Business Context and Reporting Period
The submitted filing is a Form 10-Q for Rent-A-Center, Inc. and subsidiaries, not Upbound Group, Inc. The reporting period ended March 31, 2016, and the financial statements are unaudited. Rent-A-Center operates rent-to-own stores and Acceptance Now locations in the United States, Canada, Puerto Rico and Mexico, plus a franchising business.
The company reported four operating segments: Core U.S., Acceptance Now, Mexico and Franchising. Management described a multi-year transformation focused on flexible labor, pricing, sourcing and distribution, technology, virtual transactions and e-commerce.
Key Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $835.7 million | $877.6 million | Down 4.8% |
| Gross profit | $534.9 million | $564.6 million | Down 5.3% |
| Gross margin | 64.0% | 64.3% | Down 30 basis points |
| Operating profit | $48.4 million | $56.6 million | Down 14.4% |
| Operating margin | 5.8% | 6.4% | Down 60 basis points |
| Net earnings | $25.1 million | $27.3 million | Down 8.2% |
| Diluted EPS | $0.47 | $0.51 | Down $0.04 |
| Operating cash flow | $226.5 million | $228.0 million | Down $1.5 million |
| Capital expenditures | $14.4 million | $14.2 million | Up $0.2 million |
Net interest expense was $11.9 million, compared with $12.4 million in the prior-year quarter. Income tax expense was $11.5 million, and the effective tax rate was 31.4%, compared with 38.3% in Q1 2015, primarily due to discrete tax items.
At March 31, 2016, cash and cash equivalents were $46.4 million, compared with $60.4 million at December 31, 2015. Total assets were $1.80 billion and stockholders’ equity was $495.7 million.
Debt, Liquidity and Cash Flow
- Senior debt was $208.0 million net of issuance costs, consisting primarily of $193.5 million of term loans and $20.0 million drawn on the revolving facility.
- Senior notes were $536.5 million net of issuance costs, comprising $292.7 million of 6.625% notes due 2020 and $250.0 million of 4.75% notes due 2021.
- The company repaid approximately $212.1 million of net debt during the quarter, including an approximately $27 million mandatory excess-cash-flow prepayment and repayment funded in part by an approximately $80 million tax refund.
- At March 31, 2016, $560.3 million was available under the revolving facility after $94.7 million was utilized for letters of credit. As of April 25, 2016, total revolving capacity, including the INTRUST line, was $595.3 million, with $54.1 million of cash.
- Credit agreement covenant ratios were within limits: total leverage was 2.52x versus a maximum of 4.25x, senior secured leverage was 0.66x versus a maximum of 2.75x, and fixed-charge coverage was 1.86x versus a minimum of 1.75x.
- Management stated that operating cash flow and available credit were expected to fund liquidity requirements for the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue declined $42.0 million, primarily because Core U.S. revenue fell $44.8 million, reflecting store rationalization and a 3.8% decline in Core U.S. same-store revenue.
- Core U.S. revenue decreased 7.1% to $584.4 million, while segment gross margin improved to 70.5% from 70.1%, reflecting pricing and supply-chain initiatives.
- Acceptance Now revenue increased 2.7% to $230.4 million, but operating profit declined 15.0% to $29.4 million. Higher labor and other store expenses, higher stolen-merchandise losses and lower margins offset revenue growth.
- Mexico revenue declined 23.3% to $13.7 million, while its operating loss improved to $2.6 million from $3.5 million. The company closed 14 Mexico stores and recorded $2.4 million of restructuring charges.
- Franchising revenue increased 14.7% to $7.1 million and operating profit increased 16.2% to $1.4 million.
- Store labor expense decreased 5.2% and other store expenses decreased 5.5%, mainly due to the flexible labor initiative and store-base rationalization.
- Cash used in financing increased to $224.9 million from $156.3 million, principally because of greater debt repayment. Dividends paid were $12.8 million; the quarterly dividend declared was $0.08 per share versus $0.24 in Q1 2015.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2016 capital expenditures of approximately $70 million to $80 million.
- The company planned to introduce Core U.S. e-commerce capabilities in 2016 and continued implementation of a new store information management system. An integrated finance and human-resources system was planned for the first quarter of 2017.
- Management reported approximately 5% to 9% cost-per-unit savings from the new sourcing and distribution model.
- Management identified risks related to weak consumer spending, unemployment and disposable income, execution of transformation initiatives, store labor and cost control, technology implementation, data security, supply-chain disruptions, regulation of the rent-to-own industry, interest rates, foreign currency and merchandise losses.
- Customer stolen-merchandise losses were $44.2 million, or approximately 3.5% of Core U.S. rent-to-own revenue and 9.0% of Acceptance Now revenue.
- The company was subject to a comprehensive multi-state unclaimed-property audit. Management stated that the outcome was not yet determinable.
- Guarantees supporting franchisee financing had a maximum exposure of $47.0 million, of which $9.0 million was outstanding at March 31, 2016, before considering collateral recoveries.
- New accounting standards for revenue recognition, leases and stock-based compensation had not yet been adopted; management was evaluating their effects.
- A 1.0% change in market interest rates was estimated to affect annualized pre-tax earnings by approximately $1.6 million.
- Management concluded that disclosure controls were effective as of March 31, 2016. The new store information system was expected to change certain processes and related internal controls.
Investor Verification Items
- Verify the issuer identity: the supplied metadata names Upbound Group, Inc., but the filing is for Rent-A-Center, Inc.
- Assess whether Core U.S. same-store revenue declines and store rationalization are stabilizing.
- Monitor Acceptance Now margins, stolen-merchandise losses and the profitability impact of 90-day option pricing.
- Evaluate whether debt reduction remains sustainable while maintaining merchandise purchases, transformation spending and dividends.
- Review compliance with the 1.75x fixed-charge coverage covenant, particularly given the limited cushion versus the reported 1.86x ratio.
- Assess the financial effects of the Mexico store closures, the multi-state unclaimed-property audit and the franchisee financing guarantees.
- Confirm the eventual impacts and adoption methods for the pending revenue, lease and stock-compensation accounting standards.