Note A – Basis of Presentation

The consolidated financial statements include the accounts of Aaron’s, Inc. (“we,” “our,” “us,” “Aaron’s” or the “Company”) and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The consolidated balance sheet as of June 30, 2012, the consolidated statements of earnings, and comprehensive income for the three and six months ended June 30 2012 and 2011, and consolidated statements of cash flows for the six months ended June 30, 2012 and 2011 are unaudited. The preparation of interim consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Management does not believe these estimates or assumptions will change significantly in the future absent unsurfaced and unforeseen events. Generally, actual experience has been consistent with management’s prior estimates and assumptions; however, actual results could differ from those estimates.

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly they do not include all information required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the accompanying financial statements. We suggest you read these financial statements in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2011. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of operating results for the full year.

Certain reclassifications have been made to the prior periods to conform to the current period presentation. In all periods presented, the HomeSmart division was reclassified from the Other segment to the HomeSmart segment in Note C to the consolidated financial statements. In all periods presented, bad debt expense was reclassified from change in accounts receivable to a separate line on the consolidated statements of cash flows.

Accounting Policies and Estimates

See Note A to the consolidated financial statements in the 2011 Annual Report on Form 10-K.

Cash and Cash Equivalents

Cash and cash equivalents include all highly liquid investments with maturity dates of less than three months when purchased.

Receivables

Accounts receivable, net of allowances, consisted of the following:


(In Thousands)	June 30, 2012		December 31, 2011
Customers	$	5,838	$	5,384
Corporate		24,708		29,650
Franchisee		38,976		52,437

	$	69,522	$	87,471

Accounts receivable consist primarily of receivables due from customers of Company-operated stores, corporate receivables incurred during the normal course of business and franchisee obligations.

Investments

The Company maintains investments in various corporate debt securities, or bonds. Bonds are recorded at amortized cost in the consolidated balance sheets and mature at various dates from 2012 to 2014. The amortized cost, gross unrealized gains and losses, and fair value of bonds held to maturity are as follows:


June 30, 2012 (In Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Corporate Bonds	$	114,801	$	67	$	(167	)	$	114,701
Perfect Home Bonds		16,957		—		—			16,957

	$	131,758	$	67	$	(167	)	$	131,658


December 31, 2011 (In Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Corporate Bonds	$	82,243	$	15	$	(664	)	$	81,594
Perfect Home Bonds		15,889		—		—			15,889

	$	98,132	$	15	$	(664	)	$	97,483

The amortized cost and fair value of held to maturity bonds at June 30, 2012, by contractual maturity are as follows:


(In Thousands)	Amortized Cost		Fair Value
Due in one year or less	$	85,851	$	85,840
Due in years one through two		45,907		45,818

Ending Balance	$	131,758	$	131,658

Information pertaining to held to maturity bond with gross unrealized losses is as follows:


	Less than 12 months					12 months or longer					Total
June 30, 2012 (In Thousands)	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate Bonds	$	67,361	$	(151	)	$	2,549	$	(16	)	$	69,910	$	(167	)

At December 31, 2011 all bonds with gross unrealized losses were in a continuous loss position for less than 12 months.

December 31, 2011

(In Thousands)

Fair Value

Gross
Unrealized
Losses

Corporate Bonds

72,315

(664

)

The Company evaluates bonds for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis.

The unrealized losses at June 30, 2012 related principally to the increases in short-term market interest rates that occurred since the bonds were purchased and 36 of the 61 securities are in an unrealized loss position as of June 30, 2012. The fair value is expected to recover as the bonds approach their maturity or if market yields for such investments decline. In analyzing an issuer’s financial condition, management considers whether downgrades by bond rating agencies have occurred. The Company has the intent and ability to hold the bonds until their amortized cost basis is recovered on the maturity date. As a result of management’s analysis and review, no declines are deemed to be other than temporary. At December 31, 2011, the unrealized losses related principally to the increases in short-term market interest rates that occurred since the bonds were purchased and 38 of the 44 bonds were in an unrealized loss position as of December 31, 2011.

Certificates of deposit held for investment with original maturities greater than three months and remaining maturities less than one year are classified as Investments in the consolidated balance sheets. At June 30, 2012, $25 million in certificates of deposit were classified as Investments in the consolidated balance sheets. The Company did not hold any certificates of deposit at December 31, 2011.

