THE AARON'S COMPANY, INC. The following discussion should be read in conjunction with the consolidated financial statements, including the notes to those statements, appearing elsewhere in this report. Management's Discussion and Analysis comparing the results for the year endedDecember 31, 2018 to the results for the year endedDecember 31, 2017 can be found in Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2018 , filed with theSEC onFebruary 14, 2019 , which is hereby incorporated by reference. Business OverviewAaron's, Inc. ("we," "our," "us," or the "Company") is a leading omnichannel provider of lease-purchase solutions. As ofDecember 31, 2019 , the Company's operating segments areProgressive Leasing , Aaron's Business and Vive. As discussed above, we have updated all disclosures and references of DAMI in this Annual Report on Form 10-K to reflect theJanuary 1, 2020 name change to Vive.Progressive Leasing is a virtual lease-to-own company that provides lease-purchase solutions through approximately 25,000 retail locations in 46 states and theDistrict of Columbia , including e-commerce merchants. It does so by purchasing merchandise from third-party retailers desired by those retailers' customers and, in turn, leasing that merchandise to the customers through a cancellable lease-to-own transaction.Progressive Leasing consequently has no stores of its own, but rather offers lease-purchase solutions to the customers of traditional and e-commerce retailers. Aaron's Business offers furniture, home appliances, consumer electronics and accessories to consumers with a lease-to-own agreement with no credit needed through its Company-operated stores inthe United States ,Canada andPuerto Rico , as well as through its e-commerce platform, Aarons.com. This operating segment also supports franchisees of its Aaron's stores. In addition, the Aaron's Business segment includes the operations of Woodhaven, which manufactures and supplies the majority of the bedding and a significant portion of the upholstered furniture leased and sold in Company-operated and franchised stores. Vive partners with merchants to provide a variety of revolving credit products originated through 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 marketplaces. We believe that theProgressive Leasing and Vive acquisitions have been strategically transformational in this respect by allowing the Company to diversify its presence in the market and strengthen our business, as demonstrated byProgressive Leasing's significant revenue and profit growth. The Company is also leveraging franchisee acquisition opportunities to expand into new geographic markets, enhance operational control, and benefit more fully from our business transformation initiatives on a broader scale. We believe the traditional store based lease-to-own industry has been negatively impacted in recent periods by: (i) commoditization of pricing in consumer electronics; (ii) 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; and (iii) 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; traditional and online sellers of used merchandise; and from a growing number of various types of consumer finance companies that enable our customers to shop at traditional or online retailers. 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: • Champion compliance; • Strengthen relationships ofProgressive Leasing current retail and merchant partners;
• Focus on converting existing pipeline into
partners;
• Enhance our virtual offering at
• Drive omnichannel demand generation at the Aaron's Business;
• Reposition and reinvest in our real estate at the Aaron's Business; and
• Manage the Aaron's Business stores with operational excellence.
We continue to invest in various Aaron's Business transformation initiatives
such as generating customer demand and driving sales conversion rates through
enhanced customer insights, direct response marketing and increased investment
in e-commerce. We believe Aarons.com represents an opportunity to provide our
customers with expanded product selections and shopping convenience in the
lease-to-own industry. We are focused on engaging customers in ways that are
convenient for them by providing them a seamless, direct-to-door platform
through which to shop in store or online across our product offerings.
32
--------------------------------------------------------------------------------
In addition to generating customer demand, we are also focused on executing a
balanced business approach through customer retention and renewals, investing in
our leadership talent, and improving our store staffing model to ensure we have
our staff available to meet our customers' needs. Another key focus for the
Aaron's Business includes the roll out of Rapid Customer Onboarding, which is a
decisioning tool designed to improve our customer experience by streamlining and
standardizing the decisioning process, shortening transaction times, and
establishing appropriate transaction sizes and lease payment amounts, given the
customer's profile.
Finally, we also continue to execute on various Aaron's Business store
optimization and real estate initiatives, including strategic store
consolidations. We continue to roll out our next generation store concepts to
adapt to our changing competitive environment.
As a result of store optimization initiatives and other cost-reduction
initiatives, the Company initiated a new restructuring program in 2019 to
further optimize its Company-operated Aaron's store base portfolio, which
resulted in the closure, consolidation or relocation of 155 underperforming
Company-operated stores throughout 2019. The Company also further rationalized
its home office and field support staff, which resulted in a reduction in
employee headcount in those areas to more closely align with current business
conditions. The Company closed and consolidated 139 underperforming
Company-operated stores throughout 2016, 2017 and 2018 under similar
restructuring initiatives. The Company continually evaluates its
Company-operated Aaron's Business store portfolio to determine if it will
further rationalize its store base to better align with marketplace demand.
Additional restructuring charges may result from our strategy to reposition and
reinvest in our next generation store concepts to appeal to our target customer
market in better, more profitable locations.
During 2017 and 2018, the Company acquired substantially all of the assets of
the store operations of 111 and 152 Aaron's-branded franchised stores,
respectively. The acquisitions are benefiting the Company's omnichannel platform
through added scale, strengthening its presence in certain geographic markets,
enhancing operational control, including compliance, and enabling the Company to
execute its business transformation initiatives on a broader scale.
Highlights
The following summarizes significant highlights from the year ended December 31,
2019 :
• The Company reported record revenues of $3.9 billion in 2019 compared to
$3.8 billion in 2018. Earnings before income taxes decreased to $92.8
million compared to $252.2 million in 2018. The decrease in earnings
before income taxes is primarily due to $179.3 million in regulatory
charges and legal expenses incurred related to Progressive Leasing's
tentative settlement of the FTC matter discussed in Note 10 in the
accompanying consolidated financial statements.
•
of 6.5% over 2018. Calculated on a basis consistent with the January 2019
adoption of ASC 842, Leases (see the "Use of Non-GAAP Financial
Information" section below), Progressive Leasing revenues increased 20.2%
over 2018.
in total invoice volume, which was generated through an increase in
invoice volume per active door.
income taxes decreased to
2018, due primarily to
expenses incurred related to Progressive's tentative settlement of the
matter, partially offset by revenue growth during 2019.
• Aaron's Business revenue growth was nearly flat, reporting revenues of
year-over-year include the net reduction of 145 Company-operated stores
during 2019 as well as the acquisitions of various franchisees in 2018.
Same store revenues were flat in 2019 compared to 2018.
• Aaron's Business earnings before income taxes decreased to
in 2019 compared to $84.7 million in 2018. Earnings before income taxes
for the Aaron's Business during 2019 includes restructuring charges of
$40.0 million related to the Company's closure and consolidation of
underperforming stores,
real estate properties and gains on insurance recoveries of
Aaron's Business earnings before income taxes were also impacted by a
higher provision for lease merchandise write-offs as a percentage of
Aaron's Business lease revenues and fees, which increased to 6.2% in 2019compared to 4.6% in 2018. That increase was due to the lower collections
activity resulting from the redeployment of store labor towards enhanced
sales activities, an increase in the number and type of promotional
offerings, higher ticket leases, store closure activity and an increasing
mix of e-commerce as a percentage of revenues.
