Upbound Group, Inc. (UPBD) Q1 2012 Earnings Report, Transcript and Summary

Good morning, and thank you for holding. Welcome to Rent-A-Center's First Quarter 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, April 24, 2012. Your speakers today are: Mr. Mark Speese, Chairman and Chief Executive Officer of Rent-A-Center; Mr. Mitch Fadel, President and Chief Operating Officer; Mr. Robert Davis, Chief Financial Officer; and Mr. David Carpenter, Vice President of Investor Relations. I would now like to turn the conference over to Mr. Carpenter. Please go ahead, sir.

Thank you, Tracy. Good morning, everyone, and thank you for joining us. You should have received a copy of the earnings release distributed after the market closed yesterday that outlines our operational and financial results that were made in the first quarter. If for some reason you did not receive a copy of the release, you can download it from our website at investor.rentacenter.com. In addition, certain financial and statistical information that will be discussed during the conference call will also be provided on the same website. You can also find on our website, the unit level economics for our growth initiatives. These will be updated only on an annual basis as our segments continue to grow and mature. And in accordance with SEC rules concerning non-GAAP financial measures, the reconciliation of EBITDA is provided in our earnings press release under the statement of earnings highlights. Finally, I must remind you that some of the statements made in this call such as forecast growth in revenues, earnings, operating margins, cash flow and profitability and other business or trend information are forward-looking statements. These matters are, of course, subject to many factors that could cause actual results to differ materially from our expectations reflected in the forward-looking statements. These factors are described in the earnings release issued yesterday, as well as our most recent annual report on our Form 10-K for the year ended December 31, 2011. Rent-A-Center undertakes no obligation to publicly update or revise any forward-looking statements. And now, I'd like to turn the conference call over to Mark. Mark?

Well, thank you, David. Good morning, everyone, and thank you for joining us for a review of our first quarter results. I'm going to be brief as I'm going to let Mitch and Robert provide you more detailed results and information. But let me say that I'm quite pleased with the excellent results that we delivered in the quarter. As reported, both record revenue and record earnings. Our total revenues increased 12.5%, our same-store sales were up 7.1%, and our EPS of $0.87 was plus 10%, a very strong quarter indeed. As was noted in the press release, some of that was driven by a larger-than-expected number of customers exercising their early purchase options or paying off their agreements in full. And while that helps revenue in the current quarter, it does adversely affect the future, in that the recurring revenue associated with those agreements is no longer there. Nonetheless, the traffic remains steady throughout the quarter, and we believe that we are well-positioned for another positive year. Our full 2012 expectations are on track from our previous guidance, expecting our total revenue to grow of 7% to 10% for the year and EPS growth of 3% to 10%. The macro environment has shown some positive signs recently, and we expect that continued demand for our products and services throughout the period. We remain focused on continuing to drive improvements and results in our 3,000 core rent-to-own stores, continue growing our RAC Acceptance partnership base and building our international presence in infrastructure. We are well-positioned for the future, and I appreciate all of our coworkers' contributions in the quarter and your support as well. With that, let me ask Mitch to give you more detailed information on the operating results.

Thanks, Mark, and good morning, everyone. As Mark mentioned, overall, we are quite pleased with the excellent first quarter results as we did have both record revenue and record earnings. Our 7.1% same-store sales performance is our best in 10 years. A little more half of that was our core domestic business, with the rest coming from the impact of approximately 290 RAC Acceptance locations coming into the comparison. There were more purchase options than we expected, which is what took us over our annual comp guidance range of 2.5% to 4.5%. Although that's not recurring, limiting our ability to be above that range in upcoming quarters, we do remain comfortable that we will be in that annual guidance range for fiscal 2012. I'm also happy to report that our units per agreement metric moved up in the quarter and it's back on a positive trend. We continue to believe the tight consumer credit market is driving customers our way as an increasing number of consumers who are needing or wanting high-quality brand name merchandise are attracted to our value proposition. Our weekly collections metrics remained in line, and our customer losses in our Core U.S. rent-to-own stores came in at historically low at just 2.2%. RAC Acceptance contributed over $87 million in the quarter, which was about 10.5% of our total revenue. We opened 45 locations in the quarter and had 763 as of March 31. This segment continues to perform well and we continue to be excited about its growth potential. On the international front, we opened 5 more stores in Mexico, ending the quarter with 57 and still expecting to add 60 stores there in 2012. We remain pleased with the performance in that segment and remain excited about the 1,000 store opportunity in Mexico alone. In Canada, we opened 2 more stores, ending the quarter with 30 and still expect to add 10 there in 2012. Overall, it was a great quarter. We had record revenues and record earnings. Our collections remain a strength of our company, and our growth strategy is continuing to perform as expected. I'd also like to thank our 20,000 coworkers for their excellent execution. And with that, I'll now turn the call over to Robert.

