Upbound : First Quarter 2024 Earnings Call Transcript

Upbound Group, Inc.(Q1 2024 Earnings)

May 02, 2024

Corporate Speakers:

• Jeff Chesnut; Upbound Group, Inc.; Senior Vice President, Strategy & Corporate Development
• Mitchell Fadel; Upbound Group, Inc.; Chief Executive Officer
• Fahmi Karam; Upbound Group, Inc.; Chief Financial Officer

Participants:

• Robert Griffin; Raymond James; Analyst
• Bradley Thomas; Keybanc Capital Markets; Analyst
• Hoang Nguyen; TD Cowen; Analyst
• Unidentified Participant; Jefferies; Analyst
• Alex Fuhrman; Craig-Hallum Capital Group; Analyst
• Anthony Chukumba; Loop Capital Markets; Analyst

PRESENTATION

Operator^ Welcome to the Upbound Group Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Jeff Chesnut.

Jeff Chesnut^ Good morning. And thank you all for joining us to discuss the company's performance for the first quarter of 2024. We issued our earnings release this morning before the market opened and the release and all related materials including a link to the live webcast, are available on our website at investor.upbound.com.

On the call today from Upbound Group, we have Mitchell Fadel, our CEO; and Fahmi Karam, our CFO.

As a reminder, some of the statements provided on this call are forward-looking and subject to factors that could cause actual results to differ materially and adversely from our expectations. These factors are described in our earnings release as well as in the company's SEC filings.

Upbound Group undertakes no obligation to publicly update or revise any forward- looking statements, except as required by law. This call will also include references to non-GAAP financial measures.

Please refer to today's earnings release, which can be found on our website for a description of the non-GAAP financial measures and the reconciliations to the most comparable GAAP financial measures.

Finally, Upbound Group is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. Please refer to our website for the only authorized webcast. With that, I'll turn the call over to Mitch.

Mitchell Fadel^ Thank you, Jeff. And good morning to everyone on the call today.

I'll begin with a review of the key highlights from the first quarter, and then I'll hand it off to Fahmi for a more detailed review of our financial results and our financial outlook. After that, we'll take some questions.

We are very pleased with the start to the year, which included revenues of nearly $1.1 billion, adjusted EBITDA of $109 million and non-GAAP earnings per share of $0.79. The trajectory of our business, which started accelerating last year, continued through the first quarter and into April as both segments grew the top line versus last year.

Similar to the fourth quarter, these results were driven by strong execution across our strategic operating initiatives, namely, growth in Acima merchant count and performance of existing merchants combined with disciplined underwriting decisions, diligent expense management efforts in our emerging direct-to-consumere-commerce channels.

Now before we dive into our segment results, let's discuss some of the enterprise-wide themes we've seen since the start of the year.

First, I'd like to start with what we are seeing in the external environment with our consumers. Broadly speaking, the macroeconomic conditions across the quarter were stable with continued strength in employment metrics, but also with persistent inflation trends that continue to impact our customers' discretionary spending and have altered the market's expectations on the timing and size of potential rate cuts in 2024. This quarter was also affected by tax season, which typically has a positive impact on merchandise sales.

And while the external conditions this quarter were characterized with puts and takes, our consumers are accustomed to navigating uncertainty and have remain resilient through a variety of changes in the macro landscape over the past several years. That resiliency and our focus on execution helped deliver profitable top line growth at lease charge-off rates that were in line with our plans for the quarter.

Now looking ahead, we've discussed how our durable business model can succeed in a variety of macroeconomic environments. When metrics like employment and overall consumer spending are stronger, we expect consumer confidence to drive GMV growth and to support portfolio growth and positive payment behaviors. Conversely, more difficult conditions introduce new consumers to our space through trade down when traditional lending solutions tightened availability of credit.

While we continue to assume stable conditions across the year with elevated inflation persisting, we believe we are well positioned to adjust our business to the external environment and continue to grow.

Second, we're continuing to enhance our underwriting capabilities with new tools and data sets.

For our Rent-A-Center, we're now leveraging a seamless more advanced proprietary fraud detection algorithm to drive better outcomes on our e-commerce channel, which continues to grow as a portion of the segment's total revenue, representing over 26% of the segment's revenue for the quarter.