• The Company generated cash from operating activities of
2019 compared to
operating activities was impacted by net income tax refunds of
million during 2019 compared to net income tax refunds of
2018. The Company ended 2019 with
available on our revolving credit facility.
• The Company returned
repurchase of 1.2 million shares and the payment of our quarterly cash
dividends, which we have paid for 32 consecutive years.
33-------------------------------------------------------------------------------- Key Metrics Invoice Volume. We believe that invoice volume is a key performance indicator of ourProgressive Leasing segment. Invoice volume is defined as the retail price of lease merchandise acquired and then leased to customers during the period, net of returns. The following table presents total invoice volume for theProgressive Leasing segment: For the Year EndedDecember 31 (Unaudited and In Thousands) 2019 2018
2017
Progressive Leasing Invoice Volume$ 1,747,902 $ 1,429,550
The increase in invoice volume was driven by a 19.4% increase in invoice volume per active door and a 2.4% increase in active doors. Active Doors.Progressive Leasing active doors are comprised of both (i) each retail store location where at least one virtual lease-to-own transaction has been completed during the trailing twelve-month period; and (ii) with respect to an e-commerce merchant, each state where at least one virtual lease-to-own transaction has been completed through that e-commerce merchant during the trailing twelve-month period. The following table presents active doors for theProgressive Leasing segment: Active Doors at December 31 (Unaudited) 2019 2018 2017 Progressive Leasing Active Doors 24,772 24,198 26,861
Company-operated and franchised store activity (unaudited) is summarized as follows:
2019 2018 2017
Company-operated Aaron's stores Company-operated Aaron's stores open at January 1, 1,312 1,175 1,165 Opened - - - Added through acquisition 18 152 110 Closed, sold or merged (163 ) (15 )
(100 )
Company-operated Aaron's stores open at
Franchised stores Franchised stores open at January 1, 377 551 699 Opened - 2 1 Purchased from the Company - - - Purchased by the Company (18 ) (152 ) (111 ) Closed, sold or merged (24 ) (24 ) (38 ) Franchised stores open at December 31, 335 377
551
Same Store Revenues. We believe that changes in same store revenues are a key performance indicator of the Aaron's Business. For the year endedDecember 31, 2019 , we calculated this amount by comparing revenues for the year endedDecember 31, 2019 to revenues for the year endedDecember 31, 2018 for all stores open for the entire 24-month period endedDecember 31, 2019 , excluding stores that received lease agreements from other acquired, closed or merged stores. Same store revenues were flat during the 24-month period endedDecember 31, 2019 . Key Components of Earnings Before Income Taxes In this management's discussion and analysis section, we review our consolidated results. For the years endedDecember 31, 2019 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 primarily include all revenues derived from lease agreements at retail locations serviced byProgressive Leasing and the Aaron'sBusiness Company -operated stores and e-commerce platform. 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 by Vive. Other revenues primarily relate to revenues from leasing Company-owned real estate properties to unrelated third parties, as well as other miscellaneous revenues. 34 -------------------------------------------------------------------------------- Depreciation of Lease Merchandise. Depreciation of lease merchandise primarily reflects the expense associated with depreciating merchandise held for lease and leased to customers byProgressive Leasing and our Company-operated Aaron's stores and through our e-commerce platform. 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, store maintenance, provision for lease merchandise write-offs, shipping and handling, advertising and marketing, the provision for loan losses, depreciation of property, plant and equipment, intangible asset amortization expense and professional services expense, among other expenses. Restructuring Expenses, Net. Restructuring expenses, net primarily represent the cost of optimization efforts and cost reduction initiatives related to the Aaron's Business home office and field support functions. Restructuring expenses, net are comprised principally of closed store operating lease right-of-use asset impairment and operating lease charges, the impairment of vacant store properties, including the closure of one of our store support buildings, workforce reductions, other impairment charges and reversals of previously recorded restructuring charges. Legal and Regulatory Expense. Legal and regulatory expense includes regulatory charges and legal expenses incurred related toProgressive Leasing's tentative settlement of theFTC matter discussed in Note 10 in the accompanying consolidated financial statements. Other Operating Income, Net. Other operating income, net consists of gains or losses on sales of Company-operated stores and delivery vehicles, fair value adjustments on assets held for sale, gains or losses on other transactions involving property, plant and equipment, and gains related to property damage and business interruption insurance claim recoveries. Interest Expense. Interest expense consists primarily of interest incurred on fixed and variable rate debt. Impairment of Investment. Impairment of investment consists of an other-than-temporary loss to fully impair the Company's investment in PerfectHome. Other Non-Operating Income (Expense), Net. Other non-operating income (expense), net includes the impact of foreign currency remeasurement, as well as gains and losses resulting from changes in the cash surrender value of Company-owned life insurance related to the Company's deferred compensation plan. 35 -------------------------------------------------------------------------------- Results of Operations Results of Operations - Years EndedDecember 31, 2019 and 2018 Change Year Ended December 31, 2019 vs. 2018 (In Thousands) 2019 2018 $ % REVENUES:
Lease Revenues and Fees $ 3,698,491 $ 3,506,418 $
192,073 5.5 %
Retail Sales 38,474 31,271 7,203 23.0
Non-Retail Sales 140,950 207,262 (66,312 ) (32.0 )
Franchise Royalties and Fees 33,432 44,815 (11,383 ) (25.4 )
Interest and Fees on Loans Receivable 35,046 37,318 (2,272 ) (6.1 )
Other 1,263 1,839 (576 ) (31.3 )
3,947,656 3,828,923 118,733 3.1
COSTS AND EXPENSES:
Depreciation of Lease Merchandise 1,972,358 1,727,904 244,454 14.1
Retail Cost of Sales 24,024 19,819 4,205 21.2
Non-Retail Cost of Sales 113,229 174,180 (60,951 ) (35.0 )
Operating Expenses 1,524,849 1,618,423 (93,574 ) (5.8 )
Restructuring Expenses 39,990 1,105 38,885 nmf
Legal and Regulatory Expense 179,261 - 179,261 nmf
Other Operating Income, Net (11,929 ) (2,116 ) (9,813 ) nmf
3,841,782 3,539,315 302,467 8.5
OPERATING PROFIT 105,874 289,608 (183,734 ) (63.4 )
Interest Income 1,790 454 1,336 nmf
Interest Expense (16,967 ) (16,440 ) (527 ) (3.2 )
Impairment of Investment - (20,098 ) 20,098 nmfOther Non-Operating Income (Expense), Net 2,091 (1,320 )
3,411 nmf