Thank you, Mitch. I'm going to spend just a couple of moments updating everyone on our financial results during the quarter, review our 2012 annual guidance, and then we'll open the call for questions. And as a reminder, much of the information that I'll provide, whether it's historical results or forecast results will be presented on a recurring and comparable basis, and therefore, excluding the nonrecurring charges. As outlined in the press release, our total revenues were $835.3 million during the first quarter of 2012, an increase of $93.1 million or 12.5% compared to the first quarter of last year. This increase was primarily due to an increase in revenues within both the Core U.S. RTO segment and the RAC Acceptance segment leading to our very strong same-store sales comp. Our record net earnings in the quarter were $51.9 million while diluted earnings per share equated to $0.87, an increase of 10.1%. These results do include about a $0.07 drag on earnings in the first quarter due to the investment and ramp up of our international growth initiatives. As expected, these investments had a similar impact on operating margins in the quarter, which were down quarter-over-quarter and equated to about 11%, which was similar to our full year operating margin for 2011. Our first quarter EBITDA increased 4% to $111.4 million, and a margin of 13.3%. Positive cash flow during the first quarter equaled just over $138 million on an operating basis. During the quarter, the company repaid approximately $89 million in indebtedness, which was the combination of a mandatory payment, as well as a reduction in the revolving lines of credit that were outstanding at year end. As well, the company also made our seventh consecutive quarterly dividend payment and ended the quarter with approximately $107 million in cash on hand. This combination of growth in EBITDA and the reduction in our indebtedness in the quarter allowed us to lower our leverage ratio at the end of Q1 to 1.42x, well below the floor and our covenant requirement of 3.25. So we continue to believe our balance sheet is in great shape, and as such, we believe that we remain well-positioned to execute on our growth initiatives and continue to provide long-term value to our shareholders. Turning to guidance for a moment. As you'll recall, at the beginning of 2012, and in conjunction with our adoption of segment reporting, we no longer provide quarterly guidance. Our goal is to provide high levels of disclosure and transparency about our expectations and results while also providing management with the opportunity to maintain a long-term focus on the growth and profitability of the company. As such, and based on how we performed during the first quarter, both operationally and financially, we continue to maintain confidence in our annual 2012 guidance. So as a reminder, we expect total revenues to exceed $3 billion by increasing between 7% and 10%. With this projected increase in the top line, we expect our same-store sales for 2012 to range between a positive 2.5% and 4.5%. Overall, diluted earnings per share for 2012 are still expected to be in the range of $3 and $3.20, which includes an approximate net $0.25 to $0.30 drag on EPS, primarily relating to our international growth initiatives, as RAC Acceptance overall will be a positive net contributor in 2012. And as an aside and though management no longer provides quarterly guidance, I feel it worth pointing out the following: RAC Acceptance is now profitable, and its profitability should ramp up sequentially each quarter throughout the year; that sequential profit growth ramp should offset some of our historical summer seasonality. Therefore, each of you may want to revisit your second and third quarter EPS spread as it relates to our annual EPS guidance. Now as a result of the continued growth in ramp up of RAC Acceptance, we would expect our gross profit margin to decrease approximately 100 basis points on a consolidated basis in 2012, although we expect gross profit dollars to be up between 7% and 9% as compared to 2011. We expect both our operating and EBITDA margins to decline approximately 50 basis points while we continue to invest for growth and for the long term, yet we are expecting the dollars will increase in both categories. More specifically, in terms of EBITDA and free cash flow, the company continues to believe EBITDA will range between $400 million and $420 million with free cash flow expected to be in a range between $80 million and $100 million. The 2012 guidance does not include the potential impact of any repurchases of common stock the company may make, changes to future dividends, material changes to outstanding indebtedness or the potential impact of acquisitions, dispositions or store closures that may be completed or occur after the day of the press release. That is our prepared comments and updates. Operator, we'd now like to ask you to open the call for questions.

[Operator Instructions] Your first question comes from Budd Bugatch with Raymond James.

