Penske Automotive Group, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods. Amounts are in thousands except per-share data, unless otherwise stated.
Business context
Penske Automotive Group is a global automotive retailer with 173 U.S. franchises and 152 franchises outside the U.S., primarily in the U.K. The company sells new and used vehicles, finance and insurance products, service and parts, and distributes smart fortwo vehicles. It also owns a 9.0% interest in Penske Truck Leasing. During the first nine months of 2010, the company acquired six franchises, was awarded 15 franchises, and disposed of three franchises.
Financial performance and key metrics
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | $2,756,122 | $2,588,042 | $7,945,489 | $7,065,037 |
| Gross profit | $429,853 | $422,707 | $1,270,225 | $1,184,501 |
| Operating income | $61,530 | $61,138 | $181,783 | $156,185 |
| Income from continuing operations | $31,304 | $27,919 | $81,432 | $64,110 |
| Net income attributable to common stockholders | $29,977 | $27,423 | $79,772 | $57,784 |
| Diluted EPS | $0.33 | $0.30 | $0.87 | $0.63 |
- Q3 revenue increased 6.5%, while nine-month revenue increased 12.5%.
- Q3 net income attributable to common stockholders increased 9.3%; nine-month net income increased 38.1%.
- Gross margin was approximately 15.6% in Q3 and 16.0% for the nine-month period. Operating margin was approximately 2.2% in Q3 and 2.3% for the nine-month period.
- Nine-month retail gross margin declined to 17.0% from 17.7%, primarily because lower-margin vehicle sales represented a larger share of revenue.
- Nine-month new retail unit sales rose 10.3%, used retail unit sales rose 9.1%, and finance and insurance revenue increased 15.9%. Same-store service and parts revenue declined 1.3%, although service and parts gross margin improved to 57.0% from 54.8%.
- The distribution segment remained weak: nine-month smart wholesale units fell 67.4% to 4,161, and the segment reported a $15,276 loss versus $1,376 of income in 2009.
Cash flow, debt, and liquidity
- Cash from continuing operating activities was $124,316 for the first nine months of 2010, compared with $314,453 in 2009. Management also presented operating cash flow adjusted to treat all floor-plan changes as operating: $175,805 in 2010 versus $188,457 in 2009.
- Capital expenditures were $62,717, dealership acquisitions used $12,261, and continuing investing cash flow was negative $74,978.
- Cash used in continuing financing activities was $59,068, including $156,604 used to repurchase $155,658 principal amount of convertible notes and $10,000 of U.S. term-loan repayments.
- Cash and cash equivalents declined to $6,027 at September 30, 2010, from $13,999 at December 31, 2009. Working capital was $81,200.
- Available borrowing capacity was $263,500 under the U.S. credit agreement and £37,700, or approximately $59,300, under the U.K. agreement.
- Total long-term debt was $853,385, including $375,000 of 7.75% senior subordinated notes, $150,602 principal amount of convertible notes, and $46,330 of mortgage debt. Floor-plan notes payable totaled $1,382,120.
- The company expected to redeem the remaining $150.6 million of convertible notes in April 2011 using operating cash flow, working capital, and U.S. credit capacity. Based on its ability and intent to refinance, the notes were classified as long-term.
- The U.S. credit agreement was extended through September 30, 2013. The U.K. revolving borrowing capacity was reduced from £100.0 million to £86.6 million in connection with a European reorganization.
- The company was in compliance with its credit agreement, lease, and other debt covenants at September 30, 2010.
Material changes and unusual items
- The company recorded pre-tax gains of $607 in Q3 and $1,634 for the first nine months from repurchases of convertible notes. The comparable 2009 nine-month period included a $10,429 gain.
- Prior-year Q3 results included approximately $5,200 of charges related to the terminated Saturn acquisition, closure of three U.S. franchises, and interest-rate hedges.
- A change in estimated useful lives of certain fixed assets reduced depreciation expense by $1,410 in Q3 and $4,230 for the first nine months of 2010.
- Smart USA recorded $2,900 of incentives during the first nine months that reduced gross profit and incurred $1,600 of pre-production costs related to efforts to procure a Nissan vehicle.
- The company entered into a memorandum of understanding with Nissan to procure a vehicle for distribution through the smart dealer network. Definitive agreements had not yet been completed.
Outlook, risks, and contingencies
Management stated that economic conditions were improving but would continue to affect customer traffic, vehicle sales, and service work through 2010 and 2011. Management believed existing resources, operating cash flow, joint-venture dividends, credit facilities, and floor-plan financing would fund operations and commitments for at least the next twelve months.
- Management estimated approximately $25,000 of development, engineering, and tooling costs for the potential Nissan-related vehicle.
- Key risks include economic cycles, consumer confidence, unemployment, interest rates, credit availability, fuel prices, foreign currency movements, manufacturer dependence, brand performance, vehicle volumes, and manufacturer recalls or restructuring.
- Liquidity risks include refinancing or redeeming the convertible notes, continued access to floor-plan financing, covenant compliance, and funding acquisitions, capital expenditures, or securities repurchases.
- The company is exposed to variable-rate debt. A 100-basis-point rate change was estimated to affect annual other interest expense by approximately $2,700 and annual floor-plan interest expense by approximately $9,900, based on the filing’s stated assumptions.
- Litigation, lease guarantees, sublease obligations, smart-related purchase commitments, $20,266 of letters of credit, and $14,384 of surety bonds were disclosed. No litigation was considered reasonably likely to have a material adverse effect, although outcomes cannot be predicted with certainty.
- The company’s interest-rate swaps fixed the LIBOR portion of $300,000 of floating-rate floor-plan debt at 3.67% through January 2011.
Investor verification points
- Verify the company’s ability to redeem or refinance the $150.6 million of convertible notes due for holder put or redemption in April 2011.
- Monitor cash generation, inventory growth, floor-plan borrowing, and the decline in reported operating cash flow.
- Assess whether used-vehicle margin pressure and the 1.3% same-store service and parts revenue decline persist.
- Evaluate the smart USA distribution losses, ongoing development costs, and the status and economics of the proposed Nissan vehicle.
- Review compliance headroom under U.S. and U.K. credit agreements and lease covenants, particularly given secured and variable-rate borrowings.
- Separate underlying operating performance from debt-repurchase gains, prior-year restructuring charges, depreciation-estimate changes, and Toyota recall-related service benefits.
- Consider foreign exchange exposure: management estimated that a 10% change in average exchange rates versus the U.S. dollar would have changed nine-month revenue by approximately $294,600.