UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One) | |
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
For the fiscal year ended December 31, 2018 or | ||||
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
Commission File No. 001-38047 | ||||
Rent-A-Center, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 45-0491516 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
5501 Headquarters Drive
Plano, Texas 75024
(Address, including zip code of registrant's
principal executive offices)
Registrant's telephone number, including area code: 972-801-1100
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Exchange on Which Registered | |
Common Stock, par value $0.01 per share | The Nasdaq Global Select Market, Inc. | |
Securities registered pursuant to Section 12(g) of the Act: None | ||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨
Smaller reporting company ¨ Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Aggregate market value of the 41,270,651 shares of Common Stock held by non-affiliates of the registrant at the closing sales price as reported on The Nasdaq Global Select Market, Inc. on June 30, 2018 | $ | 607,503,983 | |
Number of shares of Common Stock outstanding as of the close of business on February 19, 2019: | 53,978,616 | ||
Documents incorporated by reference:
Portions of the definitive proxy statement relating to the 2019 Annual Meeting of Stockholders of Rent-A-Center, Inc. are incorporated by reference into Part III of this report.
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TABLE OF CONTENTS
Page | ||
Item 1. | Business | |
Item 1A. | Risk Factors | |
Item 1B. | Unresolved Staff Comments | |
Item 2. | Properties | |
Item 3. | Legal Proceedings | |
Item 4. | Mine Safety Disclosures | |
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | |
Item 6. | Selected Financial Data | |
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |
Item 7A. | Quantitative and Qualitative Disclosures about Market Risk | |
Item 8. | Financial Statements and Supplementary Data | |
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |
Item 9A. | Controls and Procedures | |
Item 9B. | Other Information | |
Item 10. | Directors, Executive Officers and Corporate Governance | |
Item 11. | Executive Compensation | |
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | |
Item 13. | Certain Relationships and Related Transactions, and Director Independence | |
Item 14. | Principal Accountant Fees and Services | |
Item 15. | Exhibits and Financial Statement Schedules | |
SIGNATURES | ||
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “seeks” or words of similar meaning, or future or conditional verbs, such as “will,” “should,” “could,” “may,” “aims,” “intends,” or “projects.” A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. You should not place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. These forward-looking statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Our actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, the risks and uncertainties discussed under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Given these risks and uncertainties, you should not rely on forward-looking statements as a prediction of actual results. Any or all of the forward-looking statements contained in this Annual Report on Form 10-K and any other public statement made by us, including by our management, may turn out to be incorrect. We are including this cautionary note to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for forward-looking statements. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changes in assumptions or otherwise. Factors that could cause or contribute to these differences include, but are not limited to:
• | the general strength of the economy and other economic conditions affecting consumer preferences and spending; |
• | factors affecting the disposable income available to our current and potential customers; |
• | changes in the unemployment rate; |
• | the outcome of the litigation initiated by Vintage Capital Management, LLC (“Vintage Capital”) and B. Riley Financial, Inc. (“B. Riley”) challenging the validity of the termination of the Agreement and Plan of Merger (the “Merger Agreement”) and our right, or the ability, to collect on the $126.5 million reverse breakup fee; |
• | risks relating to operations of the business and our financial results arising out of the termination of the Merger Agreement; |
• | the effect of the termination of the Merger Agreement on our relationships with third parties, including our employees, franchisees, customers, suppliers, business partners and vendors, which may make it more difficult to maintain business and operations relationships, and negatively impact the operating results of our business segments and our business generally; |
• | the risk of material price volatility with respect to trading in our common stock during litigation related to the termination of the Merger Agreement; |
• | our ability to continue to effectively operate and execute our strategic initiatives as a stand-alone enterprise following the termination of the Merger Agreement; |
• | capital market conditions, including availability of funding sources for us; |
• | changes in our credit ratings; |
• | difficulties encountered in improving the financial and operational performance of our business segments, including our ability to execute our franchise strategy; |
• | our ability to recapitalize our debt, including our revolving credit facility expiring December 31, 2019, and senior notes maturing in November 2020 and May 2021 on favorable terms, if at all; |
• | risks associated with pricing changes and strategies being deployed in our businesses; |
• | our ability to continue to realize benefits from our initiatives regarding cost-savings and other EBITDA enhancements, efficiencies and working capital improvements; |
• | our ability to continue to effectively operate and execute our strategic initiatives; |
• | failure to manage our store labor and other store expenses; |
• | disruptions caused by the operation of our store information management system; |
• | our transition to more-readily scalable "cloud-based" solutions; |
• | our ability to develop and successfully implement digital or E-commerce capabilities, including mobile applications; |
• | disruptions in our supply chain; |
• | limitations of, or disruptions in, our distribution network, and the impact, effects and results of the changes we have made and are making to our distribution methods; |
• | rapid inflation or deflation in the prices of our products; |
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• | our ability to execute and the effectiveness of a store consolidation, including our ability to retain the revenue from customer accounts merged into another store location as a result of a store consolidation; |
• | our available cash flow; |
• | our ability to identify and successfully market products and services that appeal to our customer demographic; |
• | consumer preferences and perceptions of our brand; |
• | our ability to retain the revenue associated with acquired customer accounts and enhance the performance of acquired stores; |
• | our ability to enter into new and collect on our rental or lease purchase agreements; |
• | the passage of legislation adversely affecting the Rent-to-Own industry; |
• | our compliance with applicable statutes or regulations governing our transactions; |
• | changes in interest rates; |
• | changes in tariff policies; |
• | adverse changes in the economic conditions of the industries, countries or markets that we serve; |
• | information technology and data security costs; |
• | the impact of any breaches in data security or other disturbances to our information technology and other networks and our ability to protect the integrity and security of individually identifiable data of our customers and employees; |
• | changes in estimates relating to self-insurance liabilities and income tax and litigation reserves; |
• | changes in our effective tax rate; |
• | fluctuations in foreign currency exchange rates; |
• | our ability to maintain an effective system of internal controls; |
• | the resolution of our litigation; and |
• | the other risks detailed from time to time in our reports furnished or filed with the Securities and Exchange Commission. |
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PART I
Item 1. Business.
History of Rent-A-Center
Unless the context indicates otherwise, references to “we,” “us” and “our” refer to the consolidated business operations of Rent-A-Center, Inc., the parent, and any or all of its direct and indirect subsidiaries. For any references in this document to Note A through Note T, refer to the Notes to Consolidated Financial Statements in Item 8.
We are one of the largest rent-to-own operators in North America, focused on improving the quality of life for our customers by providing them the opportunity to obtain ownership of high-quality durable products, such as consumer electronics, appliances, computers (including tablets), smartphones, and furniture (including accessories), under flexible rental purchase agreements with no long-term obligation. We were incorporated in the State of Delaware in 1986, and our common stock is traded on the Nasdaq Global Select Market under the symbol "RCII."
Our principal executive offices are located at 5501 Headquarters Drive, Plano, Texas 75024. Our telephone number is (972) 801-1100 and our company website is www.rentacenter.com. We do not intend for information contained on our website to be part of this Annual Report on Form 10-K. We make available free of charge on or through our website our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). Additionally, we provide electronic or paper copies of our filings free of charge upon request.
The Rental Purchase Transaction
The rental purchase transaction is a flexible alternative for consumers to obtain use and enjoyment of brand name merchandise with no long-term obligation. Key features of the rental purchase transaction include:
Brand name merchandise. We offer well-known brands such as LG, Samsung, and Sony home electronics; Frigidaire, Whirlpool, Amana, and Maytag appliances; HP, Dell, Acer, Apple, Asus, Samsung and Toshiba computers and/or tablets; Samsung and Apple smartphones; and Ashley home furnishings.
Convenient payment options. Our customers make payments on a weekly, semi-monthly or monthly basis in our stores, kiosks, online or by telephone. We accept cash, credit or debit cards. Rental payments are generally made in advance and, together with applicable fees, constitute our primary revenue source. Approximately 78% and 92% of our rental purchase agreements are on a weekly term in our Core U.S. rent-to-own stores and our Mexico segment, respectively. Generally, payments are made on a monthly basis in our Acceptance Now segment.
No negative consequences. A customer may terminate a rental purchase agreement at any time without penalty.
No credit needed. Generally, we do not conduct a formal credit investigation of our customers. We verify a customer’s residence and sources of income. References provided by the customer are also contacted to verify certain information contained in the rental purchase order form.
Delivery & set-up included. We generally offer same-day or next-day delivery and installation of our merchandise at no additional cost to the customer in our rent-to-own stores. Our Acceptance Now locations rely on our third-party retail partners to deliver merchandise rented by the customer. Such third-party retail partners typically charge us a fee for delivery, which we pass on to the customer.
Product maintenance & replacement. We provide any required service or repair without additional charge, except for damage in excess of normal wear and tear. The cost to repair the merchandise may be reimbursed by the vendor if the item is still under factory warranty. If the product cannot be repaired at the customer’s residence, we provide a temporary replacement while the product is being repaired. If the product cannot be repaired, we will replace it with a product of comparable quality, age and condition.
Lifetime reinstatement. If a customer is temporarily unable to make payments on a piece of rental merchandise and must return the merchandise, that customer generally may later re-rent the same piece of merchandise (or if unavailable, a substitute of comparable quality, age and condition) on the terms that existed at the time the merchandise was returned, and pick up payments where they left off without losing what they previously paid.
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Flexible options to obtain ownership. Ownership of the merchandise generally transfers to the customer if the customer has continuously renewed the rental purchase agreement for a period of seven to 30 months, depending upon the product type, or exercises a specified early purchase option.
Our Strategy
Our strategy focuses on multiple work streams including optimizing our cost structure, enhancing our value proposition, and executing our refranchising program.
• | Optimizing our cost structure by continuing to capitalize on recent initiatives targeting overhead, supply chain, and other store expenses; in addition to identifying future opportunities to efficiently manage cost within the business. |
• | Enhance our value proposition through targeted pricing strategies across product categories aimed at improving traffic trends. |
• | Executing our refranchising program allowing us to optimize our physical footprint and improve our capital position. |
Our Operating Segments
We report four operating segments: Core U.S., Acceptance Now, Mexico, and Franchising. Additional information regarding our operating segments is presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 of this Annual Report on Form 10-K, and financial information regarding these segments and revenues by geographic area are provided in Note R to the consolidated financial statements contained in this Annual Report on Form 10-K. Substantially all of our revenues for the past three years originated in the United States.
Core U.S.
Our Core U.S. segment is our largest operating segment, comprising approximately 70% of our consolidated net revenues for the year ended December 31, 2018. Approximately 80% of our business in this segment is from repeat customers.
At December 31, 2018, we operated 2,158 company-owned stores in the United States and Puerto Rico, including 44 retail installment sales stores under the names “Get It Now” and “Home Choice.” We routinely evaluate the markets in which we operate and will close, sell or merge underperforming stores.
Acceptance Now
Through our Acceptance Now segment, we generally provide an on-site rent-to-own option at a third-party retailer’s location. In the event a retail purchase credit application is declined, the customer can be introduced to an in-store Acceptance Now representative who explains an alternative transaction for acquiring the use and ownership of the merchandise. Because we neither require nor perform a formal credit investigation for the approval of the rental purchase transaction, applicants who meet certain basic criteria are generally approved. We believe our Acceptance Now program is beneficial for both the retailer and the consumer. The retailer captures more sales because we buy the merchandise directly from them and future rental payments are generally made at the retailer’s location. We believe consumers also benefit from our Acceptance Now program because they are able to obtain the products they want and need without the necessity of credit. The gross margins in this segment are lower than the gross margins in our Core U.S. segment because we pay retail for the product by the retailer's customer. Through certain retail partners, we offer our customers the option to obtain ownership of the product at or slightly above the full retail price if they pay within 90 days. In some cases, the retailer provides us a rebate on the cost of the merchandise if the customer exercises this 90-day option.
Generally, our Acceptance Now kiosk locations consist of an area with a computer, desk and chairs. We occupy the space without charge by agreement with each retailer. Accordingly, capital expenditures with respect to a new Acceptance Now location are minimal, and any exit costs associated with the closure of an Acceptance Now location would also be immaterial on an individual basis. Our operating model is highly agile and dynamic because we can open and close kiosk locations quickly and efficiently.
We rely on our third-party retail partners to deliver merchandise rented by the customer. Such third-party retail partners typically charge us a fee for delivery, which we pass on to the customer. In the event the customer returns rented merchandise, we pick it up at no additional charge. Merchandise returned from an Acceptance Now kiosk location is subsequently offered for rent at one of our Core U.S. rent-to-own stores.
As of December 31, 2018, we operated 1,106 staffed kiosk locations inside furniture and electronics retailers located in 41 states and Puerto Rico, and 96 virtual (direct) locations.
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Mexico
Our Mexico segment currently consists of our company-owned rent-to-own stores in Mexico. At December 31, 2018, we operated 122 stores in this segment.
We are subject to the risks of doing business internationally as described under “Risk Factors.”
Franchising
The stores in our Franchising segment use Rent-A-Center's, ColorTyme's or RimTyme’s trade names, service marks, trademarks and logos, and operate under distinctive operating procedures and standards. Franchising's primary source of revenue is the sale of rental merchandise to its franchisees who, in turn, offer the merchandise to the general public for rent or purchase under a rent-to-own transaction.
At December 31, 2018, this segment franchised 281 stores in 32 states operating under the Rent-A-Center (213 stores), ColorTyme (32 stores) and RimTyme (36 stores) names. These rent-to-own stores primarily offer high quality durable products such as consumer electronics, appliances, computers, furniture and accessories, wheels and tires.
As franchisor, Franchising receives royalties of 2.0% to 6.0% of the franchisees’ monthly gross revenue and, generally, an initial fee up to $35,000 per new location.
The following table summarizes our locations allocated among these operating segments as of December 31:
2018 | 2017 | 2016 | ||||||
Core U.S. | 2,158 | 2,381 | 2,463 | |||||
Acceptance Now Staffed | 1,106 | 1,106 | 1,431 | |||||
Acceptance Now Direct | 96 | 125 | 478 | |||||
Mexico | 122 | 131 | 130 | |||||
Franchising | 281 | 225 | 229 | |||||
Total locations | 3,763 | 3,968 | 4,731 | |||||
The following discussion applies generally to all of our operating segments, unless otherwise noted.
Rent-A-Center Operations
Store Expenses
Our expenses primarily relate to merchandise costs and the operations of our stores, including salaries and benefits for our employees, occupancy expense for our leased real estate, advertising expenses, lost, damaged, or stolen merchandise, fixed asset depreciation, and other expenses.
Product Selection
Our Core U.S., Mexico, and franchise stores generally offer merchandise from five basic product categories: consumer electronics, appliances, computers (including tablets), smartphones, and furniture (including accessories). Although we seek to maintain sufficient inventory in our stores to offer customers a wide variety of models, styles and brands, we generally limit merchandise to prescribed levels to maintain strict inventory controls. We seek to provide a wide variety of high quality merchandise to our customers, and we emphasize products from name-brand manufacturers. Customers may request either new merchandise or previously rented merchandise. Previously rented merchandise is generally offered at a similar weekly, semi-monthly, or monthly rental rate as is offered for new merchandise, but with an opportunity to obtain ownership of the merchandise after fewer rental payments.
Consumer electronic products offered by our stores include high definition televisions, home theater systems, video game consoles and stereos. Appliances include refrigerators, freezers, washing machines, dryers, and ranges. We offer desktop, laptop, tablet computers and smartphones. Our furniture products include dining room, living room and bedroom furniture featuring a number of styles, materials and colors. Accessories include lamps and tables and are typically rented as part of a package of items, such as a complete room of furniture. Showroom displays enable customers to visualize how the product will look in their homes and provide a showcase for accessories.
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The merchandise assortment may vary in our non-U.S. stores according to market characteristics and consumer demand unique to the particular country in which we are operating. For example, in Mexico, the appliances we offer are sourced locally, providing our customers in Mexico the look and feel to which they are accustomed in that product category.
Acceptance Now locations offer the merchandise available for sale at the applicable third-party retailer, primarily furniture and accessories, consumer electronics and appliances.
For the year ended December 31, 2018, furniture and accessories accounted for approximately 43% of our consolidated rentals and fees revenue, consumer electronic products for 18%, appliances for 15%, computers for 6%, smartphones for 3% and other products and services for 15%.
Product Turnover
On average, in the Core U.S. segment, a rental term of 14 months or exercising an early purchase option is generally required to obtain ownership of new merchandise. Product turnover is the number of times a product is rented to a different customer. On average, a product is rented (turned over) to three customers before a customer acquires ownership. Merchandise returned in the Acceptance Now segment is moved to a Core U.S. store where it is offered for rent. Ownership is attained in approximately 35% of first-time rental purchase agreements in the Core U.S. segment. The average total life for each product in our Core U.S. segment is approximately 17 months, which includes the initial rental period, all re-rental periods and idle time in our system. To cover the higher operating expenses generated by product turnover and the key features of rental purchase transactions, rental purchase agreements require higher aggregate payments than are generally charged under other types of purchase plans, such as installment purchase or credit plans.
Collections
Store managers use our management information system to track collections on a daily basis. If a customer fails to make a rental payment when due, store personnel will attempt to contact the customer to obtain payment and reinstate the agreement, or will terminate the account and arrange to regain possession of the merchandise. We attempt to recover the rental items as soon as possible following termination or default of a rental purchase agreement, generally by the seventh day. Collection efforts are enhanced by the personal and job-related references required of customers, the personal nature of the relationships between our employees and customers, and the availability of lifetime reinstatement. Currently, we track past due amounts using a guideline of seven days in our Core U.S. segment and 30 days in the Acceptance Now segment. These metrics align with the majority of the rental purchase agreements in each segment, since payments are generally made weekly in the Core U.S. segment and monthly in the Acceptance Now segment.
If a customer does not return the merchandise or make payment, the remaining book value of the rental merchandise associated with delinquent accounts is generally charged off on or before the 90th day following the time the account became past due in the Core U.S. and Mexico segments, and on or before the 150th day in the Acceptance Now segment.
Purchasing
In our Core U.S. and Mexico segments, we purchase our rental merchandise from a variety of suppliers. In 2018, approximately 21% of our merchandise purchases were attributable to Ashley Furniture Industries. No other brand accounted for more than 10% of merchandise purchased during these periods. We do not generally enter into written contracts with our suppliers that obligate us to meet certain minimum purchasing levels. Although we expect to continue relationships with our existing suppliers, we believe there are numerous sources of products available, and we do not believe the success of our operations is dependent on any one or more of our present suppliers.
In our Acceptance Now segment, we purchase the merchandise selected by the customer from the applicable third-party retailer at the time such customer enters into a rental purchase agreement with us.
With respect to our Franchising segment, the franchise agreement requires the franchised stores to exclusively offer for rent or sale only those brands, types and models of products that Franchising has approved. The franchised stores are required to maintain an adequate mix of inventory that consists of approved products for rent as dictated by Franchising policy manuals. Franchising negotiates purchase arrangements with various suppliers it has approved. Franchisees can purchase product through us or directly from those suppliers.
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Management
Our executive management team has extensive rent-to-own or similar retail experience and has demonstrated the ability to grow and manage our business through their operational leadership and strategic vision. In addition, our regional and district managers generally have long tenures with us, and we have a history of promoting management personnel from within. We believe this extensive industry and company experience will allow us to effectively execute our strategies.
Marketing
We promote our products and services through television and radio commercials, print advertisements, store telemarketing, digital display advertisements, direct email campaigns, social networks, paid and organic search, website and store signage. Our advertisements emphasize such features as product and name-brand selection, the opportunity to pay as you go without credit, long-term contracts or obligations, delivery and set-up at no additional cost, product repair and loaner services at no extra cost, lifetime reinstatement and multiple options to acquire ownership, including 180-day option pricing, an early purchase option or through a fixed number of payments. In addition, we promote the “RAC Worry-Free Guarantee®” to further highlight these aspects of the rental purchase transaction. We believe that by leveraging our advertising efforts to highlight the benefits of the rental purchase transaction, we will continue to educate our customers and potential customers about the rent-to-own alternative to credit as well as solidify our reputation as a leading provider of high-quality, branded merchandise and services.
Franchising has established national advertising funds for the franchised stores, whereby Franchising has the right to collect up to 3% of the monthly gross revenue from each franchisee as contributions to the fund. Franchising directs the advertising programs of the fund, generally consisting of television and radio commercials and print advertisements. Franchising also has the right to require franchisees to expend up to 3% of their monthly gross revenue on local advertising.
Industry & Competition
According to a report published by the Association of Progressive Rental Organizations in 2016, the $8.5 billion rent-to-own industry in the United States, Mexico and Canada consists of approximately 9,200 stores, serves approximately 4.8 million customers and approximately 83% of rent-to-own customers have household incomes between $15,000 and $50,000 per year. The rent-to-own industry provides customers the opportunity to obtain merchandise they might otherwise be unable to obtain due to insufficient cash resources or a lack of access to credit. We believe the number of consumers lacking access to credit is increasing. According to data released by the Fair Isaac Corporation on September 24, 2018, consumers in the “subprime” category (those with credit scores below 650) made up approximately 29% of the United States population.
The rent-to-own industry is experiencing rapid change with the emergence of virtual and kiosk-based operations, such as our Acceptance Now business. These new industry participants are disrupting traditional rent-to-own stores by attracting customers and making the rent-to-own transaction more acceptable to potential customers. In addition, banks and consumer finance companies are developing products and services designed to compete for the traditional rent-to-own customer.
These factors are increasingly contributing to an already highly competitive environment. Our stores and kiosks compete with other national, regional and local rent-to-own businesses, including on-line only competitors, as well as with rental stores that do not offer their customers a purchase option. With respect to customers desiring to purchase merchandise for cash or on credit, we also compete with retail stores, online competitors, and non-traditional lenders. Competition is based primarily on convenience, store location, product selection and availability, customer service, rental rates and terms.
Seasonality
Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales than any other quarter during a fiscal year. Generally, our customers will more frequently exercise the early purchase option on their existing rental purchase agreements or purchase pre-leased merchandise off the showroom floor during the first quarter of each fiscal year, primarily due to the receipt of federal income tax refunds.
Trademarks
We own various trademarks and service marks, including Rent-A-Center® and RAC Worry-Free Guarantee® that are used in connection with our operations and have been registered with the United States Patent and Trademark Office. The duration of our trademarks is unlimited, subject to periodic renewal and continued use. In addition, we have obtained trademark registrations in Mexico, Canada and certain other foreign jurisdictions. We believe we hold the necessary rights for protection of the trademarks and service marks essential to our business. The products held for rent in our stores also bear trademarks and service marks held by their respective manufacturers.
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Franchising licenses the use of the Rent-A-Center and ColorTyme trademarks and service marks to its franchisees under the franchise agreement. Franchising owns various trademarks and service marks, including ColorTyme® and RimTyme®, that are used in connection with its operations and have been registered with the United States Patent and Trademark office. The duration of these marks is unlimited, subject to periodic renewal and continued use.
Employees
As of February 19, 2019, we had approximately 14,000 employees.
Government Regulation
Core U.S. & Acceptance Now
State Regulation. Currently, 46 states, the District of Columbia and Puerto Rico have rental purchase statutes that recognize and regulate rental purchase transactions as separate and distinct from credit sales. We believe this existing legislation is generally favorable to us, as it defines and clarifies the various disclosures, procedures and transaction structures related to the rent-to-own business with which we must comply. With some variations in individual states, most related state legislation requires the lessor to make prescribed disclosures to customers about the rental purchase agreement and transaction, and provides time periods during which customers may reinstate agreements despite having failed to make a timely payment. Some state rental purchase laws prescribe grace periods for non-payment, prohibit or limit certain types of collection or other practices, and limit certain fees that may be charged. Eleven states limit the total rental payments that can be charged to amounts ranging from 2.0 times to 2.4 times the disclosed cash price or the retail value of the rental product. Six states limit the cash price of merchandise to amounts ranging from 1.56 to 2.5 times our cost for each item.
Although Minnesota has a rental purchase statute, the rental purchase transaction is also treated as a credit sale subject to consumer lending restrictions pursuant to judicial decision. Therefore, we offer our customers in Minnesota an opportunity to purchase our merchandise through an installment sale transaction in our Home Choice stores. We operate 17 Home Choice stores in Minnesota.
North Carolina has no rental purchase legislation. However, the retail installment sales statute in North Carolina expressly provides that lease transactions which provide for more than a nominal purchase price at the end of the agreed rental period are not credit sales under the statute. We operate 96 rent-to-own stores, and 44 and 4 Acceptance Now Staffed and Acceptance Now Direct locations, respectively, in North Carolina.
Courts in Wisconsin and New Jersey, which do not have rental purchase statutes, have rendered decisions which classify rental purchase transactions as credit sales subject to consumer lending restrictions. Accordingly, in Wisconsin, we offer our customers an opportunity to purchase our merchandise through an installment sale transaction in our Get It Now stores. In New Jersey, we have modified our typical rental purchase agreements to provide disclosures, grace periods, and pricing that we believe comply with the retail installment sales act. We operate 27 Get It Now stores in Wisconsin and 43 Rent-A-Center stores in New Jersey.
There can be no assurance as to whether new or revised rental purchase laws will be enacted or whether, if enacted, the laws would not have a material and adverse effect on us.
Federal Regulation. To date, no comprehensive federal legislation has been enacted regulating or otherwise impacting the rental purchase transaction. The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) does not regulate leases with terms of 90 days or less. Because the rent-to-own transaction is for a term of week to week, or at most, month to month, and established federal law deems the term of a lease to be its minimum term regardless of extensions or renewals, if any, we believe the rent-to-own transaction is not covered by the Dodd-Frank Act.
From time to time, we have supported legislation introduced in Congress that would regulate the rental purchase transaction. While both beneficial and adverse legislation may be introduced in Congress in the future, any adverse federal legislation, if enacted, could have a material and adverse effect on us.
Mexico
No comprehensive legislation regulating the rent-to-own transaction has been enacted in Mexico. We use substantially the same rental purchase transaction in Mexico as in the U.S. stores, but with such additional provisions as we believe may be necessary to comply with Mexico’s specific laws and customs.
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Item 1A. Risk Factors.
You should carefully consider the risks described below before making an investment decision. We believe these are all the material risks currently facing our business. Our business, financial condition or results of operations could be materially adversely affected by these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. You should also refer to the other information included in this Annual Report on Form 10-K, including our consolidated financial statements and related notes.
Our success depends on the effective implementation and continued execution of our strategies.
We are focused on our mission to provide cash- and credit-constrained consumers with affordable and flexible access to durable goods that promote a higher quality of living. In 2018, we executed multiple initiatives targeting cost savings opportunities, a more competitive value proposition within our Core U.S. and Acceptance Now operating segments, and refranchising select brick and mortar locations, to improve profitability and enhance long-term value for our stockholders.
There is no assurance that we will be able to continue to implement and execute our strategic initiatives in accordance with our expectations. Our inability to lower costs or failure to achieve targeted results associated with our initiatives could adversely affect our results of operations, or negatively impact our ability to successfully execute future strategies, which may result in an adverse impact on our business and financial results.