This is TJ McConville filling in for Budd. Gentlemen, Mitch, you alluded to it a little earlier but can we have a little bit more of a quantification on what you think the higher early payouts added to the comp in the quarter? Would we have been 4.5% without the early payouts or it would have been higher than that number?

Certainly, on the high side of our range. It was a good quarter in a lot of ways. As you can see, rental fee income played a part of it when you just look at that segment reporting. So the high end of the range, but I think the difference between 4.5% and 7.1% was merely purchase options.

Okay. That's helpful. And presumably, most of that or at least a significant portion of that looking at the gross margin result were in the RAC Acceptance segment. Is there something you're learning about that business now where the customers prefer to buy this merchandise earlier? Is there a way to address that? Or is it just sort of learning this game and figuring it out a little bit more?

Well, first in the core U.S. business, the early purchase options were way up as well. So it wasn't just RAC Acceptance. They were both much higher in early purchase options than we expected. Again, that being the difference between 4.5% and 7.1%. So it was in both. And yes, we're learning on the RAC Acceptance business, a little more of a propensity to buy out little higher income consumer than our core business. So the first quarter is always higher on payouts, and it was just a little higher than we expected in both segments of the business. But yes, we're learning about that customer and what their habits are and so forth, and then we obviously take those learnings and tweak the model as we go.

Okay. And last one for me, from some of the commentary, it sounds like the agreement count of the core brand is about where you would expect. Is that what we should read from the commentary? Were you able to re-up some of these early payouts and get back to where you expected you would be at the end of the quarter?

Certainly for the most part, we were able to do that. Nothing outside our expectations, and that's why we're confirming annual guidance. So we're comfortable with where we ended the quarter.

Your next question comes from Jason Campbell with KeyBanc Capital Markets.

I was just wondering, was there any sort of geographic disparity or timing around the early payouts? Did that have anything to do with refund anticipations checks or is this just something else kind of elevated throughout the quarter?

It was elevated throughout the quarter. When we say throughout the quarter, it really starts right around February 1, because when the payouts start from income tax refunds. Refund anticipation loans aren't a big part of our -- the trend anymore. They were going back to 2010, but starting in 2011, they really started to dry up in the marketplace, not much of our business. And the early purchase options really are more direct income tax refunds that start right around the 1st of February.

Okay. And then on the RAC Acceptance, I know you guys have called out, you say it could be over $300 million of contribution. I mean, you're almost at $90 million for the first quarter, continuing to open up some and either continuing to ramp. I mean, is $400 million kind of is that how out of the question or is that kind of high end of what you guys might be looking for?

Yes, we won't be $400 million this year. Again, they have -- it is ramping up as the year goes on, but of course, the early purchase options help them in the first quarter also on the revenue. So it's still on that approximate $300 million range. And the ramp up is what Robert was talking about, as we open more of them, there's more -- it becomes more profitable as the year goes on, not necessarily that you can take the $90-some-million or close to $90 million and multiply by 4, but they just become more profitable as the year goes on, and that's why Rob was suggesting, make sure you take that into consideration when you look at how the EPS ramps up over the year to get within that range.

Okay. And then just one last one. I was wondering, would you guys breakout any sort of comp for the RAC Acceptance? I know you said overall, it contributed about half but it seems like that comp for those RAC Acceptance comp, it should be pretty strong right now?

They are strong, and that's the impact of only having 290 of them come in the comp. The impact is a little more than half in the core business, call it half, it's close enough, but that's the impact of it. If you look at the model on our website, certainly, they comp in the second year, I don't know if that might be 100% or whatever. But that's the impact of only 290 of them being -- coming into the comp. And keep in mind, when we say 290 came into the comp, about 120 of those were mature stores when we bought them from TRS in the fall of 2010. It was about 155 stores at TRS. Some of them were newer. So when we say 290 in there, about 120 of them coming in really weren't going to drive the comp the way the other ones are. So if you think about the new stores we've opened, it's about 170 new stores that are having that kind of impact on the comp.

Your next question comes from the line of Laura Champine with Canaccord.

Just wanted a little more information on that same-store sales number. When's the last time you put up a 7% same-store sales number in a quarter? And do you think that the ramp in the RAC Acceptance kiosks materially changes your comp expectations beyond 2012?

Well, the answer to the first part of your question, that was the first quarter of 2002, when we had that size of account. Can you hear us all right, Laura? We're getting an echo here. [Technical Difficulty] So anyhow, we spent 10 years. As far as future years, we haven't done a lot of work around future years. But if you think about 170 new stores coming into the comp in the first quarter, again, about 120 being mature when we bought them and having that kind of impact in the comp is certainly a positive outlook when you go down the road and there's 1,000, 1,100, 1,200, 1,300 of them all coming in the comps so.