EARNINGS BEFORE INCOME TAX EXPENSE 92,788 252,204 (159,416 ) (63.2 )
INCOME TAX EXPENSE 61,316 55,994 5,322 9.5
NET EARNINGS $ 31,472 $ 196,210 $ (164,738 ) (84.0 )%
nmf-Calculation is not meaningful
36
--------------------------------------------------------------------------------Revenues
Information about our revenues by reportable segment is as follows:
Change
Year Ended December 31, 2019 vs. 2018
(In Thousands) 2019 2018 $ %
REVENUES:
Progressive Leasing $ 2,128,133 $ 1,998,981 $ 129,152 6.5 %
Aaron's Business 1,784,477 1,792,624 (8,147 ) (0.5 )
Vive 35,046 37,318
(2,272 ) (6.1 )
Total Revenues from External Customers
The following table presents revenue by source and by segment for the year endedDecember 31, 2019 : Year Ended December 31, 2019 Progressive Aaron's (In Thousands) Leasing1 Business Vive Total Lease Revenues and Fees$ 2,128,133 $ 1,570,358 $ -$ 3,698,491 Retail Sales - 38,474 - 38,474 Non-Retail Sales - 140,950 - 140,950 Franchise Royalties and Fees - 33,432 - 33,432 Interest and Fees on Loans Receivable - - 35,046 35,046 Other - 1,263 - 1,263 Total Revenues$ 2,128,133 $ 1,784,477 $ 35,046 $ 3,947,656 1 For the year endedDecember 31, 2019 , theProgressive Leasing provision for returns and uncollectible renewal payments was$274.9 million which was recorded as a reduction to Lease Revenues and Fees as a result of the Company's adoption of ASC 842, Leases. See Note 1 in the accompanying consolidated financial statements for more information regarding the impacts of ASC 842 on the Company's financial results. The following table presents revenue by source and by segment for the year endedDecember 31, 2018 : Year Ended December 31, 2018 Progressive Aaron's (In Thousands) Leasing Business Vive Total Lease Revenues and Fees$ 1,998,981 $ 1,507,437 $ -$ 3,506,418 Retail Sales - 31,271 - 31,271 Non-Retail Sales - 207,262 - 207,262 Franchise Royalties and Fees - 44,815 - 44,815 Interest and Fees on Loans Receivable - - 37,318 37,318 Other - 1,839 - 1,839 Total Revenues$ 1,998,981 $ 1,792,624 $ 37,318 $ 3,828,923 Progressive Bad Debt Expense 227,813 - - 227,813 Total Revenues, net of Progressive Bad Debt Expense1$ 1,771,168 $ 1,792,624 $
37,318
1 See the "Use of Non-GAAP Financial Information" section below.Progressive Leasing .Progressive Leasing segment revenues increased primarily due to an annualized 22.3% increase in total invoice volume, which was driven mainly by an increase in invoice volume per active door. The increase was partially offset by the recognition of a provision for returns and uncollectible renewal payments of$274.9 million as a reduction to lease revenues in accordance with ASC 842 beginning in 2019. Calculated on a basis consistent with theJanuary 2019 adoption of ASC 842,Progressive Leasing revenues increased 20.2% during the year endedDecember 31, 2019 as compared to the prior year. Aaron's Business. The acquisitions of various franchisees throughout 2018 impacted the Aaron's Business in the form of an increase in lease revenues and fees, partially offset by lower non-retail sales and lower franchise royalties and fees during the year endedDecember 31, 2019 as compared to the prior year. 37 -------------------------------------------------------------------------------- Aaron's Business segment revenues decreased during 2019 primarily due to a$66.3 million decrease in non-retail sales and an$11.4 million decrease in franchise royalties and fees, partially offset by a$62.9 million increase in lease revenues and fees. The decrease in non-retail sales and franchise royalties and fees is primarily due to the reduction of 42 franchised stores and a net reduction of 174 franchised stores during the years endedDecember 31, 2019 and 2018, respectively. Lease revenues and fees increased during 2019 primarily due to the franchisee acquisitions during 2018, partially offset by the net reduction of 145 Company-operated stores during 2019 resulting from the Aaron's Business restructuring and store optimization initiatives. Aaron's Business e-commerce revenues were approximately 9% and 7% of the Aaron's Business total lease revenues and fees during the years endedDecember 31, 2019 and 2018, respectively. Operating Expenses Information about certain significant components of operating expenses is as follows: Change Year Ended December 31, 2019 vs. 2018 (In Thousands) 2019 2018 $ % Personnel Costs$ 706,843 $ 664,412 $ 42,431 6.4 % Occupancy Costs 230,244 223,304 6,940 3.1 Provision for Lease Merchandise Write-Offs 251,419 192,317 59,102 30.7 Bad Debt Expense 1,337 227,960 (226,623 ) (99.4 ) Shipping and Handling 74,264 75,211 (947 ) (1.3 ) Advertising 44,023 37,718 6,305 16.7 Provision for Loan Losses 21,667 21,063 604 2.9 Intangible Amortization 35,557 32,985 2,572 7.8 Professional Services 35,975 35,330 645 1.8 Other Operating Expenses 123,520 108,123 15,397 14.2 Operating Expenses$ 1,524,849 $ 1,618,423 $ (93,574 ) (5.8 )% As a percentage of total revenues, operating expenses decreased to 38.6% in 2019 from 42.3% in 2018. Calculated on a basis consistent with theJanuary 2019 adoption of ASC 842, Leases, operating expenses as a percentage of total revenues remained consistent at 38.6% for both 2019 and 2018. Personnel costs increased by$24.3 million at ourProgressive Leasing segment and by$19.5 million in our Aaron's Business segment. The increase in personnel costs is due to hiring to support the growth ofProgressive Leasing and the Aaron's Business transformation initiatives and the Aaron's Business acquisition of 152 stores during 2018, partially offset by the reduction of store support center and field support staff from our Aaron's Business restructuring programs in 2018 and 2019. Occupancy costs increased primarily due to the acquisition of franchisee stores, partially offset by the closure of underperforming stores as part of our Aaron's Business restructuring actions. The provision for lease merchandise write-offs as a percentage of lease revenues for theProgressive Leasing segment increased to 7.2% in 2019 from 7.0% in 2018, calculated on a basis consistent with theJanuary 2019 adoption of ASC 842, Leases. The provision for lease merchandise write-offs as a percentage of lease revenues and fees for the Aaron's Business increased to 6.2% in 2019 compared to 4.6% in 2018. This increase in 2019 is due to the lower collections activity resulting from the redeployment of store labor towards enhanced sales activities, an increase in the number and type of promotional offerings, higher ticket leases, store closure activity and an increasing mix of e-commerce as a percentage of revenues. Bad debt expense decreased during the year endedDecember 31, 2019 . As discussed above, the Company's adoption of ASC 842 resulted in the Company classifyingProgressive Leasing bad debt expense, which is reported within operating expenses in 2018 and prior periods, as a reduction of lease revenue and fees within the consolidated statements of earnings beginningJanuary 1, 2019 . The bad debt expense for the year endedDecember 31, 2019 relates to uncollectible merchant accounts receivable for cardholder refunded charges at Vive. Advertising expense increased during 2019 due to the Aaron's Business rebranding campaign and direct response marketing initiatives. Intangible amortization expense increased primarily due to additional intangible assets recorded as a result of the acquisitions of 152 franchised stores during 2018. 