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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to The Aaron's Company First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' prepared remarks, there will be a question-and-answer session. Instructions will be provided at that time. Thank you.
I'd like to hand the conference over to Keith Hancock, Senior Director of Corporate Affairs for the Aaron's Company. Mr. Hancock, please proceed.
Thank you. And good morning, everyone. Welcome to our first quarter 2023 earnings conference call. Joining me today are Aaron's Chief Executive Officer, Douglas Lindsay; President, Steve Olsen; and Chief Financial Officer, Kelly Wall.
After our prepared remarks we will open the call for questions. Yesterday after the market closed, we posted our earnings release on the Investor Relations section of our website at investor.aarons.com. We also posted a slide presentation that provides additional information about the first quarter results and full-year 2023 outlook.
During today's call, certain statements we make may be forward-looking including those related to our outlook for this year. For more information, including important cautionary notes about these forward-looking statements, please refer to the Safe Harbor provision that can be found at the end of the earnings release. The Safe Harbor provision identifies risks that may cause actual results to differ materially from the content of our forward-looking statements. Also, please see our Form 10-K for the year ended December 31, 2022, and other filings with the SEC for a description of the risk related to our business that may cause actual results to differ materially from our forward-looking statements.
On today's call, and in the release, we refer to certain non-GAAP financial measures, including EBITDA and adjusted EBITDA, non-GAAP net earnings, non-GAAP EPS and adjusted free cash flow, which has been adjusted for certain items which may affect the comparability of our performance with other companies. These non-GAAP measures are detailed in the reconciliation tables included in our earnings release and a supplemental investor presentation posted on our website.
With that, I will now turn the call over to our CEO, Douglas Lindsay.
Thanks, Keith. Good morning, everyone. Thank you for joining us today and for your interest in the Aaron's company. I'm pleased to report that we delivered consolidated company earnings for the first quarter that were ahead of internal expectations, despite lower revenues in both business segments.
In the Aaron's business, I’m pleased to report that we ended the quarter with a higher lease portfolio size than expected. As we've noted before, our lease portfolio size is a leading indicator for future revenues and our strong performance in the quarter was a result of fewer customers exercising early purchase options and lower write-offs. The portfolio benefited from enhancements to our lease decisioning model and we expect these benefits to carry forward in the year as leases initiated under our Titan model reflect a greater percentage of the total portfolio.
I'm also very pleased with the progress we've made in our market optimization and cost reduction initiatives, which contributed meaningfully to our bottom line in the first quarter. In addition, our e-commerce business continues to grow. And we continue to open more GenNext locations. Our GenNext stores now make up more than a quarter of Aaron's lease and retail revenues.
In the BrandsMart business, demand continues to be challenging. Macroeconomic factors continued away on our customer, who remains cautious in their purchasing decisions, especially for big ticket and discretionary product categories that we carry. We remain focused on enhancing profitability in this segment through direct procurement savings, strategic pricing actions, and cost controls. While also continuing to invest in enhancing and growing the business. We remain confident in BrandsMart’s compelling value proposition and its long-term growth opportunities. In particular, I'm excited to announce that we plan to open our first new BrandsMart store in Augusta, Georgia in the fourth quarter of this year.
Now turning to the consolidated company results. I'm pleased to report that we reduced net debt by nearly $37 million in the quarter and ended the quarter with $352 million of available liquidity. This was primarily a result of strong cash flow from operations, demonstrating the advantage of our recurring revenue model in the Aaron's business. Given our performance in Q1 and the larger and healthier lease portfolio than expected in the quarter, we have updated our outlook for the year, which reflects higher expected earnings for the Aaron's business, and lower expected earnings at BrandsMart.
In addition, our updated outlook includes both higher earnings per share and higher free cash flow for the year. I did want to note that our outlook does not assume any further credit tightening above us. However, if that were to occur, we believe that the Aaron's business would benefit over time from increased customer demand. As we look ahead, we remain focused on optimizing profitability in both businesses. We continue to make progress on the execution of our multi-year strategic plan. This includes our growth initiatives for both Aarons and BrandsMart, as well as our cost reduction initiatives that we announced last quarter.