Your next question comes from John Baugh with Stifel, Nicolaus.

I wanted to start on the core business. With payouts up so much, what does that say about the customer? Did their tax refunds, were they higher? Have they come into more income all of the sudden? I was curious as to what you think drove the customer behavior?

I haven't seen that, that it says they're higher than the past, maybe slightly higher than the year before but not dramatically. Many say that customers' in a little bit better shape than they've been in the past. Consumer confidence going up slightly. The terms on electronics, John, are lower, not all our products are from electronics, because of deflation, our terms are lower. So in a shorter agreement, you're more to buyout lower. So it may have more to do with, I think that has probably much of an impact as anything.

Okay. And if you look at the RAC early payout that increased, you talked about a blended -- they take it the term as 3x retail. You've estimated that it's probably going to average in the 2 to 2.2x, does this data suggest that, that number may be lower?

No, I won't say that. I think we're still comfortable with the data we've put out there.

Okay. And on the international losses of $0.07, I forget, I think you gave guidance for the year and forgive me if I'm wrong. It was a $0.20 loss. I may be wrong. So clarify that. And then I guess that tracks if that's the right number, that loss declined somewhat as you get a few more stores into Mexico more mature or is there something else going on?

Yes, I'll clarify that, John. And I think the last time we gave numbers, it was 20-plus-cents or something in that range, and so the $0.25 to $0.30 that we're talking about now, if you think about segment reporting in the way we're now trying out, by segment, our results of operations, we're also getting more precision around our allocation. So bottom line is that the new international drag on earnings is a fully embedded cost that includes allocation from corporate headquarters and in-country support and things of that nature. Suffice it to say, those numbers were always in our overall projections for next year. But we've now allocated some additional costs to our individual segments from year end. So that's what you're seeing, with the revised estimate is more a function of reallocation of costs than it is an increase in expenses or costs associated with that venture.

Okay. So presumably, core gets a little better in terms of whatever you were -- not that you've guided by segment, but core would be a little better, international would be worse, but the consolidated number would be the same?

That's correct.

And can you update us on Mexico in terms of what you're seeing? I mean, there was a very slight degradation there in gross margin percentage year-over-year, but I know there's a lot of ramping going on. I don't know if that means anything. There was a slight increase in inventory Held for Rent there. Again, just any color around how Mexico's going?

We're pleased with it. The customer acceptance of the proposition is there, John, and no, I wouldn't read into the gross. If the gross margin is a percent or 2 lower, it's not like the prices are lower than when we started or anything, it's just the ramp. And when you get -- if you get a few more purchase options and so forth. So no, we're still on our model and feel real comfortable what's going on in Mexico.

And my last question is back to the Core U.S. Is there going to be a promotion? Is there a promotion already underway where we're trying to restore some of the payouts. So we'll see some discounting, and so we may see a little lower comp at the core like you alluded to in the next quarter or 2, as you try to go build back a book or no, or book fine, we're not going to have to do anything?

Well, we're not going to promote from a free time as heavy as we did last year, which last year we did it in March to make it up by the end of the first quarter. We don't anticipate needing to do that again. The comp certainly will build back up. It's not going to be 7.1%, I think we're pretty clear on that. It's not going to be 7.1% in the second quarter. Because we got to build those accounts back up, and we still feel like the range is fine that we gave.

Your next question comes from DeForest Hinman with Walthausen & Co.

Just digging a little bit further into the RAC Acceptance, the gross margins were down, but the operating margin, I believe, were up. And you talked about the early purchase options. Can you help us, on a dollar basis, understand how much early purchase option is flowing through that business, so we can kind of get a better idea of how to model the margins in that business going forward?

We can follow-up with you offline. That's kind of getting into details we'd be happy to go through with you. But suffice it to say, if you go out and look at some of the unit level economics that Dave alluded to in the beginning and utilize those models that we provided in our Investor Relations website, that'll help you with modeling the impact of RAC Acceptance to what we expect from a growth standpoint.

Okay, I will do that. And my second question is on the use of capital. We have not, I believe, bought stock in 2 quarters. We're not facing any pressure on the debt side with our covenants and we're building cash. So can you kind of just update us on your thoughts with that?