38 -------------------------------------------------------------------------------- Other operating expenses increased during 2019 due to higher merchant expenses atProgressive Leasing resulting from growth in invoice volume and higher software licensing expense. Other Costs and Expenses Depreciation of lease merchandise. As a percentage of total lease revenues and fees, depreciation of lease merchandise increased to 53.3% from 49.3% in the prior year period, primarily due to a shift in lease merchandise mix from the Aaron's Business toProgressive Leasing , which is consistent with the increasing proportion ofProgressive 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 customer early buyouts, and the merchandise is generally purchased at retail prices compared to the Aaron's Business, which procures merchandise at wholesale prices.Progressive Leasing's depreciation of lease merchandise as a percentage ofProgressive Leasing's lease revenues and fees was 67.9% in 2019 compared to 68.8% in 2018, calculated on a basis consistent with theJanuary 2019 adoption of ASC 842, Leases, due to a decrease in early buyouts, which have a lower margin. Aaron's Business depreciation of lease merchandise as a percentage of Aaron's Business lease revenues and fees decreased to 33.6% in 2019 from 33.8% in 2018. Retail cost of sales. Retail cost of sales as a percentage of retail sales decreased to 62.4% from 63.4% primarily due to lower inventory purchase cost during 2019 as compared to 2018, partially offset by higher sales price discounting of pre-leased merchandise during 2019. Non-retail cost of sales. Non-retail cost of sales as a percentage of non-retail sales decreased to 80.3% from 84.0% primarily due to lower inventory purchase cost during 2019 as compared to 2018. Restructuring expenses, net. Restructuring activity for the year endedDecember 31, 2019 resulted in expenses of$40.0 million , which were primarily to record closed store operating lease right-of-use asset impairment and operating lease charges, the impairment of vacant store properties, including the closure of one of our store support buildings, workforce reductions, and other impairment charges. Legal and regulatory expense. Legal and regulatory expense for the year endedDecember 31, 2019 relates to$179.3 million in regulatory charges and legal expenses incurred related toProgressive Leasing's tentative settlement of theFTC matter. Other Operating Income, Net Information about the components of other operating income, net is as follows: Change Year Ended December 31, 2019 vs. 2018 (In Thousands) 2019 2018 $ % Net losses (gains) on sales of stores $ 4$ (185 ) $ 189 nmf Net gains on sales of delivery vehicles (1,233 ) (722 ) (511 ) (70.8 ) Gains on insurance recoveries (4,520 ) (1,094 ) (3,426 ) nmf Gains on asset dispositions and assets held for sale, net of impairment charges (6,180 ) (115 ) (6,065 ) nmf Other Operating Income, Net$ (11,929 ) $ (2,116 ) $ (9,813 ) nmf nmf-Calculation is not meaningful In 2019, other operating income, net of$11.9 million included gains from the sale of various real estate properties of$7.4 million and gains on insurance recoveries of$4.5 million related to payments received from insurance carriers for Hurricanes Harvey and Irma property and business interruption claims in excess of the related property insurance receivables. Operating Profit Interest expense. Interest expense increased to$17.0 million in 2019 from$16.4 million in 2018 due primarily to a higher outstanding debt balance during 2019. Impairment of investment. During the year endedDecember 31, 2018 , the Company recorded an other-than-temporary loss of$20.1 million to impair its remaining outstanding investment in PerfectHome, a rent-to-own company in theUnited Kingdom . 39 -------------------------------------------------------------------------------- Other non-operating income (expense), net. Other non-operating income (expense), net includes the impact of foreign currency remeasurement, as well as net gains and losses resulting from changes in the cash surrender value of Company-owned life insurance related to the Company's deferred compensation plan. Foreign currency remeasurement net losses resulting from changes in the value of theU.S. dollar against the British pound and Canadian dollar were not significant in 2019 or 2018. The changes in the cash surrender value of Company-owned life insurance resulted in net gains of$2.1 million during 2019 and net losses of$1.2 million during 2018. Earnings (Loss) Before Income Taxes Information about our earnings (loss) before income tax expense by reportable segment is as follows: Change Year Ended December 31, 2019 vs. 2018 (In Thousands) 2019 2018 $ % EARNINGS (LOSS) BEFORE INCOME TAX EXPENSE: Progressive Leasing$ 55,711 $ 175,015 $ (119,304 ) (68.2 )% Aaron's Business 46,731 84,683 (37,952 ) (44.8 ) Vive (9,654 ) (7,494 ) (2,160 ) (28.8 ) Total Earnings Before Income Tax Expense$ 92,788 $ 252,204 $
(159,416 ) (63.2 )%
The factors impacting the change in earnings (loss) before income tax expense are discussed above. Income Tax Expense Income tax expense increased to$61.3 million for the year endedDecember 31, 2019 compared to$56.0 million for 2018 due to an increase in the effective tax rate to 66.1% in 2019 from 22.2% in 2018. The increase in the effective tax rate for the year endedDecember 31, 2019 is primarily due to a$175.0 million non-deductible regulatory charge related toProgressive Leasing's tentative settlement of theFTC matter. Overview of Financial Position The major changes in the consolidated balance sheet fromDecember 31, 2018 toDecember 31, 2019 , include: • Cash and cash equivalents increased$42.5 million to$57.8 million at
Capital Resources" section below.
• Lease merchandise increased
a reduction in lease merchandise at the Aaron's Business as a result of
the 2019 store closures.
• As a result of the adoption of ASC 842 as of
has operating lease right-of-use assets and operating lease liabilities
of $329.2 million and $369.4 million , respectively, as of December 31,
2019 .
• Income tax receivable decreased $10.5 million to $18.7 million due
primarily to net income tax refunds received and current tax expense
recognized during the year ended December 31, 2019 .
• Accounts payable and accrued expenses decreased $20.3 million . Thisdecrease is primarily due to the transition to ASC 842, which resulted in
the remaining balances of the Company's deferred rent, lease incentives,
and closed store reserve, which were previously recorded within accounts
payable and accrued expenses, being reclassified as a reduction to the
operating lease right-of-use asset in the accompanying consolidated
balance sheet.
• Accrued regulatory expense of
to
• Debt decreased
primarily to scheduled repayments of
unsecured notes and net repayments of
loan and revolving credit facility. Refer to the "Liquidity and Capital
Resources" section below for further details regarding the Company's
financing arrangements.