I want to thank our teams at Aaron's, BrandsMart and Woodhaven for their hard work this quarter and for their continued focus on providing exceptional value in service to our customers.
I will now turn the call over to Steve.
Thanks Douglas, and good morning, everyone. As Douglas just mentioned, the Aaron's business delivered first quarter results ahead of our internal expectations. In the Aaron's business, merchandise deliveries across all origination channels were down mid-single-digits year-over-year. Deliveries were impacted by lower customer traffic and strategic actions we made to tighten lease decisioning.
Our lease renewal rate for the quarter was 88.5% for our company operated Aaron stores. This was down 90 basis points year-over-year. However, we are pleased that the lease renewal rate in Q1 was 270 basis points higher than the prior quarter. As typical in Q1 of each year, we experienced lease renewal rate improvement related to the tax refund season. In addition, this year we experienced further benefits from ongoing optimization of lease decisioning.
Also, I want to bring your attention to a new metric related to lease renewal activity that we are sharing for the first time in our investor presentation. Our 32-plus day non-renewal rate measures the number of leased to own customers, who are one month or more non-renewed. At the end of the first quarter, this rate was 1.6%, this was an improvement of 110 basis points from the prior quarter, and more importantly flat to the prior year period. As we look at the overall health of the portfolio, we see the 32-plus day non-renewal rate as an important leading indicator for future write-offs.
Moving to our lease portfolio size. We exceeded our internal expectations by ending the quarter with a lease portfolio size of $121.9 million. This was a decrease of 7.5%, compared to the prior year quarter. However, we are pleased with this larger than expected lease portfolio, that the tax refund season comes to an end.
Now let's talk about our important growth initiatives for the Aaron's business. As of the end of the quarter, GenNext stores now account for approximately 27% of our lease revenues in retail sales, that compares to approximately 15% in the prior year quarter. Lease originations in GenNext stores open less than one-year continue to grow at a rate of more than 20 percentage points higher than our legacy store average. In addition to opening GenNext stores, we also continue to execute our new hub and children program. So far this year, we have converted 34 additional showrooms, bringing the total number of converted locations to 63, since we launched the program.
Now turning our attention to e-commerce. Our e-commerce platform is a key vehicle for new customer acquisition and a revenue driver for the Aaron's business. In the quarter, revenues generated from leases initiated on the aarons.com platform increased 12.3% year-over-year. E-commerce now represents 17.9% of total lease revenues. This compares to 15.2% in the prior year quarter. In addition, our digital marketing strategies and tactics are gaining momentum.
I'm pleased to report that the volume of lease applications completed on aarons.com increased year-over-year. Despite the higher volume of lease applications, recurring revenue written into the portfolio from an e-commerce decreased 5.5%, compared to the prior year quarter. This decrease was a result of tighter lease decisioning, lower conversion and lower average ticket. As we continue to innovate the Aaron's business, we are focused on enabling our customers to move seamlessly among our in store and online platforms.
Now turning to BrandsMart, we continue to operate in a challenging macroeconomic environment as customers remain cautious with their discretionary purchases. As a result, we are experiencing weaker customer traffic and a lower average transaction value. Product sales were down in both our in-store and e-commerce channel, by approximately 18%, as compared to the prior year quarter.
In the face of this challenging demand environment, we continue to focus on optimizing our profitability. Direct procurement savings and strategic pricing actions helped improve our product gross margin by approximately 60 basis points, as compared to the prior year quarter. In addition, we continue to focus on expense reductions and optimizing our labor model.
As we look to the future, we remain focused on achieving transaction synergies enhancing our e-commerce platform and opening our first new BrandsMart store. Similar to the Aaron's business, e-commerce remains an important channel to acquire BrandsMart customers. We continue to invest in digital marketing and we are improving the online shopping experience.
Also, as Douglas mentioned, we plan to open our first new BrandsMart store in Augusta Georgia in Q4. I'm excited about this opportunity to bring our competitive prices, broad product selection, an exceptional customer service to Augusta. We are confident that our brand and our customer value proposition will resonate in this new market.
