Q4 2022 Aaron's Company Inc Earnings Call

Speaker 1: Thank you for your patience. The Aaron's Company 4th quarter 2022 earnings conference school will be starting in a few moments time.

Speaker 1: As a reminder, is Star 1 to ask any questions today?

Speaker 1: Welcome to the Aarons Company Fourth Quarter 2022 Earnings Conference call.

Speaker 1: At this time, all participants are in a listen only mode. After the speakers are prepared to mark, there will be a question and answer session.

Speaker 1: Instructions will be provided at the time. Thank you. I'd like to hand the conference call over to Keith Hancock, Senior Director of Corporate Affairs for the Arons Company. Mr. Hancock, you may proceed. Thank you and good morning everyone. I'm Keith Hancock, Senior Director of Corporate Affairs at the Arons Company.

Speaker 2: Welcome to our fourth quarter and full year 2022 earnings conference call. Joining me today are Aaron's Chief Executive Officer Douglas Lindsay, President Steve Olson and Chief Financial Officer Kelly Wall. After our preparedness marks, we will open the call for questions.

Speaker 2: Yesterday after the market closed, we posted our earnings release on the investor relations section of our website at investor.arans.com. We also posted a slide presentation that provides additional information about the fourth quarter and full year 2022 results, our full year 2023 outlook, and an update on our multi-year strategic plan.

Speaker 2: During today's call, certain statements we may be forward looking, including those related to our outlook for this year. From 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.

Speaker 2: The St. Harbor provision identifies risks that may cause actual results that differ materially from the content of our board looking statements. Also, please share a form 10K for the year-end of December 31, 2022 and other filings with the SEC for a description of the risks related to our business that may cause actual results and differ materially from our board looking statements.

Speaker 2: On today's call and in the release, we refer to certain non- GAAP financial measures, including EBITDA and Adjusted EBITDA, non-gap knit earnings, non-gap EPS and adjusted pre-cash flow, which have 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 the-

Speaker 2: for both revenue and adjusted earnings.

Speaker 2: and that we delivered both consolidated company and segment results for the full year 2022 that were within the revised outlook we provided on October 24th.

Speaker 2: While high inflation and other challenging economic conditions continue to impact our customers in the fourth quarter, we so improve in customer demand during the holiday season at both errands and brand smart. Despite macroeconomic pressures, our teams have done a great job of generating customer demand.

Speaker 2: through well-executed marketing and merchandising strategies designed to increase our market share. Our top priority remains optimizing profitability in both businesses. In Aaron's business, we continue to benefit from ongoing investments in lease decisioning and digital payment and servicing platforms. For example, enhancements made to our lease decisioning model earlier in 2022

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Speaker 2: And we expect to generate approximately $35 to $40 million in cost savings in 2023. In the quarter, we also made progress on execution of our strategic growth initiatives at both Aaron's and Brandsmart. At Aaron's, we remain focused on enhancing and growing our e-commerce business, and on executing our real estate repositioning and market optimization program.

Speaker 2: At Brandsmart, we remain confident in our growth potential and are optimistic about capturing the synergies we announced last April with the acquisition. As we look ahead into 2023, our outlook assumes that high inflation and other macroeconomic factors experienced in 2022 will continue to pressure customers across the credit spectrum. In both businesses,

Speaker 2: We expect continued softness in customer demand in the first half of the year for our core product categories of appliances, furniture, and electronics. And when our customers do shop, we expect they will continue to trade down to lower price products. Our outlook reflects these challenging customer demand trends, as well as higher leaf agreement payouts in the first half of the year. And the fact that our leaf portfolio size.

Speaker 2: with 7% lower at the beginning of 2023. Our outlook also reflects our expectations. The second half of the year will benefit from improved customer demand and payment activity as well as ongoing cost reductions. As we look to 2023 and beyond, I'm excited to provide an update to our multi-year strategic plan, which is designed to grow revenue, reduce costs, and strengthen our operating margins.

Speaker 2: The three pillars of our updated strategic plan include first, transforming near-and-business through investments in market optimization, e-commerce, marketing initiatives, and enhancements to relief decisioning and servicing platforms all designed to increase our market share. Second, enhancing and growing brand smart.