40-------------------------------------------------------------------------------- Liquidity and Capital Resources General Our primary capital requirements consist of buying merchandise for the operations ofProgressive Leasing and the Aaron's Business. AsProgressive Leasing continues to grow, the need for additional lease merchandise is expected to remain our major capital requirement. Other capital requirements include (i) purchases of property, plant and equipment, including leasehold improvements for our next generation store concepts; (ii) expenditures for acquisitions, including franchisee acquisitions; (iii) expenditures related to our corporate operating activities; (iv) personnel expenditures; (v) income tax payments; (vi) funding of loans receivable for Vive; and (vii) servicing our outstanding debt obligations. The Company has also historically paid quarterly cash dividends and periodically repurchases stock. Our capital requirements have been financed through: • cash flows from operations; • private debt offerings; • bank debt; and • stock offerings. As ofDecember 31, 2019 , the Company had$57.8 million of cash and$386.2 million of availability under its revolving credit facility. As discussed in Note 10 in the accompanying consolidated financial statements, the Company has accrued$175.0 million related toProgressive Leasing's tentative settlement of theFTC matter. Upon final settlement with theFTC , the Company anticipates satisfying the obligation with a combination of cash on hand and borrowings available under our revolving credit facility. Cash Provided by Operating Activities Cash provided by operating activities was$317.2 million and$356.5 million during the years endedDecember 31, 2019 and 2018, respectively. The$39.3 million decrease in operating cash flows was primarily driven by net income tax refunds of$0.7 million during 2019 compared to net income tax refunds of$63.8 million in 2018, partially offset by an increase in operating cash flows driven by the growth ofProgressive Leasing . Other changes in cash provided by operating activities are discussed above in our discussion of results for the year endedDecember 31, 2019 . Cash Used in Investing Activities Cash used in investing activities was$106.3 million and$263.1 million during the years endedDecember 31, 2019 and 2018, respectively. The$156.9 million decrease in investing cash outflows in 2019 as compared to 2018 was primarily due to: (i) cash outflows of$14.3 million for the acquisitions of businesses and contracts throughout 2019 as compared to cash outflows of approximately$190 million for the acquisitions of franchisees throughout 2018 and (ii)$4.9 million higher proceeds from the sale of property, plant and equipment in 2019 as compared to 2018; partially offset by (iii)$14.1 million of additional cash outflows related to the purchase of property, plant and equipment and (iv)$9.6 million higher net cash outflows for investments in Vive loans receivable in 2019 as compared to 2018. Cash Used in Financing Activities Cash used in financing activities was$168.6 million and$129.0 million during the years endedDecember 31, 2019 and 2018, respectively. The$39.6 million increase in financing cash outflows in 2019 as compared to 2018 was primarily due to net repayments of outstanding debt of$84.5 million in 2019 as compared to net borrowings of$55.9 million in 2018 partially offset by a$99.5 million decrease in Company repurchases of outstanding common stock in 2019 as compared to 2018. Share Repurchases We purchase our stock in the market from time to time as authorized by our Board of Directors. During the year endedDecember 31, 2019 , the Company purchased 1,156,184 shares for$69.3 million . During the year endedDecember 31, 2018 , the Company purchased 3,749,493 shares for$168.7 million . As ofDecember 31, 2019 , we have the authority to purchase additional shares up to our remaining authorization limit of$262.0 million . 41 --------------------------------------------------------------------------------
Dividends
We have a consistent history of paying dividends, having paid dividends for 32 consecutive years. Our annual common stock dividend was$0.1450 per share,$0.1250 per share and$0.1125 per share in 2019, 2018 and 2017, respectively, and resulted in aggregate dividend payments of$9.4 million ,$6.2 million and$8.0 million in 2019, 2018 and 2017, respectively. At itsNovember 2019 meeting, our Board of Directors increased the quarterly dividend by 14.3%, raising it to$0.040 per share. Subject to sufficient operating profits, any future capital needs and other contingencies, we currently expect to continue our policy of paying quarterly cash dividends. Debt Financing As ofDecember 31, 2019 ,$219.4 million in term loans were outstanding under the revolving credit and term loan agreement (the "Credit Agreement"). The total available credit under our revolving credit facility as ofDecember 31, 2019 was$386.2 million . The Credit Agreement includes an uncommitted incremental facility increase option (an "accordion facility") which, subject to certain terms and conditions, permits the Company at any time prior to the maturity date to request an increase in extensions of credit available thereunder by an aggregate additional principal amount of up to$250.0 million . OnJanuary 21 andFebruary 19, 2020 , the Company amended its Credit Agreement to, among other changes: (i) increase the revolving credit commitment from$400.0 million to$500.0 million , (ii) increase borrowings under the term loan to$225.0 million , (iii) extend the maturity date fromSeptember 18, 2022 toJanuary 21, 2025 , (iv) amend the definition of adjusted EBITDA to exclude certain charges, and (v) modify certain other terms and conditions. The amended agreement continues to provide for quarterly repayment installments of$5.6 million under the$225.0 million term loan, with the installments beginning onDecember 31, 2020 , with the remaining principal balance payable upon the maturity date ofJanuary 21, 2025 . Prior to the amendment, the term loan outstanding balance was$219.4 million as ofDecember 31, 2019 . As ofDecember 31, 2019 , the Company had outstanding$120.0 million in aggregate principal amount of senior unsecured notes issued in a private placement in connection with theApril 14, 2014 Progressive Leasing acquisition. The notes bear interest at the rate of 4.75% per year and mature onApril 14, 2021 . Quarterly payments of interest commencedJuly 14, 2014 , and annual principal payments of$60.0 million each commencedApril 14, 2017 . During the year endedDecember 31, 2018 , the Company repaid the remaining$25.0 million outstanding under its 3.95% senior unsecured notes originally issued in a private placement inJuly 2011 . Our revolving credit and term loan agreement contains certain financial covenants, which include requirements that the Company maintain ratios of (i) adjusted EBITDA plus lease expense to fixed charges of no less than 2.50:1.00 and (ii) total debt to adjusted EBITDA of no greater than 3.00:1.00. In each case, adjusted EBITDA refers to the Company's consolidated net income before interest and tax expense, depreciation (other than lease merchandise depreciation), amortization expense, and other cash and non-cash charges. If we fail to comply with these covenants, we will be in default under these agreements, and all amounts could become due immediately. We are in compliance with all of these covenants atDecember 31, 2019 and believe that we will continue to be in compliance in the future. 42 --------------------------------------------------------------------------------
Commitments
