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RENT A CENTER INC DE - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements The statements, other than statements of historical facts, included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will," "would," "expect," "intend," "could," "estimate," "should," "anticipate" or "believe." We believe the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that these expectations will occur. Our actual future performance could differ materially from such statements. 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; • economic pressures, such as high fuel costs, affecting the disposable income available to our current and potential customers; • changes in the unemployment rate; • difficulties encountered in improving the financial performance of our Core U.S. segment; • our ability to develop and successfully execute the competencies and capabilities which are the focus of our multi-year program designed to transform and modernize our operations; • costs associated with our multi-year program designed to transform and modernize our operations; • our ability to successfully market smartphones and related services to our customers; • our ability to develop and successfully implement virtual or electronic commerce capabilities; • our ability to retain the revenue from customer accounts merged into another store location as a result of the store consolidation plan; • our ability to execute and the effectiveness of the store consolidation; • rapid inflation or deflation in prices of our products; • 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; • uncertainties regarding the ability to open new locations; • our ability to acquire additional stores or customer accounts on favorable terms; • our ability to control costs and increase profitability; • our ability to enhance the performance of acquired stores; • our ability to retain the revenue associated with acquired customer accounts; • 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; • adverse changes in the economic conditions of the industries, countries or markets that we serve; • information technology and data security costs; • our ability to protect the integrity and security of individually identifiable data of our customers and employees; • the impact of any breaches in data security or other disturbances to our information technology and other networks; • changes in our stock price, the number of shares of common stock that we may or may not repurchase, and future dividends, if any; • changes in estimates relating to self-insurance liabilities and income tax and litigation reserves; 16-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES• 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 SEC reports. Additional important factors that could cause our actual results to differ materially from our expectations are discussed under the section "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013, and elsewhere in this Quarterly Report on Form 10-Q. You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Except as required by law, we are not obligated to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events. Our Business We are the largest rent-to-own operator 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, furniture and accessories, under flexible rental purchase agreements with no long-term obligation. We were incorporated in Delaware in 1986. From 1993 to 2006, we pursued an aggressive growth strategy in which we opened new stores and sought to acquire underperforming rent-to-own stores to which we could apply our operating model. As a result of this strategy, the number of our locations grew from 27 to over 3,400 in 2006, primarily through acquisitions. We acquired over 3,300 stores during this period, including approximately 390 of our franchised stores. These acquisitions occurred in approximately 200 separate transactions, including ten transactions in each of which we acquired in excess of 50 locations. In addition, we strategically opened or acquired stores near market areas served by our existing stores to enhance service levels, gain incremental sales and increase market penetration. Historically, we achieved growth in our Core U.S. segment by opening new stores and acquiring underperforming rent-to-own stores to which we could apply our operating model. As a result, the acquired stores have generally experienced more significant revenue growth during the initial periods following their acquisition than in subsequent periods. Although we continue to believe there are attractive opportunities to expand our presence in the U.S. rent-to-own industry and we intend to continue our acquisition strategy of targeting under-performing and under-capitalized rent-to-own stores, the consolidation opportunities in the U.S. rent-to-own industry are more limited than in previous periods during which we experienced significant growth through acquisitions. Therefore, our historical results of operations and period-to-period comparisons of such results and other financial data, including the rate of earnings growth, may not be meaningful or indicative of future results. As our U.S. store base matured, we began to focus on attracting new customers through sources other than our existing U.S. rent-to-own store locations and to seek additional distribution channels for our products and services. One of our current growth strategies is our "Acceptance Now" model. With this model, we operate kiosks within various traditional retailers' locations where we generally offer the rent-to-own transaction to consumers who do not qualify for financing from such retailers. We operated 1,359 Acceptance Now locations at September 30, 2014, and we intend to continue growing the Acceptance Now segment by expanding the number of our retail partners and the number of locations with our existing retail partners. In addition, our strategy includes enhancing our Acceptance Now offering by launching a virtual capability. Capital expenditures related to opening an Acceptance Now kiosk in a retailer's store are very low, since the only fixed assets required are the kiosk and computer equipment. There is no long-term lease associated with these stores and the retailer does not charge us rent. Our operating model is highly agile and dynamic because we can open locations quickly and efficiently, and we can also close locations quickly and efficiently when their performance does not meet our expectations. We recently launched a multi-year program designed to transform and modernize our operations company-wide in order to improve the profitability of the Core U.S. segment while continuing to support our Acceptance Now and Mexico segments. This program is focused on building new competencies and capabilities through a variety of operational and infrastructure initiatives such as introducing a new labor model for our Core U.S. stores, developing a new supply chain, formulating a customer-focused value-based pricing strategy and implementing new technology into our Acceptance Now locations. Total financing requirements of a typical new Acceptance Now kiosk location approximate $350,000, with roughly 80% of that amount relating to the purchase of rental merchandise. A newly opened Acceptance Now location is typically profitable on a monthly basis within seven months after its initial opening, and achieves cumulative break-even profitability in the second year after its initial opening. 17 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Total financing requirements of a typical new Mexico store approximate $610,000, with roughly 50% of that amount relating to the purchase of rental merchandise. A newly opened Mexico store is typically profitable on a monthly basis within 12 months after its initial opening. Historically, a typical Mexico store has achieved cumulative break-even profitability in the third year after its initial opening. As a result of the investment in new stores and kiosk locations and their growth curves described above, our quarterly earnings are impacted by how many new locations we opened during a particular quarter and the quarters preceding it. Rental payments are generally made in advance on a weekly basis in our Core U.S. and Mexico segments and monthly in our Acceptance Now segment and, together with applicable fees, constitute our primary revenue source. 