As that channel grows, Rent-A-Center will be better positioned to underwrite profitable outcomes and deliver higher customer service levels.

At Acima, we continue to integrate our y Acceptance Now merchants into the Acima decision engine, and we expect to approve more core to stronger-performing leases, thereby increasing GMV and improving losses at the same time.

Overall, the integration of ANow into Acima nearing completion and should result in improvements in the seamless lease charge-off rate across the balance of the year as the prior higher loss in our originated portfolio winds down.

Importantly, this unlocks a new growth opportunity for Acima because we can accelerate our efforts in our differentiated staff model with a more robust decisioning platform and can introduce full online checkout capabilities to some of our larger retailers something the y Acceptance Now platform could not do before the transition. And third, I'd like to reinforce our relentless focus on customer centricity, which for us means two stakeholders, the consumer and the retailer.

For consumers, it's building relationships to start wherever we meet them, whether in one of our 2,400 Rent-A-Center stores, or more than 600 staffed Acima locations, the 35,000 virtual doors at Acima merchant partner locations or even a variety of fully virtual channels in both segments.

Once that relationship has established, our goal is to strengthen the connection over time and expand how we serve that customer while lowering our cost of service through our ongoing digital investments.

As their needs change, we can serve those needs through the channels I just mentioned, but also directly through our direct-to-consumer efforts such as the Acima Marketplace into our credit card partnership for consumers graduating to traditional credit.

For our retail partners, it's building relationships and customizing our process to meet their needs and ultimately drive more sales, whether in-store virtually, in-store staffed,

through their website or pure e-com retailers, our goals to support our partners to drive incremental revenue while expanding access for underserved customers.

So as we work to grow our share of market with new retailer additions and our share of mind with existing merchants, with more leases per location, we also equally focused on increasing our new customers by offering more solutions that meet our customers' needs and increasing customer lifetime value.

So let's review the details behind our segment financial results on Slide 4. Starting with Acima, we achieved a strong double-digit increase in GMV for the second consecutive quarter with an improvement of nearly 20% year-over-year.

Excluding the stimulus period of 2021, we achieved a single largest first quarter GMV that Acima has ever recorded. This was powered by a number of factors.

Our business development sales team delivered all-time highs for active merchant locations and help drive more productivity per existing location. That led to significant increases year-over-year in both applications and funded leases for our Acima business.

On top of those efforts, we realized a full quarter of elevated activity from two of our enterprise partners, namely Wayfair and ansell.com channel after the realignment last year of their LTL partner relationships.

As a result, we continue to find success in the furniture vertical for Acima despite the broader challenges in that category from the pandemic-related pull forward.

Finally, our direct-to-consumer offerings continue to expand with applications on the Acima Marketplace growing 68% year-over-year in the first quarter and GMV growing 51%, albeit working from a relatively small base as we further develop the channel. Collectively, these efforts resulted in Q1 revenues up 16% year-over-year. Average ticket size was down slightly in the quarter, so the top line lift was driven by expanded penetration as we continue to add merchants and grow our staff and e-commerce businesses.

We also have a robust pipeline of integrations planned for the remainder of the year, which we believe will be a tailwind for growth in 2024 and beyond.

We are pleased to recently announce another exclusive relationship with a top 5-- excuse me, top 50 furniture retailer in the quarter, which came online in late April.

Overall, the Acima exited the first quarter with an open lease count that was more than 24% higher versus last year as well as sequentially higher than our seasonally high fourth quarter.

From an underwriting standpoint, we continue to take an active and vigilant approach to risk management.

Our Acima segment loss rate was 9.6%, up 70 basis points from the year ago period, but down 30 basis points sequentially. And despite the volume of applications increasing 32% year-over-year and all the strong growth numbers I've just been discussing, Acima accomplished all of that with an approval rate of 130 basis points below last year.

As for delinquencies, Acima's rate in the first quarter was down 80 basis points from a year going flat sequentially to the fourth quarter of last year. These results were all in line with our expectations for the first quarter. And with the Acceptance Now integration into Acima's decision engine, we remain confident in our risk management outlook for the year. Rent-A-Center finished the first quarter with a same-store lease portfolio value that was slightly positive year-over-year.

