Upbound Group Inc (UPBD) 2015 Q3 法說會逐字稿

Good morning, and thank you for holding.

Welcome to Rent-A-Center's third quarter Earnings Release conference call.

(Operator Instructions)

As a reminder, this conference is being recorded Tuesday, October 27, 2015.

Your speakers today are Mr. Robert Davis, Chief Executive Officer of Rent-A-Center; Guy Constant, Executive Vice President of Finance and Chief Financial Officer; and Ms. Maureen Short, Senior Vice President of Finance, Investor Relations, and Treasury.

I would now like to turn the conference over toes Ms. Short.

Please go ahead, ma'am.

Thank you, Amy.

Good morning, everyone, and thank you for joining us.

Our Earnings Release was distributed after market close yesterday, which outlines our operational and financial results for the third quarter.

All related materials are available on our website at investor.

Rent-A-Center.com.

As a reminder, some of these statements made on this call are forward-looking statements, which are subject to many factors that could cause actual results to differ materially from our expectations.

These factors are described in the Earnings Release issued yesterday, as well as the Company's SEC filings.

Forward-looking statements that may be discussed today include forecasted revenue, earnings, cash flow, and business trends.

Rent-A-Center undertakes no obligation to publicly update or revise any forward-looking statements.

I'd now like to turn the conference call over to Robert.

Robert?

Thank you, Maureen.

Good morning, everyone, and thank you for joining us.

For many of you, this is probably the first time that you've participated in a Rent-A-Center call without the presence of Mitch Fadel, our former Chief Operating Officer.

As many of you know, Mitch recently left the Company to pursue another opportunity, and I wanted to take just a brief moment to acknowledge all of the great contributions that Mitch has made to the Rent-A-Center business, thank him for his many years of service, and to wish him the very best in his new opportunity.

Now I'll turn our attention to the great opportunities that are present in our own Rent-A-Center business.

As promised last quarter, Acceptance Now has expanded into the direct or virtual channel.

And we have done so with a flourish.

I am pleased to say that we grew our overall location count by 15% this quarter, which is the strong strongest growth we have seen in several quarters.

While we believe the staffed model will continue to be the gold standard for the industry, given its superior ability to drive volume and profit dollars, our new direct model enables the expansion of our offering to lower volume locations and broadens our scope of potential retailers.

And while the majority of the growth this quarter came in the direct space, the outlook on the pipeline of both staffed and direct locations remains strong, and we are aggressively pursuing these opportunities.

Retailers with lower volumes have been anxiously awaiting our direct program and are rapidly signing up.

It is still early in the rollout, but the volume we are seeing in the direct locations is meeting our expectations and we are even finding some locations are doing enough business that they are very likely to become staffed locations.

We strongly believe that retailers that do not currently have a lease-to-own option in their stores are missing out on a significant sales growth opportunity.

As evidenced by the retailers that have already embraced this sales driving model, Acceptance Now typically increases retailer sales volume by 3% to 5% and, with the right partnership, can be as high as 18%.

Many times larger than any competitor in the space.

We are in the process of enhancing our commercial B2B capabilities in order to ensure that we capture the lion's share of this $20 billion market.

As more and more retailers recognize the market leading opportunity that Acceptance Now brings to their business.

In the past few quarters we have seen dramatic revenue growth, due in part to the introduction of the 90 day cash option in our retail partner network.

While customers have clearly embraced this offering, the higher mix of this transaction in our business has put pressure on overall Acceptance Now gross margins.

Over the past quarter we had committed to you that we would identify ways to work with our partners to enhance the profitability of this offering, while maintaining the compelling value proposition to the customer.

As promised, we have had discussions with a number of our retail partners regarding 90 day option economics, and they have been very productive.

Our retail partners have collaborated with us to ensure the partnership is truly a win-win relationship, and we expect the profitability of the 90 day option to improve as we move into 2016 and beyond.

The unique bond with our retail partners is forged and cemented by the relationships between the Acceptance Now coworker and the sales staff of our retail partners, and is the primary reason that enables us to see more turned down customer opportunities and ultimately drives our volume to be 8 to 10 times that of our largest competitor.

From a technology perspective, in addition to growing the number of locations as mentioned last quarter, we are using technology to drive traffic and increase revenue in existing locations and are making tremendous progress.

Most of our retail partners currently have primary and secondary financing options for customers that qualify for credit, and Acceptance Now acts as a tertiary option.

We offer several technology options for our retailers, which allow customers to complete one application for primary credit, secondary credit, and lease-to-own at the same time, increasing our capture rate for customers that are turned down for traditional credit.

Retailers have the option of either integrating the Acceptance Now approval process into, one, their existing primary and secondary financing process, their point of sale system, or via a standalone kiosk.

The number of Acceptance Now locations with these seamless approval technology options has doubled this quarter, and is already available in about 30% of our staffed locations.

Acceptance Now's approach is to have an open platform that allows us to partner with the established best-of-breed primary and secondary financing companies already in retailer locations, rather than entering into the secondary financing space ourselves.

This gives our retail partners the flexibility to choose which financing companies to do business with, using the seamless integration capabilities that we are have with the top three leading secondary finance companies.

