buying the Rosey Rental stores and having that inventory and then this situation with the court where they didn’t take the inventory. Is that right or just...

Gilbert L. Danielson

We did do some opportunistic buys too in the fourth quarter. Some of our major electronic vendors were looking to move some products so we kind of front loaded a little bit on the electronics side, but primarily LCD's and computers.

So it went up a little bit at the end of the year for that which just replaces stuff we would have bought in '09, so.

John Baugh – Stifel Nicolaus

Okay and I know it's a minor number but receivables were up materially what's the explanation?

Gilbert L. Danielson

Yes, receivables are shipments that we make to our franchisees and they can vary from quarter to quarter based on their – what we're shipping to them. And then we also make a top side entry too for our accrued revenues as we – we're on a cash basis of recognizing revenues in our stores, but when we do our financial we put everything on the accrual basis so that ends up in the accounts receivable in a deferred income on our balance sheet.

So that can change from quarter to quarter basis.

John Baugh – Stifel Nicolaus

And then last thing, Robin, comment on the office stores that are left. How are they doing, what's the prognosis, what's the strategy there?

Robin C. Loudermilk

I'll comment a little, Ken's really been leading that charge. They're doing well. We've cut some new commercials, when they start airing; I think it's going to be very positive. We've just frankly gotten the computer system in place for them to begin doing the business. It's just taking a while for IT to rewrite all of our programming in house, we have to create it from scratch.

So frankly, we've kind of been in limbo in the last year just kind of sorting out the CORT sale liquidating furniture, getting our stores in line, now we have the IT program in place, we're tweaking at the point of sales. So I think frankly, we're seeing some positive gains in that few stores that we have left. We are working through some inventory that again left over from the CORT sale but again you...

William K. Butler, Jr.

Yes, we did add three stores through the CORT acquisition. I guess there was some real estate the CORT didn’t take that we thought would be good markets for office furniture so there's some new store drags with those three stores. However, they are in very good markets.

We did delay kind of the program somewhat as we were negotiating the CORT, when I say delay we really shut down the advertising so now that we know CORT's definitely not going to buy the office furniture, we’re ramping up the advertising as Robin mentioned and we think that we’re going to see favorable results. We’ve tweaked the program and we’re ready to move forward.

Gilbert L. Danielson

John, try and keep it in perspective, I mean the annual revenue or run rate on revenue is like $20 to 25 million a year on those stores. I mean it’s really insignificant.

John Baugh – Stifel Nicolaus

And then last thing the RENCO, pretty significant pull back I guess that concept just doesn’t have legs what were the issues there? What happens with the ten stores remaining?

William K. Butler, Jr.

Well the – I think during these economic times there is one thing that I think people can live without and that’s wheels, so that is one thing that we did see a slowdown in. One thing we always kind of looked at when we dealt with RENCO stores was most of them were built through excess space that we had in the Aarons stores, so the big risk was what’s was the worst that could happen?

So we consolidated those stores, most of the stores got up to 200 to 300 customers. We’re going to continue operating it as a department within the store. I mean if you’ve got 200 sets of wheels on lease no different than a laptop computer, but we can merge the two operations and really leverage our expenses and so I think we’ve already immediately got the benefit of that.

I think the other ten stores are free standing buildings and frankly I think they can make money. They’re very close to breakeven point right now and they just need a little bit of growth. So we’re going to monitor them if they don’t get in the black then they won’t exist, if they do they’ll move forward.

Gilbert L. Danielson

John, keeping those in perspective to that annual run rates on those stores revenue wise, was like $15 million.

Operator

Thank you our next question comes from [Laura Champine] – [Cullen and Company].

[John Kernan] – [Cullen and Company]

Hi guys this is [John Kernan] standing in for Laura. Can you guys expand a little bit more on your cash flow expectations for the year, specifically your expectation for inventory investment given the increase customer account? Just wondering if it’s going to be historically higher than you guys have historically done?

Gilbert L. Danielson

Well our additions to rental merchandise were probably up 20% this year than they were in previous years. Again, we’ve made some buys during the fourth quarter that we didn’t make in the fourth quarter a year ago. And we’re also gaining customers, we’re gaining customers faster than revenue, so it’s hard to really predict quarter to quarter on what you’re cash flow is going to be out in ’09.

It will be positive for sure I mean it was in ’07 when we generated $100 million from cash flow from operations and we’ll be positive in ’08. But as we slow down the growth, when we grow at 5 to 7%, 5 to 9% a year, I believe that that growth rate that we certainly can easily self finance the business and that’s our anticipation for ’09 to self finance the business.

As of today, we have about $20 million of cash outstanding on our $140 million revolving credit facility. That credit facility has another 4 1/2 years to go; we just renewed it in May. It's LIBOR plus 7, 8 facility, so we’re certainly in great shape in the credit facility standpoint.

And our debt to cap on our balance sheet was roughly 13% at the end of December. So we have the balance sheet and the credit facilities if we need them but I don’t really think that we’re going to need the credit facility that much if any over time.