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 corporate and other expenses. 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, Sony, Toshiba and Vizio home electronics; Whirlpool appliances; Acer, Apple, Asus, Dell, Hewlett-Packard, Samsung, Sony and Toshiba computers and/or tablets; HTC and Samsung smartphones; and Albany, Ashley, England, Klaussner, Lane, Standard and Welton furniture. 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 and credit or debit cards. Rental payments are generally made in advance and, together with applicable fees, constitute our primary revenue source. Approximately 83% 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. Payments are made in advance 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 the 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. Repair services are provided through our network of service centers, the cost of which 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. 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 Operating Segments We report four operating segments: Core U.S., Acceptance Now, Mexico and Franchising. As discussed in Note 9 to the consolidated financial statements, we began reporting our Canadian stores in the Core U.S. segment effective January 1, 2014, and now we only report Mexico operations in the segment formerly reported as International. Additional information regarding our operating segments is provided in the Notes to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q. 18 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Core U.S. Our Core U.S. segment, consisting of our company-owned stores located in the United States, Canada and Puerto Rico, is our largest operating segment, comprising approximately 76% of our consolidated net revenues and approximately 69% of our operating profit for the nine-month period ended September 30, 2014. We recently launched a multi-year program designed to transform and modernize our operations company-wide in order to improve the profitability of the Core U.S. segment while continuing to support our Acceptance Now and Mexico segments. This program is focused on building new competencies and capabilities through a variety of operational and infrastructure initiatives such as introducing a new labor model in our Core U.S. stores, developing a new supply chain, formulating a customer-focused value-based pricing strategy and implementing new technology into our Acceptance Now locations. At September 30, 2014, we operated 2,841 company-owned stores nationwide, in Canada and in Puerto Rico, including 45 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 credit investigation for the approval of the rental purchase transaction, applicants who meet the 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 inventory item directly from it 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. Each Acceptance Now kiosk location typically consists 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. Likewise, any exit costs associated with the closure of a Acceptance Now location would also be immaterial on an individual basis. 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 offered for rent at one of our Core U.S. rent-to-own stores. We intend to grow the Acceptance Now segment by increasing both the number of our retail partners and the number of locations with our existing retail partners. In addition, our strategy includes enhancing our Acceptance Now offering by launching a virtual capability. At September 30, 2014, we operated 1,359 kiosk locations inside furniture and electronics retailers located in 40 states and Puerto Rico. Mexico Our Mexico segment currently consists of our company-owned rent-to-own stores in Mexico. At September 30, 2014, we operated 176 stores in Mexico. 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 September 30, 2014, this segment franchised 188 stores in 30 states operating under the Rent-A-Center (103 stores), ColorTyme (57 stores) and RimTyme (28 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 franchise fee up to $35,000 per new location. 19-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Critical Accounting Policies Involving Critical 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 $0.8 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 and vehicle liability insurance policies. 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 September 30, 2014, and December 31, 2013, the amount reserved for losses within our self-insured retentions with respect to workers' compensation, general liability and vehicle liability insurance was $118.3 million and $116.6 million, respectively. 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, or when events or circumstances indicate that impairment may have occurred. 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. During the three months ended September 30, 2014, the Company changed its annual impairment testing date from December 31 to October 1. The Company believes this new date is preferable because it allows for more timely completion of the annual goodwill impairment test prior to the end of our annual financial reporting period. This change in accounting principle does not delay, accelerate or avoid an impairment charge. The Company has 20 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES determined that it will be impracticable to objectively determine projected cash flows and related valuation estimates that would have been used as of each October 1 of prior reporting periods without the use of hindsight. As such, the Company will apply the change in annual goodwill impairment testing date prospectively beginning October 1, 2014. There were no goodwill impairment charges recognized during the three- and nine-month periods ended September 30, 2014 or 2013. Our reporting units are generally our reportable operating segments identified in Note 9 to the consolidated financial statements. At September 30, 2014, the amount of goodwill allocated to the Core U.S. and Acceptance Now segments was approximately $1,312.0 million and $54.4 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 Quarterly Report on Form 10-Q. However, we do not suggest that other general risk factors, such as those discussed in our Annual Report on Form 10-K for the year ended December 31, 2013, and elsewhere in this Quarterly Report on Form 10-Q, 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. Significant Accounting Policies Our significant accounting policies are summarized below and in Note A to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013. Revenue. 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 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. Franchise Revenue. 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. Depreciation of Rental Merchandise. Depreciation of rental merchandise is included in the cost of rentals and fees on our statement of earnings. Generally, we depreciate our rental merchandise using the income forecasting method. 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 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. Cost of Merchandise Sold. Cost of merchandise sold represents the net book value of rental merchandise at the time of sale. Salaries and Other Expenses. Salaries and other expenses include all salaries and wages paid to store-level employees, together with district managers' salaries, payroll taxes and benefits, and travel, as well as all store-level general and administrative expenses and selling, advertising, insurance, occupancy, delivery, charge offs due to customer stolen merchandise, fixed asset depreciation and other operating expenses. 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. Stock-Based Compensation Expense. 