We plan to focus on our core competency, the lease-to-own opportunity, which has higher margins and operates under a different regulatory framework than secondary financing.

Our approach is to provide retailers and customers with full transparency about the lease-to-own transaction through customer facing technology and allowing in all cases for customers to return the product at any time with no penalty.

The Acceptance Now rent-to-own option is also currently available on the websites of 15 retail partners, including Value City, HH Gregg, Bob's Discount Furniture, which are three of our top five retailers.

These websites are driving incremental business to approximately 500 locations, again, double the count from last quarter.

There are many more retailers in the pipeline for both of these technology initiatives, and we are continuing to explore innovative ways to further the customer and retailer experience.

In the core rent-to-own business, I am pleased with the progress we have made on the transformational initiatives.

The upfront work associated with our Flexible Labor and Sourcing and Distribution initiatives is substantially complete, and they remain on track for the expected annual run rate benefits of $45 million to $60 million.

With our new supply chain, we are now beginning to look at subsequent opportunities including last-mile logistics improvements, product redistribution opportunities, and optimizing store inventory levels.

The operations team continues to embrace our Flexible Labor initiative.

The new labor model has been introduced in approximately thee-quarters of our stores, and over 5,500 new part-time coworkers have joined the Company.

Only about 100 stores have migrated to the full in state labor model.

With the introduction of part-time labor and full-time coworkers with no scheduled overtime.

The benefits of both the Sourcing and Distribution and the Flexible Labor initiatives have just started this quarter, and will primarily benefit 2016 and beyond.

So, we are still in the early innings of seeing the financial benefits of these initiatives.

As we have promised, we will ensure that every margin improvement initiative that we implement will not only benefit the Company, but more importantly, the customer and our coworkers.

We know there's a wrong way to cut costs, and we simply will not sacrifice the customer or the coworker in pursuit of short-term profits.

In order to further optimize our store portfolio, approximately 100 underperforming stores were closed or sold during this quarter, including exiting the majority of our Canada stores.

The removal of these stores from our portfolio allows us to place even greater emphasis on achieving the benefits of our initiatives and improve our return on invested capital.

Through additional initiatives such as labor hour reductions and the smartphone locking feature, store expenses have been reduced by over $40 million since the beginning of 2015, which reflects clear progress on implementing the strategic initiatives that will help ensure sustained profitability.

We believe there are many other margin improvement opportunities in the core business that will provide ongoing benefit for at least the next two to three years.

In Q3, we launched the first pilot of virtual approval on Rent-A-Center.com as an additional step towards full online eCommerce capabilities.

Recently the first major website redesign since 2012 was completed, and we've also taken positive movements forward in social media.

We've also set up an online customer community focus group in order to receive feedback from customers on a consistent basis, and gain insights on what customers truly value.

Building on the customer segmentation work completed last year, these are additional steps in our journey toward becoming a more customer-centric organization.

So to summarize, Acceptance Now continues to grow rapidly and we are enhancing and expanding our offering through new technology.

Within the core rent to own business, we are seeing signs of improved profitability.

And, our outlook on the positive impact of existing and future cost efficiency initiatives is strong.

By improving the return profile of existing assets through our strategic initiatives and by optimizing the store base, we are able to reinvest in the rapidly growing Acceptance Now business and drive shareholder value.

Now I'd like to turn the call over to Guy to provide more details on the quarter.

Guy?

Thank you, Robert, and good morning, everyone.

This morning, I will walk you through the highlights of our financial results for the third quarter.

I would also like to mention that, as I refer to our third quarter performance, either this year or versus a year ago, all numbers will be presented on a recurring basis, excluding special items.

As outlined in the press release, total revenues were $792 million, which represents a 3.6% increase, driven by revenue increases in our Acceptance Now segment.

Third quarter revenues were lower by about $6 million, due to the foreign currency impact in our Mexico business, the sale of stores to franchisees, and continued rationalization of the core store footprint.

As a matter of fact, our total US same store sales combining the Acceptance Now and core performance, increased 5.2% versus a year ago, marking our sixth straight quarter of domestic same store sales growth.

Acceptance Now same store sales continued to impress, up 24.5% for the quarter, even as we begin to lap the broader rollout of our 90 day option program.

As Robert outlined in his comments, we continue to experience rapid growth and adoption of our innovative technology solutions throughout our retail partner base.

Our technology platform, coupled with our staff model will continue to differentiate us in the marketplace, as it enables us to drive more sales opportunity for our retail partners than any other competitive alternative.

In our US retail business, Q3 marked the beginning of our lap of the smartphone rollout from a year ago.

Same store sales were down 0.2%, which was in line with our expectations.

While we have seen positive momentum in other major product categories, we are challenged by computers, which are down double digits, similar to the industry at large, and we have seen some headwinds in oil industry affected markets, such as parts of Texas.

On a two year basis, same store sales in the core remain up over 1100 basis points since the first quarter of 2014.

As we lap the introduction of smartphones, we see a number of sales drivers for our core business.