Now, I'll turn the call over to Kelly to provide further details on our financial performance.
Thanks, Steve. Unless stated otherwise, my comparisons to prior periods will be on a year-over-year basis. Consolidated revenues for the first quarter of 2023 were $554.4 million, compared with $456.1 million. This is up primarily due to the acquisition of BrandsMart and offset by lower revenues at the Aaron's business.
Consolidated adjusted EBITDA was $45.9 million, compared with $57.9 million. This is mostly down due to a decline in adjusted EBITDA at the Aaron’s business, offset by the contribution of BrandsMart. As a percentage of total revenues, adjusted EBITDA was 8.3%, compared to 12.7%.
On a non-GAAP basis, diluted earnings per share were $0.66, compared to $0.87. Net earnings in the quarter included a net income tax benefit of $6.6 million or $0.21 per share. Effective as of the start of this fiscal year, we have elected to treat Aaron's LLC, a subsidiary of the company, as a corporation for income tax purposes. This election is expected to change our state apportionment percentages resulting in a favorable remeasurement of certain state deferred tax assets.
Despite the lower earnings in the quarter, adjusted free cash flow was $42.5 million, an increase of $29.9 million or over 200%. This increase was driven by higher cash provided by operations as we lowered our inventory purchases at the Aaron's business and BrandsMart to align with current customer demand trends.
During the quarter, we continued to return capital to shareholders. Declaring $3.9 million in dividends. We did not repurchase any shares during the quarter. In addition, we ended the first quarter with $44.3 million of cash and $222.1 million of debt. This is a $36.9 million reduction in our net debt balance from the end of Q4 2022 and improves our net debt to adjusted EBITDA leverage ratio to 1.1 times.
Now, I'll dive into the financial details Q1 at the business segments. First, the Aaron’s business, total revenue decreased 9.6% from the prior year to $412.1 million, primarily from lower lease revenues in the segment. These revenues were lower due to a smaller lease portfolio size, lower lease renewal rate and fewer exercises of early purchase options by our LTO customers in the quarter.
In addition, retail sales, non-retail sales, and franchise royalties and fees were lower year-over-year. Gross profit in the quarter was $260.7 million, down 8.5%. This is attributed to a smaller lease portfolio size, lower lease renewal rates and lower new lease originations. However, since fewer customers exercised their early purchase options this Q1 gross profit margin increased 80 basis points to 63.3%.
Operating expenses decreased $7.9 million, this was due mostly to lower personnel costs and a lower provision for lease merchandise write-offs and were partially offset by higher other operating expenses. We continue to be pleased with the improvement in our write-offs. The provision for lease merchandise write-offs as a percentage of lease revenues and fees was 5.4%, compared to the same 5.4% in the prior year period. Although flat year-over-year, this was a 170 basis point improvement from the fourth quarter of last year.
We believe this improvement is the result of three things. First, seasonally stronger customer payment activity. Second, enhancements we've made to fraud controls and our lease decisioning algorithms. And third, strong execution by our store operations and store support center teams.
Adjusted EBITDA at the Aaron’s business was $54.6 million, compared with $69.9 million. This decline was primarily due to a smaller lease portfolio size and a decline in our lease renewal rates. These were partially offset by lower personnel expenses and the lower provision for write-offs I just reviewed. As a percentage of revenue, adjusted EBITDA was 13.2%, compared to 15.3%.
Now turning to BrandsMart's financial results in the quarter. Retail sales were $144.2 million. Gross profit was $35.1 million or 24.4% of retail sales and adjusted EBITDA was $2.8 million. Adjusted EBITDA margin was 1.9%. Yesterday, we issued our first quarter earnings release, which includes the complete detail of our updated full-year 2023 outlook. This revised outlook assumes no significant deterioration in the current retail environment, State of the U.S. Economy or global supply chain, as compared to their current condition. It also does not reflect any meaningful impact of credit tightening for the prime and near prime credit consumer.
