PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q2 FY2012

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

Business context and reporting period

Unaudited results cover the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. Penske Automotive operated 338 retail franchises at quarter-end, including 170 in the U.S. and 168 primarily in the U.K. The company retailed and wholesaled more than 207,000 vehicles during the first six months, with 62% of revenue generated in the U.S. and Puerto Rico and 38% internationally.

The company acquired 16 franchises during the first six months, including the 14-franchise Agnew Group in the U.K., was awarded seven franchises, and disposed of six franchises. It also acquired a 7% interest in NPA Holdco, LLC for $3.0 million.

Key financial metrics

Metric	Three months ended June 30, 2012	Three months ended June 30, 2011	Six months ended June 30, 2012	Six months ended June 30, 2011
Revenue	$3,372.5 million	$2,830.0 million	$6,605.2 million	$5,568.1 million
Gross profit	$513.4 million	$456.0 million	$1,018.6 million	$893.4 million
Operating income	$90.3 million	$69.7 million	$184.8 million	$141.4 million
Income from continuing operations	$50.1 million	$39.7 million	$100.2 million	$76.0 million
Net income attributable to common stockholders	$49.1 million	$39.6 million	$95.9 million	$73.5 million
Diluted EPS	$0.54	$0.43	$1.06	$0.79

Revenue increased 19.2% in the second quarter and 18.6% year to date.
Gross margin was approximately 15.2% in the quarter and 15.4% year to date, compared with approximately 16.1% in both 2011 periods.
Operating margin was approximately 2.7% in the quarter and 2.8% year to date, compared with 2.5% in both 2011 periods.
Net income attributable to common stockholders increased 24.1% in the quarter and 30.5% year to date.
Retail gross margin declined to 16.3% in the quarter and 16.5% year to date from 17.0% in the comparable 2011 periods, primarily because vehicle sales represented a larger share of revenue and vehicle margins were lower.
Service and parts generated $368.8 million of second-quarter revenue and $737.1 million year to date, with gross margins of 58.6% and 58.1%, respectively.

Cash flow, liquidity, debt, and capital allocation

Cash from continuing operating activities was $204.2 million for the first six months, compared with $41.7 million in 2011. Including non-trade floor-plan borrowings as operating cash flow, the comparable figures were $237.0 million and $111.8 million.
Cash used in investing activities was $172.3 million, including $111.5 million for dealership acquisitions and $57.1 million for equipment and facility improvements.
Cash used in continuing financing activities was $40.2 million, including $37.8 million for repayment of convertible notes, $18.9 million of dividends, and $9.8 million of common-stock repurchases.
Cash and cash equivalents increased from $28.7 million at December 31, 2011 to $37.2 million at June 30, 2012.
Total floor-plan notes payable were $1.88 billion at June 30, 2012, up from $1.67 billion at year-end 2011, consistent with higher inventory. Inventories increased to $1.83 billion from $1.57 billion.
Total long-term debt, including the current portion, was $806.7 million at June 30, 2012, compared with $850.2 million at December 31, 2011. Debt included $375.0 million of 7.75% senior subordinated notes due 2016 and $127.0 million of U.S. term debt.
Available borrowing capacity was $226.9 million under the U.S. credit agreement and £84.3 million, or approximately $131.6 million, under the U.K. credit agreement.
The company was in compliance with its U.S. and U.K. credit agreement, lease, and debt covenants at June 30, 2012 and stated that it expected to remain compliant for the next twelve months.
The board had $98.3 million remaining under its securities repurchase authorization. A $0.12-per-share dividend was announced for September 2012.

Material changes versus the prior comparable period

New retail unit sales increased 24.8% in the second quarter and 18.1% year to date; same-store new unit sales increased 14.9% and 8.8%, respectively.
Used retail unit sales increased 16.4% in the quarter and 21.5% year to date; same-store used unit sales increased 8.5% and 13.2%.
Finance and insurance revenue increased 19.9% in the quarter and 20.1% year to date. Service and parts revenue increased 8.6% and 8.4%.
SG&A increased 9.4% in the quarter and 10.8% year to date, but declined as a percentage of gross profit from 82.1% to 79.8% in the quarter and from 81.5% to 79.2% year to date.
Floor-plan interest expense increased 44.1% in the quarter and 42.4% year to date. Other interest expense increased 10.8% and 9.4%, largely because of acquisition-related borrowings and higher floor-plan balances.
The effective tax rate increased to 34.9% year to date from 32.2% in 2011.
Discontinued operations produced a $0.5 million loss in the quarter and a $3.6 million loss year to date, compared with income of $0.3 million and a loss of $1.9 million in the respective 2011 periods. Prior periods were revised for discontinued operations.
The company redeemed or settled its 3.5% senior subordinated convertible notes. Holders converted $25.5 million of principal, and the company paid $37.8 million for the remaining notes; it paid an additional $24.9 million conversion balance in July 2012.

Guidance, outlook, risks, contingencies, and unusual items

Management cited improving U.S. automotive demand and expected continued recovery based on higher vehicle demand, an aging vehicle population, lower consumer credit costs, and new model introductions. U.S. vehicle sales increased 14.8% year to date, while U.K. registrations increased 2.7%. Management also expected resilient premium-brand sales in the U.K. No specific earnings or revenue guidance was provided.

Results remain sensitive to vehicle volumes, consumer confidence, unemployment, interest rates, fuel prices, credit availability, seasonality, weather, manufacturer incentives, and vehicle and parts availability.
Variable-rate exposure includes credit facilities and floor-plan debt. A 100-basis-point rate change was estimated to affect annual other interest expense by approximately $3.0 million and annual floor-plan interest expense by approximately $14.4 million, after considering swaps.
Interest-rate swaps fixed the LIBOR component of $400.0 million of floor-plan debt through December 2014. The swaps had a fair-value liability of $16.3 million at June 30, 2012.
The company’s 9% interest in Penske Truck Leasing contributed $12.6 million of equity earnings and $12.5 million of cash distributions during the first six months. Future distributions depend on PTL’s performance.
As part of PTL refinancing, the company agreed to indemnify GE Capital for 9% of specified principal and interest obligations on $700.0 million of Holdings bonds due 2019. The filing states that the potential principal exposure is expected to be approximately $63.1 million, plus 9% of interest, fees, and possible default interest; management did not expect material payments but noted uncertainty.
The company had $19.0 million of letters of credit and $13.7 million of surety bonds outstanding. It also retained certain lease obligations related to sold or subleased dealerships.
Management reported no legal proceedings expected to have a material adverse effect, but unfavorable outcomes could materially affect results, financial condition, or cash flows.
A 10% change in average foreign exchange rates versus the U.S. dollar would have changed reported six-month revenue by approximately $251.1 million.
Disclosure controls and procedures were deemed effective, with no material changes to internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether vehicle volumes continue to offset declining new and used vehicle gross profit per unit and lower overall retail margins.
The sustainability and classification of operating cash flow, particularly the effect of floor-plan financing and inventory growth.
Compliance with credit, lease, and other debt covenants as acquisition activity and floor-plan balances change.
Refinancing and repayment requirements for the $375.0 million of 7.75% notes due 2016 and other secured and variable-rate debt.
The financial performance of PTL and the potential indemnification exposure related to its Holdings bonds.
The effect of foreign currency movements on international revenue, earnings, and equity.
Integration and returns from the 2012 dealership acquisitions, as well as risks associated with discontinued operations and held-for-sale assets.