The successful execution of our franchise strategy is important to our future growth and profitability.
We intend to pursue opportunities for growth through new and existing franchise partners, acquisitions and divestitures. These strategic transactions involve various inherent risks, including, without limitation:
• | inaccurate assessment of the value, future growth potential, strengths, weaknesses, contingent and other liabilities and potential profitability of such strategic transactions; |
• | our ability to preserve, enhance and leverage the value of our brand; |
• | diversion of management’s attention and focus away from existing operations towards execution of strategic transactions; |
• | inability to achieve projected economic and operating benefits from our strategic transactions; |
• | challenges in successfully completing franchise transactions and integrating new franchisees into our franchise system; and |
• | unanticipated changes in business and economic conditions affecting our strategic transactions. |
We are highly dependent on the financial performance of our Core U.S. operating segment.
Our financial performance is highly dependent on our Core U.S. segment, which comprised approximately 70% of our consolidated net revenues for the year ended December 31, 2018. Any significant decrease in the financial performance of the Core U.S. segment may also have a material adverse impact on our ability to implement our growth strategies.
The uncertainty regarding the Company’s future arising out of a series of executive departures and the resulting management transitions, and the volatility in our historical financial results may adversely impact our ability to attract and retain key employees.
Executive leadership transitions can be inherently difficult to manage and may cause disruption to our business. As a result of the changes in our executive management team over the past several years, our existing management team has taken on substantially more responsibility, which has resulted in greater workload demands and could divert attention away from other key areas of our business. In addition, management transition inherently causes some loss of institutional knowledge, may be disruptive to our daily operations or affect public or market perception, any of which could negatively impact our ability to operate effectively or execute our strategies and result in a material adverse impact on our business, financial condition, results of operations or cash flows.
Our future success depends in large part upon our ability to attract and retain key management executives and other key employees. In order to attract and retain executives and other key employees in a competitive marketplace, we must provide a competitive compensation package, including cash and equity compensation. Any prolonged inability to provide salary increases or cash incentive compensation opportunities, or if the anticipated value of such equity awards does not materialize or our equity compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain and motivate executives and key employees could be weakened. In addition, the uncertainty and operational disruptions caused by the management changes and related transitions could result in additional key employees deciding to leave the Company. If we are unable to retain, attract and motivate talented employees with the appropriate skill sets, we may not achieve our objectives and our results of operations could be adversely impacted.
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We may not be able to recapitalize our debt, including our senior credit facility expiring on December 31, 2019, and senior notes maturing in November 2020 and May 2021 on favorable terms, if at all. Our inability to recapitalize our debt would materially and adversely affect our liquidity and our ongoing results of operations in the future.
Our senior credit facility matures in December 2019, and our senior notes mature in November 2020 and May 2021. We intend to recapitalize our debt structure in 2019. Our ability to effect a recapitalization will depend in part on our operating and financial performance, which, in turn, is subject to prevailing economic conditions and to financial, business, legislative, regulatory and other factors beyond our control. In addition, prevailing interest rates or other factors at the time of refinancing could increase our interest expense. A recapitalization of our debt could also require us to comply with more onerous covenants and further restrict our business operations. Failure to refinance or recapitalize our debt, or satisfy the conditions and requirements of that debt, would likely result in an event of default and potentially the loss of some or all of the assets securing our obligations under the senior credit facility. In addition, our inability to refinance or recapitalize our debt or to obtain alternative financing from other sources, or our inability to do so upon attractive terms could materially and adversely affect our business, prospects, results of operations, financial condition and cash flows, and make us more vulnerable to adverse industry and general economic conditions.
A future lowering or withdrawal of the ratings assigned to our debt securities by rating agencies may increase our future borrowing costs and reduce our access to capital.
Our indebtedness currently has a non-investment grade rating, and any rating assigned could be lowered or withdrawn entirely by a rating agency if, in that rating agency’s judgment, future circumstances relating to the basis of the rating, such as adverse changes in our business, warrant. Our indebtedness was upgraded by Standard & Poor’s in January 2019 and Moody's improved our outlook. Any downgrade by any ratings agency may increase the interest rate on our future indebtedness, limit our access to vendor financing on favorable terms or otherwise result in higher borrowing costs, and likely would make it more difficult or more expensive for us to obtain additional debt financing or recapitalize our existing debt structure.
Our arrangements with our suppliers and vendors may be impacted by our financial results or financial position.
Substantially all of our merchandise suppliers and vendors sell to us on open account purchase terms. There is a risk that our key suppliers and vendors could respond to any actual or apparent decrease in, or any concern with, our financial results or liquidity by requiring or conditioning their sale of merchandise to us on more stringent or more costly payment terms, such as by requiring standby letters of credit, earlier or advance payment of invoices, payment upon delivery or other assurances or credit support or by choosing not to sell merchandise to us on a timely basis or at all. Our arrangements with our suppliers and vendors may also be impacted by media reports regarding our financial position or other factors relating to our business. Our need for additional liquidity could significantly increase and our supply of inventory could be materially disrupted if a significant portion of our key suppliers and vendors took one or more of the actions described above, which could have a material adverse effect on our sales, customer satisfaction, cash flows, liquidity and financial position.
Failure to effectively manage our costs could have a material adverse effect on our profitability.
Certain elements of our cost structure are largely fixed in nature. Consumer spending remains uncertain, which makes it more challenging for us to maintain or increase our operating income in the Core U.S. segment. The competitive environment in our industry and increasing price transparency means that the focus on achieving efficient operations is greater than ever. As a result, we must continuously focus on managing our cost structure. Failure to manage our overall cost of operations, labor and benefit rates, advertising and marketing expenses, operating leases, charge-offs due to customer stolen merchandise, other store expenses or indirect spending could materially adversely affect our profitability.
Our Acceptance Now segment depends on the success of our third-party retail partners and our continued relationship with them.
Our Acceptance Now segment revenues depend in part on the ability of unaffiliated third-party retailers to attract customers. The failure of our third-party retail partners to maintain quality and consistency in their operations and their ability to continue to provide products and services, or the loss of the relationship with any of these third-party retailers and an inability to replace them, could cause our Acceptance Now segment to lose customers, substantially decreasing the revenues and earnings of our Acceptance Now segment. This could adversely affect our financial results. In 2018, approximately 67% of the total revenue of the Acceptance Now segment originated at our Acceptance Now kiosks located in stores operated by four retail partners. We may be unable to continue growing the Acceptance Now segment if we are unable to find additional third-party retailers willing to partner with us or if we are unable to enter into agreements with third-party retailers acceptable to us.
The success of our business is dependent on factors affecting consumer spending that are not under our control.
Consumer spending is affected by general economic conditions and other factors including levels of employment, disposable consumer income, prevailing interest rates, consumer debt and availability of credit, costs of fuel, inflation, recession and fears of recession, war and fears of war, pandemics, inclement weather, tariff policies, tax rates and rate increases, timing of receipt of tax
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refunds, consumer confidence in future economic conditions and political conditions, and consumer perceptions of personal well-being and security. Unfavorable changes in factors affecting discretionary spending could reduce demand for our products and services resulting in lower revenue and negatively impacting the business and its financial results.
If we are unable to compete effectively with the growing e-commerce sector, our business and results of operations may be materially adversely affected.
With the continued expansion of Internet use, as well as mobile computing devices and smartphones, competition from the e-commerce sector continues to grow. We have launched virtual capabilities within our Acceptance Now and Core U.S. segments. There can be no assurance we will be able to grow our e-commerce business in a profitable manner. Certain of our competitors, and a number of e-commerce retailers, have established e-commerce operations against which we compete for customers. It is possible that the increasing competition from the e-commerce sector may reduce our market share, gross and operating margins, and may materially adversely affect our business and results of operations in other ways.
Disruptions in our supply chain and other factors affecting the distribution of our merchandise could adversely impact our business.
Any disruption in our supply chain could result in our inability to meet our customers’ expectations, higher costs, an inability to stock our stores, or longer lead time associated with distributing merchandise. Any such disruption within our supply chain network could also result in decreased net sales, increased costs and reduced profits.
Our senior secured asset-based revolving credit facility limits our borrowing capacity to the value of certain of our assets. In addition, our senior secured asset-based revolving credit facility is secured by substantially all of our assets, and lenders may exercise remedies against the collateral in the event of our default.
We are party to a $200 million senior secured asset-based revolving credit facility. Our borrowing capacity under our revolving credit facility varies according to our eligible rental contracts, eligible installment sales accounts, and inventory net of certain reserves. In the event of any material decrease in the amount of or appraised value of these assets, our borrowing capacity would similarly decrease, which could adversely impact our business and liquidity. Our revolving credit facility contains customary affirmative and negative covenants and certain restrictions on operations become applicable if our available credit falls below certain thresholds. These covenants could impose significant operating and financial limitations and restrictions on us, including restrictions on our ability to enter into particular transactions and to engage in other actions that we may believe are advisable or necessary for our business. Our obligations under the revolving credit facility are secured by liens with respect to inventory, accounts receivable, deposit accounts and certain related collateral. In the event of a default that is not cured or waived within any applicable cure periods, the lenders’ commitment to extend further credit under our revolving credit facility could be terminated, our outstanding obligations could become immediately due and payable, outstanding letters of credit may be required to be cash collateralized and remedies may be exercised against the collateral, which generally consists of substantially all of our tangible and intangible assets, including intellectual property and the capital stock of our U.S. subsidiaries. If we are unable to borrow under our revolving credit facility, we may not have the necessary cash resources for our operations and, if any event of default occurs, there is no assurance that we would have the cash resources available to repay such accelerated obligations, refinance such indebtedness on commercially reasonable terms, or at all, or cash collateralize our letters of credit, which would have a material adverse effect on our business, financial condition, results of operations and liquidity.
Our current insurance program may expose us to unexpected costs and negatively affect our financial performance.
Our insurance coverage is subject to deductibles, self-insured retentions, limits of liability and similar provisions that we believe are prudent based on our operations. Because we self-insure a significant portion of expected losses under our workers' compensation, general liability, vehicle and group health insurance programs, unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses, including potential increases in medical and indemnity costs, could result in materially different amounts of expense than expected under these programs. This could have a material adverse effect on our financial condition and results of operations.
Our transactions are regulated by and subject to the requirements of various federal and state laws and regulations, which may require significant compliance costs and expose us to litigation. Any negative change in these laws or the passage of unfavorable new laws could require us to alter our business practices in a manner that may be materially adverse to us.
Currently, 46 states, the District of Columbia and Puerto Rico have passed laws that regulate rental purchase transactions as separate and distinct from credit sales. One additional state has a retail installment sales statute that excludes leases, including rent-to-own transactions, from its coverage if the lease provides for more than a nominal purchase price at the end of the rental period. The specific rental purchase laws generally require certain contractual and advertising disclosures. They also provide varying levels of substantive consumer protection, such as requiring a grace period for late fees and contract reinstatement rights in the event the
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rental purchase agreement is terminated. The rental purchase laws of eleven states limit the total amount that may be charged over the life of a rental purchase agreement and the laws of six states limit the cash prices for which we may offer merchandise.
Similar to other consumer transactions, our rental purchase transaction is also governed by various federal and state consumer protection statutes. These consumer protection statutes, as well as the rental purchase statutes under which we operate, provide various consumer remedies, including monetary penalties, for violations. In our history, we have been the subject of litigation alleging that we have violated some of these statutory provisions.
Although there is currently no comprehensive federal legislation regulating rental purchase transactions, adverse federal legislation may be enacted in the future. From time to time, both favorable and adverse legislation seeking to regulate our business has been introduced in Congress. In addition, various legislatures in the states where we currently do business may adopt new legislation or amend existing legislation that could require us to alter our business practices in a manner that could have a material adverse effect on our business, financial condition and results of operations.
Our reputation, ability to do business and operating results may be impaired by improper conduct by any of our employees, agents or business partners.
Our operations in the U.S. and abroad are subject to certain laws generally prohibiting companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business, such as the U.S. Foreign Corrupt Practices Act, and similar anti-bribery laws in other jurisdictions. Our employees, contractors or agents may violate the policies and procedures we have implemented to ensure compliance with these laws. Any such improper actions could subject us to civil or criminal investigations in the U.S. and in other jurisdictions, could lead to substantial civil and criminal, monetary and non-monetary penalties, and related shareholder lawsuits, could cause us to incur significant legal fees, and could damage our reputation.
We may be subject to legal proceedings from time to time which seek material damages. The costs we incur in defending ourselves or associated with settling any of these proceedings, as well as a material final judgment or decree against us, could materially adversely affect our financial condition by requiring the payment of the settlement amount, a judgment or the posting of a bond.
In our history, we have defended class action lawsuits alleging various regulatory violations and have paid material amounts to settle such claims. Significant settlement amounts or final judgments could materially and adversely affect our liquidity and capital resources. The failure to pay any material judgment would be a default under our senior credit facilities and the indenture governing our outstanding senior unsecured notes.
Vintage Capital and B. Riley’s lawsuit against us in connection with our termination of the Merger Agreement, has caused, and may continue to cause, us to incur significant costs, may present material distractions and, if decided adversely to us, could negatively impact our financial position.
As described in Item 3 - Legal Proceedings of this Annual Report on Form 10-K, on December 18, 2018, we terminated the Merger Agreement with Vintage Capital. On December 21, 2018, Vintage Capital filed a lawsuit in the Delaware Court of Chancery against Rent-A-Center, asserting that the Merger Agreement remained in effect, and that Vintage Capital did not owe Rent-A-Center the $126.5 million reverse breakup fee associated with our termination of the Merger Agreement. On February 11th and 12th of this year, a trial was held in the Delaware Court of Chancery in connection with the lawsuit brought by Vintage Capital (and joined by B. Riley) against Rent-A-Center. An adverse decision by the Delaware Court of Chancery could result in the possible reinstatement of the Merger Agreement, monetary exposure for litigation costs of opposing parties, denial of the right to recovery of the reverse breakup fee and other possible monetary or equitable exposure to the opposing parties. These risks, coupled with the ongoing costs of litigation and potential management distractions associated therewith, could adversely affect our business, business relationships, financial condition, results of operations, cash flows and market price.
Our operations are dependent on effective information management systems. Failure of these systems could negatively impact our business, financial condition and results of operations.
We utilize integrated information management systems. The efficient operation of our business is dependent on these systems to effectively manage our financial and operational data. The failure of our information management systems to perform as designed, loss of data or any interruption of our information management systems for a significant period of time could disrupt our business. If the information management systems sustain repeated failures, we may not be able to manage our store operations, which could have a material adverse effect on our business, financial condition and results of operations.
We invest in new information management technology and systems and implement modifications and upgrades to existing systems. These investments include replacing legacy systems, making changes to existing systems, building redundancies, and acquiring new systems and hardware with updated functionality. We take actions and implement procedures designed to ensure the successful implementation of these investments, including the testing of new systems and the transfer of existing data, with minimal disruptions
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to the business. These efforts may take longer and may require greater financial and other resources than anticipated, may cause distraction of key personnel, may cause disruptions to our existing systems and our business, and may not provide the anticipated benefits. A disruption in our information management systems, or our inability to improve, upgrade, integrate or expand our systems to meet our evolving business requirements, could impair our ability to achieve critical strategic initiatives and could materially adversely impact our business, financial condition and results of operations.
If we fail to protect the integrity and security of customer and employee information, we could be exposed to litigation or regulatory enforcement and our business could be adversely impacted.
We collect and store certain personal information provided to us by our customers and employees in the ordinary course of our business. Despite instituted safeguards for the protection of such information, we cannot be certain that all of our systems are entirely free from vulnerability to attack. Computer hackers may attempt to penetrate our network security and, if successful, misappropriate confidential customer or employee information. In addition, one of our employees, contractors or other third party with whom we do business may attempt to circumvent our security measures in order to obtain such information, or inadvertently cause a breach involving such information. Loss of customer or employee information could disrupt our operations, damage our reputation, and expose us to claims from customers, employees, regulators and other persons, any of which could have an adverse effect on our business, financial condition and results of operations. In addition, the costs associated with information security, such as increased investment in technology, the costs of compliance with privacy laws, and costs incurred to prevent or remediate information security breaches, could adversely impact our business.
A change in control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.
Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or a majority of Rent-A-Center’s Board of Directors are not continuing directors (all of the current members of our Board of Directors are continuing directors under the senior credit facility). As of December 31, 2018, we had no outstanding balance under our senior credit facilities.
Under the indenture governing our outstanding senior unsecured notes, in the event of a change in control, we may be required to offer to purchase all of our outstanding senior unsecured notes at 101% of their original aggregate principal amount, plus accrued interest to the date of repurchase. A change in control also would result in an event of default under our senior credit facilities, which would allow our lenders to accelerate indebtedness owed to them.
If a specified change in control occurs and the lenders under our debt instruments accelerate these obligations, we may not have sufficient liquid assets to repay amounts outstanding under these agreements.
Rent-A-Center's organizational documents and our debt instruments contain provisions that may prevent or deter another group from paying a premium over the market price to Rent-A-Center's stockholders to acquire its stock.
Rent-A-Center’s organizational documents contain provisions that classify its Board of Directors, authorize its Board of Directors to issue blank check preferred stock and establish advance notice requirements on its stockholders for director nominations and actions to be taken at meetings of the stockholders. In addition, as a Delaware corporation, Rent-A-Center is subject to Section 203 of the Delaware General Corporation Law relating to business combinations. Our senior credit facilities and the indentures governing our senior unsecured notes each contain various change in control provisions which, in the event of a change in control, would cause a default under those provisions. These provisions and arrangements could delay, deter or prevent a merger, consolidation, tender offer or other business combination or change in control involving us that could include a premium over the market price of Rent-A-Center’s common stock that some or a majority of Rent-A-Center’s stockholders might consider to be in their best interests.
Rent-A-Center is a holding company and is dependent on the operations and funds of its subsidiaries.
Rent-A-Center is a holding company, with no revenue generating operations and no assets other than its ownership interests in its direct and indirect subsidiaries. Accordingly, Rent-A-Center is dependent on the cash flow generated by its direct and indirect operating subsidiaries and must rely on dividends or other intercompany transfers from its operating subsidiaries to generate the funds necessary to meet its obligations, including the obligations under the senior credit facilities. The ability of Rent-A-Center’s subsidiaries to pay dividends or make other payments to it is subject to applicable state laws. Should one or more of Rent-A-Center’s subsidiaries be unable to pay dividends or make distributions, Rent-A-Center's ability to meet its ongoing obligations could be materially and adversely impacted.
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Our stock price is volatile, and you may not be able to recover your investment if our stock price declines.
The price of our common stock has been volatile and can be expected to be significantly affected by factors such as:
• | our ability to meet market expectations with respect to the growth and profitability of each of our operating segments; |
• | quarterly variations in our results of operations, which may be impacted by, among other things, changes in same store sales or when and how many locations we acquire or open; |
• | quarterly variations in our competitors’ results of operations; |
• | changes in earnings estimates or buy/sell recommendations by financial analysts; |
• | uncertainties associated with the termination of the Merger Agreement and the litigation relating to its termination; and |
• | the stock price performance of comparable companies. |
In addition, the stock market as a whole historically has experienced price and volume fluctuations that have affected the market price of many specialty retailers in ways that may have been unrelated to these companies' operating performance.
Failure to achieve and maintain effective internal controls could have a material adverse effect on our business and stock price.
Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our brand and operating results could be harmed. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
While we continue to evaluate and improve our internal controls, we cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.
If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could cause investors to lose confidence in our reported financial information, which could have a material adverse effect on our stock price.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
We lease space for all of our Core U.S. and Mexico stores and certain support facilities under operating leases expiring at various times through 2024. Most of our store leases are five year leases and contain renewal options for additional periods ranging from three to five years at rental rates adjusted according to agreed-upon formulas. Store sizes average approximately 4,800 square feet. Approximately 75% of each store’s space is generally used for showroom space and 25% for offices and storage space. Our Acceptance Now kiosks occupy space without charge in the retailer's location with no lease commitment.
We believe suitable store space generally is available for lease and we would be able to relocate any of our stores or support facilities without significant difficulty should we be unable to renew a particular lease. We also expect additional space is readily available at competitive rates to open new stores or support facilities, as necessary.
We own the land and building in Plano, Texas, in which our corporate headquarters is located. The land and improvements are pledged as collateral under our senior credit facilities.
Item 3. Legal Proceedings.
From time to time, we, along with our subsidiaries, are party to various legal proceedings arising in the ordinary course of business. We reserve for loss contingencies that are both probable and reasonably estimable. We regularly monitor developments related to these legal proceedings, and review the adequacy of our legal reserves on a quarterly basis. We do not expect these losses to have a material impact on our consolidated financial statements if and when such losses are incurred.
We are subject to unclaimed property audits by states in the ordinary course of business. The property subject to review in this audit process included unclaimed wages, vendor payments and customer refunds. State escheat laws generally require entities to report and remit abandoned and unclaimed property to the state. Failure to timely report and remit the property can result in assessments that could include interest and penalties, in addition to the payment of the escheat liability itself. We routinely remit
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escheat payments to states in compliance with applicable escheat laws. The negotiated settlements did not have a material adverse impact to our financial statements.
Alan Hall, et. al. v. Rent-A-Center, Inc., et. al.; James DePalma, et. al. v. Rent-A-Center, Inc., et. al. On December 23, 2016, a putative class action was filed against us and certain of our former officers by Alan Hall in the Federal District Court for the Eastern District of Texas in Sherman, Texas. The complaint alleges that the defendants violated Section 10(b) and/or Section 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by issuing false and misleading statements and omitting material facts regarding our business, including implementation of our point-of-sale system, operations and prospects during the period covered by the complaint. A complaint filed by James DePalma also in Sherman, Texas alleging similar claims was consolidated by the court into the Hall matter. On October 8, 2018, the parties agreed to settle this matter for $11 million. The court granted preliminary approval of the settlement on December 13, 2018. Under the terms of the settlement our insurance carrier paid an aggregate of $11 million in cash, subsequent to December 31, 2018, which will be distributed to an agreed upon class of claimants who purchased our common stock from July 27, 2015 through October 10, 2016, as well as used to pay costs of notice and settlement administration, and plaintiffs’ attorneys’ fees and expenses. A hearing to finally approve the settlement is scheduled for May 3, 2019.
Blair v. Rent-A-Center, Inc. This matter is a state-wide class action complaint originally filed on March 13, 2017 in the Federal District Court for the Northern District of California. The complaint alleges various claims, including that our cash sales and total rent to own prices exceed the pricing permitted under the Karnette Rental-Purchase Act. In addition, the plaintiffs allege that we fail to give customers a fully executed rental agreement and that all such rental agreements that were issued to customers unsigned are void under the law. The plaintiffs are seeking statutory damages under the Karnette Rental-Purchase Act which range from $100 - $1,000 per violation, injunctive relief, and attorney’s fees. We believe that these claims are without merit and intend to vigorously defend ourselves. However, we cannot assure you that we will be found to have no liability in this matter.
Vintage Rodeo Parent, LLC, Vintage Rodeo Acquisition, Inc. and Vintage Capital Management, LLC, and B. Riley Financial, Inc. v. Rent-A-Center, Inc. On December 18, 2018, after the Company did not receive an extension notice from Vintage Rodeo Parent, LLC (“Vintage”) that was required by December 17, 2018 to extend the Merger Agreement’s stated End Date, we terminated the Merger Agreement. Our Board of Directors determined that terminating the Merger Agreement was in the best interests of our stockholders, and instructed Rent-A-Center’s management to exercise the Company’s right to terminate the Merger Agreement and make a demand on Vintage for the $126.5 million reverse breakup fee owed to us following the termination of the Merger Agreement. On December 21, 2018, Vintage and its affiliates filed a lawsuit in Delaware Court of Chancery against Rent-A-Center, asserting that the Merger Agreement remained in effect, and that Vintage did not owe Rent-A-Center the $126.5 million reverse breakup fee associated with our termination of the Merger Agreement. B. Riley, a guarantor of the payment of the reverse breakup fee, later joined the lawsuit brought by Vintage in Delaware Court of Chancery. In addition, we brought a counterclaim against Vintage and B. Riley asserting our right to payment of the reverse breakup fee.
On February 11th and 12th of this year, a trial was held in Delaware Court of Chancery in the lawsuit arising from Rent-A-Center's termination of the Merger Agreement. While it is difficult to predict the outcome of litigation, we believe Rent-A-Center had a clear right to terminate the Merger Agreement under the express and unambiguous language of that agreement and that it is entitled to the $126.5 million reverse breakup fee. Oral argument on the parties' post-trial briefs is scheduled for Monday, March 11th.
Item 4. Mine Safety Disclosures.
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock has been listed on the Nasdaq Global Select Market® and its predecessors under the symbol “RCII” since January 25, 1995, the date we commenced our initial public offering.
As of February 19, 2019, there were approximately 26 record holders of our common stock.
Future decisions to pay cash dividends on our common stock continue to be at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, contractual restrictions, financial condition, future prospects and any other factors our Board of Directors may deem relevant. Cash dividend payments are subject to certain restrictions in our debt agreements. Please see Note I and Note J to the consolidated financial statements for further discussion of such restrictions.
Under our current common stock repurchase program, our Board of Directors has authorized the purchase, from time to time, in the open market and privately negotiated transactions, up to an aggregate of $1.25 billion of Rent-A-Center common stock. As of December 31, 2018, we had purchased a total of 36,994,653 shares of Rent-A-Center common stock for an aggregate purchase price of $994.8 million under this common stock repurchase program. Common stock repurchases are subject to certain restrictions in our debt agreements. Please see Note I and Note J to the consolidated financial statements for further discussion of such restrictions. No shares were repurchased during 2018 and 2017.
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Stock Performance Graph
The following chart represents a comparison of the five year total return of our common stock to the NASDAQ Composite Index and the S&P 1500 Specialty Retail Index. We selected the S&P 1500 Specialty Retail Index for comparison because we use this published industry index as the comparator group to measure our relative total shareholder return for purposes of determining vesting of performance stock units granted under our long-term incentive compensation program. The graph assumes $100 was invested on December 31, 2013, and dividends, if any, were reinvested for all years ending December 31.
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Item 6. Selected Financial Data.
The selected financial data presented below for the five years ended December 31, 2018, have been derived from our audited consolidated financial statements. The historical financial data are qualified in their entirety by, and should be read in conjunction with, the consolidated financial statements and the notes thereto, the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included in this report.