This revised outlook reflects our expectation that total revenues for the consolidated company will be between $2.15 billion and $2.25 billion. We have lowered revenues to reflect lower early purchased options and lower retail sales at the Aaron's business in Q1 and the remainder of the year. This update to consolidated revenues also includes expected lower product sales at BrandsMart. We have increased our earnings outlook for the Aaron’s business and lowered our earnings outlook for BrandsMart. With these two changes, our outlook for consolidated adjusted EBITDA is unchanged remaining at a range of $140 million to $160 million for the year.
We have raised our outlook for non-GAAP EPS and adjusted free cash flow. This increased to EPS to between $1 and $1.40 includes the benefit of the deferred tax revaluation I described earlier and lower expected depreciation and interest expense for the remainder of 2023. We are now expecting a lower year-end debt balance. In addition, we entered into an interest rate swap last month, this swap reduces our interest expense rate on a portion of our outstanding debt, as compared to our previous outlook.
And to wrap it up, I want to highlight the increase to our adjusted free cash flow outlook. This increase to a range of $75 million to $85 million for the full-year reflects our strong cash flow in Q1, higher after tax earnings, continued inventory and working capital management and lower CapEx for the year.
And with that, I will now turn the call over to the operator for Q&A.
Thank you. [Operator Instructions] And our first question today is from the line of Kyle Joseph of Jefferies. Kyle, please go ahead.
Hey, good morning, guys. Thanks taking my questions. On the credit performance, obviously, you guys outperformed your initial expectations despite the lower tax refunds. So how are you thinking about underwriting from here? How's your consumer? Are they kind of adjusting to inflation at this point? Just give us a sense for how you're thinking about that?
Hey, Kyle. It’s Douglas. You know, as I've said before, we've taken a fairly defensive stance there. I think it continues to be a wait and see, we're really encouraged. We gave a new metric this quarter 32-plus day delinquencies. And as you see, that's decreased from, kind of, the mid-2% range to 1.6% over the last 12-months, which is really encouraging. I think as we look at the consumer, we're still in the, sort of, a state of transition, I would say. It appears with the consumers acclimating the inflationary environment that we're in. I do believe that the decisioning changes that we made in the last year and that have been really ongoing. It's been optimization of benefiting us.
And we continue to make, I would say, remain cautious there. In any environment like this where you see improved loss rates and improved delinquencies of write-offs, you tend to look at your decisions going forward and make that assessment as you go and we'll continue to do that. But I would say generally in the state of the customer, is continues to be under stress. Demand continues to be pressure, but we're really happy with what we've done internally.
Got it. Very helpful. And then just got a few questions in terms of the changes to EPS versus EBITDA guidance. If EPS going up, is that just a function of delevering and then the swap you mentioned that I was -- should help control, kind of, interest expense versus initial expectations? And then on the balance sheet obviously, you did a good job delevering in the quarter. How are you thinking about leverage at this point?
Yes, Kyle, it's Kelly. I think you're spot on there, right. We had the $0.21 tax related item that we called out in some detail. So obviously that's influencing the full-year outlook, as well as lower interest expense for the remainder of the year. We also have lower depreciation expense coming through the remainder of the year, having taken our CapEx assumptions down as well.
And then as from a debt perspective, with the stronger free cash flow that we had in Q1, the continued expectation of strong free cash flow through the remainder of the year, our view is that absent some of the use of that cash, yes, our debt balances will continue to be lower also contributing to that EPS race.
Okay, got it. And then just one follow-up there. So how should we think about the tax rate going forward?
Yes. So going forward for the remainder of this year, I would use 25% for each of Q2, Q3 and Q4. And that will give you an effective tax rate for the full-year of between kind of call it 10% and 11%.
Got it. That's it for me. Thanks a lot for answering my questions.
You're welcome. Thank you.
Our next question today is from the line of Anthony Chukumba of Loop Capital. Anthony, please go ahead. Your line is open.
Thanks for taking my questions. I guess my first question is just on how you're thinking about capital allocation, particularly given the fact that you beat your internal expectations for the first quarter and you raised your free cash flow guidance and obviously your stock is depressed on a valuation basis? How do you think about that?