Income Taxes. During the year endedDecember 31, 2019 , we received net tax refunds of$0.7 million . During the year endedDecember 31, 2020 , we anticipate making estimated cash payments of$18.0 million forU.S. federal income taxes,$2.0 million for Canadian income taxes and$16.0 million for state income taxes. The Tax Act, which was enacted inDecember 2017 , provides for 100% expense deduction of certain qualified depreciable assets, including lease merchandise inventory, purchased by the Company afterSeptember 27, 2017 (but would be phased down starting in 2023). Because of our sales and lease ownership model, in which the Company remains the owner of merchandise on lease, we benefit more from bonus depreciation, relatively, than traditional furniture, electronics and appliance retailers. We estimate the tax deferral associated with bonus depreciation from the Tax Act and the prior tax legislation is approximately$321.0 million as ofDecember 31, 2019 , of which approximately 88% is expected to reverse in 2020 and most of the remainder during 2021. These amounts exclude bonus depreciation the Company will receive on qualifying expenditures afterDecember 31, 2019 . During the year endedDecember 31, 2020 , the Company estimates it will receive$0.2 million inU.S. federal income tax refunds. Leases. We lease warehouse and retail store space for most of our store-based operations, call center space, and management and information technology space for corporate functions under operating leases expiring at various times through 2033. Most of the leases contain renewal options for additional periods ranging from one to 20 years. We also lease transportation vehicles under operating and finance leases which generally expire during the next three years. We expect that most leases will be renewed or replaced by other leases in the normal course of business. Approximate future minimum rental payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as ofDecember 31, 2019 are shown in the table set forth below under "Contractual Obligations and Commitments." Franchise Loan Guaranty. We have guaranteed the borrowings of certain independent franchisees under a franchise loan agreement with one of the banks in our Credit Facilities, which had a total maximum commitment amount of$40.0 million as ofDecember 31, 2019 . OnJanuary 21 andFebruary 19, 2020 , the Company further amended the franchisee loan agreement to, among other changes: (i) reduce the maximum facility commitment from$40.0 million to$35.0 million , (ii) extend the commitment termination date thereunder fromOctober 22, 2020 toJanuary 20, 2021 , (iii) amend the definition of adjusted EBITDA to exclude certain charges, and (iv) modify certain other terms and conditions. The terms of the loan facility include an option to further reduce the maximum facility commitment amount by providing written notice to the lender, which the Company subsequently exercised onFebruary 11, 2020 to reduce the facility commitment to$25.0 million . AtDecember 31, 2019 , the total amount that we might be obligated to repay in the event franchisees defaulted was$29.4 million , all of which would be due within the next two years. However, due to franchisee borrowing limits, we believe any losses associated with defaults would be substantially mitigated through recovery of lease merchandise and other assets. Since the inception of the franchise loan program in 1994, the Company's losses associated with the program have been immaterial. The Company believes that any future amounts to be funded by the Company in connection with these guarantees will be immaterial. The carrying amount of the franchisee-related borrowings guarantee, which is included in accounts payable and accrued expenses in the consolidated balance sheets, was$0.3 million as ofDecember 31, 2019 and 2018, respectively. Contractual Obligations and Commitments. The following table shows the approximate contractual obligations, including interest, and commitments to make future payments as ofDecember 31, 2019 : Period Less Period 1-3 Period 3-5 Period Over (In Thousands) Total Than 1 Year Years Years 5 Years Debt, Excluding Finance Leases$ 339,375 $ 82,500 $ 256,875 $ - $ - Finance Leases 2,670 1,821 849 - - Interest Obligations 21,274 10,837 10,437 - - Operating Leases 404,230 108,089 161,584 81,118 53,439 Purchase Obligations 30,886 18,348 12,538 - - Severance and Retirement Obligations 829 769 24 24 12 Total Contractual Cash Obligations$ 799,264 $ 222,364 $ 442,307 $ 81,142 $ 53,451 For future interest payments on variable-rate debt, which are based on the adjusted London Interbank Overnight (LIBO) rate plus a margin ranging from 1.25% to 2.25% or the administrative agent's prime rate plus a margin ranging from 0.25% to 1.25%, as specified in the agreement, we used the variable rate in effect atDecember 31, 2019 to calculate these payments. Our variable rate debt atDecember 31, 2019 consisted of term loan borrowings under our revolving credit and term loan agreement. Future interest payments related to our revolving credit and term loan agreement are based on the borrowings outstanding atDecember 31, 2019 through the maturity date, assuming such borrowings are outstanding at that time. The variable rate for our term loan borrowings under the unsecured revolving credit and term loan agreement was 3.05% atDecember 31, 2019 . Future interest payments may be different depending on future borrowing activity and interest rates. 43 -------------------------------------------------------------------------------- Operating lease obligations represent fixed amounts scheduled to be paid through the remaining lease term for real estate, vehicle, and equipment lease contracts. These amounts do not include estimated or actual future sublease receipts. Purchase obligations are primarily related to certain consulting agreements, advertising programs, marketing programs, software licenses, hardware and software maintenance and support and telecommunications services. The table above includes only those purchase obligations for which the timing and amount of payments is certain. We have no long-term commitments to purchase merchandise nor do we have significant purchase agreements that specify minimum quantities or set prices that exceed our expected requirements for three months. Severance and retirement obligations represent primarily future severance payments to former employees under the Company's various restructuring programs as well as future payments to be made related to the retirement of a former executive officer. Deferred income tax liabilities as ofDecember 31, 2019 were approximately$310.4 million . This amount is not included in the total contractual obligations table because we believe this presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax basis of assets and liabilities and their respective book basis, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not necessarily relate to liquidity needs. Unfunded Lending Commitments. The Company, through its Vive business, has unfunded lending commitments totaling approximately$225.0 million and$316.4 million as ofDecember 31, 2019 and 2018, respectively, that do not give rise to revenues and cash flows. 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, which is included in accounts payable and accrued expenses in the consolidated balance sheets, is calculated by the Company based on historical customer usage of available credit and is approximately$0.4 million and$0.5 million as ofDecember 31, 2019 and 2018, respectively. Legal and Regulatory. As discussed in Note 10 in the accompanying consolidated financial statements, the Company has accrued$175.0 million related toProgressive Leasing's tentative settlement of theFTC matter. 44 -------------------------------------------------------------------------------- Critical Accounting Policies We discuss the most critical accounting policies below. For a discussion of the Company's significant accounting policies, see Note 1 in the accompanying consolidated financial statements. Revenue RecognitionProgressive Leasing bills customers in arrears and therefore, lease revenues are earned prior to the lease payment due date and are recorded in the statement of earnings net of related sales taxes as earned.Progressive Leasing revenues recorded prior to the payment due date results in unbilled accounts receivable in the accompanying consolidated balance sheets. Aaron's Business lease payments are due in advance of when the lease revenues are earned. Lease revenues net of related sales taxes are recognized in the statement of earnings in the month they are earned. Aaron's Business lease payments received prior to the month earned are recorded as deferred lease revenue, and this amount is included in customer deposits and advance payments in the accompanying consolidated balance sheets. Our revenue recognition accounting policy matches the lease revenue with the corresponding costs, mainly depreciation, associated with lease merchandise. AtDecember 31, 2019 and 2018, we had deferred revenue representing cash collected in advance of being due or otherwise earned totaling$89.6 million and$74.6 million , respectively, and leases accounts receivable, net of an allowance for doubtful accounts, based on historical collection rates, of$74.9 million and$59.9 million , respectively. Our accounts receivable allowance, which relates primarily to ourProgressive Leasing segment and, to a lesser extent, our Aaron's Business operations, is estimated using one year of historical write-off and collection experience. Other qualitative factors, such as seasonality and current business trends, are considered in estimating the allowance. For customer agreements that are past due, the Company's policy is to write-off lease receivables after 120 days and 60 days forProgressive Leasing and Aaron's Business, respectively. For the year endedDecember 31, 2019 and years