We are particularly pleased to see positive same-store sales growth of 80 basis points for Rent-A-Center which represented the first increase in same-store sales in eight quarters going back to the stimulus period of 2021.

In addition, we saw a slight year-over-year increases in our customer count and our open lease count is our ongoing omnichannel marketing efforts and digital investments drove higher consumer engagement outcomes.

As I mentioned earlier, Rent-A-Center's web channel volume continues to grow and represented more than 26% of revenue in the first quarter, which was an increase from both the year ago and sequential periods. These elements helped deliver revenue growth of 20 basis points, which represents the highest segment revenue since mid-2022 for Rent-A-Center. And while Rent-A-Center's top line was up slightly.

We realized the nearly 9% lift in segment adjusted EBITDA due to strength on the gross profit line. This also helped us expand our adjusted EBITDA margins by 140 basis points.

Our continued emphasis on underwriting and account management in Rent-A-Center resulted in a lease charge-off rate of 4.7% for the quarter, down 10 basis points from the first quarter of last year.

Our past due rate, which is an early indicator of potential future lease charge-offs was 3.1%, which was up 10 basis points from the year ago period, but flat sequentially.

As the tax season runs off, we expect our improvement in the second quarter, similar to trends in 2023 and consistent with our guide last quarter.

As Rent-A-Center core consumer continues to deal with higher inflation and pressure on payment behavior, our account management efforts will be an increasingly important element of customer connectivity in the near to medium term to help us maintain our delinquency and charge-off rates in our target ranges.

Overall, we're very pleased with our operating and financial results in the first quarter. Both segments successfully anticipated and met our customers and merchants' expectations, enabling us to achieve that 20% GMV growth at Acima along with positive same-store sales growth at Rent-A-Center. These results, along with the momentum we've already seen in the early April results give us confidence that we're tracking well towards achieving our full year targets.

On Slide 5, let's discuss the progress we've made on strategic priorities we outlined only last spoke. At Acima, we're committed to strong top line growth through our business development efforts with smaller and medium-sized businesses.

Our enterprise sales initiative for Super region and National Accounts and our direct-to- consumer channel.

While our enterprise client team continues to build presence and relationships with the largest retailers, our SMB team continues to add local and regional merchants as partners on our virtual leasing platform. This quarter, we realized a 9% lift in active locations year-over-year, while adding merchants and capabilities to our online direct-to-consumer marketplace as well.

We're also refining and enhancing the ways in which we work with our existing merchants and consumers with a goal of driving customer retention and more active leases per merchant location per month. This will be driven by a combination of our service first mindset as well as our investments in the digital tools to help us outperform expectations.

And by way of example, we replaced an LTO competitor and added a large regional furniture retailer last year that was realizing around $100,000 in lease activity per month. With stronger collaboration and leveraging our integration tools, e-commerce capabilities and best practices as we drove a meaningful difference to their sales.

In fact, in the first quarter, we partnered with them to achieve a significant increase to nearly $1 million of lease activity per month, showcasing that we can elevate results and exceed expectations for our partners and our customers.

At Rent-A-Center, we continue to invest in our online e-com experience, both web and mobile to help meet our customers when and where they want to interact with us.

We also executed a variety of marketing campaigns and promotions across the quarter to engage our customers and boost our value proposition, which helped deliver the top line and same-store sales growth that we booked this quarter relative to the year ago period.

Additionally, we continue to roll out our new Rent-A-Centerpoint-of-sale system known internally as RecPad, which will enhance the productivity of our store-based coworkers and provide more centralized visibility and reporting for our regional and district leaders.

It has been architected for flexibility and additional scalability, enabling it to accommodate the evolving needs of our store-based footprint.

Our Upbound team has committed to creating a shared services environment unifies and amplifies our capabilities across the organization, things like underwriting, information technology, collections and operations. To that end, this quarter, we rolled out an additional network of collection points for Acima merchandise that leverages Rent-A- Center locations for returns and customer service.

We believe this will drive improvements in Acima's lease charge operate and make it easier for customers to interact with us while simultaneously providing select Rent-A- Center locations with additional merchandise to offer for rent.

Additionally, we continue to build out our partnership with Concora as we explore the nonprime consumer credit adjacency to our current LTO space.