Speaker 2: through achieving our transaction synergies, opening new stores, and investing in e-commerce. And third, optimizing our cost structure through rationalizing our physical infrastructure and support functions. While we expect 2023 to be a reset year, we believe in the long-term strength of customer demand in both our leaks.

Speaker 2: I will now turn the call over to Steve Olson.

Speaker 2: and merchandising strategies across our store and e-commerce channels.

Speaker 2: For example, our Black Friday and Cyber Monday promotions drove the highest recurring revenue written in our e-commerce channel since we launched errands.com. Merchandise deliveries in all channels steadily improved throughout the quarter, including a strong end to the holiday season in December . Our leads for null rate.

Speaker 2: came in line with our internal expectations at 85.8% for all company operated air and stores, which was down 190 basis points year-to-year. Lease portfolio size is a key driver for future revenue. Although our lease portfolio size for all company operated stores, and of the fourth quarter ahead of our internal expectations at $126.5 million, our lease portfolio size, and of the fourth quarter, 7.2% lower than the prior year quarter. Shift into our important growth strategies in the air and business.

Speaker 2: We are pleased with the ongoing growth of our e-commerce channel. We end of the year with over 8,300 products on errands.com in increase of 137% versus the prior year quarter. Recurring revenue written into the portfolio from e-commerce lease originations increased 17.6% compared to the prior year quarter, while revenues increased 7.3% year over year. We are pleased with the ongoing growth of e-commerce lease originations increased 17.6% compared to the prior year quarter.

Speaker 2: The Ecommerce business continues to represent an increasingly higher percentage of our revenues. In the fourth quarter, Ecommerce represented 16.7% of our total E's revenues up from 14.5% in the prior year quarter. We continue to be pleased with our investments in our AERANth real estate repositioning and market optimization program. As part of that program, we continue to invest in our Gen Next stores, which now account for more than 25% of lease and retail revenues.

Speaker 2: up from 11.6% last year. Lease of Reginations in Gen-X stores open less than one year, continue to grow at a rate of more than 20% is point higher than our average legacy stores. We ended 2022 with 211 Gen-X stores, and we plan to open up to 50 additional locations in 2023. These larger Gen-X stores have enabled us to expand our market optimization program to include a new hub and show a model. In this new model, we designate one store to open up.

Speaker 2: In the long term, we believe this model will allow us to more efficiently open new locations and reduce real estate costs in our existing markets. Now turning to Brandsmark. As a result of weaker traffic and softer average transaction value, our product sales were down 10.8% for the fourth quarter as compared to the prior year quarter. But...

Speaker 2: up 1% as compared to Q4 2020. Although we face challenges at the beginning of the quarter, product sales improved during our Black Friday promotion through the end of December . Despite lower product sales in the quarter, our team optimized profitability through procurement savings, strategic pricing actions, and expense management. Through these actions, we improved product growth margin by approximately 45 basis points for the prior year quarter. Turning to our strategic initiatives for Brands Mark, e-commerce remains a long-term growth opportunity.

Speaker 2: We continue to enhance our digital marketing strategies and improve the online user experience. We are pleased with the redesign of our website launched in the quarter. Consistent with our overall performance in product sales, e-commerce product sales were down 5.1% as compared to the prior year. However, in the quarter, e-commerce product sales grew to 10.5% of total sales. We also continue to make progress in executing our integration and synergy initiatives related to the Brand Smart acquisition.

Speaker 2: We are pleased that we ended 2022 well ahead of our internal expectations for the terming energies. In addition, we added over 250 items from Brantmark to errands.com and we are making progress with our least-owned solution offered in Brantmark stores. As we look ahead into 2023, we are excited to open our first new Brantmark store in Q4. We believe that we have a compelling customer value proposition and we look forward to expanding this brand into new markets. Now, I'll turn things over to Catalete to provide further details on our financial performance. Thank you Steve.

Speaker 2: that we ended 2022 well ahead of our internal expectations for determined synergies. In addition, we added over 250 items from Brandsmark to errands.com and we are making progress with our least-owned solution offered in Brandsmark stores. As we look ahead into 2023, we are excited to open our first new Brandsmark store in Q4. We believe that we have a compelling customer value proposition and we look forward to expanding this brand into new market. Now, I'll turn things over to CatLeaks to provide further details on our financial performance. Thank you Steve. Let's start with the fourth quarter.