prior, the Aaron's Business segment recorded its provision for returns and uncollected payments as a reduction to lease revenue and fees in the consolidated statements of earnings. During the year endedDecember 31, 2019 , the Company adopted ASU 2016-02, Leases ("ASC 842"), which resulted in theProgressive Leasing provision for returns and uncollectible renewal payments being recorded as a reduction of lease revenue and fees within the consolidated statements of earnings beginningJanuary 1, 2019 . The provision for returns and uncollectible renewal payments for periods prior to 2019 are reported herein as bad debt expense within operating expenses in the consolidated statements of earnings. Revenues from the retail sale of merchandise to customers are recognized at the point of sale. Generally, the transfer of control occurs near or at the point of sale for retail sales. Revenues for the non-retail sale of merchandise to franchisees are recognized when control transfers to the franchisee, which is upon delivery of the merchandise. Vive recognizes interest income based upon the amount of the loans outstanding, which is recognized as interest and fees on loans receivable in the billing period in which they are assessed if collectibility is reasonably assured. Vive acquires loans receivable from merchants through its third-party bank partners at a discount from the face value of the loan. The discount is comprised mainly of a merchant fee discount, which represents a pre-negotiated, nonrefundable discount that generally ranges from 3% to 25% of the loan face value. The discount is designed to cover the risk of loss related to the portfolio of cardholder charges and Vive's direct origination costs. The merchant fee discount, net of the origination costs, is amortized on a net basis and is recorded as interest and fee revenue on loans receivable on a straight-line basis over the initial 24-month period that the card is active. Lease Merchandise The Company'sProgressive Leasing segment, at which substantially all merchandise is on lease, depreciates merchandise on a straight-line basis to a 0% salvage value generally over 12 months. Our Aaron's Business segment begins depreciating merchandise at the earlier of twelve months and one day or when the item is leased. We depreciate merchandise on a straight-line basis 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. 45 -------------------------------------------------------------------------------- All lease merchandise is available for lease and sale, excluding merchandise determined to be missing, damaged or unsalable. For merchandise on lease, we record a provision for write-offs using the allowance method, which primarily relates to ourProgressive Leasing operations and, to a lesser extent, our Aaron's Business operations. The allowance for lease merchandise write-offs estimates the merchandise losses incurred but not yet identified by management as of the end of the accounting period. The Company estimates its allowance for lease merchandise write-offs using one year of historical write-off experience. Other qualitative factors, such as seasonality and current business trends, are considered in estimating the allowance. For customer agreements that are past due, the Company's policy is to write-off lease merchandise after 120 days and 60 days forProgressive Leasing and Aaron's Business, respectively. As ofDecember 31, 2019 and 2018, the allowance for lease merchandise write-offs was$61.2 million and$46.7 million , respectively. The provision for lease merchandise write-offs was$251.4 million and$192.3 million for the years endedDecember 31, 2019 and 2018, respectively, and is included in operating expenses in the accompanying consolidated statements of earnings. For merchandise not on lease, our policies generally require weekly merchandise counts at our Aaron's Business store-based operations, which include write-offs for unsalable, damaged, or missing merchandise inventories. In addition to monthly cycle counting, full physical inventories are generally taken at our fulfillment and manufacturing facilities annually, and appropriate provisions made for missing, damaged and unsalable merchandise. In addition, we monitor merchandise levels and mix by division, store and fulfillment center, as well as the average age of merchandise on hand. If obsolete merchandise cannot be returned to vendors, its carrying amount is adjusted to net realizable value or written off.Goodwill and Other Intangible Assets Intangible assets are classified into one of three categories: (i) intangible assets with definite lives subject to amortization; (ii) intangible assets with indefinite lives not subject to amortization; and (iii) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying amount may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, and sooner if events or circumstances indicate that an impairment may have occurred. Factors which could necessitate an interim impairment assessment include a sustained decline in the Company's stock price, prolonged negative industry or economic trends and significant underperformance relative to historical or projected future operating results. As an alternative to this annual impairment testing for intangible assets with indefinite lives and goodwill, the Company may perform a qualitative assessment for impairment if it believes it is not more likely than not that the carrying amount of a reporting unit's net assets exceeds the reporting unit's fair value. Indefinite-lived intangible assets represent the value of trade names acquired as part of theProgressive Leasing acquisition. At the date of acquisition, the Company determined that no legal, regulatory, contractual, competitive, economic or other factors limit the useful life of the trade name intangible asset and, therefore, the useful life is considered indefinite. The Company reassesses this conclusion quarterly and continues to believe the useful life of this asset is indefinite. The Company performed a qualitative assessment to complete its indefinite-lived intangible asset impairment test as ofOctober 1, 2019 and determined that no impairment had occurred. The following table presents the carrying amount of goodwill and other intangible assets, net: December 31, (In Thousands) 2019 Goodwill$ 736,582
Other Indefinite-Lived Intangible Assets 53,000 Definite-Lived Intangible Assets, Net
137,796
Management has deemed its operating segments to be reporting units due to the fact that the components included in each operating segment have similar economic characteristics. As ofDecember 31, 2019 , the Company had three operating segments and reporting units:Progressive Leasing , Aaron's Business, and Vive. The following is a summary of the Company's goodwill by reporting unit: December 31, (In Thousands) 2019 Aaron's Business$ 447,781 Progressive Leasing 288,801 Total$ 736,582 46
-------------------------------------------------------------------------------- We performed our annual goodwill impairment testing as ofOctober 1, 2019 . When evaluating goodwill for impairment, the Company may first perform a qualitative assessment to determine whether it is more likely than not that a reporting unit or intangible asset group is impaired. The decision to perform a qualitative impairment assessment for an individual reporting unit in a given year is influenced by a number of factors, including the size of the reporting unit's goodwill, the current and projected operating results, the significance of the excess of the reporting unit's estimated fair value over carrying amount at the last quantitative assessment date and the amount of time in between quantitative fair value assessments and the date of acquisition. As ofOctober 1, 2019 , the Company performed a qualitative assessment for the goodwill of theProgressive Leasing reporting unit and concluded no indications of impairment existed. The Company may be required to recognize material impairments to theProgressive Leasing's goodwill balance in the future if: (i) actual results are unfavorable to the Company's estimates and assumptions used to calculate the most recent fair value analysis; and/or (ii) the Company experiences significant deterioration of macroeconomic market conditions in which it operates. The Company determined that there were no events that occurred or circumstances that changed in the fourth quarter of 2019 that would more likely than not reduce the fair value of a reporting unit below its carrying amount. As ofOctober 1, 2019 , the Company, with the assistance of a third-party valuation specialist, performed a quantitative assessment for the goodwill of the Aaron's Business reporting unit, which entailed an assessment of the reporting unit's fair value relative to the carrying value that