Business Context and Reporting Period
This unaudited Form 10-Q was filed by Rent-A-Center, Inc. for the three months ended March 31, 2019. The filing identifies the registrant as Rent-A-Center, Inc.; it does not identify Upbound Group, Inc. as the registrant. The company operates rent-to-own stores and related businesses through Core U.S., Acceptance Now, Mexico and Franchising segments.
Management’s strategy focuses on optimizing costs, improving the customer value proposition and expanding franchising. The company operated 3,665 locations at March 31, 2019, compared with 3,763 at the beginning of the quarter.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $696.7 million | $698.0 million | Down 0.2% |
| Gross profit | $424.9 million | $437.0 million | Down 2.8% |
| Gross margin | 61.0% | 62.6% | Down 160 basis points |
| Operating profit (loss) | $17.3 million | $(10.3) million | Improved $27.6 million |
| Operating margin | 2.5% | (1.5)% | Improved 400 basis points |
| Net earnings (loss) | $7.3 million | $(19.8) million | Improved $27.2 million |
| Diluted earnings (loss) per share | $0.13 | $(0.37) | Improved $0.50 |
| Cash flow from operations | $75.8 million | $84.5 million | Down $8.7 million |
| Capital expenditures | $2.5 million | $8.6 million | Down $6.1 million |
Cash and cash equivalents were $237.7 million at March 31, 2019, versus $155.4 million at December 31, 2018. Net rental merchandise was $771.6 million, consisting of $647.5 million on rent and $120.4 million held for rent, plus $3.7 million held for installment sale.
Senior notes had a carrying value of approximately $542.7 million before unamortized issuance costs, comprising $292.7 million of 6.625% notes due November 2020 and $250.0 million of 4.75% notes due May 2021. There were no borrowings under the $200 million revolving facility. Availability was $95.1 million, although $92 million of letters of credit had been issued. The facility matures December 31, 2019.
The company adopted ASC 842 on January 1, 2019. At March 31, 2019, it recorded $273.8 million of operating lease right-of-use assets and $284.5 million of operating lease liabilities. Adoption reduced opening retained earnings by $2.0 million, net of tax.
Material Changes Versus the Prior Comparable Period
- Revenue was broadly stable, but store revenue declined 1.0% as refranchising, store closures and the Core U.S. store rationalization offset stronger same-store performance.
- Same-store revenue increased 6.8% overall, including 5.8% in Core U.S., 10.1% in Acceptance Now and 13.1% in Mexico.
- Gross profit declined because merchandise margins deteriorated. Gross margin on merchandise sales fell to 1.0% from 10.2%, primarily due to changes in the value proposition.
- Store labor declined 10.7% and other store expenses declined 11.9%, reflecting the smaller store base and cost-savings initiatives. General and administrative expense declined 26.6%.
- Core U.S. operating profit increased 87.8% to $53.3 million despite a 1.7% revenue decline. Acceptance Now operating profit increased 39.4% to $21.5 million on essentially flat revenue.
- Mexico revenue increased 10.9% and operating profit increased 145.3%. Franchising revenue increased 82.8%, primarily due to additional franchise locations, while its gross margin declined because of revenue mix.
- Other charges increased to $33.4 million from $17.5 million. Q1 2019 charges included cost-savings and store-closure costs, impairments, the Blair class-action settlement and legal and professional fees related to the terminated merger.
- Merchandise losses increased to $46.6 million from $43.1 million. Customer-stolen merchandise losses increased to $39.7 million from $34.9 million.
Outlook, Risks, Contingencies and Unusual Items
Management stated that operating cash flow and available credit were expected to be sufficient to fund operations for the next 12 months. The filing provides no formal revenue or earnings guidance.
- The company expects to receive $92.5 million in cash in late May 2019 under the settlement of litigation related to the terminated Vintage merger and expects to retain approximately $80.0 million before tax after remaining costs, fees and expenses. The company stated it would record the settlement when payment was received.
- The company agreed in principle to settle the Blair class action for $13.0 million, including attorneys’ fees, subject to court approval; the impact was recorded in Q1 2019.
- An $11.0 million securities class-action settlement was funded by the company’s insurer in January 2019 and was approved by the court on May 3, 2019.
- In April 2019, the Federal Trade Commission issued a civil investigative demand concerning transactions involving the purchase and sale of customer lease agreements. The inquiry could lead to enforcement action, a consent order and substantial costs; the company was responding and could not predict the outcome.
- A purported Massachusetts class action involving calls to customer references seeks statutory damages of $25 per reference, potentially trebled to $75. The company intends to defend the matter but cannot assure that it will incur no liability.
- Key risks include refinancing the revolving facility maturing in December 2019 and senior notes maturing in 2020 and 2021, consumer spending and credit conditions, merchandise losses, regulatory developments affecting rent-to-own transactions, litigation, information technology and data security, and the ability to sustain cost savings.
- The company’s Consolidated Fixed Charge Coverage Ratio was 5.13:1 versus a required minimum of 1.10:1 at March 31, 2019. Management reported that disclosure controls and procedures were effective.
Important Facts for Investors to Verify
- Confirm the apparent entity mismatch: the supplied filing is for Rent-A-Center, Inc., while the request metadata names Upbound Group, Inc.
- Verify refinancing or replacement arrangements for the $200 million revolving facility before its December 2019 maturity.
- Monitor whether the $92.5 million Vintage/B. Riley settlement was received and determine the final net proceeds and accounting treatment.
- Track court approval and payment of the $13.0 million Blair settlement and developments in the FTC investigation.
- Assess whether improved operating profit is sustainable after excluding restructuring, legal, settlement and other unusual charges.
- Evaluate the sharp decline in merchandise margins and the increase in stolen merchandise losses.
- Consider the liquidity impact of contractual obligations, including $320.9 million of undiscounted operating lease liabilities and scheduled senior-note payments.