Speaker 2: And less stated otherwise, my comparison to prior periods will be on a year-over-year basis. Consolidated revenues for the fourth quarter of 2022 were $589.6 million, compared with $444.8 million, up primarily due to the Brandsmart acquisition, and offset by lower revenues at the errands business. Consolidated adjusted evidot was $27.7 million, compared with $41.3 million, down primarily due to a decline in adjusted evidot for the errands business, offset on the contribution of Brandsmart. As a percentage of total revenues, adjusted evidot was 4.7% compared to 9.3%. Compared with non-GAP diluted earnings per share of 60 cents. Adjusted free cash flow was $24.7 million, up $1.1 million, or $4.7% due to higher cash provided by operations, primarily driven by lower inventory purchases at the errands business to align with the man trends.

Speaker 2: During the quarter, we continued to return capital to shareholders through our dividend and share repurchases. We declared $3.4 million in dividends and repurchased approximately $219,000 shares for $2.3 million. Now I'll dive into the financial results for Q4 at the business seconds. First, the air business. Total revenues decreased 9.1% from the prior year to $404.3 million. Primarily due to lower lease revenues, the result of both a lower lease portfolio size and of the client and customer payment activity. Gross profit was $248.6 million, down 10.3% driven by lower lease renewal rates, lower new lease of originations and higher inventory purchase costs. As a percentage of total air and business revenues, gross profit declined to 61.5%.

Speaker 2: compared to 62.3%. Operating expenses decreased $5 million due primarily to lower performance based compensation, partially offset by a higher provision for lease merchandise write-offs and other operating expenses. The provision for lease merchandise write-offs as a percentage of lease revenues and fees was 7.1%, compared to 5.7%.

Speaker 2: This was a 40 basis point improvement from the third quarter, and we expect to see continued sequential improvement into the beginning of 2023. Adjusted EVA dock at the errands business was $36.2 million, compared with $58.1 million. Due primarily to a decrease in gross profit and a higher provision for lease merchandise write-offs, partially offset by lower personnel expenses. As a percentage of revenue.

Speaker 2: Adjusted EBITDA was 8.9% compared to 13.1%. Before I move to the full year consolidated results, here are the key Brandsmart metrics for the quarter. Retail sales were $187.7 million. Gross profit was $37.4 million or 20% of retail sales. And adjusted EBITDA was $5.3 million. Adjusted EBITDA margin was 2.8%. Now I'll summarize the key points in our full year 2022 consolidated financial results.

Speaker 2: $8.9% compared to 13.1%. Before I move to the full year consolidated results, here are the key brand smart metrics for the quarter. Retail sales were $187.7 million. Gross profit was $37.4 million or 20% of retail sales. And adjusted EBITDA was $5.3 million. Adjusted EBITDA margin was 2.8%. Now I'll summarize the key points in our full year 2022 consolidated financial results. Again, comparisons here are year over year.

Speaker 2: Consolidated revenues were $2.25 billion compared with $1.85 billion up 21.9% due to the inclusion of three quarters of brand smart offset by lower revenues at the errands business. Adjusted EBIDA was $165.8 million down from $234.1 million. You primarily to the same factors that impacted the fourth quarter year-over-year performance that I discussed earlier. The provision for lease merchandise rideoffs at the percentage of lease revenues was in line with our expectations at 6.4% compared to 4.2%. On a non-gap basis, diluted earnings per share were $2.7 compared with $3.75. So in 2022,

Speaker 2: The company also repurchased 735,000 shares of the company's common stock for $13.4 million. At the end of 2022, the company had a cash balance of $27.7 million in total debt of $242.4 million. This represents a $21.5 million reduction in our net debt balance from the end of the third quarter. Turning to our 2023 outlook.

Speaker 2: Our full year 2023 outlook for total revenues at the consolidated company is $2.2 billion to $2.3 billion. And adjusted EBITDA is $140 million to $160 million. As noted in our materials, starting with the first quarter of 2023, we will add back stock-based compensation expense to our reported adjusted EBITDA for the consolidated company. We are making this change to better align our reporting with peer companies. For comparability, adjusted EBITDA in 2022, excluding stock-based compensation expense.