It will vary from quarter to quarter, depending on our needs and our stores, new store openings, franchise needs but over time we have gone from a cash user when we were opening stores 15, 16, 17% a year for a number of years, to a much smaller growth rate; still a healthy growth as you all know, but it’s a growth rate that we think that we can handle, especially from the capital standpoint and also from a management standpoint.

[John Kernan] – [Cullen and Company]

Sounds good Gil and is there any specific regions that are materially out performing, underperforming the company as a whole?

Gilbert L. Danielson

Well I’d say that Michigan region is out performing.

William K. Butler, Jr.

No it’s pretty balanced these days. Florida is certainly not back to where it used to be but we see a comeback and so I think it’s pretty spread out. Our top franchisee came from the state of Texas and our top division came from the state of Texas.

In fact our top two did so I think that Texas and Oklahoma would lead the pack above the rest.

Operator

Thank you our next question comes from [Rob Keiys] – [Paul Partners].

[Rob Keiys] – [Paul Partners]

Hey gentlemen, a couple quick questions, one, when you acquired some of those stores in Missouri this past quarter, when did those go into the comp base?

Gilbert L. Danielson

Stores don’t go into comp base until they’ve been 15 months into the Aarons system. So it’ll be – we did that conversion I don’t know two or three months ago.

William K. Butler, Jr.

But they’re franchises so they won’t even go in our computers.

Gilbert L. Danielson

Yes. The only comps we talk about are company stores, the franchise stores are not our revenues we just look at their revenues based on our – on the royalties that we get and come up with their comp based on those.

[Rob Keiys] – [Paul Partners]

And the Rosey Rentals, those go in also after the 15th month?

Gilbert L. Danielson

Those stores were franchised stores that were purchased by the company, so they’ll come in after the 15 months.

[Rob Keiys] – [Paul Partners]

Okay. And can you kind of talk a little bit more about the Rosey Rental acquisition? I kind of went back and I saw in 2003 you converted them to Aarons, you sold them some stores, they were suppose to open a slew of stores I think they only opened one at – over that six year time frame how are those stores going to comp considering the age level and I’m assuming they are ten years plus.

William K. Butler, Jr.

Well Rosey was founded by [Brian Conn] who acquired a red zone operator who was operating under the name Ace Rentals about seven or eight years ago and we bought some stores from him when he acquired the stores out west in Phoenix and maybe a few in Ohio and as we developed a relationship, he felt like he could convert those to Aarons and we did too.

He had a very, very successful comp conversion with a very, very good operator and all the stores ended up over $100,000. He had a few stores still left to open, but he had opened up four, five, six, seven to eight stores. I’m not sure of the exact number, but he was very successful and they were in areas that we were strong management wise. So we felt like it was a very good acquisition for us.

Gilbert L. Danielson

And he was doing about in gross revenues, about $45 million on an annual basis. Would you say that again please?

[Rob Keiys] – [Paul Partners]

What were those stores comping prior to the acquisition?

Gilbert L. Danielson

I don’t know we didn’t – I don't have that number or analyzed it, but I mean they had been growing and again he said that he was doing $45 million in gross revenues.

[Rob Keiys] – [Paul Partners]

Right but when you acquire stores that are doing $45 million in revenues and your paying a percentage based on those revenues it looks like a nice multiple, you must have an idea what they were comping prior to you purchasing them, correct?

Gilbert L. Danielson

Yes we have an idea but I don’t have that number right in front of me, so. They were positive.

[Rob Keiys] – [Paul Partners]

Can you say sort of with a degree of confidence of what those comps were?

Gilbert L. Danielson

If you want to call me back after the call, we can talk about it.

Operator

Thank you our next question comes from Michael Smith – Kansas City Capital

Michael Smith – Kansas City Capital

Good morning. You guys did a good job that quarter. Just a couple of housekeeping questions as much as anything, Gil, can I get the restated results on a quarterly basis for 2008?

Gilbert L. Danielson

For all the quarters?

Michael Smith – Kansas City Capital

Yes.

Gilbert L. Danielson

Yes you can we will file a 8-K in a day or two and put all that information out there so everybody has it so it should be out there.

Michael Smith – Kansas City Capital

Great. The other question was store openings, just to make sure I understand correctly, from your prepared remarks it sounds like you’re going to open between 80 and 140 total stores and is that going to be split 2/3 company and 1/3 franchisees?

Gilbert L. Danielson

Well historically it’s been roughly an equal mix between the company and the franchise stores. I mean it…

Michael Smith – Kansas City Capital

More like 50/50 then?

Gilbert L. Danielson

Fifty-fifty or maybe a little bit more company stores but roughly in 50/50.

Michael Smith – Kansas City Capital

Okay and just to – was that the end total when you were talking about the increase in incomes of your customers to 70 to 80,000 from 50,000? Or have you empirically tested that?

William K. Butler, Jr.

No, that’s out of our data.

Gilbert L. Danielson

We were just talking to a franchise saying why the business strong and who are we seeing walk into the show room. You would think that the trade down that you read about with the Wal-Marts, McDonalds and everybody out there that you’re getting a different mix of customers and we’re just out there trying to have to figure that out and no numbers or no hard facts but he’s just saying in the applications he’s seeing, he's seeing higher incomes than we normally would see.