Year Ended December 31, | ||||||||||||||||||||
(In thousands, except per share data) | 2018 | 2017 | 2016 | 2015(8) | 2014 | |||||||||||||||
Consolidated Statements of Operations | ||||||||||||||||||||
Revenues | ||||||||||||||||||||
Store | ||||||||||||||||||||
Rentals and fees | $ | 2,244,860 | $ | 2,267,741 | $ | 2,500,053 | $ | 2,781,315 | $ | 2,745,828 | (13) | |||||||||
Merchandise sales | 304,455 | 331,402 | 351,198 | 377,240 | 290,048 | |||||||||||||||
Installment sales | 69,572 | 71,651 | 74,509 | 76,238 | 75,889 | |||||||||||||||
Other | 9,000 | 9,620 | 12,706 | 19,158 | 19,949 | |||||||||||||||
Franchise | ||||||||||||||||||||
Merchandise sales | 19,087 | 13,157 | 16,358 | 15,577 | 19,236 | |||||||||||||||
Royalty income and fees | 13,491 | 8,969 | 8,428 | 8,892 | 6,846 | |||||||||||||||
Total revenues | 2,660,465 | 2,702,540 | 2,963,252 | 3,278,420 | 3,157,796 | |||||||||||||||
Cost of revenues | ||||||||||||||||||||
Store | ||||||||||||||||||||
Cost of rentals and fees | 621,860 | 625,358 | 664,845 | 728,706 | 704,595 | |||||||||||||||
Cost of merchandise sold | 308,912 | 322,628 | 323,727 | 356,696 | 231,520 | |||||||||||||||
Cost of installment sales | 23,326 | 23,622 | 24,285 | 25,677 | 26,084 | |||||||||||||||
Other charges and (credits) | — | — | — | 34,698 | (9) | (6,836 | ) | (14) | ||||||||||||
Franchise cost of merchandise sold | 18,199 | 12,390 | 15,346 | 14,534 | 18,070 | |||||||||||||||
Total cost of revenues | 972,297 | 983,998 | 1,028,203 | 1,160,311 | 973,433 | |||||||||||||||
Gross profit | 1,688,168 | 1,718,542 | 1,935,049 | 2,118,109 | 2,184,363 | |||||||||||||||
Operating expenses | ||||||||||||||||||||
Store expenses | ||||||||||||||||||||
Labor | 683,422 | 732,466 | 789,049 | 854,610 | 888,929 | |||||||||||||||
Other store expenses | 656,894 | 744,187 | 791,614 | 833,914 | 842,254 | |||||||||||||||
General and administrative expenses | 163,445 | 171,090 | 168,907 | 166,102 | 162,316 | |||||||||||||||
Depreciation, amortization and write-down of intangibles | 68,946 | 74,639 | 80,456 | 80,720 | 83,168 | |||||||||||||||
Goodwill impairment charge | — | — | 151,320 | (6) | 1,170,000 | (10) | — | |||||||||||||
Other charges | 59,324 | (1) | 59,219 | (3) | 20,299 | (7) | 20,651 | (11) | 14,234 | (15) | ||||||||||
Total operating expenses | 1,632,031 | 1,781,601 | 2,001,645 | 3,125,997 | 1,990,901 | |||||||||||||||
Operating profit (loss) | 56,137 | (63,059 | ) | (66,596 | ) | (1,007,888 | ) | 193,462 | ||||||||||||
Write-off of debt issuance costs | 475 | (2) | 1,936 | (4) | — | — | 4,213 | (16) | ||||||||||||
Interest expense, net | 41,821 | 45,205 | 46,678 | 48,692 | 46,896 | |||||||||||||||
Earnings (loss) before income taxes | 13,841 | (110,200 | ) | (113,274 | ) | (1,056,580 | ) | 142,353 | ||||||||||||
Income tax expense (benefit) | 5,349 | (116,853 | ) | (5) | (8,079 | ) | (103,060 | ) | (12) | 45,931 | ||||||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | $ | (953,520 | ) | $ | 96,422 | ||||||||
Basic earnings (loss) per common share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | $ | (17.97 | ) | $ | 1.82 | ||||||||
Diluted earnings (loss) per common share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | $ | (17.97 | ) | $ | 1.81 | ||||||||
Cash dividends declared per common share | $ | — | $ | 0.16 | $ | 0.32 | $ | 0.96 | $ | 0.93 | ||||||||||
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Item 6. Selected Financial Data — Continued.
December 31, | |||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | 2015(8) | 2014 | ||||||||||||||
Consolidated Balance Sheet Data | |||||||||||||||||||
Rental merchandise, net | $ | 807,470 | $ | 868,991 | $ | 1,001,954 | $ | 1,136,472 | $ | 1,237,856 | |||||||||
Intangible assets, net | 57,344 | 57,496 | 60,560 | 213,899 | 1,377,992 | ||||||||||||||
Total assets | 1,396,917 | 1,420,781 | 1,602,741 | 1,974,468 | 3,271,197 | ||||||||||||||
Total debt | 540,042 | 672,887 | 724,230 | 955,833 | 1,042,813 | ||||||||||||||
Total liabilities | 1,110,400 | 1,148,338 | 1,337,808 | 1,590,878 | 1,881,802 | ||||||||||||||
Total stockholders' equity | 286,517 | 272,443 | 264,933 | 383,590 | 1,389,395 | ||||||||||||||
Operating Data (Unaudited) | |||||||||||||||||||
Core U.S. and Mexico stores open at end of period | 2,280 | 2,512 | 2,593 | 2,815 | 3,001 | ||||||||||||||
Acceptance Now Staffed locations open at end of period | 1,106 | 1,106 | 1,431 | 1,444 | 1,406 | ||||||||||||||
Acceptance Now Direct locations open at end of period | 96 | 125 | 478 | 532 | — | ||||||||||||||
Same store revenue growth (decrease) (12) | 4.7 | % | (5.4 | )% | (6.2 | )% | 5.7 | % | 1.2 | % | |||||||||
Franchise stores open at end of period | 281 | 225 | 229 | 227 | 187 | ||||||||||||||
(1) | Includes $30.4 million related to cost savings initiatives, $16.4 million in incremental legal and advisory fees, $11.6 million related to store closure costs, $1.2 million in capitalized software write-downs, and $(0.3) million related to the 2018 and 2017 hurricane impacts. |
(2) | Includes the effects of a $0.5 million financing expense related to the write-off of unamortized financing costs. |
(3) | Includes $24.0 million related to the closure of Acceptance Now locations, $18.2 million for capitalized software write-downs, $6.5 million for incremental legal and advisory fees, $5.4 million for 2017 hurricane impacts, $3.4 million for reductions at the field support center, $1.1 million for previous store closure plans, and $0.6 million in legal settlements. |
(4) | Includes the effects of a $1.9 million financing expense related to the write-off of unamortized financing costs. |
(5) | Includes a $77.5 million gain resulting from the Tax Cuts and Jobs Act. |
(6) | Includes a $151.3 million goodwill impairment charge in the Core U.S. segment. |
(7) | Includes $22.5 million primarily related to the closure of Core U.S. stores, Acceptance Now locations, and Mexico stores, partially offset by a $2.2 million legal settlement. |
(8) | Includes revisions for immaterial correction of deferred tax error associated with our goodwill impairment reported in the fourth quarter of 2015. |
(9) | Includes a $34.7 million write-down of smartphones. |
(10) | Includes a $1,170.0 million goodwill impairment charge in the Core U.S. segment. |
(11) | Includes a $7.5 million loss on the sale of Core U.S. and Canada stores, a $7.2 million charge related to the closure of Core U.S. and Mexico stores, $2.8 million of charges for start-up and warehouse closure expenses related to our sourcing and distribution initiative, a $2.0 million corporate reduction charge and $1.1 million of losses for other store sales and closures. |
(12) | Includes $6.0 million of discrete adjustments to income tax reserves. |
(13) | Includes a $0.6 million reduction of revenue due to consumer refunds as a result of an operating system programming error. |
(14) | Includes a $6.8 million credit due to the settlement of a lawsuit against the manufacturers of LCD screen displays. |
(15) | Includes store closure charges of $5.1 million, asset impairment charges of $4.6 million, corporate reduction charges of $2.8 million, and a $1.8 million loss on the sale of stores in the Core U.S. segment. |
(16) | Includes the effects of a $4.2 million financing expense related to the payment of debt origination costs and the write-off of unamortized financing costs. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Recent Developments
Merger Termination. On December 18, 2018, we terminated the Merger Agreement with Vintage Capital. On December 21, 2018, Vintage Capital and its affiliates filed a lawsuit in the Delaware Court of Chancery against Rent-A-Center, asserting that the Merger Agreement remained in effect, and that Vintage Capital did not owe Rent-A-Center the $126.5 million reverse breakup fee associated with our termination of the Merger Agreement. On February 11th and 12th of this year, a trial was held in the Delaware Court of Chancery in connection with the lawsuit brought by Vintage Capital (and joined by B Riley) against Rent-A-Center. The Delaware Court of Chancery has not yet rendered its verdict in this case. Oral argument on the parties' post-trial briefs is schedule for Monday, March 11th.
Results of Operations
The following discussion focuses on our results of operations and issues related to our liquidity and capital resources. You should read this discussion in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
Overview
During the twelve months ended December 31, 2018, we experienced a decline in revenues and gross profit driven primarily by reductions in our store base for the Core U.S. and Acceptance Now segments, partially offset by increases in same store sales. Operating profit, however, increased during the twelve months ended December 31, 2018, primarily due to cost savings initiatives, including reductions in overhead and supply chain, and lower rental merchandise losses.
Revenues in our Core U.S. segment increased approximately $20.3 million for the twelve months ended December 31, 2018, primarily due to increases in same store sales, partially offset by a reduction in our Core U.S. store base. Gross profit as a percentage of revenue increased 0.5% primarily due to the intercompany book value adjustment of Acceptance Now returned product transferred to Core U.S. stores. Operating profit increased $61.6 million for the twelve months ended December 31, 2018, primarily due to decreases of $19.8 million and $37.5 million in labor and other store expenses, respectively.
The Acceptance Now segment revenues decreased by approximately $75.4 million for the twelve months ended December 31, 2018, primarily due to kiosk closures at our former retailer partners Conn's and hhgregg, partially offset by increases in same store sales. Gross profit as a percent of revenue decreased 3.1% primarily due to the intercompany book value adjustment of Acceptance Now returned product transferred to Core U.S. stores, and the new value proposition enhancements initiated in 2018 for Acceptance Now customers. Operating profit as a percent of revenue increased 6.9% primarily due to lower rental merchandise losses.
Operating profit for the Mexico segment as a percentage of revenue increased by 5.9% for the twelve months ended December 31, 2018, driven primarily by lower rental merchandise losses.
Cash flow from operations was $227.5 million for the twelve months ended December 31, 2018. We paid down debt by $139.3 million during the year, ending the period with $155.4 million of cash and cash equivalents.
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The following table is a reference for the discussion that follows.
Year Ended December 31, | 2018-2017 Change | 2017-2016 Change | |||||||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Revenues | |||||||||||||||||||||||||
Store | |||||||||||||||||||||||||
Rentals and fees | $ | 2,244,860 | $ | 2,267,741 | $ | 2,500,053 | $ | (22,881 | ) | (1.0 | )% | $ | (232,312 | ) | (9.3 | )% | |||||||||
Merchandise sales | 304,455 | 331,402 | 351,198 | (26,947 | ) | (8.1 | )% | (19,796 | ) | (5.6 | )% | ||||||||||||||
Installment sales | 69,572 | 71,651 | 74,509 | (2,079 | ) | (2.9 | )% | (2,858 | ) | (3.8 | )% | ||||||||||||||
Other | 9,000 | 9,620 | 12,706 | (620 | ) | (6.4 | )% | (3,086 | ) | (24.3 | )% | ||||||||||||||
Total store revenues | 2,627,887 | 2,680,414 | 2,938,466 | (52,527 | ) | (2.0 | )% | (258,052 | ) | (8.8 | )% | ||||||||||||||
Franchise | |||||||||||||||||||||||||
Merchandise sales | 19,087 | 13,157 | 16,358 | 5,930 | 45.1 | % | (3,201 | ) | (19.6 | )% | |||||||||||||||
Royalty income and fees | 13,491 | 8,969 | 8,428 | 4,522 | 50.4 | % | 541 | 6.4 | % | ||||||||||||||||
Total revenues | 2,660,465 | 2,702,540 | 2,963,252 | (42,075 | ) | (1.6 | )% | (260,712 | ) | (8.8 | )% | ||||||||||||||
Cost of revenues | |||||||||||||||||||||||||
Store | |||||||||||||||||||||||||
Cost of rentals and fees | 621,860 | 625,358 | 664,845 | (3,498 | ) | (0.6 | )% | (39,487 | ) | (5.9 | )% | ||||||||||||||
Cost of merchandise sold | 308,912 | 322,628 | 323,727 | (13,716 | ) | (4.3 | )% | (1,099 | ) | (0.3 | )% | ||||||||||||||
Cost of installment sales | 23,326 | 23,622 | 24,285 | (296 | ) | (1.3 | )% | (663 | ) | (2.7 | )% | ||||||||||||||
Total cost of store revenues | 954,098 | 971,608 | 1,012,857 | (17,510 | ) | (1.8 | )% | (41,249 | ) | (4.1 | )% | ||||||||||||||
Franchise cost of merchandise sold | 18,199 | 12,390 | 15,346 | 5,809 | 46.9 | % | (2,956 | ) | (19.3 | )% | |||||||||||||||
Total cost of revenues | 972,297 | 983,998 | 1,028,203 | (11,701 | ) | (1.2 | )% | (44,205 | ) | (4.3 | )% | ||||||||||||||
Gross profit | 1,688,168 | 1,718,542 | 1,935,049 | (30,374 | ) | (1.8 | )% | (216,507 | ) | (11.2 | )% | ||||||||||||||
Operating expenses | |||||||||||||||||||||||||
Store expenses | |||||||||||||||||||||||||
Labor | 683,422 | 732,466 | 789,049 | (49,044 | ) | (6.7 | )% | (56,583 | ) | (7.2 | )% | ||||||||||||||
Other store expenses | 656,894 | 744,187 | 791,614 | (87,293 | ) | (11.7 | )% | (47,427 | ) | (6.0 | )% | ||||||||||||||
General and administrative | 163,445 | 171,090 | 168,907 | (7,645 | ) | (4.5 | )% | 2,183 | 1.3 | % | |||||||||||||||
Depreciation, amortization and write-down of intangibles | 68,946 | 74,639 | 80,456 | (5,693 | ) | (7.6 | )% | (5,817 | ) | (7.2 | )% | ||||||||||||||
Goodwill impairment charge | — | — | 151,320 | — | — | % | (151,320 | ) | (100.0 | ) | |||||||||||||||
Other charges | 59,324 | 59,219 | 20,299 | 105 | 0.2 | % | 38,920 | 191.7 | % | ||||||||||||||||
Total operating expenses | 1,632,031 | 1,781,601 | 2,001,645 | (149,570 | ) | (8.4 | )% | (220,044 | ) | (11.0 | )% | ||||||||||||||
Operating profit (loss) | 56,137 | (63,059 | ) | (66,596 | ) | 119,196 | 189.0 | % | 3,537 | 5.3 | % | ||||||||||||||
Write-off of debt issuance costs | 475 | 1,936 | — | (1,461 | ) | (75.5 | )% | 1,936 | 100.0 | % | |||||||||||||||
Interest, net | 41,821 | 45,205 | 46,678 | (3,384 | ) | (7.5 | )% | (1,473 | ) | (3.2 | )% | ||||||||||||||
Income (loss) before income taxes | 13,841 | (110,200 | ) | (113,274 | ) | 124,041 | 112.6 | % | 3,074 | 2.7 | % | ||||||||||||||
Income tax expense (benefit) | 5,349 | (116,853 | ) | (8,079 | ) | 122,202 | 104.6 | % | (108,774 | ) | (1,346.4 | )% | |||||||||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | $ | 1,839 | 27.6 | % | $ | 111,848 | 106.3 | % | ||||||||||
Comparison of the Years Ended December 31, 2018 and 2017
Store Revenue. Total store revenue decreased by $52.5 million, or 2.0%, to $2,627.9 million for the year ended December 31, 2018, from $2,680.4 million for 2017. This was primarily due to a decrease of approximately $75.4 million in the Acceptance Now segment, partially offset by an increase of $20.3 million in the Core U.S. segment, as discussed further in the segment performance section below.
Same store revenue is reported on a constant currency basis and generally represents revenue earned in 2,575 locations that were operated by us for 13 months or more, excluding any store that receives a certain level of customer accounts from another store (acquisition or merger). Receiving stores will be eligible for inclusion in the same store sales base in the twenty-fourth full month
21
following the account transfer. In addition, due to the severity of the hurricane impacts, we instituted a change to the same store sales store selection criteria to exclude stores in geographically impacted regions for 18 months. Same store revenues increased by $74.8 million, or 4.7%, to $1,653.4 million for the year ended December 31, 2018, as compared to $1,578.6 million in 2017. The increase in same store revenues was primarily attributable to an improvement in the Core U.S. segment, as discussed further in the segment performance section below.
Cost of Rentals and Fees. Cost of rentals and fees consists primarily of depreciation of rental merchandise. Cost of rentals and fees for the year ended December 31, 2018 decreased by $3.5 million, or 0.6%, to $621.9 million, as compared to $625.4 million in 2017. This decrease in cost of rentals and fees was primarily attributable to a decrease of $8.1 million in the Core U.S. segment as a result of lower rentals and fees revenue, partially offset by an increase of $3.8 million in the Acceptance Now segment. Cost of rentals and fees expressed as a percentage of rentals and fees revenue increased to 27.7% for the year ended December 31, 2018 as compared to 27.6% in 2017.
Cost of Merchandise Sold. Cost of merchandise sold represents the net book value of rental merchandise at time of sale. Cost of merchandise sold decreased by $13.7 million, or 4.3%, to $308.9 million for the year ended December 31, 2018, from $322.6 million in 2017, primarily attributable to a decrease of $18.8 million in the Acceptance Now segment, partially offset by an increase of $5.1 million in the Core U.S. segment. The gross margin percent of merchandise sales decreased to (1.5)% for the year ended December 31, 2018, from 2.6% in 2017.
Gross Profit. Gross profit decreased by $30.3 million, or 1.8%, to $1,688.2 million for the year ended December 31, 2018, from $1,718.5 million in 2017, due primarily to a decrease of $60.4 million in the Acceptance Now segment, partially offset by an increase of $23.6 million and $4.6 million in the Core U.S. and Franchising segments, respectively, as discussed further in the segment performance section below. Gross profit as a percentage of total revenue decreased to 63.5% in 2018 compared to 63.6% in 2017.
Store Labor. Store labor includes all salaries and wages paid to store-level employees and district managers' salaries, together with payroll taxes and benefits. Store labor decreased by $49.1 million, or 6.7%, to $683.4 million for the year ended December 31, 2018, as compared to $732.5 million in 2017, primarily attributable to a decrease of $29.4 million and $19.8 million in the Acceptance Now and Core U.S. segments, respectively, driven by our cost savings initiatives and lower Core U.S. store base. Store labor expressed as a percentage of total store revenue was 26.0% for the year ended December 31, 2018, as compared to 27.3% in 2017.
Other Store Expenses. Other store expenses include occupancy, charge-offs due to customer stolen merchandise, delivery, advertising, selling, insurance, travel and other store-level operating expenses. Other store expenses decreased by $87.3 million, or 11.7%, to $656.9 million for the year ended December 31, 2018, as compared to $744.2 million in 2017, primarily attributable to decreases of $51.6 million and $37.5 million in the Acceptance Now and Core U.S. segments, respectively, as a result of lower customer stolen merchandise losses for Acceptance Now and lower Core U.S. store base. Other store expenses expressed as a percentage of total store revenue decreased to 25.0% for the year ended December 31, 2018, from 27.8% in 2017.
General and Administrative Expenses. General and administrative expenses include all corporate overhead expenses related to our headquarters such as salaries, payroll taxes and benefits, stock-based compensation, occupancy, administrative and other operating expenses, as well as salaries and labor costs for our regional directors, divisional vice presidents and executive vice presidents. General and administrative expenses decreased by $7.7 million, or 4.5%, to $163.4 million for the year ended December 31, 2018, as compared to $171.1 million in 2017. General and administrative expenses expressed as a percentage of total revenue decreased to 6.1% for the year ended December 31, 2018, compared to 6.3% in 2017.
Other Charges. Other charges increased by $0.1 million, or 0.2%, to $59.3 million in 2018, as compared to $59.2 million in 2017. Other charges for the year ended December 31, 2018 primarily related to cost savings initiatives, including reductions in overhead and supply chain, incremental legal and advisory fees, Core U.S. store closures, and write-down of capitalized software assets. See Note L to the consolidated financial statements for additional detail regarding these other charges.
Operating Profit (Loss). Operating profit increased $119.2 million, or 189.0%, to $56.1 million for the year ended December 31, 2018, as compared to operating loss of $63.1 million in 2017, primarily due to increases of $61.6 million and $45.3 million in the Core U.S. and Acceptance Now segments, respectively, as discussed further in the segment performance sections below. Operating profit (loss) expressed as a percentage of total revenue was 2.1% for the year ended December 31, 2018, as compared to (2.3)% for 2017. Excluding other charges, profit was $115.5 million or 4.3% of revenue or the year ended December 31, 2018, compared to $(3.8) million or (0.1)% of revenue for the comparable period of 2017.
Income Tax Expense (Benefit). Income tax expense for the twelve months ended December 31, 2018 was $5.3 million, as compared to an income tax benefit of $116.9 million in 2017, primarily due to the impact of the Tax Cuts and Jobs Act of 2017 (“Tax Act”)
22
on our deferred tax balances in the prior year. The effective tax rate was 38.6% for the twelve months ended December 31, 2018, compared to 106.0% in 2017. Excluding impacts from the Tax Act, the effective tax rate was 41.5% for the twelve months ended December 31, 2017.
Net Earnings. Net earnings were $8.5 million for the year ended December 31, 2018 as compared to $6.7 million in 2017. Excluding impacts from other charges and the Tax Act, net earnings were $57.8 million for the year ended December 31, 2018 as compared to net loss of $28.7 million in 2017.
Comparison of the Years Ended December 31, 2017 and 2016
Store Revenue. Total store revenue decreased by $258.1 million, or 8.8%, to $2,680.4 million for the year ended December 31, 2017, from $2,938.5 million for 2016. This was primarily due to a decrease of approximately $234.3 million in the Core U.S. segment, as discussed further in the segment performance section below.
Same store revenue is reported on a constant currency basis and generally represents revenue earned in 3,376 locations that were operated by us for 13 months or more, excluding any store that receives a certain level of customer accounts from another store (acquisition or merger). Receiving stores will be eligible for inclusion in the same store sales base in the twenty-fourth full month following the account transfer. In addition, due to the severity of the hurricane impacts, we instituted a change to the same store sales store selection criteria to exclude stores in geographically impacted regions for 18 months. Same store revenues decreased by $99.2 million, or 5.4%, to $1,753.9 million for the year ended December 31, 2017, as compared to $1,853.1 million in 2016. The decrease in same store revenues was primarily attributable to a decline in the Core U.S. segment, as discussed further in the segment performance section below.
Cost of Rentals and Fees. Cost of rentals and fees consists primarily of depreciation of rental merchandise. Cost of rentals and fees for the year ended December 31, 2017, decreased by $39.5 million, or 5.9%, to $625.4 million, as compared to $664.8 million in 2016. This decrease in cost of rentals and fees was primarily attributable to a decrease of $35.7 million in the Core U.S. segment as a result of lower rentals and fees revenue. Cost of rentals and fees expressed as a percentage of rentals and fees revenue increased to 27.6% for the year ended December 31, 2017 as compared to 26.6% in 2016.
Cost of Merchandise Sold. Cost of merchandise sold represents the net book value of rental merchandise at time of sale. Cost of merchandise sold decreased by $1.1 million, or 0.3%, to $322.6 million for the year ended December 31, 2017, from $323.7 million in 2016. The gross margin percent of merchandise sales decreased to 2.6% for the year ended December 31, 2017, from 7.8% in 2016. These decreases were primarily attributable to a decrease of $6.4 million in the Core U.S. segment, partially offset by an increase of $5.3 million in the Acceptance Now segment driven by a focused effort to encourage ownership and reduce returned product.
Gross Profit. Gross profit decreased by $216.5 million, or 11.2%, to $1,718.5 million for the year ended December 31, 2017, from $1,935.0 million in 2016, due primarily to a decrease of $191.5 million in the Core U.S. segment, as discussed further in the segment performance section below. Gross profit as a percentage of total revenue decreased to 63.6% in 2017 compared to 65.3% in 2016.
Store Labor. Store labor includes all salaries and wages paid to store-level employees and district managers' salaries, together with payroll taxes and benefits. Store labor decreased by $56.6 million, or 7.2%, to $732.5 million for the year ended December 31, 2017, as compared to $789.0 million in 2016, primarily attributable to a decrease of $44.4 million and $10.7 million in the Core U.S. and Acceptance Now segments, respectively, primarily as a result of a lower Core U.S. store base and closure of Acceptance Now locations in the first half of 2017. Store labor expressed as a percentage of total store revenue increased to 27.3% for the year ended December 31, 2017, from 26.9% in 2016.
Other Store Expenses. Other store expenses include occupancy, charge-offs due to customer stolen merchandise, delivery, advertising, selling, insurance, travel and other store-level operating expenses. Other store expenses decreased by $47.4 million, or 6.0%, to $744.2 million for the year ended December 31, 2017, as compared to $791.6 million in 2016, primarily attributable to a decrease of $64.0 million in the Core U.S. segment as a result of our rationalization of the Core U.S. store base, partially offset by an increase of $17.6 million in the Acceptance Now segment primarily, partially due to a one-time, non-cash, charge to write-off unreconciled invoices with certain retail partners, in addition to increased customer stolen merchandise. Other store expenses expressed as a percentage of total store revenue increased to 27.8% for the year ended December 31, 2017, from 26.9% in 2016.
General and Administrative Expenses. General and administrative expenses include all corporate overhead expenses related to our headquarters such as salaries, payroll taxes and benefits, stock-based compensation, occupancy, administrative and other operating expenses, as well as salaries and labor costs for our regional directors, divisional vice presidents and executive vice presidents. General and administrative expenses increased by $2.2 million, or 1.3%, to $171.1 million for the year ended
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December 31, 2017, as compared to $168.9 million in 2016, primarily due to project related expenses, insurance expenses, legal and other professional fees. General and administrative expenses expressed as a percentage of total revenue increased to 6.3% for the year ended December 31, 2017, compared to 5.7% in 2016.
Goodwill Impairment Charge. During 2016, we recognized a goodwill impairment charge of $151.3 million due to an impairment of the goodwill in the Core U.S. segment. Goodwill impairment charge is discussed further in Note F to the consolidated financial statements.
Other Charges. Other charges increased by $38.9 million, or 191.7%, to $59.2 million in 2017, as compared to $20.3 million in 2016. Other charges for the year ended December 31, 2017 primarily included charges related to the closure of Acceptance Now locations, write-downs of capitalized software, incremental legal and advisory fees, damage caused by hurricanes, and reductions in our field support center, partially offset by legal settlements. Other charges for the year ended December 31, 2016 primarily included charges related to the closure of Core U.S. and Mexico stores, and Acceptance Now locations, partially offset by litigation settlements. See Note M to the consolidated financial statements for additional detail regarding these other charges.