The broader product assortment that's enabled by our supply chain initiative, the availability and flexibility of labor, which will allow us to be correctly staffed during peak periods such as those we'll see in Q4, pricing that's more reflective of the competitive marketplace and the rollout of eCommerce in 2016.

As well as the macro trends of lower gas prices, a better job market, and minimum wage increases, all of which will benefit our customers disproportionately.

Provide us with the opportunity to deliver continued strong sales results in the core.

And we won't build a cost structure that's dependent on that strong sales growth, but if we can deliver on the opportunity that's available to us with a lean cost structure, the earnings growth opportunity in the core is meaningful.

Consolidated gross profit was down $9.4 million, and gross profit margin fell 360 basis points to 66.1%.

In the core segment, gross profit margins were down 170 basis points from a year ago, but have stabilized sequentially.

Gross profit as a percent of total revenue was negatively impacted by the lower gross margin on merchandise sales and the higher mix of merchandise sales, primarily due to smartphones.

Product that was sourced through our supply chain initiative is now showing up in stores and going out on rent, so we should start to see core gross margins improve starting in the fourth quarter.

Our Acceptance Now segment experienced gross profit growth of $9.8 million.

Gross profit margins stabilized, flat sequentially, but still down 760 basis points versus a year ago.

Gross profit as a percent of total revenue was negatively impacted by lower gross profit margin on merchandise sales, and a higher mix of merchandise sales, primarily due to the increased popularity of 90 day option pricing.

I want to remind you that as you look at our merchandise sales and their respective margin dollars, these line items solely capture the final payment against the full remaining cost of the item.

However, when looking at our 90 day agreements in totality, including the attributed rentals and fees, we are in fact seeing positive gross margins of approximately 10% to 15% on our 90 day option business, along with driving incremental volume.

As Robert mentioned in his remarks, with gross margins stabilizing and the mutually productive discussions we've had with our retail partners regarding the 90 day option transaction, we would expect gross margins to improve in our Acceptance Now business starting in 2016.

Consolidated store labor, which includes the expenses associated with coworkers at our stores and at the district manager level, decreased by $8.7 million to 26.7% of store revenues, an improvement of 210 basis points versus last year.

In our core segment, store labor was down $11.7 million, an improvement of 160 basis points, and was positively impacted by lower store count year-over-year, our labor hour reductions that started in the third quarter of 2014, our new Flexible Labor initiative, and lower insurance costs.

Year-to-date, our operators have delivered, lowering our core labor expense by $35 million while increasing same store sales, a great result.

And we expect to see continued labor reduction, as we are still in the early innings of our Flexible Labor rollout.

In our Acceptance Now segment, while labor was up $4.9 million, we continue to see improved leverage in the business with labor better by 240 basis points versus a year ago.

Other store expenses, which include expenses related to occupancy, losses, advertising, delivery costs, and utilities, were down $6.8 million year-over-year on a dollar basis, 190 basis points better than a year ago.

In our core segment, other store expenses are down $5.9 million, or 60 basis points, driven by a lower store count, lower gas prices, and lower training costs for smartphones, partially offset by higher product service costs from smartphones.

Within Acceptance Now, while other store expenses are up $5.6 million, we are seeing better leverage, as other store expense improved 40 basis points versus last year.

In total, our store operators delivered on our promise of improving operating margins.

Despite the opportunity we have to improve our gross profit margins, we have continued to drive lower year-over-year operating expenses, translating into an improvement of 410 basis points.

Third quarter operating profit margins are up last year by 50 basis points, building on the momentum that started last quarter, and we expect that to continue in the fourth quarter as well.

Our core US rent to own [skip/stolen] losses came in at 3.4% in the quarter, flat to last year, even with the addition of the smartphone category.

As you may recall, as recently as Q1 this year, our skip/stolen losses were 100 basis points higher than a year ago.

Once again, our operators and the teams that support them have delivered on the promise to improve an area that needed to be addressed.

As you are you aware, our Acceptance Now team has been focused on bringing our skip/stolen losses back in line by improving execution.

While we were able to achieve this for the first half of 2015, we are disappointed in our performance in Q3 as skip/stolen losses were 8.2%, up 130 basis points from last year.

We now expect Q4 losses to be slightly above 10%, in line with last year.

We continue to see the Acceptance Now customer being over-stretched by higher levels of sub-prime consumer debt and sub-prime auto debt, both of which are impacting their ability to stay current on their payments.

We are currently reviewing the account management process in our Acceptance Now business, and we expect to make some changes to permanently improve this result in 2016 and beyond.

Now, I want to spend a couple of minutes talking to some key balance sheet and cash flow items.

Inventory on rent is down approximately $15 million versus a year ago.

Typically in the third quarter, we do see inventory on rent decrease due to the slower summer season.

A year ago, due to the rollout of smartphones, this was not the case.

But now that we've lapped smartphones, we're back to our historical seasonality.

The write-down of smartphones also lowered the value of some phones that are currently on rent.

Inventory held for rent is down approximately $21 million, which is a reversal of year-over-year increases we've seen since the introduction of smartphones a year ago.