Lease Merchandise

Lease merchandise adjustments for the three month period ended June 30 were $12.5 million and $10.4 million in 2012 and 2011, respectively. Lease merchandise adjustments for the six month period ended June 30 were $23.5 million in 2012 and $19.9 million in 2011. These adjustments are recorded as a component of operating expenses under the allowance method, which includes losses incurred but not yet identified.

Goodwill and Other Intangibles

During the six months ended June 30, 2012 the Company recorded $10.6 million in goodwill, $1.2 million in customer relationship intangibles, $830,000 in non-compete intangibles, and $578,000 in acquired franchise development rights in connection with a series of acquisitions in the Sales and Lease Ownership segment. The aggregate purchase price for these Sales and Lease Ownership acquisitions totaled $22.2 million, with the principal tangible assets acquired consisting of lease merchandise and fixtures and equipment.

Customer relationship intangibles are amortized on a straight-line basis over their estimated useful lives of two years. Other intangible assets with definite lives are amortized using the straight-line method over the life of the asset. Amortization expense was $645,000 and $476,000 for the three month periods ended June 30, 2012 and 2011, respectively, for the Sales and Lease Ownership segment. Amortization expense was $1.2 million and $976,000 for the six month periods ended June 30, 2012 and 2011, respectively, for the Sales and Lease Ownership segment. The purchase price allocations in the current year are tentative and preliminary; the Company anticipates finalizing them prior to December 31, 2012.

During the six months ended June 30, 2012 the Company recorded $476,000 in goodwill, $103,000 in customer relationship intangibles, and $51,000 in non-compete intangibles in connection with a series of acquisitions in the HomeSmart segment. The aggregate purchase price for these HomeSmart acquisitions totaled $980,000, with the principal tangible assets acquired consisting of lease merchandise, vehicles and fixtures and equipment.

Customer relationship intangibles are amortized on a straight-line basis over their estimated useful lives of two years. Other intangible assets with definite lives are amortized using the straight-line method over the life of the asset. Amortization expense was $263,000 and $518,000 for the three and six month periods ended June 30, 2012 for the HomeSmart business. There was no amortization expense for the three and six month periods ended June 30, 2011 for the HomeSmart business. The purchase price allocations in the current year are tentative and preliminary; the Company anticipates finalizing them prior to December 31, 2012.

The results of operations of the acquired businesses are included in the Company’s results of operations from the dates of acquisition and are not significant.

Stock Compensation

The results of operations for the three months ended June 30, 2012 and 2011 include $412,000 and $607,000, respectively, in compensation expense related to unvested stock option grants. The results of operations for the six months ended June 30, 2012 and 2011 include $837,000 and $1.2 million, respectively, in compensation expense related to unvested stock option grants. The results of operations for the three months ended June 30, 2012 and 2011 include $798,000 and $751,000, respectively, in compensation expense related to restricted stock unit (“RSU”) awards and restricted stock awards (“RSA”). The results of operations for the six months ended June 30, 2012 and 2011 include $1.4 million and $1.2 million, respectively, in compensation expense related to RSU and RSA awards.

The Company granted 120,000 RSUs and 142,000 RSUs in the three and six months ended June 30, 2012, respectively. The Company granted 246,000 RSUs and 20,000 RSAs during 2011. Also, 150,000 RSUs, and 137,000 RSAs vested during 2011. Approximately 55,000 and 456,000 options were exercised during the three and six month periods ended June 30, 2012, respectively. Approximately 447,000 options were exercised during 2011. The aggregate number of shares of common stock that may be issued or transferred under the Company’s incentive stock awards plan is 14,391,665 as of June 30, 2012.

For terms and conditions of the awards under the Company’s stock-based compensation plans refer to Note H in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Deferred Compensation

The Company’s Deferred Compensation Plan is an unfunded, nonqualified deferred compensation plan for a select group of management, highly compensated employees and non-employee directors. On a pre-tax basis, eligible employees can defer receipt of up to 75% of their base compensation and up to 100% of their incentive pay compensation, and eligible non-employee directors can defer receipt of up to 100% of both their cash and stock director fees. In addition, the Company may elect to make restoration matching contributions on behalf of eligible employees to compensate such employees for certain limitations on the amount of matching contributions an employee can receive under the Company’s tax-qualified 401(k) plan.