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 could include, but are not limited to, expected stock volatility over the term of the award, expected dividend yields and the predicted employee exercise behavior. We base expected life 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 as actual forfeitures occur. Stock 21 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES options are valued using a Black-Scholes pricing model. Restricted stock units are valued using the last trade before the day of the grant. 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 Quarterly Report on Form 10-Q. Overview During 2014, we have continued efforts under our multi-year program designed to transform and modernize our operations company-wide, focusing on introducing a new labor model for our Core U.S. stores, developing a new supply chain, formulating a customer-focused value-based pricing strategy and implementing new technology into our Acceptance Now locations. We also realigned our reporting structure in 2014 to move our remaining Canadian stores to the Core U.S. segment, which were previously reported in the International segment. The accompanying prior-year amounts have been revised to reflect this change, and we now refer to that segment as "Mexico" since only that country's results are reported therein. We continue to grow the Acceptance Now segment, adding a net of 34 Acceptance Now locations in the first nine months of 2014, and we had nine-month year-over-year revenue growth in that segment of 33%. Our Acceptance Now segment provided approximately 21% of our consolidated revenue and 42% of our consolidated operating profit in the first nine months of 2014. Same store sales improved sequentially over the last three quarters in the Core U.S. business, aided by the nationwide roll-out of smartphones in July 2014. Our customers remain under economic pressure and the portfolio in the Core U.S. segment is down year over year due to softer demand. Accordingly, we continually analyze every aspect of our business in an effort to improve operating and financial performance. During the second quarter of 2014, we closed 150 Core U.S. stores and merged those accounts into existing Core U.S. stores which improved profitability but reduced revenues. The investments we are making in our business have resulted in increases in certain of our expenses. Specifically, salaries and other expenses increased by $63.4 million, or 4.9%, to $1,345.3 million for the nine months ended September 30, 2014, as compared to $1,281.9 million in 2013, primarily due to increased expenses associated with the growth of our Acceptance Now segment and the store-level investments we are making under our multi-year transformation program. General and administrative expenses increased by $18.2 million, or 16.0%, to $132.5 million for the nine months ended September 30, 2014, as compared to $114.2 million in 2013, primarily due to the investments we are making at our field support center under our multi-year transformation program. 22 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIESThe following table and the operating segment discussions reflect the revisions to reserves discussed in Note 1 to the consolidated financial statements. Three Months Ended Nine Months Ended September 30, Change September 30, Change (Dollar amounts in thousands) 2014 2013 $ % 2014 2013 $ % Rentals and fees $ 678,190 $ 671,334 $ 6,856 1.0 % $ 2,056,492 $ 2,013,885 $ 42,607 2.1 % Merchandise sales 58,477 53,808 4,669 8.7 % 226,148 227,171 (1,023 ) (0.5 )% Installment sales 18,089 17,474 615 3.5 % 54,499 52,138 2,361 4.5 % Other 6,384 4,483 1,901 42.4 % 14,376 14,244 132 0.9 % Total store revenue 761,140 747,099 14,041 1.9 % 2,351,515 2,307,438 44,077 1.9 % Franchise merchandise sales 6,524 6,396 128 2.0 % 19,811 23,072 (3,261 ) (14.1 )% Franchise royalty income and fees 1,861 1,285 576 44.8 % 5,162 4,062 1,100 27.1 % Total revenues 769,525 754,780 14,745 2.0 % 2,376,488 2,334,572 41,916 1.8 % Cost of rentals and fees 177,208 170,979 6,229 3.6 % 532,590 507,826 24,764 4.9 % Cost of merchandise sold 47,569 42,344 5,225 12.3 % 174,299 175,903 (1,604 ) (0.9 )% Cost of installment sales 6,134 5,983 151 2.5 % 18,874 18,141 733 4.0 % Vendor settlement credit (7,072 ) - (7,072 ) - (7,072 ) - (7,072 ) - Franchise cost of merchandise sold 6,247 6,142 105 1.7 % 18,984 22,072 (3,088 ) (14.0 )% Total cost of revenues 230,086 225,448 4,638 2.1 % 737,675 723,942 13,733 1.9 % Gross profit 539,439 529,332 10,107 1.9 % 1,638,813 1,610,630 28,183 1.7 % Salaries and other 443,874 435,866 8,008 1.8 % 1,345,303 1,281,922 63,381 4.9 % General and administrative 41,617 37,054 4,563 12.3 % 132,471 114,227 18,244 16.0 % Amortization and write-down of intangibles 1,382 639 743 116.3 % 4,174 2,694 1,480 54.9 % Other (gains) and charges 7,743 - 7,743 - 12,120 - 12,120 - Total operating expenses 494,616 473,559 21,057 4.4 % 1,494,068 1,398,843 95,225 6.8 % Operating profit 44,823 55,773 (10,950 ) (19.6 )% 144,745 211,787 (67,042 ) (31.7 )% Finance charges from refinancing - - - - 1,946 - 1,946 - Interest, net 11,781 10,733 1,048 9.8 % 34,497 28,114 6,383 22.7 % Earnings before income taxes 33,042 45,040 (11,998 ) (26.6 )% 108,302 183,673 (75,371 ) (41.0 )% Income tax expense 7,736 17,875 (10,139 ) (56.7 )% 36,606 68,499 (31,893 ) (46.6 )% Net earnings $ 25,306 $ 27,165 $ (1,859 ) (6.8 )% $ 71,696 $ 115,174 $ (43,478 ) (37.7 )% 23-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Consolidated Performance Three Months Ended September 30, 2014, compared to Three Months Ended September 30, 2013 Store Revenue. Total store revenue increased by $14.0 million, or 1.9%, to $761.1 million for the three months ended September 30, 2014, from $747.1 million for the three months ended September 30, 2013. This was primarily due to increases of approximately $36.6 million in the Acceptance Now segment and approximately $6.9 million in the Mexico segment, partially offset by a decrease of approximately $29.5 million in the Core U.S. segment. Same store revenue generally represents revenue earned in 3,512 locations that were operated by us for 13 months or more. Same store revenues increased by $11.4 million, or 1.9%, to $622.9 million for the three months ended September 30, 2014, as compared to $611.6 million in 2013. The increase in same store revenues was attributable to growth in the Acceptance Now and Mexico segments, partially offset by a decrease in the Core U.S. segment. Cost of Rentals and Fees. Cost of rentals and fees consists of depreciation of rental merchandise. Cost of rentals and fees for the three months ended September 30, 2014, increased by $6.2 million, or 3.6%, to $177.2 million, as compared to $171.0 million in 2013. This increase in cost of rentals and fees was primarily attributable to growth in rentals and fees revenue in the Acceptance Now segment, partially offset by a decrease in rentals and fees revenue in the Core U.S. segment. Cost of rentals and fees expressed as a percentage of store rentals and fees revenue increased to 26.1% for the three months ended September 30, 2014, as compared to 25.5% in 2013, driven by increased revenue in the Acceptance Now segment, which has higher costs of rental merchandise, and more aggressive terming strategies in the Core U.S. segment. Cost of Merchandise Sold. Cost of merchandise sold increased by $5.2 million, or 12.3%, to $47.6 million for the three months ended September 30, 2014, from $42.3 million in 2013. The gross margin percent of merchandise sales decreased to 18.7% for the three months ended September 30, 2014, from 21.3% in 2013, driven by increased sales in the Acceptance Now segment, which has higher costs of rental merchandise. Vendor Settlement Credit. During the three months ended September 30, 2014, we recorded a $7.1 million credit for payment to be received as a result of a class-action settlement with the manufacturers of LCD screen displays. Gross Profit. Gross profit increased by $10.1 million, or 1.9%, to $539.4 million for the three months ended September 30, 2014, from $529.3 million in 2013, primarily due to increased store revenue in the Acceptance Now segment and the $7.1 million vendor settlement credit as discussed above. Gross profit as a percentage of total revenue was 70.1% for both the three-month periods ended