Business Context and Reporting Period
This Form 10-Q covers Rent-A-Center, Inc. and subsidiaries for the three and nine months ended September 30, 2016. The supplied metadata identifies Upbound Group, Inc., but the filing itself identifies the registrant as Rent-A-Center, Inc.; this entity discrepancy should be verified.
The company operates rent-to-own stores and Acceptance Now locations in the United States, Canada, Puerto Rico and Mexico, together with a franchising business. Management is executing a multi-year transformation involving store rationalization, flexible labor, pricing, sourcing and distribution, technology, e-commerce and Acceptance Now expansion.
Financial Performance and Liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenue | $693.9 million, down 12.3% | $2.279 billion, down 8.3% |
| Gross profit | $457.2 million; 65.9% margin | $1.492 billion; 65.5% margin |
| Operating profit | $16.7 million; 2.4% margin | $92.7 million; 4.1% margin |
| Net earnings | $6.2 million, versus a $4.1 million loss | $41.2 million, down 11.1% |
| Diluted earnings per share | $0.12, versus $(0.08) | $0.77, versus $0.87 |
| Operating cash flow | Not provided for the quarter | $374.6 million, versus $249.3 million |
- Cash and cash equivalents were $130.3 million at September 30, 2016, compared with $60.4 million at December 31, 2015.
- Debt carrying values were $187.8 million of senior debt and $537.2 million of senior notes. Term-loan principal was $192.4 million; no revolving borrowings were outstanding, although $90.7 million of commitments supported letters of credit and $584.3 million remained available.
- Capital expenditures were $46.8 million for the nine-month period; management expected full-year 2016 capital expenditures of $70 million to $80 million.
- Net cash used in financing was $254.5 million, including $284.9 million of debt repayments and $21.3 million of dividends paid. Management reported $233.3 million of net debt reduction during the period.
- The September 30 covenant ratios were 2.52x total leverage, 0.35x senior secured leverage and 1.72x fixed-charge coverage, compared with maximum or minimum requirements of 4.25x, 2.75x and 1.50x, respectively.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because of Core U.S. weakness, store closures and lower same-store sales. Nine-month same-store revenue fell 5.0%; Core U.S. same-store revenue fell 7.2%.
- Core U.S. revenue decreased 11.2% for the nine-month period and operating profit decreased 15.3%. Acceptance Now revenue increased 0.5%, but operating profit decreased 9.1% for the nine-month period.
- Gross margin improved to 65.5% for the nine-month period from 64.1%, reflecting pricing and supply-chain initiatives, mix and lower smartphone loss reserves.
- Operating profit decreased 17.9% for the nine-month period because gross-profit declines exceeded expense reductions. Reported operating profit benefited in the third quarter from the absence of a $34.7 million smartphone inventory write-down recorded in the third quarter of 2015.
- Nine-month other charges increased to $22.2 million from $16.4 million, including restructuring costs related to closures of Core U.S., Acceptance Now and Mexico locations. The company closed or merged numerous locations and ended the period with 4,698 locations, versus 5,018 at the beginning of 2016.
- Operating cash flow increased by $125.3 million, primarily due to an approximately $80 million income-tax refund and lower merchandise purchases.
Outlook, Risks, Contingencies and Unusual Items
- Management expected Mexico to achieve approximately break-even results for 2016 and believed operating cash flow plus available credit would fund liquidity requirements for the following 12 months.
- The company completed its Core U.S. e-commerce rollout substantially and planned implementation of an integrated finance and human-resources enterprise system in the first quarter of 2017.
- Unexpected capacity-related outages in the new store information management system negatively affected third-quarter results. Management implemented software releases and added hardware, but further disruptions could impair operations and financial performance.
- The company initiated its October 1 goodwill impairment test. Following a third-quarter earnings pre-release, market capitalization declined approximately 30% to about $500 million, creating a risk of a fourth-quarter 2016 noncash goodwill impairment charge. Goodwill was $206.8 million at September 30, 2016.
- A multi-state unclaimed-property audit was in progress. Management stated that the ultimate outcome was too early to determine.
- Guarantees of franchisee financing totaled up to $47.0 million, with $4.4 million outstanding at September 30, 2016, excluding potential collateral recoveries.
- The October 4, 2016 second amendment to the credit agreement, effective September 30, reduced the senior secured leverage covenant to 2.50x beginning December 31, 2016 and reduced the minimum fixed-charge coverage covenant to 1.50x beginning September 30, 2016. It also restricted dividends and prohibited share repurchases under certain covenant conditions.
- Scheduled contractual obligations totaled $1.378 billion, including debt, interest on senior notes and operating leases. Variable-rate debt exposed the company to higher interest expense; management estimated that a 1% rate change would affect pretax earnings by approximately $2.0 million.
- Revenue recognition, lease, stock-compensation and cash-flow accounting standards were pending adoption, and the company had not yet determined their effects.
Most Important Facts to Verify
- Confirm whether this filing belongs to Rent-A-Center, Inc. or Upbound Group, Inc., because the filing text names Rent-A-Center throughout.
- Verify the sustainability of revenue and same-store-sales declines, particularly in Core U.S., after system outages, store consolidation and pricing changes.
- Assess the likelihood and potential magnitude of a fourth-quarter 2016 goodwill impairment charge.
- Review compliance with the amended leverage, fixed-charge coverage and restricted-payment covenants.
- Reconcile reported operating cash flow with the one-time tax refund and determine normalized cash generation.
- Evaluate merchandise losses, which totaled $159.5 million for the nine-month period and increased from $154.6 million in the prior-year period.
- Monitor the unclaimed-property audit, franchisee financing guarantees, information-system implementation and pending accounting-standard adoptions.