Operating Loss. Operating loss decreased $3.5 million, or 5.3%, to $63.1 million for the year ended December 31, 2017, as compared to $66.6 million in 2016, due to a decrease of $87.2 million in the Core U.S. segment, primarily related to the goodwill impairment charge recorded in 2016, partially offset by increases of $57.3 million in the Acceptance Now segment as discussed in the segment performance sections below. Operating loss expressed as a percentage of total revenue was 2.3% for the year ended December 31, 2017, as compared to 2.2% for 2016. Excluding the goodwill impairment and other charges operating results as a percentage of revenue would have been (0.1)% and 3.5% in 2017 and 2016, respectively, discussed further in the segment performance sections below.
Income Tax Benefit. Income tax benefit for the twelve months ended December 31, 2017 was $116.9 million, as compared to $8.1 million in 2016. The effective tax rate was 106.0% for the twelve months ended December 31, 2017, compared to 7.1% in 2016. The increase in income tax benefit is primarily due to the impact of the Tax Act on our deferred tax balances. Excluding impacts from other charges, the Tax Act, and the goodwill impairment charge, the effective tax rate was 41.5% for the twelve months ended December 31, 2017, as compared to 29.8% in 2016.
Net Earnings (Loss). Net earnings were $6.7 million for the year ended December 31, 2017 as compared to net loss of $105.2 million in 2016. Excluding impacts from other charges, the Tax Act, and the goodwill impairment charge, net loss was $28.7 million for the year ended December 31, 2017 as compared to net earnings of $40.9 million in 2016.
Segment Performance
Core U.S. segment.
Year Ended December 31, | 2018-2017 Change | 2017-2016 Change | |||||||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Revenues | $ | 1,855,712 | $ | 1,835,422 | $ | 2,069,725 | $ | 20,290 | 1.1 | % | $ | (234,303 | ) | (11.3 | )% | ||||||||||
Gross profit | 1,299,809 | 1,276,212 | 1,467,679 | 23,597 | 1.8 | % | (191,467 | ) | (13.0 | )% | |||||||||||||||
Operating profit (loss) | 147,787 | 86,196 | (1,020 | ) | 61,591 | 71.5 | % | 87,216 | 8,550.6 | % | |||||||||||||||
Change in same store revenue | 4.4 | % | (8.0 | )% | |||||||||||||||||||||
Stores in same store revenue calculation | 1,904 | 2,118 | |||||||||||||||||||||||
Revenues. The increase in revenue for the year ended December 31, 2018 was driven primarily by an increase in rentals and fees revenue of $26.1 million, as compared to 2017. This increase is primarily due to increases in same store sales, partially offset by decreases of $3.3 million and $2.1 million in merchandise sales and installment sales, respectively, primarily due to rationalization of our Core U.S. store base.
Gross Profit. Gross profit increased in 2018 primarily due to the increase in rentals and fees revenue described above, and a decrease in cost of rentals and fees of $8.1 million, partially offset by an increase in cost of merchandise sold of $5.1 million as compared to 2017. Gross profit as a percentage of segment revenues increased to 70.0% in 2018 from 69.5% in 2017, primarily due to the intercompany book value adjustment for Acceptance Now returned product transferred to Core U.S. stores.
Operating Profit. Operating profit as a percentage of segment revenues was 8.0% for 2018 compared to 4.7% for 2017, primarily due to decreases in other store expenses of $37.5 million and store labor of $19.8 million, partially offset by other charges and higher merchandise losses. Declines in store labor and other store expenses were driven primarily by lower store count, offset by the increase in other charges primarily related to one-time charges associated with store closures. Charge-offs in our Core U.S.
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rent-to-own stores due to customer stolen merchandise, expressed as a percentage of Core U.S. rent-to-own revenues, were approximately 3.3% for the year ended December 31, 2018, compared to 2.7% in 2017. Other merchandise losses include unrepairable and missing merchandise, and loss/damage waiver claims. Charge-offs in our Core U.S. rent-to-own stores due to other merchandise losses, expressed as a percentage of revenues, were approximately 1.6% for the year ended December 31, 2018, compared to 2.1% in 2017.
Acceptance Now segment.
Year Ended December 31, | 2018-2017 Change | 2017-2016 Change | |||||||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Revenues | $ | 722,562 | $ | 797,987 | $ | 817,814 | $ | (75,425 | ) | (9.5 | )% | $ | (19,827 | ) | (2.4 | )% | |||||||||
Gross profit | 339,616 | 400,002 | 422,381 | (60,386 | ) | (15.1 | )% | (22,379 | ) | (5.3 | )% | ||||||||||||||
Operating profit | 93,951 | 48,618 | 105,925 | 45,333 | 93.2 | % | (57,307 | ) | (54.1 | )% | |||||||||||||||
Change in same store revenue | 5.9 | % | 5.2 | % | |||||||||||||||||||||
Stores in same store revenue calculation | 563 | 1,140 | |||||||||||||||||||||||
Revenues. The decrease in revenue for the year ended December 31, 2018 was driven primarily by store closures for hhgregg and Conn's locations, partially offset by increases in same store sales.
Gross Profit. Gross profit decreased for the year ended December 31, 2018 compared to 2017, primarily due to the decrease in revenue described above. Gross profit as a percentage of segment revenue decreased to 47.0% in 2018 as compared to 50.1% in 2017, primarily due to the intercompany book value adjustment of Acceptance Now returned product transferred to Core U.S. stores, and the new value proposition enhancements.
Operating Profit. Operating profit increased by 93.2% compared to 2017, primarily due to decreases in labor and other store expenses driven by the closure of our collection centers, decreased rental merchandise losses, and a decrease in charges incurred for store closures in 2017. Charge-offs in our Acceptance Now locations due to customer stolen merchandise, expressed as a percentage of revenues, were approximately 9.0% in 2018 as compared to 12.7% in 2017. Other merchandise losses include unrepairable merchandise and loss/damage waiver claims. Charge-offs in our Acceptance Now locations due to other merchandise losses, expressed as a percentage of revenues, were approximately 0.6% and 1.3% in 2018 and 2017, respectively.
Mexico segment.
Year Ended December 31, | 2018-2017 Change | 2017-2016 Change | |||||||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Revenues | $ | 49,613 | $ | 47,005 | $ | 50,927 | $ | 2,608 | 5.5 | % | $ | (3,922 | ) | (7.7 | )% | ||||||||||
Gross profit | 34,364 | 32,592 | 35,549 | 1,772 | 5.4 | % | (2,957 | ) | (8.3 | )% | |||||||||||||||
Operating profit (loss) | 2,605 | (260 | ) | (2,449 | ) | 2,865 | 1,101.9 | % | 2,189 | 89.4 | % | ||||||||||||||
Change in same store revenue | 8.5 | % | (5.1 | )% | |||||||||||||||||||||
Stores in same store revenue calculation | 108 | 118 | |||||||||||||||||||||||
Revenues. Revenues for 2018 were negatively impacted by exchange rate fluctuations of approximately $0.9 million, as compared to 2017. On a constant currency basis, revenues for the year ended December 31, 2018 increased approximately $3.5 million.
Gross Profit. Gross profit for the year ended December 31, 2018 was negatively impacted by approximately $0.6 million due to exchange rate fluctuations as compared to 2017. On a constant currency basis, gross profit increased by approximately $2.4 million for the year ended December 31, 2018, compared to 2017. Gross profit as a percentage of segment revenues remained flat at 69.3% in 2018 and 2017.
Operating Profit (Loss). Operating profit for the year ended December 31, 2018 was minimally impacted by exchange rate fluctuations compared to 2017. Operating profit as a percentage of segment revenues increased to 5.3% in 2018, compared to a loss of 0.6% in 2017.
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Franchising segment.
Year Ended December 31, | 2018-2017 Change | 2017-2016 Change | |||||||||||||||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Revenues | $ | 32,578 | $ | 22,126 | $ | 24,786 | $ | 10,452 | 47.2 | % | $ | (2,660 | ) | (10.7 | )% | ||||||||||
Gross profit | 14,379 | 9,736 | 9,440 | 4,643 | 47.7 | % | 296 | 3.1 | % | ||||||||||||||||
Operating profit | 4,385 | 5,081 | 5,650 | (696 | ) | (13.7 | )% | (569 | ) | (10.1 | )% | ||||||||||||||
Revenues. Revenues increased for the year ended December 31, 2018, compared to 2017, primarily due to an increase in merchandise sales driven by higher store count and a change in accounting for franchise advertising fees as a result of the adoption of ASC 606. During the year ended December 31, 2018 franchise advertising fees are presented on a gross basis, as revenue, in the consolidated statement of operations, rather than net of operating expenses in the consolidated statement of operations, as they are presented in 2017.
Gross Profit. Gross profit as a percentage of segment revenues increased to 44.1% in 2018 from 44.0% in 2017, primarily due to the change in accounting for franchise advertising fees described above.
Operating Profit. Operating profit as a percentage of segment revenues decreased to13.5% in 2018 from 23.0% for 2017.
Quarterly Results
The following table contains certain unaudited historical financial information for the quarters indicated:
(In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
Year Ended December 31, 2018 | |||||||||||||||
Revenues | $ | 698,043 | $ | 655,730 | $ | 644,942 | $ | 661,750 | |||||||
Gross profit | 436,978 | 423,886 | 407,740 | 419,564 | |||||||||||
Operating (loss) profit | (10,270 | ) | 27,151 | 25,632 | 13,624 | ||||||||||
Net (loss) earnings | (19,843 | ) | 13,753 | 12,918 | 1,664 | ||||||||||
Basic (loss) earnings per common share | $ | (0.37 | ) | $ | 0.26 | $ | 0.24 | $ | 0.03 | ||||||
Diluted (loss) earnings per common share | $ | (0.37 | ) | $ | 0.25 | $ | 0.24 | $ | 0.03 | ||||||
(In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
Year Ended December 31, 2017 | |||||||||||||||
Revenues | $ | 741,986 | $ | 677,635 | $ | 643,965 | $ | 638,954 | |||||||
Gross profit | 462,663 | 432,533 | 412,465 | 410,881 | |||||||||||
Operating profit (loss) | 1,152 | (873 | ) | (8,445 | ) | (54,893 | ) | ||||||||
Net (loss) earnings | (6,679 | ) | (8,893 | ) | (12,599 | ) | 34,824 | ||||||||
Basic (loss) earnings per common share | $ | (0.13 | ) | $ | (0.17 | ) | $ | (0.24 | ) | $ | 0.65 | ||||
Diluted (loss) earnings per common share | $ | (0.13 | ) | $ | (0.17 | ) | $ | (0.24 | ) | $ | 0.65 | ||||
Cash dividends declared per common share | $ | 0.08 | $ | 0.08 | $ | — | $ | — | |||||||
(As a percentage of revenues) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||
Year Ended December 31, 2018 | |||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||
Gross profit | 62.6 | % | 64.6 | % | 63.2 | % | 63.4 | % | |||
Operating (loss) profit | (1.5 | )% | 4.1 | % | 4.0 | % | 2.1 | % | |||
Net (loss) earnings | (2.8 | )% | 2.1 | % | 2.0 | % | 0.3 | % | |||
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(As a percentage of revenues) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||
Year Ended December 31, 2017 | |||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||
Gross profit | 62.4 | % | 63.8 | % | 64.1 | % | 64.3 | % | |||
Operating profit (loss) | 0.2 | % | (0.1 | )% | (1.3 | )% | (8.6 | )% | |||
Net (loss) earnings | (0.9 | )% | (1.3 | )% | (2.0 | )% | 5.5 | % | |||
Liquidity and Capital Resources
Overview. For the year ended December 31, 2018, we generated $227.5 million in operating cash flow. We paid down debt by $139.3 million from cash generated from operations, used cash in the amount of $28.0 million for capital expenditures, and received proceeds from the sale of property assets of $25.3 million, ending the year with $155.4 million of cash and cash equivalents.
Analysis of Cash Flow. Cash provided by operating activities increased by $117.0 million to $227.5 million in 2018 from $110.5 million in 2017. This was primarily attributable to the improvement in net earnings during the twelve months ended December 31, 2018 compared to 2017, receipt of our 2017 federal income tax refund of approximately $35.2 million, and other net changes in operating assets and liabilities.
Cash used in investing activities decreased approximately $58.6 million to $4.7 million in 2018 from $63.3 million in 2017, due primarily to a decrease in capital expenditures of approximately $37.5 million and an increase in proceeds from the sale of property assets of approximately $20.7 million.
Cash used in financing activities increased by $69.8 million to $140.3 million in 2018 from $70.5 million in 2017, primarily driven by our net reduction in debt of $139.3 million in 2018, as compared to a net decrease in debt of $52.5 million in 2017, offset by dividend payments of $12.8 million and higher debt issuance payments of $3.2 million during the twelve months ended December 31, 2017.
Liquidity Requirements. Our primary liquidity requirements are for rental merchandise purchases. Other capital requirements include expenditures for property assets and debt service. Our primary sources of liquidity have been cash provided by operations. Should we require additional funding sources, we maintain revolving credit facilities, including a $12.5 million line of credit at INTRUST Bank, N.A. We utilize our Revolving Facility for the issuance of letters of credit, as well as to manage normal fluctuations in operational cash flow caused by the timing of cash receipts. In that regard, we may from time to time draw funds under the Revolving Facility for general corporate purposes. Amounts are drawn as needed due to the timing of cash flows and are generally paid down as cash is generated by our operating activities.
We believe the cash flow generated from operations, together with amounts available under our Credit Agreement for the remainder of its term, will be sufficient to fund our liquidity requirements during the next 12 months. While our operating cash flow has been strong and we expect this strength to continue, our liquidity could be negatively impacted if we do not remain as profitable as we expect. At February 19, 2019, we had $181.1 million in cash on hand, and $95.9 million available under our Revolving Facility at December 31, 2018.
The availability and attractiveness of any outside sources of financing will depend on a number of factors, some of which relate to our financial condition and performance, and some of which are beyond our control, such as prevailing interest rates and general financing and economic conditions. There can be no assurance that additional financing will be available, or if available, that it will be on terms we find acceptable.
Deferred Taxes. Certain federal tax legislation enacted during the period 2009 to 2017 permitted bonus first-year depreciation deductions ranging from 50% to 100% of the adjusted basis of qualified property placed in service during such years. The depreciation benefits associated with these tax acts are now reversing. The Protecting Americans from Tax Hikes Act of 2015 ("PATH") extended the 50% bonus depreciation to 2015 and through September 26, 2017, when it was updated by the Tax Act. The Tax Act allows 100% bonus depreciation for certain property placed in service between September 27, 2017 and December 31, 2022, at which point it will begin to phase out. The bonus depreciation provided by the Tax Act resulted in an estimated benefit of $174 million for us in 2018. We estimate the remaining tax deferral associated with bonus depreciation from this act is approximately $207 million at December 31, 2018, of which approximately 78%, or $161 million, will reverse in 2019, and the majority of the remainder will reverse between 2020 and 2021.
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Merchandise Losses. Merchandise losses consist of the following:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Customer stolen merchandise | $ | 136,705 | $ | 161,912 | $ | 169,021 | |||||
Other merchandise losses(1) | 33,219 | 47,596 | 49,731 | ||||||||
Total merchandise losses | $ | 169,924 | $ | 209,508 | $ | 218,752 | |||||
(1) | Other merchandise losses include unrepairable and missing merchandise, and loss/damage waiver claims. |
Capital Expenditures. We make capital expenditures in order to maintain our existing operations as well as for new capital assets in new and acquired stores, and investment in information technology. We spent $28.0 million, $65.5 million and $61.1 million on capital expenditures in the years 2018, 2017 and 2016, respectively.
Acquisitions and New Location Openings. See Note F to the consolidated financial statements for information about cash used to acquire locations and accounts. The table below summarizes the location activity for the years ended December 31, 2018, 2017 and 2016.
Year Ended December 31, 2018 | |||||||||||||||||||||||
Core U.S. | Acceptance Now Staffed | Acceptance Now Direct | Mexico | Franchising | Total | ||||||||||||||||||
Locations at beginning of period | 2,381 | 1,106 | 125 | 131 | 225 | 3,968 | |||||||||||||||||
New location openings | — | 122 | 7 | — | 3 | 132 | |||||||||||||||||
Acquired locations remaining open | 1 | — | — | — | 71 | 72 | |||||||||||||||||
Conversions | — | (3 | ) | 3 | — | — | — | ||||||||||||||||
Closed locations | |||||||||||||||||||||||
Merged with existing locations | (137 | ) | (119 | ) | (39 | ) | (8 | ) | — | (303 | ) | ||||||||||||
Sold or closed with no surviving location | (87 | ) | — | — | (1 | ) | (18 | ) | (106 | ) | |||||||||||||
Locations at end of period | 2,158 | 1,106 | 96 | 122 | 281 | 3,763 | |||||||||||||||||
Acquired locations closed and accounts merged with existing locations | 6 | — | — | — | — | 6 | |||||||||||||||||
Total approximate purchase price (in millions) | $ | 2.0 | $ | — | $ | — | $ | — | $ | — | $ | 2.0 | |||||||||||
Year Ended December 31, 2017 | |||||||||||||||||||||||
Core U.S. | Acceptance Now Staffed | Acceptance Now Direct | Mexico | Franchising | Total | ||||||||||||||||||
Locations at beginning of period | 2,463 | 1,431 | 478 | 130 | 229 | 4,731 | |||||||||||||||||
New location openings | — | 222 | 24 | 1 | 1 | 248 | |||||||||||||||||
Acquired locations remaining open | — | — | — | — | 4 | 4 | |||||||||||||||||
Conversions | — | (63 | ) | 63 | — | — | — | ||||||||||||||||
Closed locations | |||||||||||||||||||||||
Merged with existing locations | (51 | ) | (483 | ) | (439 | ) | — | — | (973 | ) | |||||||||||||
Sold or closed with no surviving location | (31 | ) | (1 | ) | (1 | ) | — | (9 | ) | (42 | ) | ||||||||||||
Locations at end of period | 2,381 | 1,106 | 125 | 131 | 225 | 3,968 | |||||||||||||||||
Acquired locations closed and accounts merged with existing locations | 8 | — | — | — | — | 8 | |||||||||||||||||
Total approximate purchase price (in millions) | $ | 2.5 | $ | — | $ | — | $ | — | $ | — | $ | 2.5 | |||||||||||
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Year Ended December 31, 2016 | |||||||||||||||||||||||
Core U.S. | Acceptance Now Staffed | Acceptance Now Direct | Mexico | Franchising | Total | ||||||||||||||||||
Locations at beginning of period | 2,672 | 1,444 | 532 | 143 | 227 | 5,018 | |||||||||||||||||
New location openings | — | 171 | 67 | 1 | 2 | 241 | |||||||||||||||||
Acquired locations remaining open | — | — | — | — | 5 | 5 | |||||||||||||||||
Conversions | — | 1 | (2 | ) | — | — | (1 | ) | |||||||||||||||
Closed locations | |||||||||||||||||||||||
Merged with existing locations | (185 | ) | (185 | ) | — | (4 | ) | (1 | ) | (375 | ) | ||||||||||||
Sold or closed with no surviving location | (24 | ) | — | (119 | ) | (10 | ) | (4 | ) | (157 | ) | ||||||||||||
Locations at end of period | 2,463 | 1,431 | 478 | 130 | 229 | 4,731 | |||||||||||||||||
Acquired locations closed and accounts merged with existing locations | 3 | — | — | — | — | 3 | |||||||||||||||||
Total approximate purchase price (in millions) | $ | 2.3 | $ | — | $ | — | $ | — | $ | — | $ | 2.3 | |||||||||||
Senior Debt. As discussed in Note I to the consolidated financial statements, the Credit Agreement consists of a $200.0 million Revolving Facility.
We may use the full amount of the Revolving Facility for the issuance of letters of credit, of which $92.0 million had been so utilized as of February 19, 2019. The Revolving Facility has a scheduled maturity of December 31, 2019.
Senior Notes. See descriptions of the senior notes in Note J to the consolidated financial statements.
Store Leases. We lease space for all of our Core U.S. and Mexico stores and certain support facilities under operating leases expiring at various times through 2024. Most of our store leases are five year leases and contain renewal options for additional periods ranging from three to five years at rental rates adjusted according to agreed-upon formulas.
Contractual Cash Commitments. The table below summarizes debt, lease and other minimum cash obligations outstanding as of December 31, 2018:
Payments Due by Period | |||||||||||||||||||
(In thousands) | Total | 2019 | 2020-2021 | 2022-2023 | Thereafter | ||||||||||||||
6.625% Senior Notes(1) | 331,528 | 19,394 | 312,134 | — | — | ||||||||||||||
4.75% Senior Notes(2) | 279,688 | 11,875 | 267,813 | — | — | ||||||||||||||
Operating Leases | 408,649 | 145,345 | 197,147 | 63,877 | 2,280 | ||||||||||||||
Total contractual cash obligations(3) | $ | 1,019,865 | $ | 176,614 | $ | 777,094 | $ | 63,877 | $ | 2,280 | |||||||||
(1) | Includes interest payments of $9.7 million on each May 15 and November 15 of each year. |
(2) | Includes interest payments of $5.9 million on each May 1 and November 1 of each year. |
(3) | As of December 31, 2018, we have recorded $38.2 million in uncertain tax positions. Because of the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, uncertain tax positions are not reflected in the contractual obligations table. |
Seasonality. Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales than any other quarter during a fiscal year, primarily related to the receipt of federal income tax refunds by our customers. Generally, our customers will more frequently exercise the early purchase option on their existing rental purchase agreements or purchase pre-leased merchandise off the showroom floor during the first quarter of each fiscal year. Furthermore, we tend to experience slower growth in the number of rental purchase agreements in the third quarter of each fiscal year when compared to other quarters throughout the year. We expect these trends to continue in the future.
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Critical Accounting Estimates, Uncertainties or Assessments in Our Financial Statements
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent losses and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. In applying accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. We believe the following are areas where the degree of judgment and complexity in determining amounts recorded in our consolidated financial statements make the accounting policies critical.
If we make changes to our reserves in accordance with the policies described below, our earnings would be impacted. Increases to our reserves would reduce earnings and, similarly, reductions to our reserves would increase our earnings. A pre-tax change of approximately $0.7 million in our estimates would result in a corresponding $0.01 change in our diluted earnings per common share.
Self-Insurance Liabilities. We have self-insured retentions with respect to losses under our workers' compensation, general liability, vehicle liability and health insurance programs. We establish reserves for our liabilities associated with these losses by obtaining forecasts for the ultimate expected losses and estimating amounts needed to pay losses within our self-insured retentions.
We continually institute procedures to manage our loss exposure and increases in health care costs associated with our insurance claims through our risk management function, including a transitional duty program for injured workers, ongoing safety and accident prevention training, and various other programs designed to minimize losses and improve our loss experience in our store locations. We make assumptions on our liabilities within our self-insured retentions using actuarial loss forecasts, company-specific development factors, general industry loss development factors, and third-party claim administrator loss estimates which are based on known facts surrounding individual claims. These assumptions incorporate expected increases in health care costs. Periodically, we reevaluate our estimate of liability within our self-insured retentions. At that time, we evaluate the adequacy of our reserves by comparing amounts reserved on our balance sheet for anticipated losses to our updated actuarial loss forecasts and third-party claim administrator loss estimates, and make adjustments to our reserves as needed.
As of December 31, 2018, the amount reserved for losses within our self-insured retentions with respect to workers’ compensation, general liability and vehicle liability insurance was $101.6 million, as compared to $118.0 million at December 31, 2017. However, if any of the factors that contribute to the overall cost of insurance claims were to change, the actual amount incurred for our self-insurance liabilities could be more or less than the amounts currently reserved.
Income Taxes. Our annual tax rate is affected by many factors, including the mix of our earnings, legislation and acquisitions, and is based on our income, statutory tax rates and tax planning opportunities available to us in the jurisdictions in which we operate. Tax laws are complex and subject to differing interpretations between the taxpayer and the taxing authorities. Significant judgment is required in determining our tax expense, evaluating our tax positions and evaluating uncertainties. Deferred income tax assets represent amounts available to reduce income taxes payable in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. We use our historical experience and our short- and long-range business forecasts to provide insight and assist us in determining recoverability. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon the ultimate settlement with the relevant tax authority. A number of years may elapse before a particular matter, for which we have recorded a liability, is audited and effectively settled. We review our tax positions quarterly and adjust our liability for unrecognized tax benefits in the period in which we determine the issue is effectively settled with the tax authorities, the statute of limitations expires for the relevant taxing authority to examine the tax position, or when more information becomes available.
Valuation of Goodwill. We perform an assessment of goodwill for impairment at the reporting unit level annually on October 1, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Factors which could necessitate an interim impairment assessment include, but are not limited to, a sustained decline in our market capitalization, prolonged negative industry or economic trends and significant underperformance relative to historical or projected future operating results.
We use a two-step approach to assess goodwill impairment. If the fair value of the reporting unit exceeds its carrying value, then the goodwill is not deemed impaired. If the carrying value of the reporting unit exceeds fair value, we perform a second analysis to measure the fair value of all assets and liabilities within the reporting unit, and if the carrying value of goodwill exceeds its implied fair value, goodwill is considered impaired. The amount of the impairment is the difference between the carrying value
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of goodwill and the implied fair value, which is calculated as if the reporting unit had been acquired and accounted for as a business combination. As an alternative to this annual impairment testing, the Company may perform a qualitative assessment for impairment if it believes it is not more likely than not that the carrying value of a reporting unit's net assets exceeds the reporting unit's fair value.
Our reporting units are our reportable operating segments identified in Note R to the consolidated financial statements. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions that we believe are reasonable but inherently uncertain, and actual results may differ from those estimates. These estimates and assumptions include, but are not limited to, future cash flows based on revenue growth rates and operating margins, and future economic and market conditions approximated by a discount rate derived from our weighted average cost of capital. Factors that could affect our ability to achieve the expected growth rates or operating margins include, but are not limited to, the general strength of the economy and other economic conditions that affect consumer preferences and spending and factors that affect the disposable income of our current and potential customers. Factors that could affect our weighted average cost of capital include changes in interest rates and changes in our effective tax rate.
During the period from our 2017 goodwill impairment assessment through the third quarter 2018, we periodically analyzed whether any indicators of impairment had occurred. As part of these periodic analyses, we compared estimated fair value of the company, as determined based on the consolidated stock price, to its net book value. As the estimated fair value of the company was higher than its net book value during each of these periods, no additional testing was deemed necessary.
We completed a qualitative assessment for impairment of goodwill as of October 1, 2018, concluding it was not more likely than not that the carrying value of our reporting unit's net assets exceeded the reporting unit's fair value.
At December 31, 2018, the amount of goodwill allocated to the Core U.S. and Acceptance Now segments was $1.5 million and $55.3 million, respectively. At December 31, 2017 the amount of goodwill allocated to the Core U.S. and Acceptance Now segments was $1.3 million and $55.3 million, respectively.
Based on an assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe our consolidated financial statements fairly present in all material respects the financial condition, results of operations and cash flows of our company as of, and for, the periods presented in this Annual Report on Form 10-K. However, we do not suggest that other general risk factors, such as those discussed elsewhere in this report as well as changes in our growth objectives or performance of new or acquired locations, could not adversely impact our consolidated financial position, results of operations and cash flows in future periods.
