Rent-A-Center Inc. (RCII), one of the largest rent-to-own operators, recently delivered better-than-expected first-quarter 2012 results. The quarterly earnings of 87 cents a share outdid the Zacks Consensus Estimate of 84 cents, and increased 10.1% from 79 cents earned in the prior-year quarter, aided by growth in the top line.

On a reported basis, including one-time items, the quarterly earnings reflected a growth of 26.1% from 69 cents delivered in the year-ago quarter.

Rent-A-Center’s total revenue, which comprises store and franchise revenues, grew 12.5% to $835.3 million from the year-ago quarter, and handily beat the Zacks Consensus Estimate of $807 million. Comparable-store sales for the quarter rose 7.1%.

The increase in the top line was attributable to higher revenue from the RAC Acceptance and Core U.S. segments.

The company’s business model, called RAC Acceptance, is gaining traction. When a consumer is denied credit financing for a particular product from the retailer, Rent-A-Center acquires that product from the retailer by virtue of the RAC Acceptance program, and thereby offers it to the consumer under a rental-purchase transaction.

Revenue from the RAC Acceptance business more than doubled to $87.7 million from the prior-year quarter, whereas revenue from Core U.S. segment climbed 5.6% to $727.8 million.

Total store revenue rose 12.5% to $823.3 million. The growth was driven by an 11.1% advancement in rental and fees revenue to $678 million, a 23.8% increase in merchandise sales to $122.9 million and a 4.8% jump in installment sales to $17.5 million, offset by a 7.6% decline in other revenue to $4.9 million. Total franchise revenue climbed 14.6% to $12 million during the quarter.

Higher Expenses Weighing Upon Margins

We observe that higher cost of revenues kept the gross margin under pressure. Although, Rent-A-Center’s gross profit grew 7.1% to $560.4 million, gross margin shrunk 340 basis points to 67.1%. Cost of rentals and fees rose 20.4% to $163.4 million, whereas cost of merchandise sold soared 38.5% to $95 million.

Adjusted operating profit rose 1.7% to $92 million, whereas operating profit margin contracted 120 basis points to 11% due to an increase of 8.5% in salaries and other expenses, and a jump of 4.9% in general and administrative expenses.

Adjusted EBITDA climbed 4% to $111.4 million, however, adjusted the EBITDA margin shriveled 110 basis points to 13.3%.

Stores Update

During the quarter, the company opened 4 new Core U.S. locations, consolidated 14 stores into existing locations and closed 1 store bringing the total store count to 2,983. The company also opened 45 RAC Acceptance stores, consolidated 18 stores into existing locations and shuttered 14 stores, resulting in 763 stores. Seven international locations were opened during the quarter bringing the count to 87 stores. ColorTyme, which is a wholly owned subsidiary of Rent-A-Center, added 4 new locations and closed 2 stores, leading to a total count of 218 stores.

For fiscal 2012, management plans to open approximately 50 domestic rent-to-own stores. Through the year, the company targets to open 60 rent-to-own locations in Mexico and 10 in Canada. Moreover, the company aims 200 domestic RAC Acceptance kiosk additions.

Financial Aspects

Rent-A-Center ended the quarter with cash and cash equivalents of $107 million, senior debt of $351.7 million, and shareholders’ equity of $1,413.4 million. During the quarter, the company generated cash flow from operations of about $138.5 million, and lowered its outstanding indebtedness by $88.9 million. Management projected capital expenditures of approximately $105 million for fiscal 2012.

Strolling Through Guidance

Rent-A-Center witnessed healthy demand for its products and services during the quarter, and reiterated its fiscal 2012 outlook. The company continues to expect top-line growth between 7% and 10%, attributable to a low single-digit jump in the Core U.S. and a more than $300 million contribution from the RAC Acceptance business. Management expects comparable-store sales between 2.5% and 4.5%.

Management maintained its fiscal 2012 earnings projection of $3.00 to $3.20 per share, including a 25 cents to 30 cents cost related to its international expansion initiatives. The current Zacks Consensus Estimate for fiscal 2012 is $3.12, which dovetails with management’s guidance range.

Management also forecasted a 100 basis point contraction in gross profit margin for fiscal 2012. It also hinted at a 50 basis point reduction in operating profit margin for the year.

Rent-A-Center Holds Zacks #2 Rank

Currently, we have a long-term “Neutral” recommendation on the stock. Moreover, Rent-A-Center, which competes with Aaron’s Inc. (AAN) and Advance America, holds a Zacks #2 Rank that translates into a short-term “Buy” rating.

Rent-A-Center offers consumer electronics, appliances and furniture products under rental purchase schemes that allow customers to own the merchandise upon the completion of the rental period. Due to continued tightening of the credit market, customers see rent-to-own as a more flexible and viable option compared to credit.

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