We are now beginning the ramp-up phase for the Acima private label credit card, which can be used in any Acima partner location and the Acima general purpose credit card, which can be used anywhere MasterCard is accepted.

As we expressed previously we believe we can leverage our substantial in-house knowledge of nonprime consumers, extensive customer base and our brand awareness offer white label credit products that can help our customers build their credit history while shopping for the products and services they need for themselves and their families.

Over time, we believe the nonprime consumer credit adjacency will represent an important and growing contributor to our bottom line.

Finally, I'd like to share my perspective on our capital allocation philosophy. After investing in the business, we'll support our dividend first with a focus on deleveraging after that as we work to reduce our leverage ratio to less than two turns.

Our share repurchase strategy will be a tertiary goal, one that's opportunistic rather than programmatic.

So before I hand it off to Fahmi I'd like to acknowledge the collective work of our whole team because they're the reason we're able to deliver these strong results and their commitment and passion has helped deliver these terrific results in a terrific start to the year. And with that, I'll turn it over to Fahmi.

Fahmi Karam^ Thank you, Mitch. And good morning, everyone. I'll start today with a review of the first quarter results and then discuss our outlook for the rest of the year, after which we will take questions. Beginning on Page 6 of the presentation. Consolidated revenue for the first quarter was up 7.9% year-over-year, with the Acima up 16% and Rent-A-Center up 20 basis points. Rentals and fees revenue were up 8.2%,

merchandise sales revenues increased 10.3%, reflecting higher GMV at Acima and a larger portfolio of Rent-A-Center coming into the year.

Consolidated gross margin was 48.3% and decreased 150 basis points year-over-year. With a 190-basis point decrease in the Acima segment, partially offset by a 110-basis point increase in the Rent-A-Center segment. Consolidated non-GAAP operating expenses, excluding lease charge-offs and depreciation and amortization were up mid- single digits, led by mid-teens increase in general and administrative costs, which was a result of corporate investments in technology and people.

In addition to an increase in nonlabor operating expenses led by investments to support Acima application growth. The consolidated lease charge-off rate was 7.4%, a 30-basis point increase from the prior year period and in line with our expectations.

On a sequential basis, the consolidated lease charge-off rate decreased 10 basis points due to a 30-basis point sequential improvement at Acima. Putting the pieces together, consolidated adjusted EBITDA of $109.1 million decreased 2.2% year-over-year as higher Rent-A-Center segment EBITDA was offset by lower Acima segment EBITDA and higher corporate costs.

Adjusted EBITDA margin of 10% was down approximately 100 basis points compared to the prior year period with approximately 140 basis points of expansion for Rent-A- Center, offset by approximately 260 basis points of margin contraction for Acima and a 20-basis point increase in corporate cost as a percentage of revenue. I will provide more detail on segment results in a moment.

Looking below the line, first quarter net interest expense was approximately $29 million compared to $28 million in the prior year due to approximately 80 basis points of year- over-year increase in variable benchmark rates that affected our variable rate debt, which was approximately $862 million at quarter end.

The effective tax rate on a non-GAAP basis was 26% compared to 27.4% for the prior year period. The diluted average share count was $55.8 million shares in the quarter. GAAP earnings per share was $0.50 in the first quarter compared to earnings per share of $0.84 in the prior year period. After adjusting for special items that we believe do not reflect the underlying performance of our business, non-GAAP diluted EPS was $0.79 in the first quarter of 2024 compared to $0.83 in the prior year period.

During the first quarter, we generated $33.6 million of free cash flow, which decreased from $95.9 million in the prior year period, primarily due to Acima GMV growth. We distribute a quarterly dividend of $0.37 per share, an increase from $0.34 per share in the prior year.

We finished the first quarter with a net leverage ratio of approximately 2.7x, unchanged from the fourth quarter. Drilling down to the segment results starting on Page 7.

For Acima, double-digityear-over-year GMV growth continued in the first quarter. After returning to growth with a 19% year-over-year increase in the fourth quarter of 2023, GMV increased nearly 20% year-over-year in the first quarter of 2024.