September 30, 2014 and 2013. Without the $7.1 million class-action settlement discussed above, gross margin as a percentage of total revenue would have been 69.2% for the three months ended September 30, 2014, a decrease of 0.9% from the same period in the prior year, primarily due to the growth in revenues in the Acceptance Now segment, which has lower margins than the Core U.S. segment. Salaries and Other Expenses. Salaries and other expenses increased by $8.0 million, or 1.8%, to $443.9 million for the three months ended September 30, 2014, as compared to $435.9 million in 2013. This increase was primarily attributable to increased expenses associated with the growth of our Acceptance Now segment. Salaries and other expenses expressed as a percentage of total store revenue were 58.3% for both three-month periods ended September 30, 2014 and 2013. General and Administrative Expenses. General and administrative expenses increased by $4.6 million, or 12.3%, to $41.6 million for the three months ended September 30, 2014, as compared to $37.1 million in 2013, primarily due to the investments we are making at our field support center under our multi-year transformation program. General and administrative expenses expressed as a percentage of total revenue increased to 5.4% for the three months ended September 30, 2014, from 4.9% in 2013. Other (Gains) and Charges. As discussed in Note 8 to the consolidated financial statements, we eliminated certain departments and functions in our field support center during the three months ended September 30, 2014, as a part of our multi-year transformation program. The changes resulted in restructuring charges of approximately $2.8 million for severance and other payroll-related costs. We also incurred $0.4 million during the three months ended September 30, 2014, in early lease termination costs related to the closure of 150 stores in the Core U.S. segment during the second quarter of 2014. During the three months ended September 30, 2014, we recorded a $4.6 million impairment charge related to internally-developed computer software that will be placed into service in the fourth quarter of 2014. We determined that certain components developed for our new store management information system would not be utilized. Operating Profit. Operating profit decreased by $11.0 million, or 19.6%, to $44.8 million for the three months ended September 30, 2014, as compared to $55.8 million in 2013. Operating profit as a percentage of total revenue decreased to 5.8% for the three months ended September 30, 2014, from 7.4% in 2013, primarily due to the decrease in revenue and resulting decrease in gross profit in the Core U.S. segment. 24 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Net Interest. Net interest increased by $1.0 million, or 9.8%, to $11.8 million for the three months ended September 30, 2014, as compared to $10.7 million in 2013. This increase is due to increased interest on our senior credit facility. Income Tax Expense. Income tax expense decreased by $10.1 million, or 56.7%, to $7.7 million for the three months ended September 30, 2014, as compared to $17.9 million in 2013. The effective tax rate decreased 16.3% to 23.4% for the three months ended September 30, 2014, from 39.7% for the comparable period in 2013. This decrease resulted from federal credits and adjustments to deferred taxes during the three months ended September 30, 2014. Net Earnings and Earnings per Share. Net earnings decreased by $1.9 million, or 6.8% to $25.3 million for the three months ended September 30, 2014, as compared to $27.2 million in 2013. This decrease was primarily attributable to the decreases in operating profit and the increase in interest discussed above, partially offset by a $10.1 million decrease in income tax expense in 2014 as compared to 2013. Diluted earnings per share for the three months ended September 30, 2014, were $0.48, as compared to $0.50 in 2013. Nine Months Ended September 30, 2014, compared to Nine Months Ended September 30, 2013 Store Revenue. Total store revenue increased by $44.1 million, or 1.9%, to $2,351.5 million for the nine months ended September 30, 2014, from $2,307.4 million for the nine months ended September 30, 2013. This was primarily due to increases of approximately $121.9 million in the Acceptance Now segment and approximately $19.7 million in the Mexico segment, partially offset by a decrease of approximately $97.6 million in the Core U.S. segment. Same store revenue represents revenue earned in 3,971 locations that were operated by us for 13 months or more. Same store revenues increased by $8.9 million, or 0.5%, to $1,942.9 million for the nine months ended September 30, 2014, as compared to $1,934.1 million in 2013. The increase in same store revenues was attributable to growth in the Acceptance Now and Mexico segments, partially offset by a decrease in the Core U.S. segment. Cost of Rentals and Fees. Cost of rentals and fees consists of depreciation of rental merchandise. Cost of rentals and fees for the nine months ended September 30, 2014, increased by $24.8 million, or 4.9%, to $532.6 million, as compared to $507.8 million in 2013. This increase in cost of rentals and fees was primarily attributable to growth in rentals and fees revenue in the Acceptance Now segment in 2014 as compared to 2013, partially offset by a decrease in rentals and fees revenue in the Core U.S. segment. Cost of rentals and fees expressed as a percentage of store rentals and fees revenue increased to 25.9% for the nine months ended September 30, 2014, as compared to 25.2% in 2013, driven by increased revenue in the Acceptance Now segment, which has higher costs of rental merchandise. Cost of Merchandise Sold. Cost of merchandise sold decreased by $1.6 million, or 0.9%, to $174.3 million for the nine months ended September 30, 2014, from $175.9 million in 2013. The gross margin percent of merchandise sales increased to 22.9% for the nine months ended September 30, 2014, from 22.6% in 2013. Vendor Settlement Credit. During the third quarter of 2014, we recorded a $7.1 million credit for payment to be received as a result of a class-action settlement with the manufacturers of LCD screen displays. Gross Profit. Gross profit increased by $28.2 million, or 1.7%, to $1,638.8 million million for the nine months ended September 30, 2014, from $1,610.6 million in 2013, primarily due to increased store revenue in the Acceptance Now segment and the $7.1 million vendor settlement credit as discussed above. Gross profit as a percentage of total revenue remained stable at 69.0% for both of the nine-month periods ended September 30, 2014 and 2013. Without the $7.1 million vendor settlement credit discussed above, gross margin as a percentage of total revenue would have been 68.7% for the nine months ended September 30, 2014, a decrease of 0.3% from the same period in the prior year. Salaries and Other Expenses. Salaries and other expenses increased by $63.4 million, or 4.9%, to $1,345.3 million for the nine months ended September 30, 2014, as compared to $1,281.9 million in 2013. This increase was primarily attributable to increased expenses associated with the growth of our Acceptance Now segment. Salaries and other expenses expressed as a percentage of total store revenue increased to 57.2% for the nine months ended September 30, 2014, from 55.6% in 2013. General and Administrative Expenses. General and administrative expenses increased by $18.2 million, or 16.0%, to $132.5 million for the nine months ended September 30, 2014, as compared to $114.2 million in 2013, primarily due to the investments we are making at our field support center under our multi-year transformation program. General and administrative expenses expressed as a percentage of total revenue increased to 5.6% for the nine months ended September 30, 2014, from 4.9% in 2013. Other (Gains) and Charges. As discussed in Note 8 to the consolidated financial statements, we closed 150 stores in the Core U.S. segment, which resulted in a restructuring charge of $4.8 million during the nine months ended September 30, 2014. This charge included approximately $3.2 million of accelerated depreciation expense for fixed assets, leasehold improvements and write-off of merchandise inventory, $1.3 million in early lease termination costs and $0.3 million of other operating costs to decommission the stores. In addition, we eliminated certain departments and functions in our field support center during the three months ended 25-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES September 30, 2014, as a part of our multi-year transformation program. The changes resulted in restructuring charges of approximately $2.8 million for severance and other payroll-related costs. During the third quarter of 2014, we recorded a $4.6 million impairment charge related to internally-developed computer software that will be placed into service in the fourth quarter of 2014. We determined that certain components developed for our new store management information system would not be utilized. Operating Profit. Operating profit decreased by $67.0 million, or 31.7%, to $144.7 million for the nine months ended September 30, 2014, as compared to $211.8 million in 2013. Operating profit as a percentage of total revenue decreased to 6.1% for the nine months ended September 30, 2014, from 9.1% for 2013, primarily due to the decrease in revenue and resulting decrease in gross profit in the Core U.S. segment. Finance Charges From Refinancing. As discussed in Note 3 to the consolidated financial statements, we refinanced our senior credit facility during March 2014. We recognized a $1.9 million charge in the first quarter of 2014 to write off unamortized financing costs from our previous credit agreement. Net Interest. Net interest expense increased by $6.4 million, or 22.7%, to $34.5 million for the nine months ended September 30, 2014, as compared to $28.1 million in 2013. This increase is due primarily to the additional $250 million of senior unsecured notes that were issued in May 2013, and increased interest on our senior credit facility. Income Tax Expense. Income tax expense decreased by $31.9 million, or 46.6%, to $36.6 million for the nine months ended September 30, 2014, as compared to $68.5 million in 2013. The effective tax rate decreased 3.5% to 33.8% for the nine months ended September 30, 2014, from 37.3% for the comparable period in 2013. This decrease resulted from federal credits and adjustments to deferred taxes during the three months ended September 30, 2014. Net Earnings and Earnings per Share. Net earnings decreased by $43.5 million, or 37.7%, to $71.7 million for the nine months ended September 30, 2014, as compared to $115.2 million in 2013. This decrease was attributable to the decrease in operating profit as discussed above and an $8.3 million increase in net interest and financing charges, partially offset by a $31.9 million decrease in income tax expense as compared to 2013. Diluted earnings per share decreased $0.71, or 34.5%, to $1.35 for the nine months ended September 30, 2014, compared to $2.06 in 2013. Segment Performance Core U.S. segment. Three Months Ended Nine Months Ended September 30, Change September 30, Change (Dollar amounts in thousands) 2014 2013 $ % 2014 2013 $ % Revenues $ 581,600 $ 611,091 $ (29,491 ) (4.8 )% $ 1,808,403 $ 1,905,968 $ (97,565 ) (5.1 )% Gross profit 430,816 444,898 (14,082 ) (3.2 )% 1,319,325 1,371,890 (52,565 ) (3.8 )% Operating profit 27,297 44,073 (16,776 ) (38.1 )% 99,315 176,807 (77,492 ) (43.8 )% Change in same store revenue (3.6 )% (4.9 )% Stores in same store revenue calculation 2,374 2,752 Revenues. The decrease in revenue for the three- and nine-month periods ended September 30, 2014, compared to 2013 was primarily rentals and fees revenue, as well as merchandise sales. The portfolio is down year over year due to softer demand. Same store revenue generally represents revenue earned in stores that were operated by us for 13 months or more. Gross Profit. Gross profit decreased for the three- and nine-month periods ended September 30, 2014, as compared to 2013 primarily due to decreased store revenue as discussed above. Gross profit as a percentage of total segment revenue increased to 74.1% and 73.0% for the three- and nine-month periods ended September 30, 2014, respectively, from 72.8% and 72.0%, respectively in 2013. Without the $7.1 million vendor settlement credit discussed above, gross profit as a percentage of total revenue would have been 72.9% and 72.6% for the three- and nine-month periods ended September 30, 2014, respectively, primarily due to changes in early purchase option pricing. Operating Profit. Operating profit as a percentage of segment revenue decreased to 4.7% and 5.5% for the three- and nine-month periods ended September 30, 2014, respectively, from 7.2% and 9.3%, respectively in 2013. Operating profit decreased as a result of decreased gross profit. Charge offs in our Core U.S. rent-to-own stores due to customer stolen merchandise, expressed as a 26 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIESpercentage of revenues, were approximately 3.4% and 3.0% for the three- and nine-month periods ended September 30, 2014, respectively, as compared to 3.2% and 2.6%, respectively, for the comparable periods in 2013. Acceptance Now segment. Three Months Ended Nine Months Ended September 30, Change September 30, Change (Dollar amounts in thousands) 2014 2013 $ % 2014 2013 $ % Revenues $ 160,388 $ 123,798 $ 36,590 29.6 % $ 490,392 $ 368,454 $ 121,938 33.1 % Gross profit 92,911 74,083 18,828 25.4 % 275,694 209,960 65,734 31.3 % Operating profit 21,242 18,789 2,453 13.1 % 61,218 51,833 9,385 18.1 % Change in same store revenue 25.7 % 25.6 % Stores in same store revenue calculation 1,018 1,091 Revenues. The increase in revenues in the first nine months of 2014 over 2013 was driven by the growth in same store revenue and the net 105 kiosks that we added during the 12 months ended September 30, 2014. This segment contributed approximately 21% of consolidated revenues and approximately 42% of operating profit in the first nine months of 2014 compared to approximately 16% of revenue and 24% of operating profit for the comparable period in 2013. Gross profit. Gross profit increased as a result of increased revenues in this segment. Gross profit as a percentage of revenues was 57.9% and 56.2% for the three- and nine-month periods ended September 30, 2014, respectively, as compared to 59.8% and 57.0% for the comparable periods in 2013. While this margin decreased year over year, margins are still in line with our operating model. Operating profit. Operating profit as a percentage of total segment revenue was 13.2% and 12.5% for the three- and nine-month periods ended September 30, 2014, respectively, compared to 15.2% and 14.1%, respectively, for the comparable periods in 2013. This decrease was due primarily to labor and other expenses associated with the expansion in this segment. Charge-offs in our Acceptance Now locations due to customer stolen merchandise, expressed as a percentage of revenues, were approximately 6.7% and 6.9% for the three- and nine-month periods ended September 30, 2014, respectively, as compared to 5.1% and 4.9%, respectively, for the comparable periods in 2013. The ratio of agreement charge-offs to total agreements in this segment is comparable to the Core U.S. segment but the percentage of revenue is higher, primarily due to the higher cost of rental merchandise in this segment. Mexico segment. Three Months Ended Nine Months Ended September 30, Change September 30, Change (Dollar amounts in thousands) 2014 2013 $ % 2014 2013 $ % Revenues $ 19,152 $ 12,210 $ 6,942 56.9 % $ 52,720 $ 33,016 $ 19,704 59.7 % Gross profit 13,574 8,812 4,762 54.0 % 37,805 23,718 14,087 59.4 % Operating loss (4,884 ) (7,488 ) 2,604 34.8 % (17,979 ) (18,497 ) 518 2.8 % Change in same store revenue 25.9 % 21.2 % Stores in same store revenue calculation 120 128 Revenues. The increase in total revenues for the three- and nine-month periods ended September 30, 2014, over 2013 has been driven by the growth in same store revenue and the net 26 stores that we added during the 12 months ended September 30, 2014. Gross Profit. Gross profit increased for the