Sure. Our thoughts are consistent with the way our thoughts have been for the last several years, that our approach to share repurchases are on opportunistic basis. And where the stocks have been trading lately, we just didn't feel like it was a prudent use of capital and when you think about at year end, with our revolvers being extended a little bit above and where they were historically, we wanted to create some additional liquidity on our revolver for timing purposes. And as the stock trades here going forward, obviously share repurchase will be an option that we'll continue to consider. But we look at it and view it more as an opportunistic view on share repurchases.

[Operator Instructions] Your next question comes from Rohan Juneja with Seawolf Capital.

Can you give us a breakup of the net charge-offs between the core business and RAC, if you don't mind?

The charge-offs in the core business, as I said, are 2.2%, were 2.2% for the quarter. We're not reporting charge-offs by segment. The segments are so small Rohan. Like Mexico and Canada are so small and so new that they don't run at the model level yet. There's some volatility in there when the stores are brand-new, and if they have one loss, that can be 8% of the revenue that month and so forth. So because of the size of those segments, we're only reporting on core at 2.2%.

Understood. Also on -- just following up on the previous question on the use of capital. There is also -- you had mentioned on the last quarter's conference call, to about the deferred tax liability, and I think in the K it's mentioned, it's something to the effect of $196 million that gets reversed this year. I mean, is -- how do you think about the cash taxes that you have to pay versus no buybacks in your guidance for this year, how should we think about that?

Yes. So that's obviously another component that goes into the equation. So when we -- in my prepared comments, I mentioned our free cash flow expectations for 2010 is $80 million to $100 million, and that's before our dividend. Our dividend requirement is $45-plus million. So about half of our free cash flow is going to dividend payment. So we're returning value to our shareholders through that venue, and so given the fact that our cash tax obligation is higher than it has been in the last several years, it obviously factors into the impact on our free cash flow. After that free cash flow going to dividends, we've got a little dry powder for opportunistic share repurchase, depending on how the stock trades, that's kind of how we view our use of capital.

Got you. And then just last question. I mean, again, following up on the previous question. How should we think about sustainable gross margins for RAC given that in this quarter, they actually came in below 50%? I mean, what is the sustainable level you think for the RAC business?

Well, certainly the first quarter's going to be at a lower percentage, Rohan, because of early purchase options, just like in the core business, because the early purchase options even though it's more dollars, it's our lowest gross margin of the year, and it'll be the same in RAC Acceptance. So I think for the year, it will hit within the model...

Right.

There's obviously -- sorry Mitch. There's obviously seasonality in the quarter that you see on both the core side and the RAC A side. And again, out on our website, we're going to have posted or is already posted, unit level economics by segment. The expectation for management for gross profit on RAC Acceptance is 58% roughly, give or take 1 point or 2 here or there. I think that we can still get to that level during the course of all 2012, even though it was less than that in the first quarter just due to early payout. So we're still confident in gross profit overall in RAC A and expect to see those numbers by the year -- end of the year.

Your next question comes from John Duskin with Macellum Capital.

Just help me, tell me if I'm missing something. So I think you're saying RAC Acceptance added about, it was about half the comp, so let's call it 3 and change of the total comp, and I think you said about 170 stores that weren't matured TRS. I understand the early prepayment options will make the core business probably come down from the trend it had in the quarter, which I think you were indicating was kind of at the top end of your range. But let's just say that, that made the core comp go to 0 we've got again, our numbers might be a little bit off, but I think you've got like another 100 stores hitting the comp base from RAC each quarter. And if the ratio holds consistent that 170 drove the 3.5%, as those other 100s are hitting, that 3.5% should continue to accelerate by a couple of points each quarter, which then kind of -- I don't know if you're being overly conservative on the balance of the year or I'm missing something, there's another drawdown that is occurring that I don't understand?

Well, I think the impact in the first quarter will be little higher ratio to those 170 stores just based on the early purchase options. So I think that the ratio of half -- that 3-plus percent impact from RAC Acceptance on 170 stores, you've got to discount that a little bit because it was the first quarter and take down that 3% to some lower number not -- obviously, not to 0, but you've got to take that 3% down a little bit. But certainly, the positive impact on same-store sales, you're right on target there, John.

There are no further questions at this time. Mr. Mark Speese, I turn the call back over to you.

Okay. Well, thank you again for joining us. Thank you for your continued support of Rent-A-Center. It's a great strong start to the year. We believe that we're well-positioned for another positive year, and we look forward to visiting with you again next quarter to provide further updates. Thanks again and have a great day.

This concludes today's conference call. You may now disconnect.