AutoNation, Inc. — First Quarter 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. AutoNation operated 336 new-vehicle franchises in 244 stores, 76 collision centers, and more than 325 locations nationwide. The company reports Domestic, Import, and Premium Luxury segments. Financial statements are unaudited and prepared under U.S. GAAP.
Financial performance and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $5,259.9 million | $5,139.4 million | 2.3% increase |
| Gross profit | $842.3 million | $819.8 million | 2.7% increase |
| Operating income | $185.8 million | $206.7 million | 10.1% decrease |
| Income from continuing operations | $93.3 million | $98.2 million | 5.0% decrease |
| Net income | $93.7 million | $98.1 million | 4.5% decrease |
| Diluted EPS | $1.01 | $0.97 | Increase |
| Operating margin | 3.5% | 4.0% | Down 50 basis points |
- Revenue increased primarily from used vehicles, finance and insurance, and parts and service. New-vehicle revenue was broadly flat despite a 2.1% decline in retail unit sales, as revenue per vehicle increased.
- Gross profit increased in used vehicles by 11.4%, finance and insurance by 8.7%, and parts and service by 3.9%. New-vehicle gross profit declined 10.1%, with gross profit per vehicle down 8.2% to $1,748.
- Retail new-vehicle sales were 74,178 units, down 2.1%; retail used-vehicle sales were 62,210 units, up 2.6%. Total retail unit sales were essentially flat.
- SG&A increased 5.3% to $626.8 million, or 74.4% of gross profit versus 72.6% in the prior-year quarter, reflecting brand-extension investments, higher compensation, and timing of stock-based compensation.
- Effective income tax rate was 26.1%, compared with 38.5% in Q1 2017, principally reflecting the lower federal corporate tax rate under the Tax Cuts and Jobs Act.
Cash flow, balance sheet, debt, and liquidity
- Operating cash flow was $198.7 million, compared with $185.6 million in Q1 2017. Investing cash flow was an outflow of $13.2 million, including $101.5 million of property and equipment purchases and $89.2 million of net proceeds from business divestitures.
- Financing cash flow was an outflow of $197.7 million, including $26.6 million of share repurchases, $60.0 million of net commercial-paper repayments, and $124.2 million of net payments on non-trade vehicle floorplan borrowings.
- Cash and cash equivalents were $57.5 million at March 31, 2018, compared with $69.2 million at December 31, 2017. Total cash, cash equivalents, and restricted cash were $58.9 million.
- Vehicle floorplan payable totaled $3.739 billion, consisting of $2.233 billion of trade floorplan debt and $1.506 billion of non-trade floorplan debt. New-vehicle floorplan facilities had approximately $4.8 billion of capacity, of which $3.4 billion was borrowed.
- Commercial paper outstanding was $270.0 million at a weighted-average annual rate of 2.26% and a weighted-average remaining term of 14 days. Non-vehicle long-term debt, including current maturities, was approximately $2.388 billion before discounts and issuance costs.
- The company had no revolving-credit borrowings, approximately $1.365 billion of borrowing capacity under the revolving facility after covenant limitations, and $26.7 million of available secured used-vehicle floorplan capacity.
- AutoNation reported compliance with its debt covenants. The leverage ratio was 2.81x versus a 4.25x limit, and the capitalization ratio was 61.3% versus a 70.0% limit.
- In April 2018, the company repaid its $400.0 million of 6.75% senior notes using commercial paper.
Material changes versus the prior comparable period
- Revenue and gross profit grew, but operating income and net income from continuing operations declined because of lower new-vehicle margins, higher SG&A, and higher interest expense.
- Floorplan interest expense increased to $28.3 million from $21.5 million, and other interest expense increased to $32.3 million from $28.8 million, primarily because of higher average interest rates and debt issued in November 2017.
- New-vehicle gross profit per vehicle declined to $1,748 from $1,904, while used-vehicle gross profit per vehicle increased to $1,318 from $1,236 and finance and insurance gross profit per vehicle increased to $1,766 from $1,625.
- The company divested seven Domestic stores, two Import stores, one Premium Luxury store, and one collision center, recording a net gain of $6.5 million. It also acquired one collision center, opened one automotive auction, and opened two AutoNation USA stores.
- AutoNation adopted ASC Topic 606 revenue recognition on January 1, 2018, using the modified retrospective method. The adoption produced a $10.1 million after-tax cumulative increase to retained earnings and modestly increased reported Q1 net income by approximately $0.5 million versus the amounts that would have been reported under prior guidance.
- The company repurchased approximately 0.5 million shares for $26.6 million during the quarter. In April 2018, the board authorized an additional $250.0 million of repurchases.
Outlook, management commentary, risks, and unusual items
- Management expects cash, operating cash flow, the revolving facility, commercial paper program, and floorplan facilities to be sufficient for working capital, debt service, taxes, commitments, and seasonal requirements for the foreseeable future.
- Management is continuing its customer-focused brand-extension strategy, including branded parts and accessories, collision centers, auctions, and AutoNation USA locations. It also entered into a multiyear partnership with Waymo, which it does not expect to materially affect early-period financial results.
- U.S. industry retail new-vehicle unit sales declined 2% in Q1 2018. Management cited a plateauing market, elevated leasing and manufacturer incentives, competitive pricing, disruptive manufacturer programs, and increased off-lease used-vehicle supply.
- Interest-rate exposure is significant: a 100-basis-point change would affect annual floorplan interest expense by approximately $37.4 million and annual commercial-paper interest expense by approximately $2.7 million based on March 31 balances.
- The company expects adoption of the new lease standard on January 1, 2019, to add approximately $375 million to $475 million of operating lease liabilities and corresponding right-of-use assets.
- Annual goodwill and franchise-rights impairment testing was scheduled for April 30, 2018. Goodwill and indefinite-lived franchise rights are significant assets and could require material non-cash impairment charges.
- Legal proceedings, manufacturer dependence, economic and automotive-market conditions, regulatory compliance, cybersecurity, natural disasters, debt covenants, and the success of strategic investments remain material risks.
- The company settled a California hazardous-waste investigation in February 2018. The payment was within previously established accruals and was not material.
- Management stated that no material loss, or additional material loss, was reasonably possible regarding disclosed legal contingencies, although adverse outcomes cannot be predicted with certainty.
Important facts for investors to verify
- Whether new-vehicle pricing and manufacturer incentive pressure continue to reduce gross profit per vehicle.
- Whether used-vehicle, finance and insurance, and parts-and-service gains offset weaker new-vehicle profitability.
- The effect of higher LIBOR and other interest rates on floorplan expense, commercial paper, and earnings.
- The April 2018 repayment of the $400.0 million senior notes and the resulting commercial-paper balance and liquidity profile.
- Results of the scheduled goodwill and franchise-rights impairment testing.
- The execution and returns from the brand-extension strategy, AutoNation USA expansion, collision-center investments, and Waymo partnership.
- The eventual impact of ASC 606 and the January 2019 lease-accounting adoption on reported revenue, earnings, assets, and liabilities.