In addition to the normalization of the year-over-year numbers due to the lap of smartphones, the write-down discussed earlier also lowered the value of phones that were idle.

This result came despite the fact that we are investing in inventory both to stock our newly opened distribution centers, and in anticipation of our busier holiday season.

Our inventory held for rent in the core is 34.4% of total inventory, which is essentially flat to last year.

We ended the quarter with approximately $60 million in cash and cash equivalents.

Our quarter ending leverage ratio was 2.9 times, well below our covenant requirement of 4.5 times and down over a half a turn as compared to the end of 2014.

In fact, our total debt is down almost $130 million since the end of 2014.

This includes $150 million drawn on our revolving credit facility as of the end of the third quarter, down $20 million from last quarter, and leaving approximately $430 million of available capacity.

During the quarter, we were also able to complete the repurchase of approximately $7 million of our 6-5/8% 2020 senior notes.

This is consistent with our plan to lower our debt ratio to 2.5 times over the next year, which will free us from the current restricted payments basket, increasing the flexibility the Company will have to make optimal capital allocation decisions.

During the third quarter, we determined it was necessary to adjust our smartphone inventory.

Upon standing at the category a year ago, we purchased inventory to support a spectrum of options, including both newer and older generation phones, consistent with our good, better, best approach in other product categories.

Over the past year, the demand for newer generation phones has exceeded our expectations, but older generation phones have fallen short, which has resulted in excess smartphone inventory.

In the third quarter, we finalized the sale of excess phones in the secondary market, as well as taking several steps to move through older generation phone inventory via bundling offers, clearance sales and repricing, all of which have seen some success.

However, we did not move through as much of the excess inventory as we would have liked, so we deemed it necessary to correct our inventory position and are writing down the value of our smartphone inventory and accelerating the secondary market disposition of excess phone inventory.

In connection with this decision, we recorded a pre-tax $35 million inventory write-down in cost of sales during the quarter.

As we've discussed previously, over the past two quarters, we have dramatically improved the profitability of our smartphone category.

As we move forward with this category, we will continue to refine our approach, taking the learnings from our initial year of experience, and making the category an even richer contributor to the future success of our core business.

One final note.

As you may have seen in our press release, we wanted to give some additional color on the balance of the year.

Comparable store sales in the core for Q4 are projected to be flat to down 1%, and Acceptance Now comps are now expected to be approximately 20%.

And as mentioned earlier, we expect Acceptance Now losses similar to Q4 of last year until we are ready to implement the changes to our account management process.

Given these expectations, we now project full year 2015 EPS to be $2 to $2.10, which equates to Q4 EPS of $0.52 to $0.62.

With that, I'll turn the call back over to Amy to open the line for questions.

(Operator Instructions)

Your first question comes from the line of Brad Thomas with KeyBanc Capital Markets.

Brad, your line is open.

Yes, thank you.

Good morning, Robert, Guy, and Maureen.

Couple things I wanted to ask about.

I know there will be a lot of other people wanting to ask questions.

Maybe I could first ask about guidance and then, secondly, ask about the phones.

With respect to guidance and, specifically, the outlook for same-store sales in the Core business, could you share a little bit more about what you've been seeing over the last few months as you have anniversaried the rollout of smartphones?

So, as you saw with the third-quarter comps, Brad, we held close to that flattish expectation that we were expecting as we started the first quarter of the lap over smartphones, so we felt good about how the first quarter's gone.

The other categories, other than smartphones, have all continued to improve sequentially, as we expected, as we went through the lap of the smartphones, and as you see by our guidance today, our expectation is to stay pretty close to that flattish expectation that we expected a year ago.

The portfolio remains strong, similar to where it was last year, maybe slightly down, which is the best indication we've got going into the quarter of what we think comps -- the result of comps will be.

But, clearly, the fourth quarter's a high-volume quarter for us, and so we need to be able to continue to add to the portfolio as we go through this busier volume season that we're about to embark on here in a couple weeks.

And just one additional comment, Brad.

I think in Guy's prepared comments, and maybe the press release even talked about the oil-affected markets, just a little bit more color there.

Texas, the state of Texas, our comps were down about 4% in Texas and higher than that in some of the Odessa markets and Houston markets, as an example.

So, if Texas had been just flattish, like the majority of the rest of the business, our comps actually would have been a positive 0.2%, given that 10% of our stores and revenue really comes from this state.

So that macro impact really had an effect as well.

Got you.

And, Guy, I think you mentioned the on-rent merchandise down 15%.

And so just so I understand you right, that's what you normally would see seasonally from the end of 3Q into the start of 4Q?

So that number still makes you feel comfortable, as you guide to comps for the fourth quarter?

Yes, so actually it was down $15 million, Brad, not 15%.

But, yes, we still have that comfort level that our customers in the summer season tends to be a little more challenging for them, so it tends to be our lowest volume season, and also the season where it's a little more challenging to collect from our customers.

And if you look back before last year, you'll see typically that this is the low point of our inventory on rent numbers.

So, last year was a bit of an anomaly, because we were rolling out smartphones during that season, so not typical what we usually see.

Right, right.

