PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q2 FY2014

Penske Automotive Group, Inc. — Form 10-Q Summary

Business Context and Reporting Period

Quarterly report for the three and six months ended June 30, 2014. Penske Automotive Group operates automotive dealerships, commercial vehicle distribution businesses and Hertz car rental franchises in the United States, Western Europe, Australia and New Zealand. At quarter-end, it operated 324 automotive retail franchises and employed approximately 19,900 people. Automotive dealerships generated 97.2% of six-month revenue and 96.0% of gross profit.

Six-month automotive dealership revenue mix: 61% United States and Puerto Rico; 39% international.
Approximately 71% of automotive dealership revenue came from premium brands.
The company acquired two automotive retail franchises during the first half of 2014 and disposed of seven franchises. In July 2014, it invested $16.6 million for a 50% interest in eight BMW and MINI franchises in Barcelona, Spain.

Financial Results and Key Metrics

Metric	Three Months Ended June 30, 2014	Three Months Ended June 30, 2013	Six Months Ended June 30, 2014	Six Months Ended June 30, 2013
Total revenue	$4,406.7 million	$3,630.6 million	$8,454.7 million	$6,979.9 million
Gross profit	$666.9 million	$559.5 million	$1,290.9 million	$1,086.1 million
Operating income	$136.2 million	$112.1 million	$255.9 million	$217.3 million
Income from continuing operations	$81.3 million	$63.5 million	$147.8 million	$121.1 million
Net income attributable to common stockholders	$72.9 million	$62.0 million	$140.4 million	$119.7 million
Diluted EPS	$0.81	$0.69	$1.55	$1.32

Six-month revenue increased 21.1%, gross profit increased 18.9%, operating income increased 17.8%, and diluted EPS increased 17.4% year over year.
Approximate six-month consolidated gross margin was 15.3%, operating margin was 3.0%, and net margin attributable to common stockholders was 1.7%. Second-quarter gross margin was approximately 15.1% and operating margin was approximately 3.1%.
Six-month revenue growth reflected higher new and used vehicle sales, finance and insurance revenue, service and parts revenue, and the contribution from the commercial vehicle business acquired in August 2013.
Six-month same-store new vehicle units increased 6.2% and used vehicle units increased 9.1%. Same-store finance and insurance revenue increased 16.1%, while same-store service and parts revenue increased 7.6%.
Retail gross margin declined to 15.8% for the first half from 16.1%, primarily because vehicle sales represented a larger proportion of revenue than higher-margin activities. Used vehicle gross margin declined to 7.2% from 7.7%.
SG&A increased 19.2% to $1,001.0 million for the first half, while SG&A as a percentage of revenue improved to 11.8% from 12.0%. SG&A as a percentage of gross profit increased modestly to 77.5% from 77.3%.
Equity in earnings of affiliates increased to $16.0 million from $11.2 million, primarily due to improved earnings from Penske Truck Leasing and other joint ventures.

Cash Flow, Debt and Liquidity

Cash provided by continuing operating activities was $211.4 million for the first six months, compared with $174.0 million in the prior-year period. Including non-trade floor plan borrowings as operating activity, adjusted operating cash flow was $243.8 million versus $211.6 million.
Continuing investing cash outflow was $210.5 million, including $72.9 million for equipment and facility improvements, $76.3 million for rental vehicles and $86.2 million for dealership acquisitions.
Continuing financing cash outflow was $19.4 million, including $33.5 million of dividends and $15.5 million of share repurchases, partially offset by $32.4 million of net non-trade floor plan borrowings.
Cash and cash equivalents increased to $61.4 million at June 30, 2014 from $49.8 million at December 31, 2013.
Total floor plan notes payable were $2,651.3 million, consisting of $1,717.3 million of trade floor plan notes and $934.0 million of non-trade floor plan notes.
Total long-term debt was $1,088.4 million, including $550.0 million of 5.75% senior subordinated notes due 2022, $121.0 million under the rental car revolver, $130.4 million of mortgage facilities and $198.0 million under the U.S. credit agreement. Net long-term debt, after current maturities, was $1,006.8 million.
Available borrowing capacity at June 30, 2014 was $350.0 million under the U.S. credit agreement, £82.0 million, or approximately $140.3 million, under the U.K. credit agreement, and AU$28.0 million, or approximately $25.9 million, under the Australian working capital facility.
The U.S. credit agreement was amended in April 2014, increasing revolving capacity from $375.0 million to $450.0 million and reducing the rate on collateralized borrowings to LIBOR plus 2.00%. Management reported compliance with applicable credit agreement and lease covenants.
The company estimates total future rent obligations under operating leases at approximately $4.9 billion, including optional extension periods.