Effect of New Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which replaces existing accounting literature relating to the classification of, and accounting for, leases. Under ASU 2016-02, a company must recognize for all leases (with the exception of leases with terms less than 12 months) a liability representing a lessee's obligation to make lease payments arising from a lease, and a right-of-use asset representing the lessee's right to use, or control the use of, a specified asset for the lease term. Lessor accounting is largely unchanged, with certain improvements to align lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. Adoption under ASU 2016-02 requires the use of a modified retrospective transition method to measure leases at the beginning of the earliest period presented in the consolidated financial statements. In July 2018, the FASB issued ASU 2018-11, allowing companies to apply a transition method for adoption of the new standard as of the adoption date, with recognition of any cumulative-effects as adjustments to the opening balance of retained earnings in the period of adoption. The adoption of the new lease standard and all related ASU's is required for us beginning January 1, 2019. We will elect the transition method under ASU 2018-11 upon adoption of the new standard.
The company's rent-to-own agreements which comprise the majority of our annual revenue will fall within the scope of ASU 2016-02 under lessor accounting, however, we have determined that adoption of the new standard will not significantly affect the timing of recognition or presentation of revenue for our rental contracts.
As a lessee, the new standard will also affect a substantial portion of our real estate, vehicle, and other equipment lease contracts. Upon adoption we will recognize a right-to-use asset and lease liability for the majority of these operating lease contracts within the consolidated balance sheet. We also expect to be affected by the requirement under the new standard to determine whether impairment indicators exist for the right-of-use asset at the asset or asset group level. If impairment indicators exist, a recoverability test is performed to determine whether an impairment loss exists. In accordance with the transition guidance for the new standard we are required to determine if an impairment loss exists immediately prior to the date of adoption. We are in the process of finalizing our impairment assessment for our Product Service Center facilities and Core U.S. stores previously identified for closure in 2019. The determination of any impairment losses as part of this assessment will be recorded as a cumulative adjustment to retained earnings as of the date of adoption. Otherwise we do not expect the impact of adoption to significantly affect our consolidated statements of operations or cash flows.
31
We plan to elect a package of optional practical expedients in our adoption of the new standard, including the option to retain the current classification for leases entered into prior to the date of adoption; the option not to reassess initial direct costs for capitalization for leases entered into prior to the date of adoption; and the option not to separate lease and non-lease components for our rent-to-own agreements as a lessor, and our real estate, fleet, and certain equipment leases as a lessee.
In conjunction with the adoption of the new lease accounting standard, we are in the process of implementing a new back-office lease administration and accounting system to support the new accounting and disclosure requirements as a lessee. In addition, we are also in the process of finalizing changes to our existing accounting policies, processes, and internal controls to ensure compliance with the new standard following adoption; as well as finalizing the impacts to our consolidated balance sheet upon the date of adoption for our operating leases, including development of the incremental borrowing rate that will be used to calculate the present value of our lease liability.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating the hypothetical purchase price allocation and instead using the difference between the carrying amount and the fair value of the reporting unit. The adoption of ASU 2017-04 will be required for us on a prospective basis beginning January 1, 2020, with early adoption permitted. We are currently in the process of determining our adoption date and what impact the adoption of this ASU will have on our financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a company to reclassify to retained earnings the disproportionate income tax effects of the Tax Act on items with accumulated other comprehensive income that the FASB refers to as having been stranded in accumulated other comprehensive income. The adoption of ASU 2018-02 will be required for us beginning January 1, 2019, with early adoption permitted. We do not intend to exercise the option to reclassify stranded tax effects within accumulated other comprehensive income in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act (or portion thereof) is recorded.
In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 ("SAB 118") (SEC Update), which amends paragraphs in ASC 740, Income Taxes, to reflect SAB 118, which provides guidance for companies that are not able to complete their accounting for the income tax effects of the Tax Act in the period of enactment. The Tax Act, enacted on December 22, 2017 significantly changed existing U.S. tax law and includes numerous provisions that affect our business, such as reducing the U.S. federal corporate tax rate from 35% to 21%, effective January 1, 2018 and bonus depreciation that allows for full expensing of qualified property. At December 31, 2017, we had not completed our accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, we made reasonable estimates of the effects and recorded provisional amounts. We recognized an income tax benefit of $76.5 million in the year ended December 31, 2017 associated with the revaluation of our net deferred tax liability. Our provisional estimate of the one-time transition tax resulted in $0.7 million additional tax expense. We also recorded a federal provisional benefit of $9.7 million based on our intent to fully expense all qualifying expenditures incurred during 2017. In 2018, we finalized our analysis over the one-year measurement period that ended on December 22, 2018, resulting in an immaterial income tax benefit recorded in our consolidated statement of operations.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which removes, modifies, and adds certain disclosure requirements in ASC 820, to improve the effectiveness of the fair value measurement disclosures. The adoption of ASU 2018-13 will be required for us beginning January 1, 2020, with early adoption permitted. We are currently in the process of determining our adoption date and what impact the adoption of this ASU will have on our financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40); Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement, which requires implementation costs incurred by customers in cloud computing arrangements (CCAs) to be deferred and recognized over the term of the arrangement, if those costs would be capitalized by the customer in a software licensing agreement under the internal-use software guidance in ASC 350-40. The adoption of ASU 2018-15 will be required for us beginning January 1, 2020, with early adoption permitted. We are currently in the process of determining our adoption date and what impact the adoption of this ASU will have on our financial statements.
From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of any other recently issued standards that are not yet effective are either not applicable to us at this time or will not have a material impact on our consolidated financial statements upon adoption.
32
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Interest Rate Sensitivity
As of December 31, 2018, we had $292.7 million in senior notes outstanding at a fixed interest rate of 6.625% and $250.0 million in senior notes outstanding at a fixed interest rate of 4.75%. The fair value of the 6.625% senior notes, based on the closing price at December 31, 2018, was $285.5 million. The fair value of the 4.75% senior notes, based on the closing price at December 31, 2018, was $239.1 million.
Market Risk
Market risk is the potential change in an instrument’s value caused by fluctuations in interest rates. Our primary market risk exposure is fluctuations in interest rates. Monitoring and managing this risk is a continual process carried out by our senior management. We manage our market risk based on an ongoing assessment of trends in interest rates and economic developments, giving consideration to possible effects on both total return and reported earnings. As a result of such assessment, we may enter into swap contracts or other interest rate protection agreements from time to time to mitigate this risk.
Interest Rate Risk
Interest rates on borrowings under our Credit Agreement are variable, indexed to prime or Eurodollar rates that expose us to the risk of increased interest costs if interest rates rise. As of December 31, 2018, we did not have any outstanding borrowings under our Revolving Facility.
Foreign Currency Translation
We are exposed to market risk from foreign exchange rate fluctuations of the Mexican peso to the U.S. dollar as the financial position and operating results of our stores in Mexico are translated into U.S. dollars for consolidation. Resulting translation adjustments are recorded as a separate component of stockholders' equity.
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Item 8. Financial Statements and Supplementary Data.
INDEX TO FINANCIAL STATEMENTS
Page | |
Rent-A-Center, Inc. and Subsidiaries | |
Consolidated Statements of Operations | |
Consolidated Statements of Comprehensive Income (Loss) | |
Consolidated Balance Sheets | |
Consolidated Statements of Stockholders’ Equity | |
Consolidated Statements of Cash Flows | |
34
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Rent-A-Center, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Rent-A-Center, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2019, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP |
We have served as the Company's auditor since 2013. |
Dallas, Texas |
March 1, 2019 |
35
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Rent-A-Center, Inc.:
Opinion on Internal Control over Financial Reporting
We have audited Rent-A-Center, Inc.’s and subsidiaries (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated March 1, 2019, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP |
Dallas, Texas |
March 1, 2019 |
36
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Management of the Company, including the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control system was designed to provide reasonable assurance to management and the Company’s Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. A system of internal control may become inadequate over time because of changes in conditions, or deterioration in the degree of compliance with the policies or procedures. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on this assessment, management has concluded that, as of December 31, 2018, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles based on such criteria.
KPMG LLP, the Company’s independent registered public accounting firm, has issued an audit report on the effectiveness of the Company’s internal control over financial reporting, which is included elsewhere in this Annual Report on Form 10-K.
37
RENT-A-CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, | |||||||||||
(In thousands, except per share data) | 2018 | 2017 | 2016 | ||||||||
Revenues | |||||||||||
Store | |||||||||||
Rentals and fees | $ | 2,244,860 | $ | 2,267,741 | $ | 2,500,053 | |||||
Merchandise sales | 304,455 | 331,402 | 351,198 | ||||||||
Installment sales | 69,572 | 71,651 | 74,509 | ||||||||
Other | 9,000 | 9,620 | 12,706 | ||||||||
Total store revenues | 2,627,887 | 2,680,414 | 2,938,466 | ||||||||
Franchise | |||||||||||
Merchandise sales | 19,087 | 13,157 | 16,358 | ||||||||
Royalty income and fees | 13,491 | 8,969 | 8,428 | ||||||||
Total revenues | 2,660,465 | 2,702,540 | 2,963,252 | ||||||||
Cost of revenues | |||||||||||
Store | |||||||||||
Cost of rentals and fees | 621,860 | 625,358 | 664,845 | ||||||||
Cost of merchandise sold | 308,912 | 322,628 | 323,727 | ||||||||
Cost of installment sales | 23,326 | 23,622 | 24,285 | ||||||||
Total cost of store revenues | 954,098 | 971,608 | 1,012,857 | ||||||||
Franchise cost of merchandise sold | 18,199 | 12,390 | 15,346 | ||||||||
Total cost of revenues | 972,297 | 983,998 | 1,028,203 | ||||||||
Gross profit | 1,688,168 | 1,718,542 | 1,935,049 | ||||||||
Operating expenses | |||||||||||
Store expenses | |||||||||||
Labor | 683,422 | 732,466 | 789,049 | ||||||||
Other store expenses | 656,894 | 744,187 | 791,614 | ||||||||
General and administrative expenses | 163,445 | 171,090 | 168,907 | ||||||||
Depreciation, amortization and write-down of intangibles | 68,946 | 74,639 | 80,456 | ||||||||
Goodwill impairment charge | — | — | 151,320 | ||||||||
Other charges | 59,324 | 59,219 | 20,299 | ||||||||
Total operating expenses | 1,632,031 | 1,781,601 | 2,001,645 | ||||||||
Operating profit (loss) | 56,137 | (63,059 | ) | (66,596 | ) | ||||||
Write-off of debt issuance costs | 475 | 1,936 | — | ||||||||
Interest expense | 42,968 | 45,996 | 47,181 | ||||||||
Interest income | (1,147 | ) | (791 | ) | (503 | ) | |||||
Earnings (loss) before income taxes | 13,841 | (110,200 | ) | (113,274 | ) | ||||||
Income tax expense (benefit) | 5,349 | (116,853 | ) | (8,079 | ) | ||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | ||||
Basic earnings (loss) per common share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | ||||
Diluted earnings (loss) per common share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | ||||
Cash dividends declared per common share | $ | — | $ | 0.16 | $ | 0.32 | |||||
See accompanying notes to consolidated financial statements.
38
RENT-A-CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | ||||
Other comprehensive income (loss): | |||||||||||
Foreign currency translation adjustments, net of tax of ($73), $2,822, and ($2,794) for 2018, 2017 and 2016, respectively | (274 | ) | 5,241 | (5,188 | ) | ||||||
Total other comprehensive income (loss) | (274 | ) | 5,241 | (5,188 | ) | ||||||
Comprehensive income (loss) | $ | 8,218 | $ | 11,894 | $ | (110,383 | ) | ||||
See accompanying notes to consolidated financial statements.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, | |||||||
(In thousands, except share and par value data) | 2018 | 2017 | |||||
ASSETS | |||||||
Cash and cash equivalents | $ | 155,391 | $ | 72,968 | |||
Receivables, net of allowance for doubtful accounts of $4,883 and $4,167 in 2018 and 2017, respectively | 69,645 | 69,823 | |||||
Prepaid expenses and other assets | 51,352 | 64,577 | |||||
Rental merchandise, net | |||||||
On rent | 683,808 | 701,803 | |||||
Held for rent | 123,662 | 167,188 | |||||
Merchandise held for installment sale | 3,834 | 4,025 | |||||
Property assets, net of accumulated depreciation of $551,750 and $525,673 in 2018 and 2017, respectively | 226,323 | 282,901 | |||||
Deferred tax asset | 25,558 | — | |||||
Goodwill | 56,845 | 56,614 | |||||
Other intangible assets, net | 499 | 882 | |||||
Total assets | $ | 1,396,917 | $ | 1,420,781 | |||
LIABILITIES | |||||||
Accounts payable — trade | $ | 113,838 | $ | 90,352 | |||
Accrued liabilities | 337,459 | 298,018 | |||||
Deferred tax liability | 119,061 | 87,081 | |||||
Senior debt, net | — | 134,125 | |||||
Senior notes, net | 540,042 | 538,762 | |||||
Total liabilities | 1,110,400 | 1,148,338 | |||||
STOCKHOLDERS’ EQUITY | |||||||
Common stock, $.01 par value; 250,000,000 shares authorized; 109,909,504 and 109,681,559 shares issued in 2018 and 2017, respectively | 1,099 | 1,097 | |||||
Additional paid-in capital | 838,436 | 831,271 | |||||
Retained earnings | 805,924 | 798,743 | |||||
Treasury stock at cost, 56,369,752 shares in 2018 and 2017 | (1,347,677 | ) | (1,347,677 | ) | |||
Accumulated other comprehensive loss | (11,265 | ) | (10,991 | ) | |||
Total stockholders' equity | 286,517 | 272,443 | |||||
Total liabilities and stockholders' equity | $ | 1,396,917 | $ | 1,420,781 | |||
See accompanying notes to consolidated financial statements.
40
RENT-A-CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Common Stock | Additional Paid-In Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Total | |||||||||||||||||||||
(In thousands) | Shares | Amount | ||||||||||||||||||||||||
Balance at January 1, 2016 | 109,442 | $ | 1,094 | $ | 818,339 | $ | 922,878 | $ | (1,347,677 | ) | $ | (11,044 | ) | $ | 383,590 | |||||||||||
Net loss | — | — | — | (105,195 | ) | — | — | (105,195 | ) | |||||||||||||||||
Other comprehensive loss | — | — | — | — | — | (5,188 | ) | (5,188 | ) | |||||||||||||||||
Vesting of restricted share units | 77 | 1 | (1 | ) | — | — | — | — | ||||||||||||||||||
Shares withheld for employee taxes on awards vested & exercised | — | — | (440 | ) | — | — | — | (440 | ) | |||||||||||||||||
Stock-based compensation | — | — | 9,209 | — | — | — | 9,209 | |||||||||||||||||||
Dividends declared | — | — | — | (17,043 | ) | — | — | (17,043 | ) | |||||||||||||||||
Balance at December 31, 2016 | 109,519 | 1,095 | 827,107 | 800,640 | (1,347,677 | ) | (16,232 | ) | 264,933 | |||||||||||||||||
Net earnings | — | — | — | 6,653 | — | — | 6,653 | |||||||||||||||||||
Other comprehensive income | — | — | — | — | — | 5,241 | 5,241 | |||||||||||||||||||
Exercise of stock options | 27 | — | 270 | — | — | — | 270 | |||||||||||||||||||
Vesting of restricted share units | 136 | 2 | (2 | ) | — | — | — | — | ||||||||||||||||||
Stock-based compensation | — | — | 3,896 | — | — | — | 3,896 | |||||||||||||||||||
Dividends declared | — | — | — | (8,550 | ) | — | — | (8,550 | ) | |||||||||||||||||
Balance at December 31, 2017 | 109,682 | 1,097 | 831,271 | 798,743 | (1,347,677 | ) | (10,991 | ) | 272,443 | |||||||||||||||||
Net earnings | — | — | — | 8,492 | — | — | 8,492 | |||||||||||||||||||
Other comprehensive income | — | — | — | — | — | (274 | ) | (274 | ) | |||||||||||||||||
Exercise of stock options | 138 | 1 | 1,399 | — | — | — | 1,400 | |||||||||||||||||||
Vesting of restricted share units | 90 | 1 | (1 | ) | — | — | — | — | ||||||||||||||||||
Shares withheld for employee taxes on awards vested & exercised | — | — | (194 | ) | — | — | — | (194 | ) | |||||||||||||||||
Stock-based compensation | — | — | 5,961 | — | — | — | 5,961 | |||||||||||||||||||
ASC 606 adoption | — | — | — | (1,311 | ) | — | — | (1,311 | ) | |||||||||||||||||
Balance at December 31, 2018 | 109,910 | 1,099 | 838,436 | 805,924 | (1,347,677 | ) | (11,265 | ) | 286,517 | |||||||||||||||||
See accompanying notes to consolidated financial statements.
41
RENT-A-CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Cash flows from operating activities | |||||||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | ||||
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities | |||||||||||
Depreciation of rental merchandise | 616,640 | 618,390 | 657,090 | ||||||||
Bad debt expense | 14,610 | 15,702 | 15,449 | ||||||||
Stock-based compensation expense | 5,961 | 3,896 | 9,209 | ||||||||
Depreciation of property assets | 68,275 | 73,685 | 77,361 | ||||||||
Loss on sale or disposal of property assets | 7,388 | 15,795 | 3,718 | ||||||||
Goodwill impairment charge | — | — | 151,320 | ||||||||
Amortization of impairment of intangibles | 671 | 4,908 | 2,176 | ||||||||
Amortization of financing fees | 5,486 | 4,667 | 2,217 | ||||||||
Write-off of debt financing fees | 475 | 1,936 | — | ||||||||
Deferred income taxes | 6,816 | (86,063 | ) | (32,994 | ) | ||||||
Changes in operating assets and liabilities, net of effects of acquisitions | |||||||||||
Rental merchandise | (569,717 | ) | (487,130 | ) | (523,697 | ) | |||||
Receivables | (14,431 | ) | (15,741 | ) | (15,914 | ) | |||||
Prepaid expenses and other assets | 13,105 | (9,622 | ) | 104,379 | |||||||
Accounts payable — trade | 23,486 | (17,886 | ) | 11,883 | |||||||
Accrued liabilities | 40,248 | (18,657 | ) | (2,929 | ) | ||||||
Net cash provided by operating activities | 227,505 | 110,533 | 354,073 | ||||||||
Cash flows from investing activities | |||||||||||
Purchase of property assets | (27,962 | ) | (65,460 | ) | (61,143 | ) | |||||
Proceeds from sale of stores | 25,317 | 4,638 | 5,262 | ||||||||
Acquisitions of businesses | (2,048 | ) | (2,525 | ) | (3,098 | ) | |||||
Net cash used in investing activities | (4,693 | ) | (63,347 | ) | (58,979 | ) | |||||
Cash flows from financing activities | |||||||||||
Exercise of stock options | 1,401 | 270 | — | ||||||||
Shares withheld for payment of employee tax withholdings | (317 | ) | (225 | ) | (338 | ) | |||||
Debt issuance costs | (2,098 | ) | (5,258 | ) | — | ||||||
Proceeds from debt | 27,060 | 347,635 | 52,245 | ||||||||
Repayments of debt | (166,358 | ) | (400,151 | ) | (286,065 | ) | |||||
Dividends paid | — | (12,811 | ) | (25,554 | ) | ||||||
Net cash used in financing activities | (140,312 | ) | (70,540 | ) | (259,712 | ) | |||||
Effect of exchange rate changes on cash | (77 | ) | 926 | (349 | ) | ||||||
Net increase (decrease) in cash and cash equivalents | 82,423 | (22,428 | ) | 35,033 | |||||||
Cash and cash equivalents at beginning of year | 72,968 | 95,396 | 60,363 | ||||||||
Cash and cash equivalents at end of year | $ | 155,391 | $ | 72,968 | $ | 95,396 | |||||
Supplemental cash flow information: | |||||||||||
Cash paid during the year for: | |||||||||||
Interest | $ | 37,530 | $ | 41,339 | $ | 44,469 | |||||
Income taxes (excludes $47,837, $7,321, and $84,884 of income taxes refunded in 2018, 2017 and 2016, respectively) | $ | 2,227 | $ | 1,983 | $ | 18,536 | |||||
See accompanying notes to consolidated financial statements.
42
RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A — Nature of Operations and Summary of Accounting Policies
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:
Principles of Consolidation and Nature of Operations
These financial statements include the accounts of Rent-A-Center, Inc. and its direct and indirect subsidiaries. All intercompany accounts and transactions have been eliminated. Unless the context indicates otherwise, references to “Rent-A-Center” refer only to Rent-A-Center, Inc., the parent, and references to “we,” “us” and “our” refer to the consolidated business operations of Rent-A-Center and any or all of its direct and indirect subsidiaries. We report four operating segments: Core U.S., Acceptance Now, Mexico and Franchising.
Our Core U.S. segment consists of company-owned rent-to-own stores in the United States and Puerto Rico that lease household durable goods to customers on a rent-to-own basis. We also offer merchandise on an installment sales basis in certain of our stores under the names “Get It Now” and “Home Choice.” At December 31, 2018, we operated 2,158 company-owned stores nationwide and in Puerto Rico, including 44 retail installment sales stores.
Our Acceptance Now segment generally offers the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer through kiosks located within such retailers' locations. At December 31, 2018, we operated 1,106 Acceptance Now Staffed locations and 96 Acceptance Now Direct locations.
Our Mexico segment consists of our company-owned rent-to-own stores in Mexico that lease household durable goods to customers on a rent-to-own basis. At December 31, 2018, we operated 122 stores in Mexico.
Rent-A-Center Franchising International, Inc., an indirect wholly-owned subsidiary of Rent-A-Center, is a franchisor of rent-to-own stores. At December 31, 2018, Franchising had 281 franchised stores operating in 32 states. Our Franchising segment's primary source of revenue is the sale of rental merchandise to its franchisees, who in turn offer the merchandise to the general public for rent or purchase under a rent-to-own transaction. The balance of our Franchising segment's revenue is generated primarily from royalties based on franchisees' monthly gross revenues and upfront fees charged to new franchisees.
Rental Merchandise
Rental merchandise is carried at cost, net of accumulated depreciation. Depreciation for merchandise is generally provided using the income forecasting method, which is intended to match as closely as practicable the recognition of depreciation expense with the consumption of the rental merchandise, and assumes no salvage value. The consumption of rental merchandise occurs during periods of rental and directly coincides with the receipt of rental revenue over the rental purchase agreement period. Under the income forecasting method, merchandise held for rent is not depreciated and merchandise on rent is depreciated in the proportion of rents received to total rents provided in the rental contract, which is an activity-based method similar to the units of production method. We depreciate merchandise (including computers and tablets) that is held for rent for at least 180 consecutive days using the straight-line method over a period generally not to exceed 18 months. Beginning in 2016, smartphones are depreciated over an 18-month straight-line basis beginning with the earlier of on rent or 90 consecutive days on held for rent.
Rental merchandise which is damaged and inoperable is expensed when such impairment occurs. If a customer does not return the merchandise or make payment, the remaining book value of the rental merchandise associated with delinquent accounts is generally charged off on or before the 90th day following the time the account became past due in the Core U.S. and Mexico segments, and on or before the 150th day in the Acceptance Now segment. We maintain a reserve for these expected expenses. In addition, any minor repairs made to rental merchandise are expensed at the time of the repair.
Cash Equivalents
Cash equivalents include all highly liquid investments with an original maturity of three months or less. We maintain cash and cash equivalents at several financial institutions, which at times may not be federally insured or may exceed federally insured limits. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risks on such accounts.
Revenues
Merchandise is rented to customers pursuant to rental purchase agreements which provide for weekly, semi-monthly or monthly rental terms with non-refundable rental payments. Generally, the customer has the right to acquire title either through a purchase option or through payment of all required rentals. Rental revenue and fees are recognized over the rental term and merchandise sales revenue is recognized when the customer exercises the purchase option and pays the cash price due. Cash received prior to
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
the period in which it should be recognized is deferred and recognized according to the rental term. Revenue is accrued for uncollected amounts due based on historical collection experience. However, the total amount of the rental purchase agreement is not accrued because the customer can terminate the rental agreement at any time and we cannot enforce collection for non-payment of future rents.
Revenues from the sale of merchandise in our retail installment stores are recognized when the installment note is signed, the customer has taken possession of the merchandise and collectability is reasonably assured.
Revenues from the sale of rental merchandise are recognized upon shipment of the merchandise to the franchisee. Franchise royalty income and fee revenue is recognized upon completion of substantially all services and satisfaction of all material conditions required under the terms of the franchise agreement. Initial franchise fees charged to franchisees for new or converted franchise stores are recognized on a straight-line basis over the term of the franchise agreement.
Receivables and Allowance for Doubtful Accounts
The installment notes receivable associated with the sale of merchandise at our Get It Now and Home Choice stores generally consists of the sales price of the merchandise purchased and any additional fees for services the customer has chosen, less the customer’s down payment. No interest is accrued and interest income is recognized each time a customer makes a payment, generally on a monthly basis.
We have established an allowance for doubtful accounts for our installment notes receivable. Our policy for determining the allowance is based on historical loss experience, as well as the results of management’s review and analysis of the payment and collection of the installment notes receivable within the previous year. We believe our allowance is adequate to absorb any known or probable losses. Our policy is to charge off installment notes receivable that are 120 days or more past due. Charge-offs are applied as a reduction to the allowance for doubtful accounts and any recoveries of previously charged off balances are applied as an increase to the allowance for doubtful accounts.
The majority of Franchising’s trade and notes receivable relate to amounts due from franchisees. Credit is extended based on an evaluation of a franchisee’s financial condition and collateral is generally not required. Trade receivables are due within 30 days and are stated at amounts due from franchisees net of an allowance for doubtful accounts. Accounts that are outstanding longer than the contractual payment terms are considered past due. Franchising determines its allowance by considering a number of factors, including the length of time receivables are past due, Franchising’s previous loss history, the franchisee’s current ability to pay its obligation to Franchising, and the condition of the general economy and the industry as a whole. Franchising writes off trade receivables that are 90 days or more past due and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
Property Assets and Related Depreciation
Furniture, equipment and vehicles are stated at cost less accumulated depreciation. Depreciation is provided over the estimated useful lives of the respective assets (generally 5 years) by the straight-line method. Our corporate office building is depreciated over 40 years. Leasehold improvements are amortized over the useful life of the asset or the initial term of the applicable leases by the straight-line method, whichever is shorter.
We have incurred costs to develop computer software for internal use. We capitalize the costs incurred during the application development stage, which includes designing the software configuration and interfaces, coding, installation, and testing. Costs incurred during the preliminary stages along with post-implementation stages of internally developed software are expensed as incurred. Internally developed software costs, once placed in service, are amortized over various periods up to 10 years.
We incur repair and maintenance expenses on our vehicles and equipment. These amounts are recognized when incurred, unless such repairs significantly extend the life of the asset, in which case we amortize the cost of the repairs for the remaining useful life of the asset utilizing the straight-line method.