Yes, Anthony. So I'd say our capital allocation strategy really remains unchanged from what we've described, you know, last quarter. So just a quick reminder, right? First, we're focused on investing into the business where we're achieving appropriate targeted returns, right? Second, we're focused on maintaining a conservative leverage profile more specifically between EBITDA leverage ratio of between 1 times and 1.5 times, which clearly we did -- we continue to improve our leverage ratio in Q1 and we're at the low-end of that range coming out of the quarter.
Third, the third leg of our capital allocation strategy is returning capital to shareholders. We've done that in the past through a combination of dividends and share repurchases. And while we didn't repurchase any shares in Q1, we do have $133.5 million remaining under the share repurchase authorization that our Board had approved the year before last.
And then finally, we will selectively look at opportunistic M&A. To answer your question a bit more specifically, right, we don't give specific guidance on exactly how we're going to use the cash, but we use that framework to make decisions as we go quarter-to-quarter. So hopefully that's helpful.
That is helpful. Thank you. And then just one quick follow-up. Can you just give us an update in terms of integrating the Aaron's lease-to-own solution into BrandsMart stores. I know it's in the stores, but if I -- my understanding is that you want to make some sort of refinements to it? So I was just wondering if we can get an update there.
Sure. Hi, Anthony. This is Steve. Today, we're pleased with the performance and we would say we're ahead of our internal expectations on the key LTO metrics, things like portfolio size, renewal rate, and just the overall demand coming into BrandsMart leasing. Just to remind you, we rolled it out in May of last year. So we're just about a year into that rollout and we're making continuous improvements both from a process standpoint in the systems and we feel we're well positioned if and when the credit tightening above us occurs.
Yes, Anthony, I'd just add, I mean, the team has done a fantastic job to launch that, and we believe there's additional operational enhancements to gain more market share there and streamline the process. We're sort of early innings on that, but we're optimistic about the future of that synergy.
That's very helpful. Thank you.
The next question today is from the line of Bobby Griffin of Raymond James. Bobby, your line is now open. Please proceed.
Good morning, everybody. Thanks for taking my questions. I guess first Kelly, just on the guidance, just trying to unpack the changes a little bit more. Was the upside with the higher now Aaron's core guidance just for the upside during the quarter or did the expectations for that segment of the business change over the remaining nine months that you guys have to report?
Yes. So the increase on the earnings side there does reflect Q1, but it also reflects the larger lease portfolio size we have going into the beginning of Q2. And that carrying through the remainder of the year relative to our initial expectations. The other thing -- two areas where we've updated our view one on write-offs. I know, but I hit it, Douglas if you have also hit on this as well, right. Great, continued momentum in the benefit of our lease decisioning changes over the last year. And so if you see it clearly in the 32-plus day non-renewal rate that we're now disclosing and tracking that over the last year, as compared to the prior year.
So continued benefit of the write-offs is part of what we're continuing to factor in, as well as the cost control initiatives that we've really leaned into this year we're seeing good results there. So all three of those put together is helping contribute to that increase on the Aaron’s business side.
Now the -- I guess the counter is with the portfolio side coming in better, write-offs coming in better, the cost control only moving $5 million. Is there any offset there or is it just some conservatism and then obviously the consumer is still very tough to predict. We don't quite know what's going to happen with trade down. Just trying to kind of unpack, if it does seem like the core leasing business has some good developments taking place now versus trends over the last 12 to 18 months?
Yes, hey, Bobby, it's Douglas. I mean, I would say the offset to that is demand pressure. We continue to see demand pressure in the first quarter and that has persisted through April. So we have tweaked our demand assumptions down in the first-half of the year incrementally. From our original outlook, leaving the second-half of the year. Alone as we think, while the second-half of the year will be down year-over-year, there's -- will be slight improvement there relatively speaking. But we continue to look at industry data. We look at what we're seeing in our data so far this year and are assessing how much to pull forward the demand and how long will that will persist relative to the product life cycle. So we've taken all that into account. So Kelly outlined the three positives, I would say that's the pressure on the business right now. And there's a pressure on BrandsMart and on Aaron’s.