Compensation deferred under the plan is credited to each participant’s deferral account and a deferred compensation liability is recorded in accounts payable and accrued expenses in the consolidated balance sheets. The deferred compensation plan liability was $7.8 million and $6.3 million as of June 30, 2012 and December 31, 2011, respectively. Liabilities under the plan are recorded at amounts due to participants, based on the fair value of participants’ selected investments. The Company has established a Rabbi Trust to fund obligations under the plan with Company-owned life insurance (“COLI”) contracts. The obligations are unsecured general obligations of the Company and the participants have no right, interest or claim in the assets of the Company, except as unsecured general creditors. The cash surrender value of these COLI contracts totaled $7.1 million and $5.8 million as of June 30, 2012 and December 31, 2011, respectively, and is included in prepaid expenses and other assets in the consolidated balance sheets.

Deferred compensation expense charged to operations for the Company’s matching contributions totaled $84,000 and $90,000 in the three month periods ended June 30, 2012 and 2011, respectively. Deferred compensation expense charged to operations for the Company’s matching contributions totaled $162,000 and $191,000 in the six month periods ended June 30, 2012 and 2011, respectively. Total benefits of $565,000 and $27,000 were paid in the first six months of 2012 and 2011, respectively.

Income Taxes

The Company files a federal consolidated income tax return in the United States, and the Company and its subsidiaries file in various state and foreign jurisdictions. With few exceptions, the Company is no longer subject to federal, state and local tax examinations by tax authorities for years before 2008.

As of June 30, 2012 and December 31, 2011, the amount of uncertain tax benefits that, if recognized, would affect the effective tax rate is $1.2 million, including interest and penalties. The Company recognizes potential interest and penalties related to uncertain tax benefits as a component of income tax expense.

Earnings Per Share

Earnings per share is computed by dividing net earnings by the weighted average number of shares of Common Stock outstanding during the period. The computation of earnings per share assuming dilution includes the dilutive effect of stock options, RSUs and RSAs. Stock options had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 843,000 and 1.1 million for the three months ended June 30, 2012 and 2011, respectively. Stock options had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 859,000 and 985,000 for the six months ended June 30, 2012 and 2011, respectively. RSUs had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 204,000 and 160,000 for the three months ended June 30, 2012 and 2011, respectively. RSUs had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 193,000 and 165,000 for the six months ended June 30, 2012 and 2011, respectively. RSAs had the effect of increasing the weighted average shares outstanding assuming dilution by approximately 5,000 for the three and six months ended June 30, 2012 and had no impact for the three and six months ended June 30, 2011.

There were no anti-dilutive stock options excluded from the computation of earnings per share assuming dilution for the three months ended June 30, 2012 or 2011. There were no anti-dilutive stock options excluded from the computation for earnings per share assuming dilution for the six months ended June 30, 2012 and anti-dilutive stock options excluded from the computation of earnings per share assuming dilution were 293,000 for the six months ended June 30, 2011. Anti-dilutive RSUs and RSAs excluded from the computation of earnings per share assuming dilution were 11,000 and 6,000 for the three months ended June 30, 2012 and 2011. Anti-dilutive RSUs and RSAs excluded from the computation of earnings per share assuming dilution were 9,000 and 6,000 for the six months ended June 30, 2012 and 2011, respectively.

Assets Held for Sale

Certain properties, primarily consisting of parcels of land, met the held for sale classification criteria at June 30, 2012 and December 31, 2011. After adjustment to fair value, the $12.4 million and $9.9 million carrying value of these properties has been classified as assets held for sale in the consolidated balance sheets as of June 30, 2012 and December 31, 2011, respectively. The Company estimated the fair values of these properties using the market values for similar properties and these are considered Level 2 fair value measurements as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements.

Variable Interest Entities

On October 14, 2011, the Company purchased 11.5% of the common stock of Perfect Home Holdings Limited (“Perfect Home”), a privately-held rent-to-own company that is primarily financed by subordinated debt. Perfect Home is based in the United Kingdom and operates 47 retail stores. As part of the transaction, the Company also received notes, an option to acquire the remaining interest in Perfect Home at anytime through December 31, 2013, and an option to sell its interest in Perfect Home. If the Company does not exercise the option prior to December 31, 2013, it will be obligated to sell the common stock and notes back to Perfect Home at the original purchase price plus interest. The Company’s investment is denominated in British Pounds.

For accounting purposes Perfect Home is considered a variable interest entity, or VIE, as it does not have sufficient equity at risk; however, the Company is not the primary beneficiary and lacks the power through voting or similar rights to direct those activities of Perfect Home that most significantly affect its economic performance. As such, the VIE is not consolidated by the Company.