Goodwill and Other Intangible Assets
We record goodwill when the consideration paid for an acquisition exceeds the fair value of the identifiable net tangible and identifiable intangible assets acquired. Goodwill is not subject to amortization but must be periodically evaluated for impairment. Impairment occurs when the carrying value of goodwill is not recoverable from future cash flows. We perform an assessment of goodwill for impairment at the reporting unit level annually as of October 1, or when events or circumstances indicate that impairment may have occurred.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Our reporting units are our reportable operating segments. Factors which could necessitate an interim impairment assessment include a sustained decline in our stock price, prolonged negative industry or economic trends and significant underperformance relative to expected historical or projected future operating results.
We determine the fair value of each reporting unit using methodologies which include the present value of estimated future cash flows and comparisons of multiples of enterprise values to earnings before interest, taxes, depreciation and amortization. The analysis is based upon available information regarding expected future cash flows and discount rates. Discount rates are based upon our cost of capital. We use a two-step approach to assess goodwill impairment. If the fair value of the reporting unit exceeds its carrying value, then the goodwill is not deemed impaired. If the carrying value of the reporting unit exceeds fair value, we perform a second analysis to measure the fair value of all assets and liabilities within the reporting unit, and if the carrying value of goodwill exceeds its implied fair value, goodwill is considered impaired. The amount of the impairment is the difference between the carrying value of goodwill and the implied fair value, which is calculated as if the reporting unit had been acquired and accounted for as a business combination. As an alternative to this annual impairment testing, we may perform a qualitative assessment for impairment if it believes it is not more likely than not that the carrying value of a reporting unit's net assets exceeds the reporting unit's fair value.
Acquired customer relationships are amortized utilizing the straight-line method over a 21-month period, non-compete agreements are amortized using the straight-line method over the contractual life of the agreements, vendor relationships are amortized using the straight-line method over a 7 or 15 year period, and other intangible assets are amortized using the straight-line method over the life of the asset.
Accounting for Impairment of Long-Lived Assets
We evaluate all long-lived assets, including intangible assets, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Impairment is recognized when the carrying amounts of such assets cannot be recovered by the undiscounted net cash flows they will generate.
Self-Insurance Liabilities
We have self-insured retentions with respect to losses under our workers' compensation, general liability, vehicle liability and health insurance programs. We establish reserves for our liabilities associated with these losses by obtaining forecasts for the ultimate expected losses and estimating amounts needed to pay losses within our self-insured retentions. We make assumptions on our liabilities within our self-insured retentions using actuarial loss forecasts, company-specific development factors, general industry loss development factors, and third-party claim administrator loss estimates which are based on known facts surrounding individual claims. These assumptions incorporate expected increases in health care costs. Periodically, we reevaluate our estimate of liability within our self-insured retentions. At that time, we evaluate the adequacy of our reserves by comparing amounts reserved on our balance sheet for anticipated losses to our updated actuarial loss forecasts and third-party claim administrator loss estimates, and make adjustments to our reserves as needed.
Foreign Currency Translation
The functional currency of our foreign operations is the applicable local currency. Assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the current rate of exchange on the last day of the reporting period. Revenues and expenses are generally translated at a daily exchange rate and equity transactions are translated using the actual rate on the day of the transaction.
Other Comprehensive Income (Loss)
Other comprehensive income (loss) is comprised exclusively of our foreign currency translation adjustment.
Income Taxes
We record deferred taxes for temporary differences between the tax and financial reporting bases of assets and liabilities at the enacted tax rate expected to be in effect when those temporary differences are expected to be recovered or settled. Income tax accounting requires management to make estimates and apply judgments to events that will be recognized in one period under rules that apply to financial reporting in a different period in our tax returns. In particular, judgment is required when estimating the value of future tax deductions, tax credits and net operating loss carryforwards (NOLs), as represented by deferred tax assets. We evaluate the recoverability of these future tax deductions and credits by assessing the future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. We use our historical experience and our short- and long-range business forecasts to provide insight and assist us in determining recoverability. When it is determined the recovery of all or a portion of a deferred
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
tax asset is not likely, a valuation allowance is established. We include NOLs in the calculation of deferred tax assets. NOLs are utilized to the extent allowable due to the provisions of the Internal Revenue Code of 1986, as amended, and relevant state statutes.
We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon the ultimate settlement with the relevant tax authority. A number of years may elapse before a particular matter, for which we have recorded a liability, is audited and effectively settled. We review our tax positions quarterly and adjust our liability for unrecognized tax benefits in the period in which we determine the issue is effectively settled with the tax authorities, the statute of limitations expires for the relevant taxing authority to examine the tax position, or when more information becomes available. We classify accrued interest and penalties related to unrecognized tax benefits as interest expense and general & administrative expense, respectively.
Sales Taxes
We apply the net basis for sales taxes imposed on our goods and services in our consolidated statements of operations. We are required by the applicable governmental authorities to collect and remit sales taxes. Accordingly, such amounts are charged to the customer, collected and remitted directly to the appropriate jurisdictional entity.
Earnings (Loss) Per Common Share
Basic earnings (loss) per common share are based upon the weighted average number of common shares outstanding during each period presented. Diluted earnings (loss) per common share are based upon the weighted average number of common shares outstanding during the period, plus, if dilutive, the assumed exercise of stock options and vesting of stock awards at the beginning of the year, or for the period outstanding during the year for current year issuances.
Advertising Costs
Costs incurred for producing and communicating advertising are expensed when incurred. Advertising expense was $74.6 million, $86.1 million and $90.6 million, for the years ended December 31, 2018, 2017 and 2016, respectively.
Stock-Based Compensation
We maintain long-term incentive plans for the benefit of certain employees and directors, which are described more fully in Note M. We recognize share-based payment awards to our employees and directors at the estimated fair value on the grant date. Determining the fair value of any share-based award requires information about several variables that include, but are not limited to, expected stock volatility over the term of the award, expected dividend yields, and the risk free interest rate. We base the expected term on historical exercise and post-vesting employment-termination experience, and expected volatility on historical realized volatility trends. In addition, all stock-based compensation expense is recorded net of an estimated forfeiture rate. The forfeiture rate is based upon historical activity and is analyzed at least annually as actual forfeitures occur. Compensation costs are recognized net of estimated forfeitures over the requisite service period on a straight-line basis. We issue new shares to settle stock awards. Stock options are valued using a Black-Scholes pricing model. Time-vesting restricted stock units are valued using the closing price on the Nasdaq Global Select Market on the day before the grant date, adjusted for any provisions affecting fair value, such as the lack of dividends or dividend equivalents during the vesting period. Performance-based restricted stock units will vest in accordance with a total shareholder return formula, and are valued by a third-party valuation firm using Monte Carlo simulations.
Stock-based compensation expense is reported within general and administrative expenses in the consolidated statements of operations.
Reclassifications
Certain reclassifications may be made to the reported amounts for prior periods to conform to the current period presentation. These reclassifications have no impact on net earnings or earnings per share in any period.
Use of Estimates
In preparing financial statements in conformity with U.S. generally accepted accounting principles, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent losses and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. In applying accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.
Newly Adopted Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which clarifies existing accounting literature relating to how and when a company recognizes revenue. We adopted ASU 2014-09 and all related amendments beginning January 1, 2018, using the modified retrospective adoption method. We recognized the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
Under Topic 606, initial franchise fees charged to franchisees for new stores are recognized over the term of the franchise agreement, rather than when they are paid by the franchisee, upon the opening of a new location. Furthermore, franchise advertising fees are presented on a gross basis, as revenue, in the consolidated statement of operations, rather than net of operating expenses in the consolidated statement of operations. Impacts resulting from adoption were not material to the consolidated statement of operations. See descriptions of the revenues in Note B.
The cumulative effect of the changes made to our condensed consolidated balance sheet for the adoption of Topic 606 were as follows:
(In thousands) | January 1, 2018 | Adjustments due to Topic 606 | December 31, 2017 | ||||||||
LIABILITIES | |||||||||||
Accrued liabilities | $ | 299,683 | $ | (1,665 | ) | $ | 298,018 | ||||
Deferred tax liability | 86,727 | 354 | 87,081 | ||||||||
Total liabilities | 1,149,649 | (1,311 | ) | 1,148,338 | |||||||
STOCKHOLDERS’ EQUITY | |||||||||||
Retained earnings | $ | 797,432 | $ | 1,311 | $ | 798,743 | |||||
Total stockholders' equity | 271,132 | 1,311 | 272,443 | ||||||||
In accordance with Topic 606, the disclosure of the impact of adoption on our condensed consolidated statements of operations and condensed consolidated balance sheets for the periods ended December 31, 2018 is as follows:
Condensed Consolidated Statements of Operations | Twelve Months Ended December 31, 2018 | |||||||
(In thousands) | As Reported | Adjustments due to Topic 606 | Balances without Adoption of Topic 606 | |||||
Royalty income and fees | 13,491 | (1,844 | ) | 11,647 | ||||
Total revenues | 2,660,465 | (1,844 | ) | 2,658,621 | ||||
Gross profit | 1,688,168 | (1,844 | ) | 1,686,324 | ||||
Other store expenses | 656,894 | (3,965 | ) | 652,929 | ||||
Total operating expenses | 1,632,031 | (3,965 | ) | 1,628,066 | ||||
Operating profit | 56,137 | 2,121 | 58,258 | |||||
Earnings before income taxes | 13,841 | 2,121 | 15,962 | |||||
Income tax expense | 5,349 | 657 | 6,006 | |||||
Net earnings | 8,492 | 1,464 | 9,956 | |||||
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidated Balance Sheets | December 31, 2018 | ||||||||||
(In thousands) | As Reported | Adjustments due to Topic 606 | Balances without Adoption of Topic 606 | ||||||||
LIABILITIES | |||||||||||
Accrued liabilities | $ | 337,459 | $ | (3,786 | ) | $ | 333,673 | ||||
Deferred tax liability | 119,061 | 1,011 | 120,072 | ||||||||
Total liabilities | 1,110,400 | (2,775 | ) | 1,107,625 | |||||||
STOCKHOLDERS’ EQUITY | |||||||||||
Retained earnings | $ | 805,924 | $ | 2,775 | $ | 808,699 | |||||
Total stockholders' equity | 286,517 | 2,775 | 289,292 | ||||||||
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance on the treatment of cash receipts and cash payments for certain types of cash transactions, to eliminate diversity in practice in the presentation of the cash flow statement. Rent-A-Center adopted ASU 2016-15 beginning January 1, 2018, on a retrospective basis. The adoption of ASU 2016-15 had no impact to the financial statements as of December 31, 2018.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which introduces amendments that are intended to make the guidance in ASC 805 on the definition of a business more consistent and cost-efficient. The amendments narrow the definition of a business and provide a framework that gives entities a basis for making reasonable judgments about whether a transaction involves an asset or a business. Rent-A-Center adopted ASU 2017-01 beginning January 1, 2018, using the prospective approach. The adoption of ASU 2017-01 had an immaterial impact to the financial statements as of December 31, 2018.
In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Under the new guidance, modification accounting is required if the fair value, vesting conditions or classification (equity or liability) of the new award are different from the original award immediately before the original award is modified. Rent-A-Center adopted ASU 2017-09 beginning January 1, 2018, on a prospective basis. The adoption of ASU 2017-09 had no impact to the financial statements as of December 31, 2018.
Note B — Revenues
The following table disaggregates our revenue:
Twelve Months Ended December 31, 2018 | |||||||||||||||||||
Core U.S. | Acceptance Now | Mexico | Franchising | Consolidated | |||||||||||||||
(In thousands) | Unaudited | ||||||||||||||||||
Store | |||||||||||||||||||
Rentals and fees | $ | 1,640,839 | $ | 557,592 | $ | 46,429 | $ | — | $ | 2,244,860 | |||||||||
Merchandise sales | 136,878 | 164,432 | 3,145 | — | 304,455 | ||||||||||||||
Installment sales | 69,572 | — | — | — | 69,572 | ||||||||||||||
Other | 8,423 | 538 | 39 | — | 9,000 | ||||||||||||||
Total store revenues | 1,855,712 | 722,562 | 49,613 | — | 2,627,887 | ||||||||||||||
Franchise | |||||||||||||||||||
Merchandise sales | — | — | — | 19,087 | 19,087 | ||||||||||||||
Royalty income and fees | — | — | — | 13,491 | 13,491 | ||||||||||||||
Total revenues | $ | 1,855,712 | $ | 722,562 | $ | 49,613 | $ | 32,578 | $ | 2,660,465 | |||||||||
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Rental-Purchase Agreements
Core U.S., Acceptance Now, and Mexico
Rentals and Fees. Merchandise is leased to customers pursuant to rental purchase agreements which provide for weekly, semi-monthly or monthly rental terms with non-refundable rental payments. At the expiration of each rental term customers renew the rental agreement by pre-paying for the next rental term. Generally, the customer has the right to acquire title of the merchandise either through a purchase option or through payment of all required rental terms. Customers can terminate the agreement at the end of any rental term without penalty. Therefore, rental transactions are accounted for as operating leases and rental revenue is recognized over the rental term. Cash received for rental payments, including processing fees, prior to the period in which it should be recognized is deferred and recognized according to the rental term. Revenue related to various payment, reinstatement or late fees are recognized when paid by the customer at the point service is provided. Rental merchandise is depreciated using the income forecasting method and is recognized in cost of sales over the rental term. We offer additional product plans along with our rental agreements which provide customers with liability protection against significant damage or loss of a product, and club membership benefits, including various discount programs and product service and replacement benefits in the event merchandise is damaged or lost. Customers renew product plans in conjunction with their rental term renewals, and can cancel the plans at any time. Revenue for product plans is recognized over the term of the plan. Costs incurred related to product plans are primarily recognized in cost of sales. At December 31, 2018 and December 31, 2017, we had $42.1 million and $41.1 million, respectively, in deferred revenue included in accrued liabilities related to our rental purchase agreements.
Revenue from contracts with customers
Core U.S., Acceptance Now, and Mexico
Merchandise Sales. Merchandise sales include payments received for the exercise of the early purchase option offered through our rental purchase agreements or merchandise sold through point of sale transactions. Revenue for merchandise sales is recognized when payment is received and ownership of the merchandise passes to the customer. The remaining net value of merchandise sold is recorded to cost of sales at the time of the transaction.
Installment Sales. Revenue from the sale of merchandise in our retail installment stores is recognized when the installment note is signed and control of the merchandise has passed to the customer. The cost of merchandise sold through installment agreements is recognized in cost of sales at the time of the transaction. We offer extended service plans with our installment agreements which are administered by third parties and provide customers with product service maintenance beyond the term of the installment agreement. Payments received for extended service plans are deferred and recognized, net of related costs, when the installment payment plan is complete and the service plan goes into effect. Customers can cancel extended service plans at any time during the installment agreement and receive a refund for payments previously made towards the plan. At both December 31, 2018 and December 31, 2017, we had $3.0 million in deferred revenue included in accrued liabilities related to other product plans.
Other. Other revenue primarily consists of external maintenance and repair services provided by the Company’s service department, in addition to other miscellaneous product plans offered to our rental and installment customers. The Company’s service department is a licensed warranty service provider and performs service maintenance and merchandise repair for qualified warranty guarantees, on behalf of merchandise vendors. In addition, we provide external maintenance and repair services for our franchisees, and other external businesses and individual customers. Revenue for warranty services is recognized when service is complete and a claim has been submitted to the original vendor issuing the warranty guarantee. Revenue for external repair and maintenance services are recognized when services provided are complete and the customer has been billed. Costs incurred for repair services are recognized as incurred in labor and other store expenses. Revenue for other product plans is recognized in accordance with the terms of the applicable plan agreement.
Franchising
Merchandise Sales. Revenue from the sale of rental merchandise is recognized upon shipment of the merchandise to the franchisee.
Royalty Income and Fees. Franchise royalties, including franchisee contributions to corporate advertising funds, represent sales-based royalties calculated as a percentage of gross rental payments and sales. Royalty revenue is recognized as rental payments and sales occur. Franchise fees are initial fees charged to franchisees for new or converted franchise stores. Franchise fee revenue is recognized on a straight-line basis over the term of the franchise agreement. At December 31, 2018 and December 31, 2017, we had $4.1 million and $1.7 million, respectively, in deferred revenue included in accrued liabilities related to franchise fees.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note C — Receivables and Allowance for Doubtful Accounts
Receivables consist of the following:
December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
Installment sales receivable | $ | 54,746 | $ | 55,516 | |||
Trade and notes receivables | 19,782 | 18,474 | |||||
Total receivables | 74,528 | 73,990 | |||||
Less allowance for doubtful accounts | (4,883 | ) | (4,167 | ) | |||
Total receivables, net of allowance for doubtful accounts | $ | 69,645 | $ | 69,823 | |||
The allowance for doubtful accounts related to installment sales receivable was $3.6 million and $3.6 million, and the allowance for doubtful accounts related to trade and notes receivable was $1.3 million and $0.6 million at December 31, 2018 and 2017, respectively.
Changes in our allowance for doubtful accounts are as follows:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Beginning allowance for doubtful accounts | $ | 4,167 | $ | 3,593 | $ | 3,614 | |||||
Bad debt expense | 14,610 | 15,702 | 15,449 | ||||||||
Accounts written off | (14,475 | ) | (15,791 | ) | (16,095 | ) | |||||
Recoveries | 581 | 663 | 625 | ||||||||
Ending allowance for doubtful accounts | $ | 4,883 | $ | 4,167 | $ | 3,593 | |||||
Note D — Rental Merchandise
December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
On rent | |||||||
Cost | $ | 1,110,968 | $ | 1,176,240 | |||
Less accumulated depreciation | (427,160 | ) | (474,437 | ) | |||
Net book value, on rent | $ | 683,808 | $ | 701,803 | |||
Held for rent | |||||||
Cost | $ | 147,300 | $ | 198,471 | |||
Less accumulated depreciation | (23,638 | ) | (31,283 | ) | |||
Net book value, held for rent | $ | 123,662 | $ | 167,188 | |||
Note E — Property Assets
December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
Furniture and equipment | $ | 512,056 | $ | 511,527 | |||
Building and leasehold improvements | 251,975 | 269,522 | |||||
Land and land improvements | 6,737 | 6,747 | |||||
Transportation equipment | 3,765 | 10,585 | |||||
Construction in progress | 3,540 | 10,193 | |||||
Total property assets | 778,073 | 808,574 | |||||
Less accumulated depreciation | (551,750 | ) | (525,673 | ) | |||
Total property assets, net of accumulated depreciation | $ | 226,323 | $ | 282,901 | |||
50
RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We had $1.9 million and $7.3 million of capitalized software costs included in construction in progress at December 31, 2018 and 2017, respectively. For the years ended December 31, 2018, 2017 and 2016, we placed in service internally developed software of approximately $9.7 million, $32.1 million and $84.5 million, respectively.
Note F — Intangible Assets and Acquisitions
Goodwill Impairment Charge
In the fourth quarter of 2018, we completed a qualitative assessment for impairment of goodwill as of October 1, 2018, concluding it was not more likely than not that the carrying value of our reporting unit's net assets exceeded the reporting unit's fair value and therefore no impairment of goodwill existed as of December 31. 2018.
During 2016, we recorded a goodwill impairment charge of $151.3 million in our Core U.S. segment.
Intangible Assets
Amortizable intangible assets consist of the following:
December 31, 2018 | December 31, 2017 | ||||||||||||||||
(Dollar amounts in thousands) | Avg. Life (years) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||
Customer relationships | 2 | $ | 79,942 | $ | 79,695 | $ | 79,670 | $ | 79,274 | ||||||||
Vendor relationships | 11 | 860 | 860 | 860 | 860 | ||||||||||||
Non-compete agreements | 3 | 6,745 | 6,493 | 6,748 | 6,262 | ||||||||||||
Total other intangible assets | $ | 87,547 | $ | 87,048 | $ | 87,278 | $ | 86,396 | |||||||||
Aggregate amortization expense (in thousands):
Year Ended December 31, 2018 | $ | 671 | |
Year Ended December 31, 2017 (1) | $ | 4,908 | |
Year Ended December 31, 2016 | $ | 2,176 | |
(1) Includes impairment charge of $3.9 million to our intangible assets, related to a vendor relationship, in the ANOW segment during the first quarter of 2017.
Estimated amortization expense, assuming current intangible balances and no new acquisitions, for each of the years ending December 31, is as follows:
(In thousands) | Estimated Amortization Expense | ||
2019 | $ | 451 | |
2020 | 48 | ||
Thereafter | — | ||
Total amortization expense | $ | 499 | |
At December 31, 2018, the amount of goodwill attributable to the Core U.S. and Acceptance Now segments was approximately $1.5 million and $55.3 million, respectively. At December 31, 2017, the amount of goodwill allocated to the Core U.S. and Acceptance Now segment was approximately $1.3 million and $55.3 million, respectively.
A summary of the changes in recorded goodwill follows:
Year Ended December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
Beginning goodwill balance | $ | 56,614 | $ | 55,308 | |||
Additions from acquisitions | 169 | 1,217 | |||||
Post purchase price allocation adjustments | 62 | 89 | |||||
Ending goodwill balance | $ | 56,845 | $ | 56,614 | |||
51
RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Acquisitions
The following table provides information concerning the acquisitions made during the years ended December 31, 2018, 2017 and 2016.
Year Ended December 31, | |||||||||||
(Dollar amounts in thousands) | 2018 | 2017 | 2016 | ||||||||
Number of stores acquired remaining open | 1 | — | — | ||||||||
Number of stores acquired that were merged with existing stores | 6 | 8 | 3 | ||||||||
Number of transactions | 7 | 4 | 3 | ||||||||
Total purchase price | $ | 2,048 | $ | 2,547 | $ | 2,302 | |||||
Amounts allocated to: | |||||||||||
Goodwill | $ | 169 | $ | 1,217 | $ | 1,442 | |||||
Non-compete agreements | — | — | — | ||||||||
Customer relationships | 289 | 550 | 181 | ||||||||
Rental merchandise | 1,590 | 780 | 679 | ||||||||
Purchase prices are determined by evaluating the average monthly rental income of the acquired stores and applying a multiple to the total for rent-to-own store acquisitions. Operating results of the acquired stores and accounts have been included in the financial statements since their date of acquisition.
The weighted average amortization period was approximately 21 months for intangible assets added during the year ended December 31, 2018. Additions to goodwill due to acquisitions in 2018 were tax deductible.
Note G — Accrued Liabilities
December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
Accrued insurance costs | $ | 109,505 | $ | 124,760 | |||
Accrued compensation | 55,789 | 37,783 | |||||
Deferred revenue | 53,348 | 51,742 | |||||
Taxes other than income | 27,711 | 27,415 | |||||
Income taxes payable | 26,797 | — | |||||
Accrued legal settlement | 11,000 | — | |||||
Deferred compensation | 8,687 | 11,323 | |||||
Accrued interest payable | 5,643 | 5,707 | |||||
Deferred rent | 3,503 | 3,937 | |||||
Accrued other | 35,476 | 35,351 | |||||
Total Accrued liabilities | $ | 337,459 | $ | 298,018 | |||
Note H — Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Act”) was enacted which, among other things, reduced the U.S. federal income tax rate from 35% to 21% in 2018, instituted a dividends received deduction for foreign earnings with a related tax for the deemed repatriation of unremitted foreign earnings in 2017, and created a new U.S. minimum tax on earnings of foreign subsidiaries. The Tax Act also allowed for 100% bonus depreciation for assets purchased after September 27, 2017, until December 31, 2023. We recognized an income tax benefit of $76.5 million in the year ended December 31, 2017, associated with the revaluation of the net deferred tax liability at the date of enactment. Our provisional estimate of the one-time transition tax resulted in $0.7 million of additional tax expense. We also recorded a federal provisional benefit of $9.7 million based on our intent to fully expense all qualifying expenditures. In 2018, we finalized our analysis over the one-year measurement period that ended on December 22, 2018, in accordance with SAB 118, resulting in an immaterial income tax benefit recorded in our consolidated statement of operations.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
For financial statement purposes, income (loss) before income taxes by source was comprised of the following:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Domestic | $ | 11,290 | $ | (109,615 | ) | $ | (110,347 | ) | |||
Foreign | 2,551 | (585 | ) | (2,927 | ) | ||||||
Income (loss) before income taxes | $ | 13,841 | $ | (110,200 | ) | $ | (113,274 | ) | |||
A reconciliation of the federal statutory rate of 21% for 2018 and 35% for 2017 and 2016 to actual follows:
Year Ended December 31, | ||||||||
2018 | 2017 | 2016 | ||||||
Tax at statutory rate | 21.0 | % | 35.0 | % | 35.0 | % | ||
Tax Cuts and Jobs Act of 2017 | — | % | 70.3 | % | — | % | ||
Goodwill impairment | — | % | — | % | (29.3 | )% | ||
State income taxes | 17.6 | % | (1.8 | )% | 3.3 | % | ||
Effect of foreign operations, net of foreign tax credits | (1.2 | )% | 3.5 | % | (0.2 | )% | ||
Effect of current and prior year credits | (31.4 | )% | 1.7 | % | 2.9 | % | ||
Change in unrecognized tax benefits | 10.9 | % | — | % | — | % | ||
Other permanent differences | 14.9 | % | — | % | — | % | ||
Prior year return to provision adjustments | 7.3 | % | — | % | — | % | ||
Adjustments to deferred taxes | — | % | 1.6 | % | 0.6 | % | ||
Valuation allowance | (0.5 | )% | (1.6 | )% | (6.6 | )% | ||
Other, net | — | % | (2.7 | )% | 1.4 | % | ||
Effective income tax rate | 38.6 | % | 106.0 | % | 7.1 | % | ||
The components of income tax expense (benefit) are as follows:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Current expense (benefit) | |||||||||||
Federal | $ | (2,573 | ) | $ | (34,445 | ) | $ | 23,752 | |||
State | 816 | 1,216 | 779 | ||||||||
Foreign | 724 | (1,417 | ) | (582 | ) | ||||||
Total current | (1,033 | ) | (34,646 | ) | 23,949 | ||||||
Deferred expense (benefit) | |||||||||||
Federal | 4,691 | (89,820 | ) | (27,307 | ) | ||||||
State | 3,325 | 9,266 | (6,586 | ) | |||||||
Foreign | (1,634 | ) | (1,653 | ) | 1,865 | ||||||
Total deferred | 6,382 | (82,207 | ) | (32,028 | ) | ||||||
Total income tax expense (benefit) | $ | 5,349 | $ | (116,853 | ) | $ | (8,079 | ) | |||
53
RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Deferred tax assets (liabilities) consist of the following:
December 31, | |||||||
(In thousands) | 2018 | 2017 | |||||
Deferred tax assets | |||||||
Net operating loss carryforwards | $ | 56,701 | $ | 38,914 | |||
Accrued liabilities | 50,558 | 49,619 | |||||
Intangible assets | 20,346 | 26,029 | |||||
Other assets including credits | 23,070 | 11,967 | |||||
Foreign tax credit carryforwards | 6,601 | 6,601 | |||||
Total deferred tax assets | 157,276 | 133,130 | |||||
Valuation allowance | (39,961 | ) | (40,074 | ) | |||
Deferred tax assets, net | 117,315 | 93,056 | |||||
Deferred tax liabilities | |||||||
Rental merchandise | (177,794 | ) | (139,425 | ) | |||
Property assets | (32,571 | ) | (40,712 | ) | |||
Other liabilities | (453 | ) | — | ||||
Total deferred tax liabilities | (210,818 | ) | (180,137 | ) | |||
Net deferred taxes | $ | (93,503 | ) | $ | (87,081 | ) | |
At December 31, 2018, we have net operating loss carryforwards of approximately $65.6 million for federal, $453.2 million for state, and $61.2 million for foreign jurisdictions, partially offset by valuation allowance. We also had federal, state and foreign tax credit carryforwards of approximately $16.9 million of which a portion has been offset by a valuation allowance. The net operating losses and credits will expire in various years from 2019 and 2038. The federal net operating loss will be carried forward indefinitely.