And then, just on phones, and I'm sure others will ask about this, but two questions.

For one, how much was this an acute issue due to the new models that have just come out in the last few months versus something that has been sort of ongoing and how you've been planning your inventory over the course of the last year that you've been in smartphones in all of your stores?

And then, just how much might this affect the profitability on a go-forward basis for phones?

So, Brad, it's more a product of standing up the category, a new category.

For those who have followed the Company for some time, we don't have write-downs like this, and we haven't in our historic categories that we have a lot more experience managing and do very well.

Smartphones were a new category, and while we were able to test in some markets, it's difficult to test everything associated with smartphones, like what national media will do to you.

It's hard to test that in a regional market.

So we entered into the category with a broad assortment of phones, sort of a good-better-best approach that is what we typically do with our other categories.

And what we've seen over the year as we've learned -- a lot being driven by our own business, but some of what you see out in the marketplace, where newer phones are starting to become much more common as the carriers and the manufacturers make it much more simple -- simpler through their agreements for you to always have a newer phone -- while our customers can't necessarily tap into that, it does create an expectation in the marketplace that phones tend to be newer.

What we've seen is newer phones perform very well, and older generation phones be a little more challenged.

And so, I think as we move forward with the category, we likely will see probably more of a skew towards newer-generation phones in the category, moving forward.

We'll have to look at our pricing and we'll have to look at inventory levels to make sure that we have those right.

And we probably will want to look at our depreciation policy, too, to make sure it's consistent with how quickly those newer models turn over.

But we do expect that the momentum we've seen recently with locking and some of the progress we've made on service costs will continue in the future, and we think it will be a profitable category and we plan to stay in it.

Got you.

So just to be clear, knowing what you know today about -- you do think that this can continue to be a profitable category for you?

Absolutely.

We do.

And knowing what we do today, we would have not had as many older-generation phones in our inventory to begin with.

And that's really what we're trying to address here is ensuring we're focusing on the more popular items that customers resonate with them.

Got you.

All right.

I'll turn it over to others.

Thank you so much.

Thank you, Brad.

Thanks, Brad.

Your next question comes from the line of Anthony Chukumba from BB&T Capital Markets.

Anthony, your line is open.

Thanks for taking my question.

Good morning.

Hi.

Just one follow-up question on the smartphone write-down.

That $35 million, can you give us a sense for what that was as a percentage of your total smartphone inventory?

Anthony, it was about 35% of our total smartphone inventory.

Okay.

That's helpful.

And then, just one unrelated question.

In terms of the comps, particularly in the Core, any -- can you give us any color just in terms of how that worked out over the course of the quarter, like on a monthly basis?

Well, that can be difficult, Anthony, because of the mismatch of months and how many weekend days fall in a month as opposed to the year previously.

But I think it's fair to say that, earlier on in the quarter, we felt very good about our portfolio.

And I think as we got more towards the end of the quarter, that declined a little bit, which is why, now, our expectation of flattish for the fourth quarter is now more flat to down 1%.

Because the portfolio's slightly weaker ending the quarter than it was starting the quarter.

Okay.

That's helpful as well.

Thank you.

Thank you, Anthony.

Your next question comes from the line of J.R. Bizzell with Stephens, Inc.

J.R., your line is open.

Good morning, and thanks for taking my questions.

Good morning.

Robert, kind of building on your commentary, I know we're going to beat this phone inventory thing to death.

But, kind of building on your comment about how you -- if you had to go back and do it again and kind of thinking about how you wouldn't have as many old phone options, thinking about that moving forward, I'm guessing you all are addressing this inventory moving forward?

And just if you could, I guess my question is, kind of walk us through maybe how you're addressing the inventory moving forward, and how you're going to handle that moving forward?

Well, I think -- as was mentioned in the press release and as Guy alluded to, we are ensuring that all of the learnings that we've had were applied, going forward.

So whether it's from an assortment perspective, a pricing perspective, our depreciation policy perspective -- all of that are things that will be addressed moving forward.

So it's hard, from a competitive perspective, to give you too much color on that, knowing that our competitor is entertaining the notion of getting into this category.

So I hesitate to share too much.

But the fact is, we do believe that the category has been a popular item, one that really gave us a shot in the arm last year from a top-line perspective, and from a profitability perspective, has been profitable but improving along the way with some of the locking features and the service-cost initiatives that we've undertaken.

So, we would expect the category to actually improve going forward as well.

Great color.

And then, building on that, maybe for you, Guy, it would be fair to assume that we're not going to expect a big write-down on a go-forward basis now that we've got more color around the inventory levels?

No, we don't expect that, J.R. As I said earlier, we've been managing our other product categories for quite some time and have never experienced a write-down.

And, as I mentioned in my earlier comments, this write-down is more associated with standing up a new category that we hadn't done before, and getting a read and learning over the year since we've rolled it about what our customers value most.

So, no, I wouldn't expect that, moving forward.

Understood.

And then, last one from me, building on the -- switching gears to the 90-day buyout.

That continues to be successful and driving nice volume.

Just wondering, Robert, I know you alluded to some changes with your partners in 2016.