three- and nine-month periods ended September 30, 2014, compared to 2013 primarily due to increased revenue as discussed above. Gross profit as a percentage of total revenues was 70.9% and 71.7% for the three- and nine-month periods ended September 30, 2014, respectively, compared to 72.2% and 71.8%, respectively, in 2013. Operating Loss. Operating loss as a percentage of total segment revenue decreased to 25.5% and 34.1% for the three-and nine-month periods ended September 30, 2014, respectively, from 61.3% and 56.0%, respectively, for the comparable periods in 2013. We added a net 26 stores in Mexico during the 12 months ended September 30, 2014, and this expansion dilutes operating profit 27 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES due to additional operating expenses, primarily payroll-related. As the older stores in Mexico become profitable, those profits have been offset by the losses experienced in the newly opened stores. Franchising segment. Three Months Ended Nine Months Ended September 30, Change September 30, Change (Dollar amounts in thousands) 2014 2013 $ % 2014 2013 $ % Revenues $ 8,385 $ 7,681 $ 704 9.2 % $ 24,973 $ 27,134 $ (2,161 ) (8.0 )% Gross profit 2,138 1,539 599 38.9 % 5,989 5,062 927 18.3 % Operating profit 1,168 399 769 192.7 % 2,191 1,644 547 33.3 % Revenues. Merchandise sales increased $0.1 million for the three months ended September 30, 2014, from the same period in 2013, due to the launch of smartphones in July 2014, partially offset by a smaller store base. Merchandise sales decreased $3.3 million for the nine months ended September 30, 2014, compared to 2013 due to the rebranding initiative, which decreased overall store count in this segment. Royalty income and fees increased in both periods due to increased royalty rates. Gross Profit. Gross profit as a percentage of revenues increased to 25.5% and 24.0% for the three- and nine-month periods ended September 30, 2014, respectively, from 20.0% and 18.7% respectively, for the comparable periods in 2013, primarily due to an increase in royalty revenue due to the increased royalty fee percentage paid by Rent-A-Center franchisees. Operating Profit. Operating profit as a percentage of total segment revenue increased to 13.9% and 8.8% for the three- and nine-month periods ended September 30, 2014, respectively, compared to 5.2% and 6.1%, respectively, for 2013, primarily due to the increase in gross profit discussed above. Liquidity and Capital Resources Overview. During the nine months ended September 30, 2014, we generated $63.3 million in operating cash flow. We refinanced our senior credit facility, used cash in the amount of $61.7 million for capital expenditures, used $36.5 million for payment of dividends and borrowed a net $58.9 million, ending the nine-month period with $62.0 million of cash and cash equivalents. Analysis of Cash Flow. Cash provided by operating activities decreased $109.6 million to $63.3 million for the nine months ended September 30, 2014, from $172.9 million in 2013. This was primarily attributable to a decrease in net earnings and the timing of cash flows related to income taxes. Cash used in investing activities decreased approximately $17.8 million to $68.2 million for the nine months ended September 30, 2014, from $86.0 million in 2013, due primarily to a reduction in capital expenditures, partially offset by an increase in cash proceeds from the sale of assets. Net cash provided by financing activities was $25.0 million for the nine months ended September 30, 2014, compared to $95.0 million used in financing activities in 2013, a change of $120.0 million. We made no repurchases of our common stock during the nine months ended September 30, 2014, compared to $217.4 million purchased in the comparable period of 2013, partially offset by a reduction in net cash inflows from proceeds and repayments of debt. Liquidity Requirements. Our primary liquidity requirements are for rental merchandise purchases, implementation of our growth strategies, capital expenditures and debt service. Our primary sources of liquidity have been cash provided by operations and borrowings. In the future, to provide any additional funds necessary for the continued operations and expansion of our business, we may incur from time to time additional short-term or long-term bank indebtedness and may issue, in public or private transactions, equity and debt securities. 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. The global financial markets continue to experience volatility and adverse conditions and such conditions in the capital markets may affect our ability to access additional sources of financing. There can be no assurance that additional financing will be available, or if available, that it will be on terms we find acceptable. We believe the cash flow generated from operations, together with amounts available under our Credit Agreement, will be sufficient to fund our liquidity requirements as discussed above during the next 12 months. Our revolving credit facilities, including our $20.0 million line of credit at INTRUST Bank, provide us with revolving loans in an aggregate principal amount not exceeding $695.0 million, of which $398.8 million was available at October 20, 2014, at which date we had $69.7 million in cash. To the extent we have available cash that is not necessary to fund the items listed above, we may declare and pay dividends on our common stock, repurchase additional shares of our common stock or make additional payments to service our existing debt. While our 28 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES 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. A change in control would result in an event of default under our senior credit facilities which would allow our lenders to accelerate the indebtedness owed to them. In addition, if a change in control occurs, we may be required to offer to repurchase all of our outstanding senior unsecured notes at 101% of their principal amount, plus accrued interest to the date of repurchase. Our senior credit facilities restrict our ability to repurchase the senior unsecured notes, including in the event of a change in control. In the event a change in control occurs, we cannot be sure we would have enough funds to immediately pay our accelerated senior credit facilities and senior note obligations or that we would be able to obtain financing to do so on favorable terms, if at all. Deferred Taxes. Certain federal tax legislation enacted during the period 2009 to 2013 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 and had a negative effect on our 2013 cash flow. We estimate the negative effect of these acts in 2013 was $14 million. We estimate that the remaining tax deferral associated with these acts approximates $167 million at December 31, 2013, of which approximately 75%, or $126 million will reverse in 2014, and the remainder will reverse between 2015 and 2016. We intend to reinvest substantially all of the unremitted earnings of our non-U.S. subsidiaries and postpone their remittance indefinitely. Accordingly, no provision for U.S. income taxes for these non-U.S. subsidiaries was recorded in the accompanying Consolidated Statements of Earnings. Merchandise. A reconciliation of merchandise, which includes purchases, follows: Three Months Ended Three Months Ended September 30, 2014 September 30, 2013 (In thousands) Beginning merchandise value $ 1,106,913 $ 1,071,680 Merchandise additions through acquisitions 760 2,187 Purchases 299,827 251,175 Depreciation of rental merchandise (169,823 ) (164,276 ) Cost of goods sold (53,703 ) (48,327 ) Skips and stolens (33,875 ) (27,413 ) Other merchandise deletions (1) (12,190 ) (9,004 ) Ending merchandise value $ 1,137,909 $ 1,076,022 Nine Months Ended Nine Months Ended September 30, 2014 September 30, 2013 (In thousands) Beginning merchandise value $ 1,129,106 $ 1,024,545 Merchandise additions through acquisitions 6,519 4,607 Purchases 841,704 828,136 Depreciation of rental merchandise (509,596 ) (487,412 ) Cost of goods sold (193,173 ) (194,044 ) Skips and stolens (95,079 ) (73,027 ) Other merchandise deletions (1) (41,572 ) (26,783 ) Ending merchandise value $ 1,137,909 $ 1,076,022 (1) Other merchandise deletions include loss/damage waiver claims and unrepairable and missing merchandise, as well as acquisition write-offs. 