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: September 30, 2008
Business Overview: The registrant is the largest operator in the U.S. rent-to-own industry, operating 3,045 company-owned stores and franchising 225 stores via ColorTyme, Inc. The company leases household durable goods on a rent-to-own basis and offers financial services (loans, check cashing) in 350 locations.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 |
|---|---|---|
| Total Revenues | $708,755 | $2,184,422 |
| Net Earnings | $29,379 | $103,478 |
| Diluted EPS | $0.44 | $1.54 |
| Operating Profit | $58,549 | $210,523 |
| Operating Margin | 8.3% | 9.6% |
| Cash from Operations (9mo) | $314,802 | |
| Cash & Equivalents (Sep 30, 2008) | $99,188 | |
| Total Debt (Senior + Subordinated) | $994,339 |
Material Changes vs. Prior Period
- Revenue: Total revenue for the nine months ended Sep 30, 2008, decreased slightly by 0.2% ($4.7 million) compared to the prior year. Same-store sales increased by 2.8% due to higher average prices and increased merchandise/financial services sales, offset by a reduction in store count (approx. 316 fewer stores) from the 2007 consolidation plan.
- Profitability: Net earnings for the nine months increased 26.8% to $103.5 million. This improvement was primarily driven by a $51.3 million litigation charge recorded in the prior year (2007) and a significant decrease in interest expense (down 25.7% due to lower debt levels and interest rates).
- Expenses: Salaries and other expenses decreased 1.5% due to the store consolidation. However, cost of merchandise sold increased 30.9%, and gross margins on merchandise sales declined from 27.5% to 22.7% due to increased promotional activity and lower-margin prepaid service sales.
- Debt Reduction: The company reduced outstanding indebtedness by approximately $265 million during the nine-month period, including the repurchase of $59.6 million in subordinated notes.
Guidance, Outlook, Risks, and Unusual Items
- Restructuring: The company is executing a store consolidation plan announced in late 2007. As of Sep 30, 2008, 282 of 283 targeted stores were closed or merged. Remaining cash outlays for this plan are estimated between $10.9 million and $15.2 million, expected to be settled by Q2 2013.
- Litigation: Total litigation accruals stand at $20.2 million. Key items include an $11.0 million settlement for the Shafer/Johnson wage and hour matter (final approval received) and a $9.1 million restitution fund for the California Attorney General settlement. Payments are expected in Q4 2008 and Q1 2009.
- Market Risk: The company has significant exposure to variable interest rates on $754 million of term loans. A hypothetical 1.0% increase in rates would result in a $7.6 million pre-tax charge. Lehman Brothers is a lender in the revolving credit facility; management does not believe its bankruptcy will materially affect liquidity.
- Outlook: Management expects operating cash flow to benefit from the Economic Stimulus Act of 2008 (bonus depreciation), estimating an increase of $60-$70 million in 2008 operating cash flow. The company plans to focus on revenue growth in existing stores and financial services expansion rather than aggressive new store openings.
Investor Verification Checklist
- Margin Compression: Verify the sustainability of the decline in merchandise gross margins (22.7% vs 27.5% prior year) and the impact of increased promotional activity on future profitability.
- Litigation Cash Flow: Confirm the timing and impact of the $20.2 million in accrued litigation settlements on Q4 2008 and Q1 2009 liquidity.
- Debt Covenants: Monitor compliance with the senior credit facility leverage ratio (currently 2.59:1 vs 3.50:1 limit) and fixed charge coverage ratio (1.75:1 vs 1.35:1 limit), especially given the volatility in credit markets.
- Financial Services Growth: Assess the profitability timeline for the 350 locations offering financial services, as new locations typically do not attain positive cash flow in their first year.
- Lehman Exposure: Review the status of the $37.3 million commitment from Lehman Brothers within the revolving credit facility to ensure no disruption to liquidity.