Speaker 2: was $177.1 million. Our 2023 non-GAP EPS outlook is $0.70 to $1.10 per share, which has been impacted by lower adjusted EBITDA in both segments, higher depreciation expense, higher interest expense, and a higher effective tax rate versus last year. For the four years 2023, we are assuming an effective tax rate of 25 to 26 percent, a diluted weighted average share count of 31.5 million shares and no share reversices.

Speaker 2: The primary factors influencing our 2023 outlook include starting in the year with a 7% lower lease portfolio size at the errands business and lower customer demand, which is driven by expected lower traffic and lower average ticket size at both business segments, both partially offset by improving customer payment activity and cost savings we are achieving through our operational efficiency and optimization program. We believe an ongoing high inflationary environment in the first half of the year for both the company and our customers will continue to negatively pressure average ticket size in both businesses, errands lease portfolio size and the provision expense for lease merchandise write offs.

Speaker 2: For the call savings, which we expect will be recognized primarily at the errands business segment and within unallocated corporate expenses, we have identified several areas to improve efficiencies across our stores, supply chain network, and corporate functions. Through these various initiatives, we expect to achieve between $35 to $40 million in total expense reductions.

Speaker 2: in 2023, for the additional savings expected in 2024 and 2025. We are well underway with these initiatives and look forward to updating you in the future. As we think about performance over the course of the year, we expect adjusted EBITDA to be spread roughly evenly by quarter with the first half of the year slightly higher than the second half of the year. Our 2023 outlook includes a full year contribution of brand smart and a return to more normal seasonal payment trends in the errands business. As a result of this and our cost reduction initiatives, we expect adjusted EBITDA in the second half of 2023 to be higher than the second half of 2022.

Speaker 2: We also expect net earnings to follow a similar spread and to be slightly higher in the first half of 2023 to, in part, to an increase in appreciation expense. And finally, our capital allocation priorities are investing in errands and brand smart growth initiatives.

Speaker 2: maintaining a conservative leverage profile of one to one and a half times net debt to adjusted EBITDA. Returning capital to shareholders through dividends and share repurchases and evaluating acquisitions on an opportunistic basis. As it relates to returning capital to shareholders, yesterday we announced an increase to our quarterly dividend. We will pay 12.5 cents per share on April 4th to shareholders of record as of close of business on March 16th. Now we'll move to Q&A.

Speaker 1: Operator, are you there? Thank you. If you would like to ask a question, please press star then one on your telephone keypads. If you change your mind, please press star two. We have the first question on the phone line from Kyle Joseph of Jeffries. Your line is open. Good morning, guys. Thanks for taking my question. Just for 23 kind of subscribers is a reset year, I think Douglas. You know, in terms of demand.

Speaker 4: to see that downward pressure, really both in store traffic and average ticket. Steve mentioned average ticket across both brands, both errands and brands smart. You know, we're expecting some challenges going into the first quarter in our core categories for intellectual electronics and appliances and both businesses. And this is really based on industry outlook as we talk to vendors in our industry and others out there. What we've seen so far in our numbers and then really the lasting effects of a cool toward into demand.

Speaker 4: In the first quarter, we're seeing a slightly smaller tax season so far, which is putting some pressure on demand. But due to fewer payouts, that could result in our portfolio size being up because the portfolio will hold better than it does when we see larger tax refunds. We have all that factored in. And they importantly, we have not seen any impact of credit tightening above us and our guide. And we believe we're well positioned to benefit from that and capture that if it does occur.

Speaker 4: at the peak of stimulus in 2021. The average term for our lease is about 20 months. We expect those to have a higher impact on the churn the first half of the year, but are decisioning and all the things that we put in place in 2022 kicking in in the second half of the year. And the last thing I'd say just to put a wrap around 23 is we do expect renewal rates and customer payment improvements over the course of the year, including improvements in write offs. And we see that in our business in the first quarter really.

Speaker 2: We're really focused in both businesses on taking share right now and really driving our value prop. We think we're really well positioned to do that and what you'll see that in our marketing customer acquisition activities going forward. Yeah, thank you. And then just in terms of overall store count, obviously recognizing the gen X builds and then the apologies if I put you this, but the hub, not the hub is spoke but the hub and hub and showroom model. But in terms of overall store count, I mean, where do you see that trending incoming years? Yeah, hey, college, it's Kelly. I mean, I would expect that there we'd see that the trend.