Is that -- is it just simply going to be something of a discount on the purchase?

Is there -- if you could add some color there, I don't know how much you can.

But, if you could, just maybe some more details around maybe some margin improvement opportunities, moving forward with that.

I think there's a variety of ways that we're addressing that, J.R. And, again, I hesitate to share too much with you, but I think it's fair to say that we don't want to have top-line growth that's not productive from a bottom-line perspective.

And so, as we've seen that feature, if you will -- or that proposition to the customer -- gain in popularity, we believed it was necessary to address the overall profitability of that option.

So, we have been in conversations with some of our top partners from a retailer perspective, and those have been very productive.

So we would expect that to enhance as we move into 2016 and beyond.

And what percentage of transactions were that 90-day buyout this quarter?

About 33%.

A third of our overall transactions customers took that option, and we expected that to actually go down from Q2 -- I think it was the mid-30%s in Q2.

And, while it came down just a couple of points, not as much as we would have otherwise expected, coming out of tax season.

So it does appear that customers will continue to choose that offer going forward, and so we felt it necessary to go back to our partners and have some productive discussions.

Thanks for taking my questions.

Thank you.

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

Laura, your line is open.

Good morning.

Guy, my question is about the guidance for Q4.

The implied range when we spoke in July was $0.10 higher than it is today.

Are the differences solely the increased losses versus your prior expectations in Acceptance Now, and the accelerated sell-through at lower margins of older generation smartphones, or is there something else happening impacting the guidance?

No, it's really those three factors I mentioned in my remarks, Laura: it's the Core comp expectation being just a little bit lower than we might have thought, related to the portfolio question I got earlier; a little clarification on where we're going to be with Acceptance Now comps, as we get more color into the lap of the 90-day option; and then the losses related to Acceptance Now.

Got it.

And on the losses on Acceptance Now -- that's an issue that, obviously, you've been facing for a while -- what are the specific steps that you're taking to try to improve that?

Well, today, Laura, the collections process occurs largely in the stores, and so as we look at opportunities to improve our collections approach, we think there's some other resources we can use to supplant that or to at least support that and provide additional ways for us to manage that number down.

So, we'll talk more about that as we get into 2016, but I think, in Acceptance Now, we have historically managed the losses similarly to how we've done it in the Core business.

And I think what we recognize now is there's perhaps some opportunities for us to manage it a little differently in the Core -- than we do in the Core business, and do it a little more effectively related to the unique characteristics of that business.

Because collections is such a key part of the Core, it's tough for me to understand why those same processes wouldn't be even better when applied to the higher FICOs in Acceptance Now.

So I'm just wondering if I can get more specifics on how it might change, and also whether this will impact growth in Acceptance Now as perhaps you limit approvals?

So, Laura, maybe the biggest difference I can draw for you is, in the Core, because of the weekly payment model and the customer -- where the customer sits on the demographics spectrum versus Acceptance Now, we tend to see those customers much more regularly as they come into the stores to make payments.

And so managing the collections process largely from the store, where the relationship is much deeper and more established, works very well in the Core.

As you can see, we've made great progress on managing losses in the Core.

We don't have that same sort of relationship in Acceptance Now, where it's a monthly model, and more people are perhaps paying electronically than you might see in the Core, or we don't see them as frequently.

And so, the ability to leverage the in-store coworker in Acceptance Now is not as effective as it is in the Core.

And so, we see some other opportunities to perhaps manage that or support it more centrally than we do today and become more effective at managing the losses that way.

Got it.

Thanks.

And then just one more follow-up and then I will yield.

On the Core same-store sales, you're now looking to be lower than your prior expectations.

I wasn't clear on what that impact is.

Is it just Texas, or are there other things impacting the Core comp?

I think I mentioned earlier, Laura, I think the portfolio's not quite as good as it was at the start of the quarter, and I don't want that to sound alarming.

It's not in bad shape.

But it's not quite as good as it was at the start of the quarter.

And so, that's why we've made what I call more of an adjustment down from expecting flat comps to being flat to down 1%.

It's not a dramatic reduction in our expectation, but it is more in line with what we expect now.

Thank you.

Thank you, Laura.

Your next question comes from the line of John Baugh with Stifel.

John, your line is open.

Thank you for taking my questions this morning.

I was wondering, on the Acceptance Now losses.

So, you mentioned looking at collections, but, frequently, when you have sub-prime go bad it's not so much a collections but an underwriting decision problem.

Is there something you're going to be looking at there to maybe tighten approvals or change the way you approve?

Yes, John, that's a good question.

Certainly, one thing that we believe is an opportunity for us -- particularly given the technology that we've deployed into Acceptance Now -- is our ability to mine data and understand the different profiles of consumers, given their employment record, their reference checks, and so forth.

We believe that the underwriting process can be enhanced going forward, as it relates to using that technology.

So, they are part and parcel with one another, as you know, having followed us for so long.

So, not only the back-end process that Guy alluded to, but also the front-end approval process are both areas that we have opportunity.

Robert, do you think that would result in maybe a slightly lower approval rate to improve the profitability, or you're not sure yet?

We're not sure yet.

Okay.