Material Changes Versus the Prior Comparable Period

Revenue growth was broad-based, with six-month new vehicle revenue up 18.1%, used vehicle revenue up 20.7%, finance and insurance revenue up 20.3%, and service and parts revenue up 11.6%.
The commercial vehicle business contributed $205.8 million of revenue and $33.8 million of gross profit in the first half of 2014; it was acquired on August 30, 2013 and therefore did not contribute to the comparable prior-year period.
Car rental revenue increased to $30.4 million from $21.8 million, and car rental gross profit increased to $17.0 million from $13.9 million, primarily due to expansion into Indiana markets.
Foreign currency translation produced a $26.1 million favorable adjustment in other comprehensive income for the first half, compared with a $35.1 million unfavorable adjustment in 2013. The stronger British pound contributed approximately $18.4 million to second-quarter gross profit.
Discontinued operations generated a six-month net loss of $6.0 million versus a $0.6 million loss in the prior-year period. Related revenue declined to $76.2 million from $271.7 million.
First-quarter severe weather caused approximately 280 combined service days to be lost in dealerships in the Northeast and Central/Midwest, negatively affecting service and parts results and adding certain general and administrative costs.
The company repurchased 175,000 shares for $8.0 million under its authorization and acquired an additional 160,350 shares for $7.5 million through employee award net share settlements. Remaining authorization was $77.6 million at June 30, 2014.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide specific quantitative earnings or revenue guidance. Management expected continued improvement in U.S. and U.K. automotive markets, supported by vehicle demand, an aging vehicle fleet, consumer credit availability and new model introductions. Management expected the Australian commercial vehicle market to lag 2013, while New Zealand was showing growth.

Key operating sensitivities include vehicle volumes, consumer confidence, interest rates, credit availability, fuel prices, unemployment, weather, manufacturer incentives and vehicle supply.
Variable-rate debt creates material interest-rate exposure. A 100-basis-point change was estimated to affect annual other interest expense by approximately $2.5 million and annual floor plan interest expense by approximately $20.2 million.
A 10% change in average foreign exchange rates versus the U.S. dollar would have changed six-month revenue by approximately $344.5 million.
The company uses interest-rate swaps through December 2014 to fix the LIBOR component of $400.0 million of floor plan debt. The swaps increased the weighted-average floor plan borrowing rate by approximately 28 basis points.
Potential contingencies include litigation, self-insurance claims, lease guarantees for previously sold dealerships, obligations relating to subleased properties, letters of credit of $15.1 million and surety bonds of $12.2 million.
The company has agreed to indemnify GECC for 9% of specified principal and interest obligations related to Penske Truck Leasing’s $700.0 million senior unsecured notes. The expected 2019 principal repayment is $63.1 million; management did not expect material payments under the indemnity but noted that the outcome is uncertain.
Car rental results are exposed to residual-value losses on approximately 6,800 vehicles, particularly if used-vehicle values decline or vehicle recalls restrict fleet availability.
Management stated that existing cash flow, distributions from investments and available credit and floor plan facilities should fund operations and commitments for at least the next twelve months, but significant acquisitions, repurchases or refinancing could require additional capital.
Adoption of the new revenue recognition standard, ASC 606, is required beginning after January 1, 2017; the company was assessing its impact. Adoption of the revised discontinued-operations standard is expected to result in fewer disposals qualifying for discontinued-operations treatment.

Important Facts for Investors to Verify

Whether strong same-store unit growth can continue while used-vehicle and overall retail gross margins remain under pressure.
The contribution, integration and profitability of the commercial vehicle acquisition and the July 2014 Barcelona investment.
Floor plan financing availability, covenant compliance and sensitivity to higher interest rates after the interest-rate swaps expire.
Cash conversion after acquisitions, facility investments, rental-fleet purchases, dividends and share repurchases.
Exposure to foreign exchange movements, severe weather, vehicle recalls, manufacturer franchise terms and economic cyclicality.
Potential obligations associated with leases, PTL guarantees, litigation, self-insurance and other contingent liabilities.