UPBD

Business Context and Reporting Period

Company: Rent-A-Center, Inc. (Note: Metadata listed "UPBOUND GROUP, INC." but filing content is for Rent-A-Center, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: The registrant is the largest operator in the U.S. rent-to-own industry, operating 2,997 company-owned stores and franchising 207 stores via ColorTyme, Inc. The company leases household durable goods on a rent-to-own basis and offers financial services (loans, check cashing) in 320 locations.

Key Financial Metrics

Margins: Operating profit margin increased to 12.3% in Q1 2010 from 11.3% in Q1 2009. Cost of rentals and fees as a percentage of store rentals revenue decreased to 22.3% from 22.6%.

Material Changes vs. Prior Period

• Revenue: Total revenue decreased 1.3% ($9.8 million) primarily due to the November 2009 divestiture of the prepaid telecommunications and energy subsidiary, which contributed $14.0 million in merchandise sales in Q1 2009. Same-store revenue decreased 0.5%.
• Profitability: Net earnings increased 13.4% ($6.1 million) driven by an 8.1% increase in operating profit and a 34.1% decrease in interest expense.
• Expenses: Salaries and other expenses decreased 2.5% due to cost control initiatives. Interest expense dropped significantly due to reduced debt levels and lower Eurodollar rates.
• Cash Flow: Operating cash flow decreased 48.6% ($67.9 million) primarily due to increased purchases of rental merchandise inventory.

Guidance, Outlook, and Risks

Outlook and Strategy: Management expects to expand financial services to approximately 400 store locations by the end of 2010. Capital expenditures for the remainder of 2010 are expected to be approximately $66.9 million, focused on point-of-sale systems. The company anticipates seasonal trends where Q1 typically sees higher merchandise sales due to tax refunds.

Liquidity: The company maintains a $999 million senior credit facility. As of April 27, 2010, $251.5 million was available under revolving facilities. Management believes cash flow from operations and credit facilities are sufficient for the next 12 months.

Risks and Contingencies:

• Legal Proceedings: The company is involved in litigation regarding regulatory violations. No accrual for probable losses was recorded as of March 31, 2010. A tax court trial regarding a dispute over 2003-2007 tax years is scheduled for June 2010.
• Regulatory: Rent-to-own and financial services are heavily regulated; adverse legislative changes could alter business practices or expose the company to penalties.
• Debt Covenants: The company is subject to financial covenants (leverage ratio max 3.25:1; fixed charge coverage min 1.35:1). As of March 31, 2010, actual ratios were 1.57:1 and 2.13:1, respectively.
• Change of Control: A change of control (35% ownership threshold) would trigger an event of default, potentially accelerating debt repayment.

Investor Verification Checklist

• Divestiture Impact: Verify the long-term revenue impact of the prepaid telecommunications/energy business divestiture on Q1 2010 comparisons.
• Debt Reduction: Confirm the sustainability of the debt reduction strategy given the $636 million outstanding senior debt and scheduled maturities.
• Financial Services Expansion: Assess the profitability timeline for the planned expansion of financial services to 400 locations, noting that new locations often do not attain positive cash flow in the first year.
• Tax Litigation: Monitor the outcome of the U.S. Tax Court trial scheduled for June 2010 regarding the 2003-2007 tax dispute.
• Inventory Levels: Review the reconciliation of merchandise inventory, noting $15.1 million in "skips and stolens" (losses) for the quarter.