Because the Company is not able to exercise significant influence over the operating and financial decisions of Perfect Home, the equity portion of the investment in Perfect Home, totaling less than a thousand dollars at June 30, 2012 and December 31, 2011, is accounted for as a cost method investment and is included in prepaid expenses and other assets. The notes purchased from Perfect Home totaling $17.0 million at June 30, 2012 and $15.9 million at December 31, 2011 are accounted for as held to maturity securities in accordance with ASC Topic 320, Debt and Equity Securities, and are included in investments. Utilizing a Black-Scholes model, the options to buy the remaining interest in Perfect Home and to sell the Company’s interest in Perfect Home were determined to have only nominal values. The Company recorded aggregate foreign currency exchange (losses) gains related to the investment of ($321,000) and $183,000 during the three and six months ended June 30, 2012, respectively. The Company’s maximum exposure to any potential losses associated with this VIE is equal to its total recorded investment of $17.0 million at June 30, 2012.

Concentration of Credit Risk

The Company maintained its cash and cash equivalents in a limited number of banks. Bank balances typically exceed coverage provided by the Federal Deposit Insurance Corporation. However, due to the size and strength of the banks where the balances are held, such exposure to loss is considered minimal.

Fair Value Measurements

The fair values of the Company’s cash and cash equivalents, Perfect Home bonds, certificates of deposit, accounts receivable and accounts payable approximate their carrying values due to their short-term nature.

The following tables summarize assets measured at fair value on a nonrecurring basis:


June 30, 2012 (In Thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets Held for Sale	$	12,368	$	—	$	12,368	$	—

December 31, 2011 (In Thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets Held for Sale	$	9,885	$	—	$	9,885	$	—

Assets Held for Sale primarily represents real estate properties that consist mostly of parcels of land. The Company estimated the fair values of these properties using the market values for similar properties. In accordance with FASB ASC Topic 360, Property, Plant and Equipment, assets held for sale are written down to fair value. During the three and six month periods ended June 30, 2012, the Company had a $600,000 write down in assets held for sale, which is recorded in operating expenses. During the three and six month periods ending June 30, 2011 no assets held for sale were written down in value. During the year ended December 31, 2011, assets held for sale with a carrying amount of $10.4 million were written down to their fair value of $9.9 million, resulting in a loss of $453,000 which is included in operating expenses. The highest and best use of these assets is as real estate land parcels for development or real estate properties for use or lease; however, the Company has chosen not to develop these properties.

The following tables summarize the fair value of assets (liabilities) that are not measured at fair value in the consolidated balance sheets, but for which the fair value is disclosed:


June 30, 2012 (In Thousands)	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Corporate Bonds	$	114,701		$	—	$	114,701		$	—
Fixed Rate Long Term Debt		(139,537	)		—		(139,537	)		—


December 31, 2011 (In Thousands)	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Corporate Bonds	$	81,594		$	—	$	81,594		$	—
Fixed Rate Long Term Debt		(135,031	)		—		(135,031	)		—

The fair value of Corporate Bonds is determined through the use of model-based valuation techniques for which all significant assumptions are observable in the market. The fair value of fixed rate long term debt is estimated using the present value of underlying cash flows discounted at a current market yield for similar instruments. The carrying value and fair value of fixed rate long term debt at June 30, 2012 was $137.0 million and $139.5 million, respectively, and $137.0 million and $135.0 million, respectively, at December 31, 2011.

Recent Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (“ASU 2011-04”). ASU 2011-4 is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. The amendments are of two types: (i) those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and (ii) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. ASU 2011-4 is effective for annual periods beginning after December 15, 2011 and the Company adopted ASU 2011-04 effective January 1, 2012. The adoption of ASU 2011-04 did not have a material effect on the Company’s financial statements.

In May 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 eliminated the option to report other comprehensive income and its components in the statement of shareholders’ equity. Instead, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 also required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented.

In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update (“ASU 2011-05”). ASU 2011-05 indefinitely defers the guidance related to the presentation of reclassification adjustments. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011 and should be applied retrospectively. The Company elected to report other comprehensive income and its components in a separate statement of comprehensive income for the three and six months ended June 30, 2012. The adoption of ASU 2011-05 did not have a material effect on the Company’s financial statements.