GMV growth was above our expectations and was driven by year-over-year growth in key underlying drivers with active merchant locations up over 9% year-over-year, more productivity per merchant and the full quarter of the enterprise e-comm partners Mitch mentioned earlier, which resulted in overall applications increasing over 30%. Those tailwinds were partially offset by lower approval rates across all major categories as we remain disciplined in our underwriting approach as inflation continues to impact our core consumer base.

The asset value of inventory under lease was up mid-teensyear-over-year. Revenue increased 16% year-over-year including a 16.3% year-over-year increase in rentals and fees revenue and a 15.2% increase in merchandise sales revenue due to a larger beginning portfolio in 2024 compared to last year. Lease charge-offs for the Acima segment were 9.6%, 70 basis points higher year-over-year and 30 basis points lower sequentially.

The year-over-year increase in Acima lease charge-offs was slightly better than our expectation as the ANow leases originated on the legacy decision engine will now begin to wind down. The conversion will strengthen our underwriting capabilities and should reduce lease charge-off rates as lease cohorts from the legacy system wind down throughout the year.

Operating costs, excluding lease charge-offs were up approximately $7 million in the first quarter, which was flat as a percentage of revenue. Adjusted EBITDA of $64.9 million was down 5.4% year-over-year, primarily due to a 19.3% increase in cost of goods sold that was partially offset by a 16% increase in revenue. Adjusted EBITDA margin of 11.6% decreased approximately 260 basis points year-over-year, while gross margins contracted approximately 190 basis points.

The decrease in margins were due to a few factors including a growing portfolio where revenue lags higher incentive, labor and underwriting costs, an increase in merchandise sales in the quarter from a dollar perspective due to a larger portfolio interim tax season than last year and the performance of the legacy ANow portfolio, all of which is in line with our expectations.

For the Rent-A-Center segment at quarter end, the same-store lease portfolio value was slightly up year-over-year, while same-store sales increased 80 basis points year-over- year, improving from a 1.6% decrease in the fourth quarter of 2023. Total segment revenues returned to growth in the first quarter, increasing 20 basis points year-over-year, improving from a 1.7% decrease in the fourth quarter. The increase in revenues was driven by an 80-basis point increase in rental and fees revenue.

First quarter merchandise sales revenue decreased 3.6% due primarily to fewer customers electing early purchase options compared to the prior year period and represented an improvement of 12.2% decline in the fourth quarter.

Lease charge-offs improved year-over-year, driven by ongoing underwriting and account management efforts decreasing 10 basis points to 4.7%. 30-day past due rates averaged 3.1% for the first quarter, up 10 basis points from the prior year period and flat sequentially.

Adjusted EBITDA margin for the first quarter increased 140 basis points year-over-year to 16.6%, primarily due to higher gross margins in addition to a 10-basis point year-over- year decrease in the ratio of non-GAAP operating expenses, excluding lease charge-offs as a percent of revenue. Adjusted EBITDA margin increased 210 basis points from the fourth quarter, reflecting the effect of higher revenues on less variable costs.

For the Mexico segment, adjusted EBITDA was higher year-over-year, and the franchise segment's adjusted EBITDA was lower due to timing of operating expenses compared to last year.

Non-GAAP corporate expenses were approximately 12% higher compared to the prior year, primarily due to additional investments in technology and people.

Shifting to the financial outlook. Considering the trajectory of our business and the latest projections for the macroeconomic environment, we believe that we are well positioned to achieve the targets we shared for 2024 in our previous earnings call.

As a reminder, the forecast assumes a stable macro environment with durable goods demand remaining under pressure, continued disciplined underwriting and no additional material benefit from trade down. With that backdrop, we'd like to share a bit more on the quarterly cadence of our performance.

Note that references to growth or decreases in generally refer to year-over-year changes unless otherwise stated.

At Acima, we expect to see a similar increase in GMV in the second quarter, continuing the trend we have experienced in the last two quarters including a strong April.

For the year, we are updating GMV guidance from up mid-to-high single digits to double-digit growth. Rent-A-Center portfolio should be up slightly in the second quarter from the first quarter based on what we saw in April from a consumer demand perspective.

For both Acima and Rent-A-Center, we expect the second quarter revenue to follow the same sequential pattern as in 2023, with a slight step back in line with typical seasonal patterns coming off tax season and lower merchandise sales.