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 $61.7 million and $73.8 million on capital expenditures during the nine-month periods ended September 30, 2014 and 2013, respectively, and expect to spend an aggregate of approximately $95.0 million in 2014. 29 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Acquisitions and New Location Openings. During the first nine months of 2014, we acquired the assets of one of our suppliers of rental merchandise for approximately $5.5 million, and acquired locations and accounts for approximately $6.9 million in 14 different transactions. The table below summarizes the location activity for the nine-month period ended September 30, 2014. Nine Months Ended September 30, 2014 Core U.S. Acceptance Now Mexico Franchising Total Locations at beginning of period 3,010 1,325 151 179 4,665 New location openings 10 140 30 23 203 Acquired locations remaining open 2 - - - 2 Closed locations Merged with existing locations 163 105 5 - 273 Sold or closed with no surviving location 18 1 - 14 33 Locations at end of period 2,841 1,359 176 188 4,564 Acquired locations closed and accounts merged with existing locations 7 - - - 7 Total approximate purchase price of acquired stores (in thousands) $ 6,913 $ - $ - $ - $ 6,913 Senior Debt. As discussed in Note 3 to the consolidated financial statements, we refinanced our Prior Credit Agreement on March 19, 2014. The following discussion refers to the new Credit Agreement, its Term Loans and its Revolving Facility described therein. The new $900.0 million Credit Agreement consists of $225.0 million, seven-year Term Loans and a $675.0 million, five-year Revolving Facility. The table below shows the scheduled maturity dates of our Term Loans outstanding at September 30, 2014: Year Ending December 31, (In thousands) 2014 $ 563 2015 2,250 2016 2,250 2017 2,250 2018 2,250 Thereafter 214,312 $ 223,875 The full amount of the Revolving Facility may be used for the issuance of letters of credit, of which $111.2 million had been so utilized as of October 20, 2014, at which date $185.0 million was outstanding and $378.8 million was available. The Term Loans are scheduled to mature on March 19, 2021, and the Revolving Facility has a scheduled maturity of March 19, 2019. Borrowings under our Revolving Facility bear interest at varying rates equal to either the Eurodollar rate plus 1.50% to 2.75%, or the ABR rate plus 0.50% to 1.75%, at our election. The margins on the Eurodollar rate and on the ABR rate for borrowings under the Revolving Facility, which were 2.50% and 1.50%, respectively, at October 20, 2014, 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. The weighted average margin for the nine months ended September 30, 2014, was 2.61%. Interest periods range from seven days (for borrowings under the revolving credit facility only) to one, two, three or six months, at our election. The weighted average Eurodollar rate on our outstanding debt was 0.47% at October 20, 2014. The margins on the Eurodollar rate and on the ABR rate for Term Loans, which are 3.00% and 2.00%, respectively, may also fluctuate in the event the all-in pricing for any subsequent incremental Term Loan exceeds the all-in pricing for existing Term Loans by more than 0.50% per annum. 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 leverage ratio. The commitment fee at September 30, 2014, is equal to 0.50% of the unused portion of the Revolving Facility. We have not entered into any interest rate protection agreements with respect to Term Loans under our Credit Agreement. 30 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES 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. The Credit Agreement also permits us to increase the amount of the Term Loans and/or the Revolving Facility from time to time on up to three occasions, in an aggregate amount of no more than $250 million, provided that we are not in default at the time and have obtained the consent of the administrative agent and the lenders providing such increase. Subject to a number of exceptions, the Credit Agreement contains, without limitation, covenants that generally limits our ability and the ability of our subsidiaries to: • incur additional debt; • repurchase capital stock, 6.625% notes and 4.75% notes and/or pay cash dividends (subject to a restricted payments basket under which approximately $84.1 million is available); • incur liens or other encumbrances; • merge, consolidate or sell substantially all property or business; • sell, lease or otherwise transfer assets (other than in the ordinary course of business); • make investments or acquisitions (unless they meet financial tests and other requirements); or • enter into an unrelated line of business. The Credit Agreement requires us to comply with several financial covenants, including: (i) a consolidated total leverage ratio of no greater than 4.50:1 from the quarter ended March 31, 2014, to the quarter ended September 30, 2015, 4.25:1 from the quarter ended December 31, 2015, to the quarter ended September 30, 2016, and 4.00:1 thereafter; (ii) a consolidated senior secured leverage ratio of no greater than 2.75:1; and (iii) a consolidated fixed charge coverage ratio of no less than 1.50:1 from the quarter ended March 31, 2014, to December 31, 2015, and 1.75:1 thereafter. The table below shows the required and actual ratios under the Credit Agreement calculated as of September 30, 2014: Required Ratio Actual Ratio Consolidated total leverage ratio No greater than 4.50:1 3.43:1 Consolidated senior secured leverage ratio No greater than 2.75:1 1.40:1 Consolidated fixed charge coverage ratio No less than 1.50:1 1.78:1 These financial covenants, as well as the related components of their computation, are defined in the Credit Agreement, which is included as an exhibit to our Current Report on Form 8-K dated as of March 20, 2014. In accordance with the Credit Agreement, the consolidated total leverage ratio was calculated by dividing the consolidated funded debt outstanding at September 30, 2014 ($938.2 million) by consolidated EBITDA for the 12-month period ending September 30, 2014 ($273.2 million). For purposes of the covenant calculations, (i) "consolidated funded debt" is defined as outstanding indebtedness less cash in excess of $25.0 million, and (ii) "consolidated EBITDA" is generally defined as consolidated net income (a) plus the sum of income taxes, interest expense, depreciation and amortization expense, extraordinary non-cash expenses or losses, and other non-cash charges, and (b) minus the sum of interest income, extraordinary income or gains, other non-cash income, and cash payments with respect to extraordinary non-cash expenses or losses recorded in prior fiscal quarters. Consolidated EBITDA is a non-GAAP financial measure that is presented not as a measure of operating results, but rather as a measure used to determine covenant compliance under our senior credit facilities. The consolidated senior secured leverage ratio was calculated pursuant to the Credit Agreement by dividing the consolidated senior secured debt outstanding at September 30, 2014 ($381.9 million) by consolidated EBITDA for the 12-month period ending September 30, 2014 ($273.2 million). For purposes of the covenant calculation, "consolidated senior secured debt" is generally defined as the aggregate principal amount of consolidated funded debt that is then secured by liens on property or assets of the Company or its subsidiaries. The consolidated fixed charge coverage ratio was calculated pursuant to the Credit Agreement by dividing consolidated EBITDA for the 12-month period ending September 30, 2014, and to the extent reducing consolidated net earnings for such period, consolidated lease expense ($519.0 million), by consolidated fixed charges for the 12-month period ending September 30, 2014 ($290.9 million). For purposes of the covenant calculation, "consolidated fixed charges" is defined as the sum of consolidated interest expense and consolidated lease expense. 