Business Context and Reporting Period
This unaudited Form 10-Q covers the three and nine months ended September 30, 2012. The filing identifies the registrant as Rent-A-Center, Inc. and subsidiaries, not Upbound Group, Inc.; investors should verify the company mapping. The business operates rent-to-own stores and kiosks in the United States, Puerto Rico, Canada and Mexico, plus ColorTyme franchised stores.
At September 30, 2012, the company operated 2,983 Core U.S. stores, 882 RAC Acceptance locations, 114 International stores and 220 ColorTyme franchised stores, for 4,199 total locations.
Key Financial Metrics
| In thousands, except per-share data | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $739.3 million | $704.3 million | $2.324 billion | $2.145 billion |
| Gross profit | $519.3 million | $505.7 million | $1.607 billion | $1.535 billion |
| Gross margin | 70.2% | 71.8% | 69.1% | 71.6% |
| Operating profit | $68.1 million | $57.8 million | $239.2 million | $211.4 million |
| Operating margin | 9.2% | 8.2% | 10.3% | 9.9% |
| Net earnings | $39.9 million | $31.2 million | $136.0 million | $115.3 million |
| Diluted EPS | $0.67 | $0.52 | $2.28 | $1.84 |
Net cash provided by operating activities was $258.7 million for the nine months, compared with $266.7 million in the prior-year period. Capital expenditures were $73.1 million, acquisitions used $5.2 million, dividends totaled $28.5 million and share repurchases totaled $30.1 million. Cash declined to $81.8 million from $88.1 million at December 31, 2011.
At September 30, 2012, senior debt was $293.3 million and senior notes were $300.0 million. The senior notes mature in 2020 and bear interest at 6.625%. The credit facilities had $218.8 million outstanding under the term loan and $65.0 million under the revolving facility; $318.8 million of revolving capacity was reported available at September 30. The filing separately reported $359.1 million of aggregate revolving capacity available at October 22, 2012, including the Intrust line.
Actual credit ratios were within covenant limits: consolidated leverage was 1.31:1 versus a maximum of 3.25:1, and fixed-charge coverage was 1.66:1 versus a minimum of 1.35:1. Covenant EBITDA for the nine-month period was $401.1 million.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 5.0%, operating profit increased 17.9% and net earnings increased 27.8%. Nine-month revenue increased 8.4%, operating profit increased 13.2% and net earnings increased 17.9%.
- Growth was led by RAC Acceptance, whose revenue increased to $83.8 million in Q3 from $51.3 million and to $248.6 million for the nine months from $130.6 million. RAC Acceptance added 132 locations during the first nine months.
- Same-store revenue increased 1.2% in Q3 and 2.8% for the nine months. Core U.S. same-store performance was weaker, while RAC Acceptance growth was favorable.
- Gross margins declined because of higher merchandise costs in RAC Acceptance and changes in Core U.S. promotional strategies. Nine-month merchandise-sales margin fell to 20.8% from 25.5%.
- Results benefited from the absence of 2011 charges, including a $7.6 million restructuring charge in Q3 2011, a $7.3 million impairment charge, a $4.9 million restructuring charge and a $2.8 million litigation charge during the first nine months of 2011.
- Unusually high early-payment-option exercises accelerated revenue recognition, but reduced the number of agreements on rent and shifted revenue from future periods into 2012.
- The International segment remained loss-making, with a nine-month operating loss of $23.6 million versus $7.7 million in 2011. A $1.0 million goodwill impairment charge was recorded in Q3 for underperforming Canadian stores.
Guidance, Outlook, Risks and Unusual Items
Management expected approximately 200 additional RAC Acceptance kiosks, five additional Canadian stores and 40 additional Mexican stores during 2012. It expected 2012 capital expenditures of approximately $105.0 million. Management stated that operating cash flow and available credit were expected to fund liquidity requirements for the next twelve months, although additional financing availability could be affected by market conditions.
- The mature Core U.S. store base, planned cannibalization, economic weakness, unemployment and reduced customer disposable income could pressure revenue and profitability.
- RAC Acceptance depends heavily on third-party retail partners; in 2011, approximately 66.2% of RAC Acceptance revenue came from four partner groups.
- International expansion, particularly in Mexico, exposes the company to foreign-exchange, political, regulatory, security and economic risks.
- Variable-rate debt creates interest-rate exposure. Management estimated that a 1.0% rate change would affect pretax earnings by approximately $2.9 million.
- Debt agreements restrict dividends, repurchases, acquisitions, additional debt and other corporate actions. A change of control could accelerate credit-facility debt and require repurchase of the senior notes at 101% of principal.
- The company had no reserves for probable litigation losses at September 30, 2012, but disclosed that regulatory litigation, settlements or judgments could materially affect liquidity. A pending IRS dispute for tax years 2003 through 2007 was expected to be decided later in 2012; management did not expect a material impact.
- Self-insurance reserves were $118.5 million, up from $114.2 million at December 31, 2011. ColorTyme-related franchise financing guarantees had a maximum exposure of $50.0 million, with $23.8 million outstanding.
- Disclosure controls were evaluated as effective, and no material changes to internal control over financial reporting were reported.
Most Important Facts to Verify
- Confirm that this Rent-A-Center filing is the intended filing for the requested Upbound Group, Inc. issuer.
- Assess whether early purchase-option activity represents sustainable demand or merely accelerates future revenue.
- Monitor RAC Acceptance margins, partner concentration and the pace and profitability of kiosk expansion.
- Evaluate the International segment’s losses, Canadian goodwill impairment and Mexican expansion risks.
- Reconcile debt, revolving availability, letters of credit and covenant calculations, including the October 22, 2012 liquidity update.
- Review the effect of lower gross margins, tax-deferral reversals, variable interest rates and potential litigation or tax outcomes on future cash flow.