Yes. And Bob, to your point, right? We are not assuming any trade down in credit, so we're at to happen that could, kind of, counteract balance that demand pressure that Douglas had mentioned before. So just another thing to kind of keep in mind in terms of potential upside going forward?
Yes, and I would say the last thing is -- and is based on Kyle's original questions to the extent we continue to see lower write-offs, we reduced our lease affordable rates by several hundred basis points year-over-year. And to the extent those low write-offs continue, that is also an opportunity for us. If we were to loosen there [Multiple Speakers]
Thank you. That's helpful too. And I guess Kelly, on the subject of trade down, none assumed going forward. Have you seen any signs that it might be coming or did you see a little bit in 1Q that gives you kind of hopes that maybe we're entering this period that credit actually is going to tighten a tiny bit either from an application standpoint or some -- your customer demand that are applying or anything like that?
Yes, Bobby, this is Douglas. I would say as of right now, we're not seeing an increase in demand. From credit tightening above us either at Aaron's or BrandsMart, it’s really tough to gauge what's going on right now. It seems to me things are getting tougher with the prime and near prime consumer. And as Kelly said, should credit tighten above us, default rates increase credit get restricted, we believe that our market will expand. We get external data every day. We run that through our lease decision and committee and we're looking at what's coming into our funnel. We have not seen evidence of that. We see some slight evidence of demand coming in from our peer group, I would say, with lower approval rates, but not necessarily from above us.
We do [Technical Difficulty] data that comes through BrandsMart and we're looking that as well in BrandsMart leasing. So we continue to focus on the external factors and how they may influence that going forward gas prices, housing prices, food prices are major factors for our customer. And of course, the near prime consumer is their savings rates diminish and credit increases, those will be important factors. But we'll continue to keep you updated on that.
Absolutely. Well, I appreciate the details. Best of luck here going forward.
Thank you.
Thanks, Bobby.
[Operator Instructions] And the next question is from the line of Scot Ciccarelli of Truist. Scot, please go ahead. Your line is open.
Hi, good morning, guys. This is Joe Chalhoub on for Scot. Thanks for taking my question. I just wanted to dive a little deeper into the 170 basis point sequential improvement in write-offs? And how we should think about the full-year guidance? I think last time you guys said 5.5% to 6.5% for this year, and then longer term, kind of, getting back to the 5% to 6% range. Just wanted to see if those changed at all?
Yes, Joe. It's Kelly. Thanks for the question, so our outlook or guide right for write-offs for the full-year is unchanged at the 5.5% to 6.5%. I mean we are trending towards the lower end of that now. But just given some of the volatility right we've seen over the last four quarters, we're not ready to, kind of, tighten that range. But certainly based on what we're seeing in terms of the results in charge offs and write-offs and the 32-plus day non-renewal rates from the management of our lease decisioning over the last several months. More seeing there, we're increasingly confident in that 5% to 6% range as you move into 2024 and beyond.
Got it. Great. And then one follow-up on that. If you keep seeing write-offs come in lower than expected, would you decide to then loosen credit standards again? Or is that like off the table for this year?
Yes, this is Douglas. I would say it's not off the table, we're constantly optimizing our lease decisioning. We have a recurring lease committee meeting that we do that in and we'll continue to assess the current environment and what we're seeing in the future to make those decisions. So tightening or loosening happens at real time in our business. And so that is not off the table for sure.
Got it, great. Thanks.
Thanks, Joe.
Thank you. And we have no further questions in the queue today. So it's my pleasure to hand back to Douglas Lindsay for some closing remarks.
Thank you, operator. As we wrap up, I just want to reiterate how encouraged I am by our execution to start [Technical Difficulty]. Our larger as we said our larger and healthier lease portfolio size combined with lower delinquencies set us up really well for the future. Despite a softer tax season, I'm really pleased with the efforts by the team to consolidate our efforts to integrate BrandsMart in the business and achieve our transaction synergies and I'm excited to open our first store in Augusta, Georgia this year at BrandsMart.
So again, I want to thank our team members, our franchisees for a great first quarter and thank you for joining us today. We look forward to speaking with you soon.
Thank you for joining today, everyone, this concludes the call and you may now disconnect your lines.