We are subject to federal, state, local and foreign income taxes. Along with our U.S. subsidiaries, we file a U.S. federal consolidated income tax return. With few exceptions, we are no longer subject to U.S. federal, state, foreign and local income tax examinations by tax authorities for years before 2012. We are currently under examination in the U.S. and various states. We do not anticipate that adjustments as a result of these audits, if any, will have a material impact to our consolidated statement of operations, financial condition, statement of cash flows or earnings per share.
As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets. In 2018, we increased the valuation allowance against net operating losses and credits in multiple state jurisdictions. The valuation allowance related to foreign deferred tax assets was decreased due to utilization of losses in the current year. However, management believes certain foreign losses and deferred tax assets will not be realized and has recorded a valuation allowance related to these assets.
A reconciliation of the beginning and ending amount of unrecognized tax benefits follows:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Beginning unrecognized tax benefit balance | $ | 37,319 | $ | 33,723 | $ | 27,164 | |||||
(Reductions) additions based on tax positions related to current year | (206 | ) | (2,280 | ) | 773 | ||||||
Additions for tax positions of prior years | 735 | 6,688 | 8,396 | ||||||||
Reductions for tax positions of prior years | (488 | ) | (368 | ) | (2,246 | ) | |||||
Settlements | (996 | ) | (444 | ) | (364 | ) | |||||
Ending unrecognized tax benefit balance | $ | 36,364 | $ | 37,319 | $ | 33,723 | |||||
Included in the balance of unrecognized tax benefits at December 31, 2018, is $6.2 million, net of federal benefit, which, if ultimately recognized, will affect our annual effective tax rate.
During the next twelve months, we anticipate that it is reasonably possible that the amount of unrecognized tax benefits could be reduced by approximately $19.7 million either because our tax position will be sustained upon audit or as a result of the expiration of the statute of limitations for specific jurisdictions.
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As of December 31, 2018, we have accrued approximately $3.4 million for the payment of interest for uncertain tax positions and recorded interest expense of approximately $80 thousand for the year then ended, which are excluded from the reconciliation of unrecognized tax benefits presented above. These amounts are net of the reversal of interest expense due to settlement of certain tax positions.
The effect of the tax rate change for items originally recognized in other comprehensive income was properly recorded in tax expense from continuing operations. This results in stranded tax effects in accumulated other comprehensive income at December 31, 2018. Companies can make a policy election to reclassify from accumulated other comprehensive income to retained earnings the stranded tax effects directly arising from the change in the federal corporate tax rate. We did not exercise the option to reclassify stranded tax effects within accumulated other comprehensive income in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act (or portion thereof) is recorded.
Note I— Senior Debt
We are party to a Credit Agreement with BBVA Compass Bank, HSBC, and SunTrust Bank, as syndication agents, JPMorgan Chase Bank, N.A., as administrative agent (the "Agent"), and the several lenders from time to time parties thereto, dated March 19, 2014, as amended on February 1, 2016, September 30, 2016, March 31, 2017, June 6, 2017, and December 12, 2018 (the “Fifth Amendment”) and as so amended, (the "Credit Agreement"). The Credit Agreement currently provides a senior credit facility consisting of a $200.0 million revolving credit facility (the "Revolving Facility").
There were no outstanding borrowings under the Term Loans or Revolving Facility at December 31, 2018 and $48.6 million and $85.0 million at December 31, 2017, respectively. Total unamortized debt issuance costs reported in the consolidated balance sheet at December 31, 2018 and 2017 were $2.6 million and $5.2 million, respectively. The Revolving Facility has a scheduled maturity of December 31, 2019.
The debt facilities as of December 31, 2018 and 2017 are as follows:
December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||||
(In thousands) | Facility Maturity | Maximum Facility | Amount Outstanding | Amount Available | Maximum Facility | Amount Outstanding | Amount Available | ||||||||||||||||||
Senior Debt: | |||||||||||||||||||||||||
Term Loan(1) | $ | — | $ | — | $ | — | $ | 225,000 | $ | 48,563 | $ | — | |||||||||||||
Revolving Facility | December 31, 2019 | 200,000 | — | 95,900 | 350,000 | 85,000 | 109,700 | ||||||||||||||||||
Total | 200,000 | — | 95,900 | 575,000 | 133,563 | 109,700 | |||||||||||||||||||
Other indebtedness: | |||||||||||||||||||||||||
Line of credit | August 20, 2019 | 12,500 | — | 12,500 | 12,500 | 5,735 | 6,765 | ||||||||||||||||||
Total | $ | 212,500 | — | $ | 108,400 | $ | 587,500 | 139,298 | $ | 116,465 | |||||||||||||||
Unamortized debt issuance costs | — | (2) | (5,173 | ) | |||||||||||||||||||||
Total senior debt, net | $ | — | $ | 134,125 | |||||||||||||||||||||
(1) During the third quarter of 2018 the outstanding Term Loans were repaid in full.
(2) At December 31, 2018 there was $2.6 million in unamortized debt issuance costs included in other assets on the consolidated balance sheet.
The full amount of the revolving credit facility may be used for the issuance of letters of credit. At December 31, 2018 and 2017, the amounts available under the revolving credit facility were reduced by approximately $92.0 million and $94.0 million, respectively, for our outstanding letters of credit, resulting in availability of $95.9 million in our revolving credit facility, net of Reserves, as defined in the Credit Agreement.
Borrowings under the Revolving Facility bear interest at varying rates equal to either the Eurodollar rate plus 1.50% to 3.00%, or the prime rate plus 0.50% to 2.00% (ABR), at our election. The margins on the Eurodollar loans and on the ABR loans for borrowings under the Revolving Facility, which were 2.00% and 1.00%, respectively, at December 31, 2018, may fluctuate based upon an increase or decrease in our Consolidated Total Leverage Ratio as defined by a pricing grid included in the Credit Agreement. A commitment fee equal to 0.30% to 0.50% of the unused portion of the Revolving Facility is payable quarterly, and fluctuates dependent upon an increase or decrease in our Consolidated Total Leverage Ratio. The commitment fee for the fourth quarter of 2018 was $1.0 million and was equal to 0.50% of the unused portion of the Revolving Facility.
The aggregate outstanding amounts (including after any draw request) under the Revolving Facility may not exceed the Borrowing Base. The Borrowing Base is tied to the Eligible Installment Sales Accounts, Inventory and Eligible Rental Contracts, reduced by
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Reserves, as defined in the Credit Agreement. We provide to the Agent information necessary to calculate the Borrowing Base within 30 days of the end of each calendar month, unless liquidity is less than 20% of the maximum borrowing capacity of the Revolving Facility or $60 million, in which case we must provide weekly information.
Our borrowings under the Credit Agreement are, subject to certain exceptions, secured by a security interest in substantially all of our tangible and intangible assets, including intellectual property, and are also secured by a pledge of the capital stock of our U.S. subsidiaries.
Subject to a number of exceptions, the Credit Agreement contains, without limitation, covenants that generally limit our ability and the ability of our subsidiaries to:
• | incur additional debt; |
• | pay cash dividends in excess of $15 million annually when the Consolidated Total Leverage Ratio is greater than 3.75:1; |
• | incur liens or other encumbrances; |
• | merge, consolidate or sell substantially all property or business; |
• | sell, lease or otherwise transfer assets (if not in the ordinary course of business, limited in any fiscal year to an amount equal to 5% of Consolidated Total Assets as of the last day of the immediately preceding fiscal year); |
• | make investments or acquisitions (unless they meet financial tests and other requirements); or |
• | enter into an unrelated line of business; |
• | guarantee obligations of Foreign Subsidiaries in excess of $10 million at any time; and |
• | exceed an aggregate outstanding amount of $10 million in indebtedness, including Capital Lease Obligations, mortgage financings and purchase money obligations that are secured by Liens permitted under the Credit Agreement. |
In addition, we are prohibited from repurchasing our common stock or 6.625% and 4.75% Senior Notes for the remaining term of the Credit Agreement.
The Credit Agreement permits us to increase the amount of the Revolving Facility from time to time on up to three occasions, in an aggregate amount of no more than $100 million. We may request an Incremental Revolving Loan, provided that at the time of such request, we are not in default, have obtained the consent of the administrative agent and the lenders providing such increase, and after giving effect thereto, (i) the Consolidated Fixed Charge Coverage Ratio on a pro forma basis is no less than 1.10:1, (ii) the Total Revolving Extensions of Credit do not exceed the Borrowing Base, and (iii) if the request occurs during a Minimum Availability Period, the Availability must be more than the Availability Threshold Amount.
The Credit Agreement permits the Agent, in its sole discretion, to make loans to us that it deems necessary or desirable (i) to preserve or protect the Collateral, (ii) to enhance the likelihood of, or maximize the amount of, repayment of the Loans and other Obligations, or (iii) to pay any other amount chargeable to or required to be paid by us pursuant to the terms of the Credit Agreement. The aggregate amount of such Protective Advances outstanding at any time may not exceed $35 million.
In connection with entering into the Fifth Amendment to the Credit Agreement, we recorded a write-down of previously unamortized debt issuance costs of approximately $0.5 million in the fourth quarter of 2018. In addition, we paid arrangement and amendment fees to the Agent and the lenders that provided their consent to the Amendment of approximately $2.1 million, which were capitalized in the fourth quarter of 2018, and will be amortized to interest expense over the remaining term of the agreement.
The Credit Agreement requires us to comply with a Consolidated Fixed Charge Coverage ratio of no less than 1.10:1. Breach of this covenant shall result in a Minimum Availability Period, which requires us to maintain $50.0 million of excess availability on the Revolving Facility.
The table below shows the required and actual ratios under the Credit Agreement calculated as of December 31, 2018:
Required Ratio | Actual Ratio | ||||
Consolidated Fixed Charge Coverage Ratio | No less than | 1.10:1 | 3.64:1 | ||
The actual Consolidated Fixed Charge Coverage ratio was calculated pursuant to the Credit Agreement by dividing the sum of consolidated EBITDA minus Unfinanced Capital Expenditures minus the excess (to the extent positive) of (i) expenses for income taxes paid in cash minus (ii) cash income tax refunds received for the 12-month period ending December 31, 2018 ($156.4 million), by consolidated fixed charges for the 12-month period ending December 31, 2018 ($42.9 million). For purposes of the calculation, “consolidated fixed charges” is defined as the sum of consolidated interest expense and scheduled principal payments on indebtedness actually made during such period. The actual Consolidated Fixed Charge Coverage Ratio of 3.64:1 as of December
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
31, 2018 was above the minimum requirement of 1.10:1 under the Credit Agreement. Availability under our Revolving Facility was $95.9 million at December 31, 2018.
Events of default under the Credit Agreement include customary events, such as a cross-acceleration provision in the event that we default on other debt. In addition, an event of default under the Credit Agreement would occur if a change of control occurs. This is defined to include the case where a third party becomes the beneficial owner of 35% or more of our voting stock or a majority of Rent-A-Center’s Board of Directors are not Continuing Directors (all of the current members of our Board of Directors are Continuing Directors under the terms of the Credit Agreement). An event of default would also occur if one or more judgments were entered against us of $50.0 million or more and such judgments were not satisfied or bonded pending appeal within 30 days after entry.
In addition to the Revolving Facility discussed above, we maintain a $12.5 million unsecured, revolving line of credit with INTRUST Bank, N.A. to facilitate cash management. As of December 31, 2018, we had no outstanding borrowings against this line of credit and $5.7 million outstanding borrowings at December 31, 2017.
Liquidity
As described above, our Revolving Facility is scheduled to mature in December 2019. Our primary liquidity requirements are for rental merchandise purchases. Other capital requirements include expenditures for property assets and debt service. Our primary sources of liquidity have been cash provided by operations. We utilize our Revolving Facility for the issuance of letters of credit, as well as to manage normal fluctuations in operational cash flow caused by the timing of cash receipts. In that regard, we may from time to time draw funds under the Revolving Facility for general corporate purposes. Amounts are drawn as needed due to the timing of cash flows and are generally paid down as cash is generated by our operating activities. We believe cash flow generated from operations, together with availability under our Credit Agreement for the remainder of its term, will be sufficient to fund our operations during the next 12 months.
Note J — Senior Notes
On November 2, 2010, we issued $300.0 million in senior unsecured notes due November 2020, bearing interest at 6.625%, pursuant to an indenture dated November 2, 2010, among Rent-A-Center, Inc., its subsidiary guarantors and The Bank of New York Mellon Trust Company, as trustee. A portion of the proceeds of this offering were used to repay approximately $200.0 million of outstanding term debt under our Prior Credit Agreement. The remaining net proceeds were used to repurchase shares of our common stock. The principal amount of the 6.625% notes outstanding as of December 31, 2018 and 2017, was $292.7 million, reduced by $1.2 million and $1.8 million of unamortized issuance costs, respectively.
On May 2, 2013, we issued $250.0 million in senior unsecured notes due May 2021, bearing interest at 4.75%, pursuant to an indenture dated May 2, 2013, among Rent-A-Center, Inc., its subsidiary guarantors and The Bank of New York Mellon Trust Company, as trustee. A portion of the proceeds of this offering were used to repurchase shares of our common stock under a $200.0 million accelerated stock buyback program. The remaining net proceeds were used to repay outstanding revolving debt under our Prior Credit Agreement. The principal amount of the 4.75% notes outstanding as of December 31, 2018 and 2017, was $250.0 million, reduced by $1.5 million and $2.1 million of unamortized issuance costs, respectively.
The indentures governing the 6.625% notes and the 4.75% notes are substantially similar. Each indenture contains covenants that limit our ability to:
• | incur additional debt; |
• | sell assets or our subsidiaries; |
• | grant liens to third parties; |
• | pay cash dividends or repurchase stock when total leverage is greater than 2.50:1 (subject to an exception for cash dividends in an amount not to exceed $20 million annually); and |
• | engage in a merger or sell substantially all of our assets. |
Events of default under each indenture include customary events, such as a cross-acceleration provision in the event that we default in the payment of other debt due at maturity or upon acceleration for default in an amount exceeding $50.0 million, as well as in the event a judgment is entered against us in excess of $50.0 million that is not discharged, bonded or insured.
The 6.625% notes may be redeemed on or after November 15, 2015, at our option, in whole or in part, at a premium declining from 103.313% (the current premium is 100%). The 6.625% notes may be redeemed on or after November 15, 2018, at our option, in whole or in part, at par. The 6.625% notes also require that upon the occurrence of a change of control (as defined in the 2010
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
indenture), the holders of the notes have the right to require us to repurchase the notes at a price equal to 101% of the original aggregate principal amount, together with accrued and unpaid interest, if any, to the date of repurchase.
The 4.75% notes may be redeemed on or after May 1, 2016, at our option, in whole or in part, at a premium declining from 103.563% (the current premium is 101.188%). The 4.75% notes may be redeemed on or after May 1, 2019, at our option, in whole or in part, at par. The 4.75% notes also require that upon the occurrence of a change of control (as defined in the 2013 indenture), the holders of the notes have the right to require us to repurchase the notes at a price equal to 101% of the original aggregate principal amount, together with accrued and unpaid interest, if any, to the date of repurchase.
Any mandatory repurchase of the 6.625% notes and/or the 4.75% notes would trigger an event of default under our Credit Agreement. We are not required to maintain any financial ratios under either of the indentures.
Rent-A-Center and its subsidiary guarantors have fully, jointly and severally, and unconditionally guaranteed the obligations of Rent-A-Center with respect to the 6.625% notes and the 4.75% notes. Rent-A-Center has no independent assets or operations, and each subsidiary guarantor is 100% owned directly or indirectly by Rent-A-Center. The only direct or indirect subsidiaries of Rent-A-Center that are not guarantors are minor subsidiaries. There are no restrictions on the ability of any of the subsidiary guarantors to transfer funds to Rent-A-Center in the form of loans, advances or dividends, except as provided by applicable law.
Note K — Commitments and Contingencies
Leases
We lease space for all of our Core U.S. and Mexico stores, certain support facilities and the majority of our delivery vehicles under operating leases expiring at various times through 2024. Certain of the store leases contain escalation clauses for increased taxes and operating expenses. Rental expense was $206.3 million, $209.7 million and $231.3 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Future minimum rental payments under operating leases with remaining lease terms in excess of one year at December 31, 2018 are as follows:
(In thousands) | Operating Leases | ||
2019 | $ | 145,345 | |
2020 | 116,785 | ||
2021 | 80,362 | ||
2022 | 47,417 | ||
2023 | 16,460 | ||
Thereafter | 2,280 | ||
Total future minimum rental payments | $ | 408,649 | |
Contingencies
From time to time, the Company, along with our subsidiaries, is party to various legal proceedings arising in the ordinary course of business. We reserve for loss contingencies that are both probable and reasonably estimable. We regularly monitor developments related to these legal proceedings, and review the adequacy of our legal reserves on a quarterly basis. We do not expect these losses to have a material impact on our consolidated financial statements if and when such losses are incurred.
We are subject to unclaimed property audits by states in the ordinary course of business. The property subject to review in this audit process included unclaimed wages, vendor payments and customer refunds. State escheat laws generally require entities to report and remit abandoned and unclaimed property to the state. Failure to timely report and remit the property can result in assessments that could include interest and penalties, in addition to the payment of the escheat liability itself. We routinely remit escheat payments to states in compliance with applicable escheat laws. The negotiated settlements did not have a material impact to our financial statements.
Alan Hall, et. al. v. Rent-A-Center, Inc., et. al.; James DePalma, et. al. v. Rent-A-Center, Inc., et. al. On December 23, 2016, a putative class action was filed against us and certain of our former officers by Alan Hall in the Federal District Court for the Eastern District of Texas in Sherman, Texas. The complaint alleges that the defendants violated Section 10(b) and/or Section 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by issuing false and misleading statements and omitting material facts regarding our business, including implementation of our point-of-sale system, operations and prospects during the period covered by the complaint. A complaint filed by James DePalma also in Sherman, Texas alleging similar claims was
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
consolidated by the court into the Hall matter. On October 8, 2018, the parties agreed to settle this matter for $11 million. The court granted preliminary approval of the settlement on December 13, 2018. Under the terms of the settlement our insurance carrier paid an aggregate of $11 million in cash, subsequent to December 31, 2018, which will be distributed to an agreed upon class of claimants who purchased our common stock from July 27, 2015 through October 10, 2016, as well as used to pay costs of notice and settlement administration, and plaintiffs’ attorneys’ fees and expenses. A hearing to finally approve the settlement is scheduled for May 3, 2019.
Blair v. Rent-A-Center, Inc. This matter is a state-wide class action complaint originally filed on March 13, 2017 in the Federal District Court for the Northern District of California. The complaint alleges various claims, including that our cash sales and total rent to own prices exceed the pricing permitted under the Karnette Rental-Purchase Act. In addition, the plaintiffs allege that we fail to give customers a fully executed rental agreement and that all such rental agreements that were issued to customers unsigned are void under the law. The plaintiffs are seeking statutory damages under the Karnette Rental-Purchase Act which range from $100 - $1,000 per violation, injunctive relief, and attorney’s fees. We believe that these claims are without merit and intend to vigorously defend ourselves. However, we cannot assure you that we will be found to have no liability in this matter.
Vintage Rodeo Parent, LLC, Vintage Rodeo Acquisition, Inc. and Vintage Capital Management, LLC, and B. Riley Financial, Inc. v. Rent-A-Center, Inc. On December 18, 2018, after the Company did not receive an extension notice from Vintage Rodeo Parent, LLC (“Vintage”) that was required by December 17, 2018 to extend the Merger Agreement’s stated End Date, we terminated the Merger Agreement. Our Board of Directors determined that terminating the Merger Agreement was in the best interests of our stockholders, and instructed Rent-A-Center’s management to exercise the Company’s right to terminate the Merger Agreement and make a demand on Vintage for the $126.5 million reverse breakup fee owed to us following the termination of the Merger Agreement. On December 21, 2018, Vintage and its affiliates filed a lawsuit in Delaware Court of Chancery against Rent-A-Center, asserting that the Merger Agreement remained in effect, and that Vintage did not owe Rent-A-Center the $126.5 million reverse breakup fee associated with out termination of the Merger Agreement. B. Riley, a guarantor of the payment of the reverse breakup fee, later joined the lawsuit brought by Vintage in Delaware Court of Chancery. In addition, we brought a counterclaim against Vintage and B. Riley asserting our right to payment of the reverse breakup fee.
On February 11th and 12th of 2019, a trial was held in Delaware Court of Chancery in the lawsuit arising from Rent-A-Center's termination of the Merger Agreement. While it is difficult to predict the outcome of litigation, we believe Rent-A-Center, under the express and unambiguous language of that agreement, had a clear right to terminate the Merger Agreement and that it is entitled to the $126.5 million reverse breakup fee. Oral argument on the parties' post-trial briefs is scheduled for Monday, March 11th.
In the event that the Merger Agreement is reinstated by the court and the transaction is completed, we expect to pay estimated financial advisory fees of approximately $15 million.
Note L — Other Charges
2018 Cost Savings Initiatives. During the year ended December 31, 2018, we began execution of multiple cost savings initiatives, including reductions in overhead and supply chain, resulting in pre-tax charges of $13.1 million in severance and other payroll-related costs, $6.8 million in contract termination fees, $2.3 million in other miscellaneous shutdown costs, $3.4 million in lease obligation costs, $1.9 million in legal and advisory fees, $1.9 million related to the write-down of capitalized software, and $1.0 million in disposal of fixed assets.
Store Consolidation Plan. During the year ended December 31, 2018, we closed 138 Core U.S. stores and 9 locations in Mexico, resulting in pre-tax charges of $11.2 million, consisting of $8.1 million in lease obligation costs, $1.6 million in disposal of fixed assets, $1.3 million in other miscellaneous shutdown costs, and $0.2 million in severance and other payroll-related cost.
Write-down of Capitalized Software. During 2018 and 2017, we discontinued certain IT software projects and as a result incurred pre-tax charges of $1.2 million and $18.2 million, respectively, related to the write-down of capitalized assets and termination of associated license agreements.
Effects of Hurricanes. During the second half of 2018, Hurricane Florence and Michael caused damage in North Carolina, South Carolina, and Florida resulting in pre-tax expenses of approximately $0.6 million for inventory losses, store repair costs, fixed asset write-offs, and employee assistance. During the third quarter of 2017, Hurricanes Harvey, Irma and Maria caused significant damage in the continental United States and surrounding areas, including Texas, Florida, and Puerto Rico, resulting in pre-tax expenses of approximately $4.5 million for inventory losses, store repair costs, fixed asset write-offs, and employee assistance. Approximately $2.1 million of these pre-tax expenses related to Hurricanes Harvey and Irma, while the remaining $2.4 million related to Hurricane Maria.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Acceptance Now Store Closures. During the first six months of 2017, we closed 319 Acceptance Now manned locations and 9 Acceptance Now direct locations, related to the hhgregg bankruptcy and liquidation plan and the Conn's referral contract termination. These closures resulted in pre-tax charges of $19.2 million for the year ended December 31, 2017, consisting primarily of rental merchandise losses, disposal of fixed assets, and other miscellaneous labor and shutdown costs. In addition, we recorded a pre-tax impairment charge of $3.9 million to our intangible assets for our discontinued vendor relationship.
Corporate Cost Rationalization. During the first nine months of 2017, we executed a head count reduction that impacted approximately 10% of our field support center workforce. This resulted in pre-tax charges for severance and other payroll-related costs of approximately $3.4 million for the year ended December 31, 2017.
Core U.S. Store and Acceptance Now Consolidation Plan. During the second quarter of 2016, we closed 167 Core U.S. stores and 96 Acceptance Now locations, resulting in pre-tax charges of $20.1 million consisting of lease obligation costs, disposal of fixed assets, and other miscellaneous shutdown costs.
Mexico Store Consolidation Plan. During the first quarter of 2016, we closed 14 stores in Mexico, resulting in pre-tax charges of $2.3 million in the Mexico segment for disposal of rental merchandise, disposal of fixed assets and leasehold improvements, and other miscellaneous shutdown costs.
Claims Settlement. In the fourth quarter of 2016, we recognized a gain of $2.2 million related to a legal claims settlement.
Activity with respect to other charges for the years ended December 31, 2017 and 2018 is summarized in the below table:
(In thousands) | Accrued Charges at December 31, 2016 | Charges & Adjustments | Payments | Accrued Charges at December 31, 2017 | Charges & Adjustments | Payments | Accrued Charges at December 31, 2018 | ||||||||||||||||||||
Cash charges: | |||||||||||||||||||||||||||
Labor reduction costs | $ | 1,393 | $ | 3,765 | $ | (3,484 | ) | $ | 1,674 | $ | 13,321 | $ | (7,372 | ) | $ | 7,623 | |||||||||||
Lease obligation costs | 6,628 | 457 | (4,980 | ) | 2,105 | 11,952 | (9,175 | ) | 4,882 | ||||||||||||||||||
Contract termination costs | — | — | — | — | 6,750 | (6,750 | ) | — | |||||||||||||||||||
Other miscellaneous | — | 723 | (723 | ) | — | 2,696 | (2,696 | ) | — | ||||||||||||||||||
Total cash charges | $ | 8,021 | 4,945 | $ | (9,187 | ) | $ | 3,779 | 34,719 | $ | (25,993 | ) | $ | 12,505 | |||||||||||||
Non-cash charges: | |||||||||||||||||||||||||||
Rental merchandise losses | 18,417 | 620 | |||||||||||||||||||||||||
Asset impairments, including capitalized software | 19,237 | 6,825 | |||||||||||||||||||||||||
Impairment of intangible asset | 3,896 | — | |||||||||||||||||||||||||
Other(1) | 12,724 | 17,160 | |||||||||||||||||||||||||
Total other charges | $ | 59,219 | $ | 59,324 | |||||||||||||||||||||||
(1) Other primarily includes incremental legal and advisory fees associated with our strategic review and merger related activities, partially offset by insurance claims recoveries related to 2017 hurricanes for the year ended December 31, 2018 and primarily includes incremental legal and advisory fees, effects of hurricanes, and legal settlements for the year ended December 31, 2017.