Again just these guys want flexibility, so it’s just a trend but we'll certainly be looking at it here and but we haven't changed our advertising or marketing or anything, I think it's just that I think the other people are seeing the value of our proposition, of our programs.

Michael Smith – Kansas City Capital

Good job. Thanks.

Gilbert L. Danielson

Thank you.

Operator

Our next question comes from Joel Havard – Hilliard Lyons.

Joel K. Havard – Hilliard Lyons

Ken, probably more for you, we'll call the first one kind of product and the second one follow up question process. On the product side with the talk of deflation in the air, is there any sort of magic merchandise point sliding down into your $1,000 sweet spot?

William K. Butler, Jr.

The thing that just started with the LCD over the last two years, it's steadily coming down and we have to be careful not to drop the prices too quick but there's no question there for about a year, year and a half, we didn't have that sweet $99 big screen anymore, since the analogs disappeared the LCDs were still a little bit high, in fact I think a year and a half ago, we were leasing a 42 inch LCD for $199 a month.

Today, we're leasing that same TV with some surround sound system now, for $99 a month. Our DLP business has been through the roof. Our customers still like big and DLP in the retail market place has not been that strong, but with us it has been, because we can hit the sweet spot of $99 with a 60 inch DLP that we can't hit with the LCD, I know that's a lot of initials out here, but it's still, with price deflation it's definitely helped us. There's no question about it.

Joel K. Havard – Hilliard Lyons

Okay, and on the process side, it's still very early in this, but where you've got some stronger Circuit City overlap, are y'all starting to notice anything that you'd be able to talk about yet?

William K. Butler, Jr.

I haven't seen anything, I mean I think we're going to get some opportunistic closeout purchases, not only from Circuit City, but we're seeing it in the furniture arena too, that we – our buying's just going to get a little bit better because we're one of the few people out there still buying.

Joel K. Havard – Hilliard Lyons

All right, great answers. Thanks guys and good luck.

Operator

Thank you our next question comes from John Curti – Principal Global Investors.

John Curti – Principal Global Investors

With respect to your planned store openings, are they going to be spread out fairly evenly throughout the year, or are they more back half weighted?

William K. Butler, Jr.

Yes I hope they're going to be spread out, but sometimes it just doesn't seem to work out that way. We really believe and make an effort to try to do that and sometimes, in spite of ourselves, it happens and sometimes it doesn't.

Gilbert L. Danielson

That was our plan in '08. It worked out we opened a lot of stores at the end of the year.

John Curti – Principal Global Investors

Based on that 5 to 9% net opening, what would be your CapEx requirements, in terms of merchandise for the stores and store build out?

Gilbert L. Danielson

Yes, to open one store, historically takes about $550,000 and $650,000 of net cash out the first year, I mean that's your cash out flow for one store, a new store and probably 70% is for the rental merchandise to outfit the store and to start the business and start renting TVs and stuff.

CapEx kind of depends on how their lease is structured, but usually maybe up to $100,000 for the lease holds to open a store, and then the stores will lose money. That's our new store drag we talk about all the time. Stores will lose $100 to $150,000 the first year.

So that's your CapEx or your total cash out to open one store and so I mean it adds up to quite a bit of money if you open a lot of stores, which has been an issue for us or a thing we've dealt with for all these years and the dollars to open a store haven't really changed that much through the years, and then how the stores ramp up in revenues and earnings is pretty consistent through the years.

John Curti – Principal Global Investors

Based on the guidance that you gave today, the updated guidance, how much of an anticipated new store drag is that?

Gilbert L. Danielson

The new store drag historically around here has always been about $0.03 or $0.04 a quarter. It's been much higher than that in recent quarters for a lot of reasons we talked about it was $0.05 in the fourth quarter.

I believe looking at the numbers and going through for next year on a quarterly basis we'll probably be back to that more normal $0.03 to $0.04 to open a store.

John Curti – Principal Global Investors

And where do you think your debt levels will be at year end, since you should have another strong year of free cash?

Gilbert L. Danielson

I don't really project debt levels necessarily, but again our debt level at the end of December was about $25 about $30 million of cash outstanding on our revolving credit facility, and we had another $58 million of longer term debt we have with some insurance companies, so that's about $90 million. I would expect I mean all things being equal and looking at our plans now, that our debt level will be less at the end of this year, certainly than they are at the end of '08.

Unless something big happens, acquisitions, we don't foresee anything but there's always some things that come up, franchise acquisitions, things like that could certainly affect the debt level.

John Curti – Principal Global Investors

But there's probably some just scheduled payments on the insurance notes?

Gilbert L. Danielson

Yes the insurance notes go down I think another $22 million this year in the summertime, so they would continue to go down.

Operator

Thank you. (Operator Instructions). And I'm showing no further questions.

Robin C. Loudermilk, Jr.

Okay well thank you all for joining us today.

Operator

Thank you ladies and gentlemen, this concludes today's conference. Thank you for participating. You may all disconnect.

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Source: Aaron Rents Inc. Q4 2008 Earnings Call Transcript
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