Speaker 2: down thumb, not as much as what we were thinking when we looked at the next strategy. Look, if we look at this hub and showroom model, we're keeping more locations open. But I would say we're probably going to close 10 to 20 stores this year and less than that going forward. And that's met, again, against anything that any new stores we may open as we're pushing out this new strategy. Thanks very much for answering the questions. Thank you.

Speaker 2: Thank you. Thank you. You now have Bobby Griffin of Raymond James. Your line is open. Hey, good morning, buddy. It's your taking the questions. I guess, Kelly, first, let's me to follow up on your comments there. That is a little bit different of a store count than we talked about post spin. Just curious, unpack, you know, kind of that change and trajectory is just what you're seeing out there in the market. Potential, you know, you see a better opportunity for markets or games or the customers change a little bit. Anything to help us understand, you know, the changes your deck are on the store count.

Speaker 4: Bobbi, this is Douglas. I'll take that. I mean, you know, we're coming off of really strong 2020 and 2021 where profitability spiked in our business and we really encourage there. We slid down the pace of our store closures to be there for our customers. And we were pleased with the profitability in our stores. I think as we look forward, we do feel like we should have fewer larger stores and a more efficient market presence. We're doing that in a number of ways. We're doing that through re-positioning our gen-next stores and making them larger and capturing more market share. But we're also doing that through this new hub and showroom concept.

Speaker 4: And this is really designed to drive market profitability and grow our share in the market, while still ensuring the great customer experience of our customers have come to expect. So we're historically, and this is morphed over time, and really been enabled by this new new gym next store concept. So historically we may have closed merged.

Speaker 4: two or three stores into one. We're now able, because of the gen north next door Concept in our digital servicing platforms and payments platforms. We're now able to service larger adjacent markets with one big Hub Store that can do servicing, warehousing and delivery and then having smaller sales stores around that hub that are

Speaker 4: then we can more efficiently expand our market presence at the same time. So we're really encouraged about that. We're super excited about that. And as we've mentioned, we have 29 hub and showroom, store locations open so far this year. And we plan to convert 100 showrooms next year with 50 gym next stores. Yeah, Bobby, and I just want to add that while

Speaker 2: on a net basis, it is fewer closed stores. With this hub and showroom strategy, we are achieving call savings on the personnel side, the occupancy side, as well as working capital free up for reduced inventory, because these showroom locations, while they do have merchandise on the floor, we don't need to keep a backroom full of inventory for delivery, so that's done at the hub.

Speaker 2: Okay, I appreciate that. And I guess, I want to switch over maybe to Brandt Mark. And just maybe kind of look, obviously, the environment for that business is tough right now. One of the big electronic competitors kind of really starting this morning also talk about demand pressure going forward in the 2023. But what do you think the long term margin profile is in that business? And I guess I'm just asking in the concept of, for 2023, the guide implies we've got down verse 2022 despite having one more quarter in the results. So just curious, you know, how we built in that profile and kind of what you think when synergies are close.

Speaker 2: on earnings and impacting margin. So as we take into account the impact of those new store openings, we're looking over the next three years, we're going to average probably three and a half percent or so EBITDA margins, but again a little highlight, that's impacted by the downward pressure from opening new stores.

Speaker 2: a dollar range of call it three to seven million dollars per store in the third year.

Speaker 1: Okay, I appreciate the details of best luck here in 2023. Thanks, bye. Thank you. You now have school.

Speaker 2: So, Sirelli, both terrorist securities, please go ahead when you're ready. Hey guys, this is Joanne for Scott. I was just wondering if you can talk about any new trends you're seeing in centralized data and, you know, if any concerns might cause you to further tighten credit standards like you did last year. And how much of that, if any, is baked into the guidance. Thank you. Yeah, hey, this is time. Let's say we're really pleased with the.

Speaker 4: improving trends in Q4 and we're really encouraged as I said before of what we're seeing in Q1. Our delinquencies are trending down and right now we are trending towards pre-pandemic write-off levels by the end of Q1, which is really good. As of right now, whereas today we expect write-offs to reduce sequentially going into the first quarter by approximately another 100 basis points.