We're in the early innings, if you will, in terms of mining that data.

But, certainly, our ability to have those insights are going to just enrich our process and opportunity, going forward.

Okay.

Just curious, you and your competitor throw out this $20 billion industry opportunity numbers related to this transaction.

Could you just maybe give us the two or three key assumptions that go into that?

And also, staying on Acceptance Now, you mentioned the 30%, I believe, of the staff locations have the seamless technology.

I guess that's referring to the one-application process.

Do I understand that correctly?

When would we have it in all of the staffed stores, and is that technology available to your unstaffed models?

Thank you.

Yes, I'll take the first one, John.

The market-sizing work that we did really took a top-down approach and a bottoms-up approach, and both of those triangulated around the $20 billion to $25 billion addressable market.

When you look at retailers, more broadly, that are in our categories, our traditional space categories -- furniture, appliance, computers, electronics -- and then you look through the process of how many of those sales in the market on an annual basis are cash sales, how many go through non-cash, be it prime or non-prime factors, and then you go through this process of shrinking the market until you ultimately get to a market sizing of around $20 billion.

So, we can walk through that in more detail with you at a later date, but we did take a top-down and bottoms-up approach and came to a similar number in terms of the opportunities that our competitor did, as well.

On your second question --

John, I can answer your second question.

So, when we talk about that technology opportunity, it's both -- the seamless application you talk about, which, ours will work across multiple primary partners and multiple secondary partners, which we think is a unique proposition in the space, since we believe we're the only one that will allow for that open platform that will allow everyone to participate.

So we believe that, that much more an inclusive approach will drive bigger volumes.

And, as well, it relates to the ability to be on our partner websites, which we know already is contributing to comp-store performance in Acceptance Now.

In terms of the seamless application being available in our [Van Direct] system, we've been focusing more on the larger partners now and trying to affect the larger pool of revenue opportunity, as Robert talked about, working with some of our largest partners first.

We will have it as part of Van Direct but right now we're focusing on our largest partners first.

Okay.

My last question, just quickly, if I could.

Core inventory on rent I believe was down 6.5%, year over year.

I understand there was timing of smartphones.

There was the write-down of inventory, a whole lot of moving parts.

But your comp guidance is flat to slightly down, and yet the inventory on rent going into the quarter is materially down.

So could you connect those dots, please?

Thank you.

Well, there's a few things going on.

You pointed to one of them, John, is that last year was a bit of an anomaly because we were standing up the smartphone category.

So, we generated a lot of volume of bringing on new deliveries with smartphones last year, putting product on rent, but very early in the revenue cycle because they were brand-new agreements.

If you go back -- and, obviously, John, you followed the business for a long time -- 2013, 2012, 2011, you typically see this inventory on rent performance like we're seeing this year.

So I think we're back to more a normal seasonality for the business.

Now, we're not looking at that percentage and making an assumption of what that drives in the comp.

The other piece I would say is -- as we enter into this busier-volume season, this is probably the quarter where much more of the volume that contributes to comps comes from what we drive in this busier season, as opposed to what the portfolio drives.

So, while it is important to look at the portfolio, this particular quarter will be driven more so by the volume we generate as part of the busier holiday season than perhaps other quarters.

Great.

Thank you, and good luck.

Thank you, John.

Thanks, John.

Your next question comes from the line of Budd Bugatch with Raymond James.

Budd, your line is open.

Good morning, everyone.

This is David, on for Budd.

Hi, David.

Was hoping you can just shed a little bit more light on the smartphone issue.

I hate to beat it to death, but when did you -- I guess, when did you see this becoming an issue?

You've had the -- the category's been stood up for a while.

When you bought in, you bought across the spectrum.

So, when did you, I guess, realize that the lower -- or the older generation models weren't renting as well and the inventory may have had to be written down?

I'd say, David, probably over the last couple of quarters, the issue's been building a little bit.

And so, what happened, particularly in this quarter, though, was a couple of events that really brought us to where we are today.

The first was we completed a sale of market -- of phones in the secondary market at a value that was less than what we had on the books for those phones.

So, that was the first trigger that caused us to realize that we were looking to take a step like this.

The second one was that our belief was we would be able to use some clearance events and some bundling approaches, a couple of which occurred in this third quarter.

And while we had a little bit of success in that, we didn't see as much as we would have liked.

And so those two particular events brought us to the point where we realized the excess inventory was going to cause us to have to make this correction that we did this quarter.

So, while we knew we had excess phones in the inventory, I think our belief was that we would either be able to monetize them in the secondary market or clear them.

But the third quarter we had a couple of events that told us, while that would be somewhat successful, it wouldn't be as successful as we thought.

Got it.

When in the quarter did the sale in the secondary market happen?

And I'm guessing that, that triggered a lower cost -- or a lower-of-cost-from-market event, where you had to evaluate the rest of your inventory?

We probably started talking about it in August.

I think we completed the sale in early September.

The clearance events were -- we had one sort of earlier in the quarter and one later in the quarter, so combination of those three factors.

Got it.

And then, my last question on the issue, does this change -- will this have an effect on the rental terms of some of the newer model phones?