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 situations where a third party becomes the beneficial owner of 35% or more of our voting stock or certain 31 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES changes in the composition of Rent-A-Center's Board of Directors occur. 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. We utilize our revolving credit 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 credit 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. In addition to the senior credit facilities discussed above, we maintain a $20.0 million unsecured, revolving line of credit with INTRUST Bank, N.A. to facilitate cash management. The outstanding balance of this line of credit was $6.3 million and $18.3 million at September 30, 2014, and December 31, 2013, respectively. 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 Credit Agreement. The remaining net proceeds were used to repurchase shares of our common stock. 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 Credit Agreement. 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 (subject to a restricted payment basket under which approximately $84.1 million is available); 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 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 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 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. 32-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES Store Leases. We lease space for substantially all of our rent-to-own stores and certain support facilities under operating leases expiring at various times through 2023. 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. Franchising Guarantees. Our subsidiary, ColorTyme Finance, Inc. ("ColorTyme Finance"), is a party to an agreement with Citibank, N.A., pursuant to which Citibank provides up to $27.0 million in aggregate financing to qualifying franchisees of Franchising. Under the Citibank agreement, upon an event of default by the franchisee under agreements governing this financing and upon the occurrence of certain other events, Citibank can assign the loans and the collateral securing such loans to ColorTyme Finance, with ColorTyme Finance paying or causing to be paid the outstanding debt to Citibank and then succeeding to the rights of Citibank under the debt agreements, including the right to foreclose on the collateral. Rent-A-Center and ColorTyme Finance guarantee the obligations of the franchise borrowers under the Citibank facility. An additional $20.0 million of financing is provided by Texas Capital Bank, National Association ("Texas Capital Bank") under an agreement similar to the Citibank financing, which is guaranteed by Rent-A-Center East, Inc., a subsidiary of Rent-A-Center. The maximum guarantee obligations under these agreements, excluding the effects of any amounts that could be recovered under collateralization provisions, is $47.0 million, of which $15.8 million was outstanding as of September 30, 2014. Contractual Cash Commitments. The table below summarizes debt, lease and other minimum cash obligations outstanding as of September 30, 2014: Payments Due by Period Contractual Cash Obligations Total 2014 2015-2016 2017-2018 Thereafter (In thousands) Senior Debt (including current portion)(1) $ 425,135 $ 563 $ 10,760 $ 4,500 $ 409,312 6.625% Senior Notes(2) 429,188 9,938 39,750 39,750 339,750 4.75% Senior Notes(3) 333,126 5,938 23,750 23,750 279,688 Operating Leases 534,629 47,986 316,070 149,663 20,910 Total(4) $ 1,722,078 $ 64,425 $ 390,330 $ 217,663 $ 1,049,660 (1) Amount referenced does not include interest payments. Our senior credit facilities bear interest at varying rates equal to the Eurodollar rate plus 1.50% to 3.00% or the ABR rate plus 0.50% to 2.00% at our election. The weighted average Eurodollar rate on our outstanding debt at September 30, 2014, was 0.46%. (2) Includes interest payments of $9.9 million on each of May 15 and November 15 of each year. (3) Includes interest payments of $5.9 million on each of May 1 and November 1 of each year. (4) As of September 30, 2014, we have $12.5 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. Repurchases of Outstanding Securities. 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 September 30, 2014, and December 31, 2013, under this common stock repurchase program. No shares were repurchased during the first three quarters of 2014. 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 federal income tax refunds. 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. Effect of New Accounting Pronouncements In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the criteria for identifying a discontinued operation. Under ASU 2014-08, the definition of a discontinued operation is limited to the disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has, or will have, a major effect on an entity's operations and financial results. Rent-A-Center will be required to apply ASU 33-------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES 2014-08 to disposals (or classifications as held for sale) of components of an entity that occur on or after January 1, 2015, and early adoption is permitted only for disposals (or classifications as held for sale) that have not been reported in previously issued financial statements. We plan to adopt this ASU on January 1, 2015, and do not expect this standard to have a significant impact on our financial position, results of operations or cash flows. 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. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. ASU 2014-09 will be effective for Rent-A-Center beginning January 1, 2017, and early adoption is not permitted. The ASU allows adoption with either retrospective application to each prior period presented, or retrospective application with the cumulative effect recognized as of the date of initial application. We are currently in the process of determining what impact, if any, the adoption of this ASU will have on our financial position, results of operations and cash flows, and we are evaluating the transition alternatives. 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk. Interest Rate Sensitivity As of September 30, 2014, we had $300.0 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%. We also had $223.9 million outstanding in term loans, $195.0 million outstanding on our revolving credit facility and $6.3 million outstanding on our INTRUST line of credit, each at interest rates indexed to the Eurodollar rate or the prime rate. The fair value of the 6.625% senior notes, based on the closing price at September 30, 2014, was $284.0 million. The fair value of the 4.75% senior notes, based on the closing price at September 30, 2014, was $206.1 million. Carrying value approximates fair value for all other indebtedness. 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 We have outstanding debt with variable interest rates indexed to prime or Eurodollar rates that exposes us to the risk of increased interest costs if interest rates rise. As of September 30, 2014, we have not entered into any interest rate swap agreements. The credit markets have experienced adverse conditions, including wide fluctuations in rates. Such volatility in the credit markets could increase the costs associated with our existing long-term debt. Based on our overall interest rate exposure at September 30, 2014, a hypothetical 1.0% increase or decrease in interest rates would have the effect of causing a $2.9 million additional pre-tax charge or credit to our statement of earnings. Foreign Currency Translation We are exposed to market risk from foreign exchange rate fluctuations of the Mexican peso and Canadian dollar to the U.S. dollar as the financial position and operating results of our stores in those countries are translated into U.S. dollars for consolidation. Resulting translation adjustments are recorded as a separate component of stockholders' equity. 34 -------------------------------------------------------------------------------- RENT-A-CENTER, INC. AND SUBSIDIARIES |