Speaker 2: So that's really encouraging. So all the actions that we've taken in 2022 are paying off and we'll continue to optimize it and decide whether we tighten or expand approval rates on an ongoing basis. Big expand on that. Our 2023 outlook does not include any further adjustments to our decisioning, but obviously as macro economic conditions and the activity we're seeing from our customers directly.

Speaker 2: change to the course of the year, we could adjust that either, whether it means losing or tightening as we go forward. Got it, thanks. And then we said 100 basis points to the quintal improvement. Is that that's just 4Q to 1Q or is that have to do with seasonal factors as well? So it takes both into account. So it's a sequential improvement, but it's taking into account both benefits we're seeing from decisioning and the seasonal changes. Got it, great, thank you. Thank you.

Speaker 1: To ask any further questions, is staff loaded by one? We now have Jason Hans of Thank for America. Jason Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hans Hey, good morning and thanks for taking my questions. I'm curious to give us an update on how Least To Own is performing at Brands Marna and I know that was rolled out somewhat recently. So I'm curious how that's been progressing. Thanks.

Speaker 2: Yes, hey Jason, this is Steve Olson. Thanks for the question. Yeah, we continue to make progress on our brand smart leasing solution that is in our brand smart stores just to remind you we launched this solution in the major time frame of last year. Thank you.

Speaker 2: I'm still really early in the process. Teams are working very well together between the Brand Smart Stores and our Brand Smart Leasing team and we continue to refine the business processes, procedures and the necessary tools to run that business and it's a small percentage of the overall pie but we're pleased with the progress we're making.

Speaker 5: Great, thank you. And then Doug, I wanted to follow up on your comments just earlier about using an improvement in write offs in one queue. Is that, do you think that's largely reflecting tighter decisioning and those leases that were decisioned later with tighter standards is bringing the write offs down? Or are you seeing any signs that the customers may be stabilizing on with inflation rates like moderating at least a little bit here? Just curious if there's any sort of signs of the macro improving or if that was more internally driven? Yeah, I think it's a little bows. I think your customers...

Speaker 4: a lot of proactive management in terms of our least decision.

Speaker 2: We're really encouraged with the results that we've got momentum on that going into the year despite the demand trends. Yeah, and Jason, it's Kelly. And what I would add is that we are expecting for the full year 2023 to write off to improve relative to 2022. For 2023, we're expecting your office to come in.

Speaker 2: kind of a range of 5.5 to 6.5%. So that's about a 50 basis point improvement from range that we gave in 2022. And as we continue to make progress through the course of the year, both the benefits from our decision activities as well as improvement in customer activity in a back part of the year. As we go into 2024 and beyond, we'd expect to be down in that kind of four to five, five, five to six percent range.

Speaker 5: going forward, long-term. Great. Thank you. And if I could squeeze one more in, I think you mentioned that you're not factoring in any benefit from credit tightening in the guidance. I'm just curious what your thoughts are in terms of, you know, we have seen some others talk about better hiring the credit stack, talk about, you know, tightening. I don't think a lot of your peers have, you know, meaningfully seen the tightening yet. So it's curious to get your thoughts on, you know, even though it's not in guidance at any thought on my when.

Speaker 4: when we may see some benefit from credit tightening. Yeah, right now we're not seeing any increase in demand from higher credit scores coming into either errands or grants mark leasing. It's really tough to gauge what's going on with the consumer right now and then we're all looking at rising debt balances and lower savings rates, et cetera, with our customers. The only thing I would say is we don't have that baked under our guidance, any benefit for that during the year.

Speaker 4: But should default rates continue to rise and prime credit and get restricted, we believe our market will expand and will be the beneficiaries. We're continuing to look at external data sources in our own internal data sources to see if that's happening, both at Brandsmark and at the Air and so far we've seen no strong signs of it, but we'll continue to moderate. But I mean, Jason, what I'd say is we're ready for it and we feel like we'll be the beneficiaries and we feel like we've positioned our stores in our e-commerce business to capture that. Great, thank you. Thank you. We have no further questions. I'd like to hand it back to Doug Liston, Z for any final remarks.

Speaker 6: I.