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, 2014. The supplied metadata identifies Upbound Group, Inc., but the filing itself is for Rent-A-Center, Inc., its predecessor corporate name. The company operates rent-to-own stores and kiosks in the United States, Canada, Puerto Rico, Mexico and through franchisees.
- Operating segments: Core U.S., Acceptance Now, Mexico and Franchising.
- Locations at September 30, 2014: 2,841 Core U.S. stores, 1,359 Acceptance Now kiosks, 176 Mexico stores and 188 franchised stores.
- Common shares outstanding as of October 20, 2014: 52.9 million.
Financial Results and Key Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total revenue | $769.5 million | $754.8 million | $2.376 billion | $2.335 billion |
| Gross profit | $539.4 million | $529.3 million | $1.639 billion | $1.611 billion |
| Gross margin | 70.1% | 70.1% | 69.0% | 69.0% |
| Operating profit | $44.8 million | $55.8 million | $144.7 million | $211.8 million |
| Operating margin | 5.8% | 7.4% | 6.1% | 9.1% |
| Net earnings | $25.3 million | $27.2 million | $71.7 million | $115.2 million |
| Diluted EPS | $0.48 | $0.50 | $1.35 | $2.06 |
- Q3 revenue increased 2.0%, while nine-month revenue increased 1.8% year over year.
- Q3 net earnings declined 6.8%; nine-month net earnings declined 37.7%.
- Net interest expense increased 9.8% in Q3 and 22.7% for the nine-month period. Nine-month results also included $1.9 million of refinancing charges.
- Effective tax rates were 23.4% in Q3 2014 versus 39.7% in Q3 2013, and 33.8% for the first nine months versus 37.3% in the prior-year period.
- Cash dividends declared were $0.23 per share in Q3 and $0.69 per share for the first nine months.
Cash Flow, Liquidity and Debt
- Nine-month operating cash flow was $63.3 million, down from $172.9 million in 2013, primarily because of lower earnings and the timing of income-tax payments.
- Investing cash outflow was $68.2 million, including $61.7 million of capital expenditures and $12.5 million for acquisitions.
- Financing activities provided $25.0 million, including net debt proceeds of approximately $58.9 million, offset by $36.5 million of dividends. No shares were repurchased during the first nine months.
- Cash and cash equivalents were $62.0 million at September 30, 2014, compared with $42.3 million at December 31, 2013.
- Balance-sheet debt comprised $425.1 million of senior debt and $550.0 million of senior notes. The company also had $6.3 million outstanding under an unsecured INTRUST revolving line.
- At September 30, 2014, the company had $223.9 million of term loans, $195.0 million drawn under its revolving facility and $375.3 million of revolving capacity available after letters of credit.
- Credit agreement covenant ratios were compliant: total leverage of 3.43x versus a 4.50x maximum, senior secured leverage of 1.40x versus a 2.75x maximum and fixed-charge coverage of 1.78x versus a 1.50x minimum.
- 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
- Core U.S. revenue declined 4.8% in Q3 and 5.1% for the first nine months; Core U.S. operating profit declined 38.1% and 43.8%, respectively. Management attributed the weakness to softer demand and a lower customer portfolio.
- Acceptance Now revenue increased 29.6% in Q3 and 33.1% for the first nine months. However, operating margins fell to 13.2% in Q3 and 12.5% for the nine-month period because of labor and other expansion costs.
- Mexico revenue increased 56.9% in Q3 and 59.7% for the first nine months, but the segment remained unprofitable as newly opened stores incurred start-up costs.
- The company closed 150 Core U.S. stores during Q2 and merged accounts into existing stores, reducing revenue but improving profitability in the affected markets.
- Salaries and other expenses increased 4.9% for the first nine months, and general and administrative expenses increased 16.0%, reflecting Acceptance Now growth and the company-wide transformation program.
- Rental merchandise charge-offs increased, with Core U.S. charge-offs at approximately 3.0% of revenue for the first nine months versus 2.6% previously, and Acceptance Now at 6.9% versus 4.9%.
- The company refinanced its senior credit facility on March 19, 2014, replacing prior term and revolving debt with a $900 million facility.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2014 capital expenditures of approximately $95.0 million and planned continued expansion of Acceptance Now, including a virtual capability.
- The multi-year transformation program includes a new Core U.S. labor model, supply-chain development, value-based pricing and new technology systems. Execution costs and the ability to improve Core U.S. profitability remain key uncertainties.
- Q3 included a $7.1 million vendor settlement credit related to an LCD antitrust class-action settlement. Excluding the credit, Q3 gross margin would have been approximately 69.2% rather than 70.1%.
- Other Q3 charges included $2.8 million of corporate restructuring costs, $0.4 million of store-closure lease costs and a $4.6 million impairment of internally developed software. Nine-month restructuring and related charges totaled $12.1 million.
- The company changed its annual goodwill impairment testing date from December 31 to October 1, prospectively. No goodwill impairment was recorded during the periods presented.
- A multi-state unclaimed-property audit was in progress; management stated that the ultimate outcome could not yet be determined.
- Franchisee financing guarantees had a maximum exposure of $47.0 million, with $15.8 million outstanding at September 30, 2014, before considering collateral recoveries.
- The company faces consumer demand, unemployment, regulatory, credit-collection, merchandise-loss, foreign-exchange, data-security and interest-rate risks. A hypothetical 1% change in interest rates would have affected annualized pre-tax earnings by approximately $2.9 million.
- The Enterprise corporate management system was scheduled for completion in Q4 2014 and was expected to change related business processes and internal controls. Management reported disclosure controls as effective at September 30, 2014.
Most Important Facts to Verify
- Confirm the issuer identity: the filing is for Rent-A-Center, Inc., not Upbound Group, Inc.
- Assess whether the Core U.S. revenue decline and higher merchandise charge-offs are stabilizing.
- Determine whether Acceptance Now growth can offset lower-margin economics and higher operating costs.
- Reconcile reported earnings with the $7.1 million settlement credit, restructuring charges and software impairment.
- Monitor operating cash flow, rental-merchandise investment and debt-funded liquidity requirements.
- Review compliance with leverage and fixed-charge covenants and the availability of revolving credit.
- Evaluate the remaining execution, cost and internal-control risks associated with the transformation program and Enterprise system implementation.
- Follow the multi-state unclaimed-property audit, franchisee guarantees and other contingencies for potential cash impacts.