was derived using a combination of both income and market approaches. The fair value measurement involved significant unobservable inputs (Level 3 inputs). Our income approach utilized the discounted future expected cash flows, which required assumptions about short-term and long-term revenue growth rates, operating margins, capital requirements, and a weighted-average cost of capital. Our income approach reflects assumptions and estimates of future cash flows related to our strategy to reposition and reinvest in our next generation store concepts to adapt to our changing competitive environment. Our market approach, which includes the guideline public company method, utilized pricing multiples derived from an analysis of comparable publicly traded companies. We believe the comparable companies we evaluate as marketplace participants serve as an appropriate reference when calculating fair value because those companies have similar risks, participate in similar markets, provide similar products and services for their customers and compete with us directly. Based on testing as ofOctober 1, 2019 , the fair value of the Aaron's Business reporting unit exceeded its carrying value by a substantial amount and thus, goodwill is not impaired. The short-term and long-term revenue growth rates, operating margins, capital requirements and weighted-average cost of capital are the assumptions that are most sensitive and susceptible to change as they require significant management judgment. The Company may be required to recognize material impairments to the Aaron's Business goodwill balance in the future if: (i) the Company fails to successfully execute on one or more elements of the Aaron's Business strategic plan; (ii) actual results are unfavorable to the Company's estimates and assumptions used to calculate fair value; (iii) the Aaron's Business carrying value increases, such as through a material franchisee acquisition(s), without an associated increase in the fair value; and/or (iv) the Company experiences significant deterioration of macroeconomic market conditions in which it operates. The Company determined that there were no events that occurred or circumstances that changed in the fourth quarter of 2019 that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Provision for Loan Losses and Loan Loss Allowance 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 rates 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 our estimates of uncollectible loans receivable, the Company's results of operations and liquidity could be materially affected. The Company initially 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. 47 -------------------------------------------------------------------------------- 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 merchant fee discounts and promotional fee discounts for loans receivable in nonaccrual status. Loans receivable are removed from nonaccrual status when cardholder payments resume, the loan becomes 90 days or less 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. The provision for loan losses was$21.7 million and$21.1 million for the years endedDecember 31, 2019 and 2018, respectively. The allowance for loan losses was$14.9 million and$13.0 million as ofDecember 31, 2019 and 2018, respectively. Leases and Right-of-Use Asset Impairment The majority of our Company-operated stores are operated from leased facilities under operating lease agreements. The majority of the leases are for periods that do not exceed five years, although lease terms range in length up to approximately 15 years. Leasehold improvements related to these leases are generally amortized over periods that do not exceed the lesser of the lease term or useful life. For operating leases which contain escalating payments, we record the related lease expense on a straight-line basis over the lease term. We generally do not obtain significant amounts of lease incentives or allowances from landlords. Any incentive or allowance amounts we receive are recorded as reductions of the operating lease right-of-use asset within the consolidated balance sheet and are amortized within operating expenses over the lease term in the consolidated statements of earnings. From time to time, we close or consolidate stores. Our primary costs associated with closing stores are the future lease payments and related commitments. Prior to the 2019 adoption of ASC 842, the Company recorded an estimate of the future obligation related to closed stores based upon the present value of the future lease payments and related commitments, net of estimated savings from lease buyouts or terminations and sublease receipts based upon historical experience. As ofDecember 31, 2018 , this amount was$10.7 million and was recorded as a liability in accounts payable and accrued expenses on the consolidated balance sheet. Upon the 2019 adoption of ASC 842, this amount was reclassified to a reduction of operating lease right-of-use assets. EffectiveJanuary 1, 2019 , the Company began recording estimates of future obligations related to closed stores as described above as impairments of the right-of-use asset for all subsequent store closures. Due to changes in market conditions, our estimates related to future lease buyouts and sublease receipts may change. Excluding actual and estimated sublease receipts, our future obligations related to closed stores on an undiscounted basis were$36.5 million and$23.7 million as ofDecember 31, 2019 and 2018, respectively. Insurance Programs We maintain insurance contracts to fund workers compensation, vehicle liability, general liability and group health insurance claims. Using actuarial analyses and projections, we estimate the liabilities associated with open and incurred but not reported workers compensation, vehicle liability and general liability claims. This analysis is based upon an assessment of the likely outcome or historical experience. Our gross estimated liability for workers compensation insurance claims, vehicle liability, and general liability was$43.3 million and$39.7 million atDecember 31, 2019 and 2018, respectively, which was recorded within accounts payable and accrued expenses in our consolidated balance sheets. In addition, we have prefunding balances on deposit and other insurance receivables with the insurance carriers of$22.5 million and$24.9 million atDecember 31, 2019 and 2018, respectively, which were recorded within prepaid expenses and other assets in our consolidated balance sheets. If we resolve insurance claims for amounts that are in excess of our current estimates, we will be required to pay additional amounts beyond those accrued atDecember 31, 2019 . The assumptions and conditions described above reflect management's best assumptions and estimates, but these items involve inherent uncertainties as described above, which may or may not be controllable by management. As a result, the accounting for such items could result in different amounts if management used different assumptions or if different conditions occur in future periods. Recent Accounting Pronouncements Refer to Note 1 to the Company's consolidated financial statements for a discussion of recently issued accounting pronouncements. 48
--------------------------------------------------------------------------------
Use of Non-GAAP Financial Information The "Results of Operations" sections above disclose non-GAAP revenues as if the lessor accounting impacts of ASC 842 were in effect for the twelve months endedDecember 31, 2018 . "Total Revenues, net of Progressive Bad Debt Expense" and the related percentages for the comparable prior year periods are a supplemental measure of our performance that are not calculated in accordance with generally accepted accounting principles inthe United States ("GAAP") in place during 2018. These non-GAAP measures assume that Progressive bad debt expense is recorded as a reduction to lease revenues and fees instead of within operating expenses in 2018. Management believes these non-GAAP measures for 2018 provide relevant and useful information for users of our financial statements, as it provides comparability with the financial results we are reporting beginning in 2019 when ASC 842 became effective and we began reporting Progressive bad debt expense as a reduction to lease revenues and fees. We believe these non-GAAP measures provide management and investors the ability to better understand the results from the primary operations of our business in 2019 compared with 2018 by classifying Progressive bad debt expense consistently between the periods. These non-GAAP financial measures should not be used as a substitute for, or considered superior to, measures of financial performance prepared in accordance with GAAP.
© Edgar Online, source