Because a newer phone becomes an old phone in about 12 months, I'm guessing that's around the cycle.

So will we see a -- are you going to look at shortening the rental term, adjusting pricing?

Can we have a little color there?

I think as Robert said, David, I think we're going to -- the changes we'll make will cover the [water front] in that area.

So, I think we now have a better understanding after a year of being in the category of what works for customers and what won't.

So, it will be pricing.

It will be our depreciation schedule.

It will be terms.

It will be assortment.

It will be inventory levels.

The changes we're making will be across the board.

Great.

All right.

Thank you very much.

Thank you, David.

Your next question comes from the line of Carla Casella from JPMorgan.

Carla, your line is open.

Hi.

Sorry about that; I was on mute.

On the 90-day option, can you just talk about -- how does the economics of that differ?

You did mention that it's not a lower-margin product, but can you just explain a little more detail?

Yes, so the 90-day option Acceptance Now, Carla, what -- it looks like a normal agreement when the customer signs up for it, but the difference is, is that they have the ability to elect to pay a cash option prior to the end of the 90 days from the start of the agreement.

And so, previously, we had not offered that in our Acceptance Now business, more than a year ago.

We've always offered it in our Core business.

But, clearly, with that stronger customer that we see in the Acceptance Now business, they perhaps have a little more ability to take advantage of that than our Core customer would.

And so, what you're seeing is, with us buying the product at retail, that the margin we earn on the product comes in the form of a discount for the product that we can tap into, or with the ability to mark up the cash price in the store.

Either way, though, that is a lower-margin transaction than what we would see in our normal rentals and fees business.

I think I said in my prepared comments, something more like a 10% to 15% margin, when we typically earn a margin that's more like in the 60%s for our rentals and fees business.

Now, we don't think it's a highly cannibalistic business.

Clearly, it wouldn't take a lot of transactions to cannibalize our normal business for it to not be a good idea for us to be in 90-day cash option.

But what we think is happening is that we're bringing people in that perhaps wouldn't have considered a longer-term rental agreement, but are those that are predisposed to take advantage of the 90-day cash option, that their only other option would have been to save the money for longer and try and purchase it a few months from now.

Okay.

And then, when you talked about moving from a direct to staffed, are you the one initiating that, typically, or is it the retailer?

And how is the labor market?

Are you having any problems finding staff, or you pull from your existing staff?

It depends on the volume that we generate in the particular location, Carla.

So, it does cost us to put staffing in a location, and so we want to make sure that a certain amount of volume could be driven in order to justify the cost of the staffing.

And, generally, when we start off with a retailer, we're staffed in all of their locations, but then as we gain some experience in terms of what volumes are driven, often we'll -- historically, we would have closed the location that wasn't doing enough volume.

Now, we have the ability to convert that location to a direct location, where the transaction would simply be an electronic one and not supported by an actual staff member in the store.

So, usually, retailers would like us to be staffed, because the staff model is so much better than the online model in terms of driving volume.

But there are just some locations that can't support the staff model, so the direct option is a good one for those locations.

Okay.

It sounds like, though, you're moving the other direction in some -- moving from direct back to staffed?

Yes, I think, in Robert's comments, what he said was, in some locations we've started with direct at our smaller locations today, but we've been really pleased by the volumes that we've been generating.

These locations may actually reach the point where it does make sense for us to be staffed.

But those are typically smaller locations starting out, not larger retailers.

Yes, if we can generate the volumes necessary to do the staffed model, we prefer to do that, because it's better for the retailer and it's certainly better for our business, too.

Okay.

And then, just one comment on the labor market.

Are you having any trouble staffing either those or your stores, given all your changes in the labor model?

We haven't seen that.

In fact, we've been very pleased with the rate at which our flexible labor model has ramped up and our ability to source, recruit, and hire, as I mentioned, 5,500 plus part-time coworkers in a short span of time.

So, at this point in time, the labor market seems to be sufficient to allow us to make this transition.

Haven't seen any challenges.

Yes, we'll see, Carla, on -- the thing about the labor market is, as wage rates push up, that's a good thing for our business, because our customers are those minimum-wage earners -- or close to minimum-wage earners -- that are all going to be seeing salary increases, which will allow them to shop in our stores.

Our hourly wages are typically up above $10 an hour anyway, so we're not at minimum-wage levels, today.

Certainly, in some micro markets where the wages are higher than that, we'll have to pay a little bit more.

But, on balance, rising minimum wages is a good thing for our business, not a bad thing.

Okay.

Great.

Thank you.

Thank you.

Thanks, Carla.

This concludes our question-and-answer session.

I would now like to turn the call back over to Robert Davis for closing remarks.

Thank you, Amy, and thank you, everyone, for joining us.

We appreciate your time and interest in Rent-A-Center, in our Company.

We certainly look forward to reporting back to you next quarter as we come out of our seasonally strongest period, our fourth quarter selling season.

And look forward to the opportunity for all of our initiatives to continue to add value and create opportunities for all of us, going forward.

So, thank you for your time and attention.

This concludes today's conference call.

You may now disconnect.