Note M — Stock-Based Compensation
We maintain long-term incentive plans for the benefit of certain employees and directors. Our plans consist of the Rent-A-Center, Inc. 2006 Long-Term Incentive Plan (the “2006 Plan”), the Rent-A-Center, Inc. 2006 Equity Incentive Plan (the “Equity Incentive Plan”), and the Rent-A-Center 2016 Long-Term Incentive Plan (the "2016 Plan") which are collectively known as the “Plans.”
On March 9, 2016, upon the recommendation of the Compensation Committee, the Board adopted, subject to stockholder approval, the 2016 Plan and directed that it be submitted for the approval of the stockholders. On June 2, 2016, the stockholders approved the 2016 Plan. The 2016 Plan authorizes the issuance of a total of 6,500,000 shares of common stock. Any shares of common stock granted in connection with an award of stock options or stock appreciation rights will be counted against this limit as one share and any shares of common stock granted in connection with awards of restricted stock, restricted stock units, deferred stock or similar forms of stock awards other than stock options and stock appreciation rights will be counted against this limit as two shares of common stock for every one share of common stock granted in connection with such awards. No shares of common stock will be deemed to have been issued if (1) such shares covered by the unexercised portion of an option that terminates, expires, or is cancelled or settled in cash or (2) such shares are forfeited or subject to awards that are forfeited, canceled, terminated or settled
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
in cash. In any calendar year, (1) no employee will be granted options and/or stock appreciation rights for more than 800,000 shares of common stock; (2) no employee will be granted performance-based equity awards under the 2016 Plan (other than options and stock appreciation rights), covering more than 800,000 shares of common stock; and (3) no employee will be granted performance-based cash awards for more than $5,000,000. At December 31, 2018 and 2017, there were 2,625,206 and 1,705,660 shares, respectively, allocated to equity awards outstanding in the 2016 Plan.
The 2006 Plan authorizes the issuance of 7,000,000 shares of Rent-A-Center’s common stock that may be issued pursuant to awards granted under the 2006 Plan, of which no more than 3,500,000 shares may be issued in the form of restricted stock, deferred stock or similar forms of stock awards which have value without regard to future appreciation in value of or dividends declared on the underlying shares of common stock. In applying these limitations, the following shares will be deemed not to have been issued: (1) shares covered by the unexercised portion of an option that terminates, expires, or is canceled or settled in cash, and (2) shares that are forfeited or subject to awards that are forfeited, canceled, terminated or settled in cash. At December 31, 2018 and 2017, there were 1,022,482 and 1,554,931 shares, respectively, allocated to equity awards outstanding in the 2006 Plan. The 2006 Plan expired in accordance with its terms on March 24, 2016, and all shares remaining available for grant under the 2006 Plan were canceled.
We acquired the Equity Incentive Plan (formerly known as the Rent-Way, Inc. 2006 Equity Incentive Plan) in conjunction with our acquisition of Rent-Way in 2006. There were 2,468,461 shares of our common stock reserved for issuance under the Equity Incentive Plan. There were 677,074 and 1,037,514 shares allocated to equity awards outstanding in the Equity Incentive Plan at December 31, 2018 and 2017, respectively. The Equity Incentive Plan expired in accordance with its terms on January 13, 2016, and all shares remaining available for grant under the Equity Incentive Plan were canceled.
Options granted to our employees generally become exercisable over a period of 1 to 4 years from the date of grant and may be exercised up to a maximum of 10 years from the date of grant. Options granted to directors were immediately exercisable.
We grant restricted stock units to certain employees that vest after a three-year service requirement has been met. We recognize expense for these awards using the straight-line method over the requisite service period based on the number of awards expected to vest. We also grant performance-based restricted stock units that vest between 0% and 200% depending on our stock performance against an index using a total shareholder return formula established at the date of grant for the subsequent three-year period. We record expense for these awards over the requisite service period, net of the expected forfeiture rate, since the employee must maintain employment to vest in the award.
Stock-based compensation expense for the years ended December 31, 2018, 2017 and 2016 is as follows:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Stock options | $ | 1,388 | $ | 2,023 | $ | 2,954 | |||||
Restricted share units | 4,573 | 1,873 | 6,255 | ||||||||
Total stock-based compensation expense | 5,961 | 3,896 | 9,209 | ||||||||
Tax benefit recognized in the statements of earnings | 1,739 | 1,442 | 658 | ||||||||
Stock-based compensation expense, net of tax | $ | 4,222 | $ | 2,454 | $ | 8,551 | |||||
We issue new shares of stock to satisfy option exercises and the vesting of restricted stock units.
The fair value of unvested options that we expect to result in compensation expense was approximately $2.4 million with a weighted average number of years to vesting of 2.52 at December 31, 2018.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Information with respect to stock option activity related to the Plans for the year ended December 31, 2018 follows:
Equity Awards Outstanding | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | Aggregate Intrinsic Value (In thousands) | |||||||||
Balance outstanding at January 1, 2018 | 2,953,694 | $ | 21.34 | |||||||||
Granted | 522,731 | 8.73 | ||||||||||
Exercised | (137,509 | ) | 10.19 | |||||||||
Forfeited | (373,690 | ) | 12.79 | |||||||||
Expired | (496,326 | ) | 27.40 | |||||||||
Balance outstanding at December 31, 2018 | 2,468,900 | $ | 19.37 | 6.06 | $ | 2,090 | ||||||
Exercisable at December 31, 2018 | 1,424,800 | $ | 25.81 | 4.38 | $ | 2,090 | ||||||
The intrinsic value of options exercised during the years ended December 31, 2018 and 2017 was $418.9 thousand and $53.3 thousand, respectively, resulting in tax benefits of $146.6 thousand and $18.7 thousand, respectively, which are reflected as an outflow from operating activities and an inflow from financing activities in the consolidated statements of cash flows. There were no options exercised during the year ended December 31, 2016.
The weighted average fair values of the options granted under the Plans were calculated using the Black-Scholes method. The weighted average grant date fair value and weighted average assumptions used in the option pricing models are as follows:
Year Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Weighted average grant date fair value | $ | 3.80 | $ | 2.92 | $ | 3.06 | |||||
Weighted average risk free interest rate | 2.51 | % | 1.78 | % | 1.31 | % | |||||
Weighted average expected dividend yield | — | % | 3.03 | % | 3.16 | % | |||||
Weighted average expected volatility | 49.58 | % | 45.44 | % | 39.64 | % | |||||
Weighted average expected life (in years) | 4.63 | 4.50 | 4.63 | ||||||||
Information with respect to non-vested restricted stock unit activity follows:
Restricted Awards Outstanding | Weighted Average Grant Date Fair Value | |||||
Balance outstanding at January 1, 2018 | 1,344,411 | $ | 10.87 | |||
Granted | 1,188,565 | 8.73 | ||||
Vested | (188,029 | ) | 23.34 | |||
Forfeited | (489,085 | ) | 8.66 | |||
Balance outstanding at December 31, 2018 | 1,855,862 | $ | 8.82 | |||
Restricted stock units are valued using the closing price reported by the Nasdaq Global Select Market on the trading day immediately preceding the day of the grant. Unrecognized compensation expense for unvested restricted stock units at December 31, 2018, was approximately $7.3 million expected to be recognized over a weighted average period of 1.84 years.
Note N — Deferred Compensation Plan
The Rent-A-Center, Inc. Deferred Compensation Plan (the “Deferred Compensation Plan”) is an unfunded, nonqualified deferred compensation plan for a select group of our key management personnel and highly compensated employees. The Deferred Compensation Plan first became available to eligible employees in July 2007, with deferral elections taking effect as of August 3, 2007.
The Deferred Compensation Plan allows participants to defer up to 50% of their base compensation and up to 100% of any bonus compensation. Participants may invest the amounts deferred in measurement funds that are the same funds offered as the investment options in the Rent-A-Center, Inc. 401(k) Retirement Savings Plan. We may make discretionary contributions to the Deferred Compensation Plan, which are subject to a three-year graded vesting schedule based on the participant’s years of service with us.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We are obligated to pay the deferred compensation amounts in the future in accordance with the terms of the Deferred Compensation Plan. Assets and associated liabilities of the Deferred Compensation Plan are included in prepaid and other assets and accrued liabilities in our consolidated balance sheets. For the years ended December 31, 2018, 2017 and 2016, we made matching cash contributions of approximately $50 thousand, $100 thousand and $300 thousand, respectively, which represents 50% of the employees’ contributions to the Deferred Compensation Plan up to an amount not to exceed 6% of each employee's respective compensation. No other discretionary contributions were made for the years ended December 31, 2018, 2017 and 2016. The deferred compensation plan assets and liabilities were approximately $8.7 million and $11.3 million as of December 31, 2018 and 2017, respectively.
Note O — 401(k) Plan
We sponsor a defined contribution plan under Section 401(k) of the Internal Revenue Code for certain employees who have completed at least three months of service. Employees may elect to contribute up to 50% of their eligible compensation on a pre-tax basis, subject to limitations. We may make discretionary contributions to the 401(k) plan. Employer matching contributions are subject to a three-year graded vesting schedule based on the participant's years of service with us. For the years ended December 31, 2018, 2017 and 2016, we made matching cash contributions of $6.3 million, $7.0 million and $7.6 million, respectively, which represents 50% of the employees’ contributions to the 401(k) plan up to an amount not to exceed 6% of each employee's respective compensation. Employees are permitted to elect to purchase our common stock as part of their 401(k) plan. As of December 31, 2018 and 2017, 6.2% and 6.0%, respectively, of the total plan assets consisted of our common stock.
Note P — Fair Value
We follow a three-tier fair value hierarchy, which classifies the inputs used in measuring fair values, in determining the fair value of our non-financial assets and non-financial liabilities, which consist primarily of goodwill. These tiers include: Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. There were no changes in the methods and assumptions used in measuring fair value during the period.
At December 31, 2018, our financial instruments include cash and cash equivalents, receivables, payables, senior debt and senior notes. The carrying amount of cash and cash equivalents, receivables and payables approximates fair value at December 31, 2018 and 2017, because of the short maturities of these instruments. Our senior debt is variable rate debt that re-prices frequently and entails no significant change in credit risk and, as a result, fair value approximates carrying value.
The fair value of our senior notes is based on Level 1 inputs and was as follows at December 31, 2018 and 2017:
December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||
(In thousands) | Carrying Value | Fair Value | Difference | Carrying Value | Fair Value | Difference | |||||||||||||||||
6.625% senior notes | $ | 292,740 | $ | 285,509 | $ | (7,231 | ) | $ | 292,740 | $ | 278,835 | $ | (13,905 | ) | |||||||||
4.75% senior notes | 250,000 | 239,050 | (10,950 | ) | 250,000 | 237,500 | (12,500 | ) | |||||||||||||||
Total senior notes | $ | 542,740 | $ | 524,559 | $ | (18,181 | ) | $ | 542,740 | $ | 516,335 | $ | (26,405 | ) | |||||||||
Note Q — Stock Repurchase Plan
Under our current common stock repurchase program, our Board of Directors has authorized the purchase, from time to time, in the open market and privately negotiated transactions, of up to an aggregate of $1.25 billion of Rent-A-Center common stock. We have repurchased a total of 36,994,653 shares of Rent-A-Center common stock for an aggregate purchase price of $994.8 million as of December 31, 2018. No shares were repurchased during 2018 and 2017.
Common stock repurchases are currently prohibited under the Fifth Amendment to our Credit Agreement. Please see Note I for further discussion of this restriction.
Note R — Segment Information
The operating segments reported below are the segments for which separate financial information is available and for which segment results are evaluated by the chief operating decision makers. Our operating segments are organized based on factors including, but not limited to, type of business transactions, geographic location and store ownership. All operating segments offer merchandise from four basic product categories: consumer electronics, appliances, computers (including tablets), and furniture
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(including accessories), and our Core U.S., Mexico and franchising segments also offer smartphones. Reportable segments and their respective operations are defined as follows.
Our Core U.S. segment primarily operates rent-to-own stores in the United States and Puerto Rico whose customers enter into weekly, semi-monthly or monthly rental purchase agreements, which renew automatically upon receipt of each payment. We retain the title to the merchandise during the term of the rental purchase agreement and ownership passes to the customer if the customer has continuously renewed the rental purchase agreement through the end of the term or exercises a specified early purchase option. This segment also includes the 44 stores operating in two states that utilize a retail model which generates installment credit sales through a retail sale transaction. Segment assets include cash, receivables, rental merchandise, property assets and other intangible assets.
Our Acceptance Now segment operates kiosks within various traditional retailers’ locations where we generally offer the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer. The transaction offered is generally similar to that of the Core U.S. segment; however, the majority of the customers in this segment enter into monthly rather than weekly agreements. Segment assets include cash, rental merchandise, property assets, goodwill and other intangible assets.
Our Mexico segment currently consists of our company-owned rent-to-own stores in Mexico. The nature of this segment's operations and assets are the same as our Core U.S. segment.
The stores in our Franchising segment use Rent-A-Center’s, ColorTyme’s or RimTyme’s trade names, service marks, trademarks and logos, and operate under distinctive operating procedures and standards. Franchising’s primary source of revenue is the sale of rental merchandise to its franchisees who, in turn, offer the merchandise to the general public for rent or purchase under a rent-to-own program. As franchisor, Franchising receives royalties of 2.0% to 6.0% of the franchisees' monthly gross revenue and initial fees for new locations. Segment assets include cash, franchise fee receivables, property assets and intangible assets.
Segment information as of and for the years ended December 31, 2018, 2017 and 2016 is as follows:
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Revenues | |||||||||||
Core U.S. | $ | 1,855,712 | $ | 1,835,422 | $ | 2,069,725 | |||||
Acceptance Now | 722,562 | 797,987 | 817,814 | ||||||||
Mexico | 49,613 | 47,005 | 50,927 | ||||||||
Franchising | 32,578 | 22,126 | 24,786 | ||||||||
Total revenues | $ | 2,660,465 | $ | 2,702,540 | $ | 2,963,252 | |||||
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Gross profit | |||||||||||
Core U.S. | $ | 1,299,809 | $ | 1,276,212 | $ | 1,467,679 | |||||
Acceptance Now | 339,616 | 400,002 | 422,381 | ||||||||
Mexico | 34,364 | 32,592 | 35,549 | ||||||||
Franchising | 14,379 | 9,736 | 9,440 | ||||||||
Total gross profit | $ | 1,688,168 | $ | 1,718,542 | $ | 1,935,049 | |||||
Beginning in 2018, we implemented an intercompany book value adjustment charge for all rental merchandise transfers from Acceptance Now locations to Core U.S. stores. For the twelve months ended December 31, 2018, book value adjustments on intercompany rental merchandise transfers were $12.0 million, resulting in a corresponding increase in gross profit for the Core U.S. and decrease in gross profit for Acceptance Now.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Operating profit (loss) | |||||||||||
Core U.S. | $ | 147,787 | $ | 86,196 | $ | (1,020 | ) | ||||
Acceptance Now | 93,951 | 48,618 | 105,925 | ||||||||
Mexico | 2,605 | (260 | ) | (2,449 | ) | ||||||
Franchising | 4,385 | 5,081 | 5,650 | ||||||||
Total segments | 248,728 | 139,635 | 108,106 | ||||||||
Corporate | (192,591 | ) | (202,694 | ) | (174,702 | ) | |||||
Total operating profit (loss) | $ | 56,137 | $ | (63,059 | ) | $ | (66,596 | ) | |||
Beginning in 2018, we implemented an intercompany book value adjustment charge for all rental merchandise transfers from Acceptance Now locations to Core U.S. stores. For the twelve months ended December 31, 2018, book value adjustments for inventory charge-offs related to intercompany rental merchandise transfers were $2.2 million, resulting in a corresponding increase in operating profit for the Core U.S. and decrease in operating profit for Acceptance Now.
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Depreciation, amortization and write-down of intangibles | |||||||||||
Core U.S.(1) | $ | 25,566 | $ | 31,070 | $ | 39,734 | |||||
Acceptance Now(2) | 1,677 | 2,498 | 3,309 | ||||||||
Mexico | 1,006 | 1,973 | 3,179 | ||||||||
Franchising | 172 | 177 | 177 | ||||||||
Total segments | 28,421 | 35,718 | 46,399 | ||||||||
Corporate | 40,525 | 38,921 | 34,057 | ||||||||
Total depreciation, amortization and write-down of intangibles | $ | 68,946 | $ | 74,639 | $ | 80,456 | |||||
(1) We recorded a goodwill impairment charge of $151.3 million in the Core U.S. segment during the fourth quarter of 2016, not included in the table above.
(2) We recorded an impairment of intangibles of $3.9 million in the Acceptance Now segment during the first quarter of 2017 that is not included in the table above. The impairment charge was recorded to Other Charges in the Consolidated Statement of Operations.
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Capital expenditures | |||||||||||
Core U.S. | $ | 17,173 | $ | 26,506 | $ | 20,802 | |||||
Acceptance Now | 203 | 2,723 | 2,330 | ||||||||
Mexico | 295 | 124 | 283 | ||||||||
Total segments | 17,671 | 29,353 | 23,415 | ||||||||
Corporate | 10,291 | 36,107 | 37,728 | ||||||||
Total capital expenditures | $ | 27,962 | $ | 65,460 | $ | 61,143 | |||||
December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
On rent rental merchandise, net | |||||||||||
Core U.S. | $ | 424,829 | $ | 408,993 | $ | 426,845 | |||||
Acceptance Now | 242,978 | 278,443 | 354,486 | ||||||||
Mexico | 16,001 | 14,367 | 13,787 | ||||||||
Total on rent rental merchandise, net | $ | 683,808 | $ | 701,803 | $ | 795,118 | |||||
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Held for rent rental merchandise, net | |||||||||||
Core U.S. | $ | 117,294 | $ | 156,039 | $ | 192,718 | |||||
Acceptance Now | 1,207 | 4,940 | 7,489 | ||||||||
Mexico | 5,161 | 6,209 | 6,629 | ||||||||
Total held for rent rental merchandise, net | $ | 123,662 | $ | 167,188 | $ | 206,836 | |||||
December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Assets by segment | |||||||||||
Core U.S. | $ | 714,914 | $ | 776,296 | $ | 860,717 | |||||
Acceptance Now | 312,151 | 350,970 | 432,383 | ||||||||
Mexico | 29,321 | 33,529 | 31,415 | ||||||||
Franchising | 4,287 | 3,802 | 2,197 | ||||||||
Total segments | 1,060,673 | 1,164,597 | 1,326,712 | ||||||||
Corporate | 336,244 | 256,184 | 276,029 | ||||||||
Total assets | $ | 1,396,917 | $ | 1,420,781 | $ | 1,602,741 | |||||
December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Assets by country | |||||||||||
United States | $ | 1,366,405 | $ | 1,383,004 | $ | 1,567,933 | |||||
Mexico | 29,321 | 33,529 | 31,415 | ||||||||
Canada | 1,191 | 4,248 | 3,393 | ||||||||
Total assets | $ | 1,396,917 | $ | 1,420,781 | $ | 1,602,741 | |||||
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Rentals and fees by inventory category | |||||||||||
Furniture and accessories | $ | 962,241 | $ | 921,159 | $ | 927,537 | |||||
Consumer electronics | 410,184 | 459,942 | 553,976 | ||||||||
Appliances | 344,548 | 351,893 | 391,539 | ||||||||
Computers | 120,756 | 124,158 | 148,889 | ||||||||
Smartphones | 62,592 | 57,927 | 93,449 | ||||||||
Other products and services | 344,539 | 352,662 | 384,663 | ||||||||
Total rentals and fees | $ | 2,244,860 | $ | 2,267,741 | $ | 2,500,053 | |||||
Year Ended December 31, | |||||||||||
(In thousands) | 2018 | 2017 | 2016 | ||||||||
Revenue by country | |||||||||||
United States | $ | 2,610,432 | $ | 2,654,819 | $ | 2,911,613 | |||||
Mexico | 49,612 | 47,005 | 50,927 | ||||||||
Canada | 421 | 716 | 712 | ||||||||
Total revenues | $ | 2,660,465 | $ | 2,702,540 | $ | 2,963,252 | |||||
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RENT-A-CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note S — Earnings Per Common Share
Summarized basic and diluted earnings per common share were calculated as follows:
Year Ended December 31, | |||||||||||
(In thousands, except per share data) | 2018 | 2017 | 2016 | ||||||||
Numerator: | |||||||||||
Net earnings (loss) | $ | 8,492 | $ | 6,653 | $ | (105,195 | ) | ||||
Denominator: | |||||||||||
Weighted-average shares outstanding | 53,471 | 53,282 | 53,121 | ||||||||
Effect of dilutive stock awards(1) | 1,071 | 562 | — | ||||||||
Weighted-average dilutive shares | 54,542 | 53,844 | 53,121 | ||||||||
Basic earnings (loss) per share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | ||||
Diluted earnings (loss) per share | $ | 0.16 | $ | 0.12 | $ | (1.98 | ) | ||||
Anti-dilutive securities excluded from diluted earnings (loss) per common share: | |||||||||||
Anti-dilutive restricted share units | — | — | 482 | ||||||||
Anti-dilutive performance share units | 200 | 329 | 880 | ||||||||
Anti-dilutive stock options | 1,498 | 2,554 | 3,072 | ||||||||
(1) | There was no dilutive effect to the loss per common share for the year ended December 31, 2016 due to the net loss incurred for the period. |
Note T — Unaudited Quarterly Data
Summarized quarterly financial data for the years ended December 31, 2018, and 2017 is as follows:
(In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
Year Ended December 31, 2018 | |||||||||||||||
Revenues | $ | 698,043 | $ | 655,730 | $ | 644,942 | $ | 661,750 | |||||||
Gross profit | 436,978 | 423,886 | 407,740 | 419,564 | |||||||||||
Operating profit (loss) | (10,270 | ) | 27,151 | 25,632 | 13,624 | ||||||||||
Net (loss) earnings | (19,843 | ) | 13,753 | 12,918 | 1,664 | ||||||||||
Basic (loss) earnings per common share | $ | (0.37 | ) | $ | 0.26 | $ | 0.24 | $ | 0.03 | ||||||
Diluted (loss) earnings per common share | $ | (0.37 | ) | $ | 0.25 | $ | 0.24 | $ | 0.03 | ||||||
(In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
Year Ended December 31, 2017 | |||||||||||||||
Revenues | $ | 741,986 | $ | 677,635 | $ | 643,965 | $ | 638,954 | |||||||
Gross profit | 462,663 | 432,533 | 412,465 | 410,881 | |||||||||||
Operating profit (loss) | 1,152 | (873 | ) | (8,445 | ) | (54,893 | ) | ||||||||
Net earnings (loss) | (6,679 | ) | (8,893 | ) | (12,599 | ) | 34,824 | ||||||||
Basic earnings (loss) per common share | $ | (0.13 | ) | $ | (0.17 | ) | $ | (0.24 | ) | $ | 0.65 | ||||
Diluted earnings (loss) per common share | $ | (0.13 | ) | $ | (0.17 | ) | $ | (0.24 | ) | $ | 0.65 | ||||
Cash dividends declared per common share | $ | 0.08 | $ | 0.08 | $ | — | $ | — | |||||||
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
In accordance with Rule 13a-15(b) under the Securities Exchange Act of 1934, an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that, as of December 31, 2018, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were effective.
Management’s Annual Report on Internal Control over Financial Reporting
Please refer to Management’s Annual Report on Internal Control over Financial Reporting in Part II, Item 8, of this Annual Report on Form 10-K.
Auditor's Report Relating to Effectiveness of Internal Control over Financial Reporting
Please refer to the Report of Independent Registered Public Accounting Firm in Part II, Item 8, of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
For the year ended December 31, 2018, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that, in the aggregate, have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.(*)
Item 11. Executive Compensation.(*)
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.(*)
Item 13. Certain Relationships and Related Transactions, and Director Independence.(*)
Item 14. Principal Accountant Fees and Services.(*)
* | The information required by Items 10, 11, 12, 13 and 14 is or will be set forth in the definitive proxy statement relating to the 2019 Annual Meeting of Stockholders of Rent-A-Center, Inc., which is to be filed with the SEC pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. This definitive proxy statement relates to a meeting of stockholders involving the election of directors and the portions therefrom required to be set forth in this Form 10-K by Items 10, 11, 12, 13 and 14 are incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K. |
68
PART IV
Item 15. Exhibits and Financial Statement Schedules.
1. Financial Statements
The financial statements included in this report are listed in the Index to Financial Statements in Part II, Item 8, of this Annual Report on Form 10-K.
2. Financial Statement Schedules
Schedules for which provision is made in the applicable accounting regulations of the SEC are either not required under the related instructions or inapplicable.
3. Exhibits
Exhibit No. | Description |
2.1 | |
3.1 | |
3.2 | |
3.3 | |
3.4 | |
4.1 | |
4.2 | |
4.3 | |
4.4 | |
10.1† | |
10.2 | |
10.3† | |
10.4† | |
69
10.5† | |
10.6† | |
10.7† | |
10.8† | |
10.9† | |
10.10† | |
10.11† | |
10.12† | |
10.13† | |
10.14† | |
10.15† | |
10.16† | |
10.17† | |
10.18† | |
10.19† | |
10.20† | |
10.21† | |
10.22 | |
70
10.23† | |
10.24 | |
10.25 | |
10.26 | |
10.27 | |
10.28 | |
10.29 | |
10.30† | |
10.31† | |
10.32† | |
10.33 | |
10.34† | |
10.35 | |
10.36 | |
10.37 | |
71
10.38† | |
10.39 | |
10.4 | |
18.1 | |
21.1 | |
23.1* | |
31.1* | |
31.2* | |
32.1* | |
32.2* | |
101.INS* | XBRL Instance Document |
101.SCH* | XBRL Taxonomy Extension Schema Document |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
† | Management contract or compensatory plan or arrangement. |
* | Filed herewith. |
** | The XBRL-related information in Exhibit No. 101 to this Annual Report on Form 10-K is filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. |
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
RENT-A-CENTER, INC. | ||
By: | /s/ MITCHELL E. FADEL | |
Mitchell E. Fadel | ||
Chief Executive Officer | ||
Date: March 1, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature | Title | Date | ||
/s/ MITCHELL E. FADEL | Chief Executive Officer and Director (Principal Executive Officer) | March 1, 2019 | ||
Mitchell E. Fadel | ||||
/s/ MAUREEN B. SHORT | Chief Financial Officer (Principal Financial and Accounting Officer) | March 1, 2019 | ||
Maureen B. Short | ||||
/s/ JEFFREY J. BROWN | Director | March 1, 2019 | ||
Jeffrey J. Brown | ||||
/s/ MICHAEL J. GADE | Director | March 1, 2019 | ||
Michael J. Gade | ||||
/s/ CHRISTOPHER B. HETRICK | Director | March 1, 2019 | ||
Christopher B. Hetrick | ||||
/s/ J. V. LENTELL | Director | March 1, 2019 | ||
J. V. Lentell | ||||
73