RUSH ENTERPRISES INC annual report, FY2011

Rush Enterprises, Inc. — 2011 Form 10-K

Business context and reporting period. The filing covers the fiscal year ended December 31, 2011; quarterly data are unaudited. Rush operates a full-service commercial-vehicle dealership network, reported as one Truck Segment, with 70 Rush Truck Centers in 14 states. Services include new and used truck sales, parts, repairs, leasing and rental, financing, and insurance. Its John Deere construction-equipment business was sold in 2010 and is reported as discontinued operations.

Financial performance and position

Metric	2011	2010
Total revenue	$2,580.6 million	$1,497.9 million
Gross profit / margin	$423.3 million / 16.4%	$284.9 million / 19.0%
Operating income / margin	$97.3 million / 3.8%	$41.7 million / 2.8%
Continuing-operations income	$55.2 million	$24.6 million
Net income	$55.2 million	$31.3 million
Diluted EPS	$1.42	$0.82
Net interest expense	$7.2 million	$5.4 million

Revenue rose 72.3%, led by new and used commercial-vehicle sales, up 94.5%. New vehicle sales increased 103.8%; parts and service revenue rose 38.0%.
Vehicle sales grew to 69.8% of revenue from 61.9%, while higher-margin parts and service fell to 26.2% from 32.7%. This mix shift reduced consolidated gross margin despite parts/service gross margin improving to 39.5% from 38.5%.
Parts, service and body-shop operations produced 63% of gross profit. Dealership absorption rate improved to 113.9% from 105.5%.
Fourth-quarter 2011 revenue was $776.1 million versus $463.0 million in fourth-quarter 2010; net income was $19.4 million versus $9.2 million, and diluted EPS was $0.50 versus $0.24.
Cash and cash equivalents were $207.8 million; working capital was $189.2 million. Operating cash flow was negative $81.4 million, mainly reflecting increased inventory and receivables. Management’s non-GAAP adjusted operating cash flow, which includes floor-plan borrowings and excludes acquisition-related floor-plan draws, was $188.3 million.
Investing cash outflow was $231.8 million, including $148.5 million of property and equipment purchases and $94.6 million for acquisitions. Financing cash inflow was $352.0 million, including $282.9 million of net floor-plan borrowings. Cash increased $38.8 million.
At year-end, floor-plan notes payable were $520.7 million, long-term debt including current maturities was $328.3 million, and capital-lease obligations including current maturities were $45.6 million. Total assets were $1.718 billion and shareholders’ equity was $531.2 million.

Material changes and notable items

2011 acquisitions included dealerships in Orlando, metro Atlanta, Whittier and West Texas; the West Texas Peterbilt purchase extended Rush’s Peterbilt representation across Texas. Acquisitions contributed to growth and make year-over-year comparisons less directly comparable.
New truck unit sales increased sharply: heavy-duty sales rose 90.7% and medium-duty sales 93.9%. Rush’s U.S. Class 8 market share reached 5.2%, up from 4.3% in 2010.
Gross margin declined as vehicle sales took a larger share of revenue. Truck valuation allowances included $1.6 million for new heavy-duty, $1.9 million for new medium-duty and $2.3 million for used vehicles.
Long-term debt rose from $252.1 million to $328.3 million, and floor-plan notes payable increased from $237.8 million to $520.7 million, alongside higher inventory and acquisitions.
The company placed its SAP enterprise and dealership-management software into service in August 2011. Capitalized software costs were approximately $41.9 million; rollout across the network is planned over three years.
Goodwill increased to $182.6 million, mainly from acquisitions; the annual impairment test found no impairment. Auction-rate securities had a $6.6 million fair value against a $7.6 million cost basis and remained illiquid; the impairment was treated as temporary in other comprehensive income.

Outlook, risks and contingencies

Management expected 2012 U.S. Class 8 retail sales of approximately 200,000–215,000 units and Class 4–7 sales of about 163,000 units. Rush projected 10,000–10,800 Class 8 sales and 6,800–7,500 Class 4–7 sales, subject to market demand and manufacturer production capacity.
Other 2012 expectations included lease/rental revenue growth of 20%–25%; parts, service and body-shop gross margins of 39%–41%; Class 8 margins of 6.5%–7.5%; medium-duty margins of 4.5%–5.5%; and used-vehicle margins of 8%–10%. These are management estimates, not guarantees.
Year-end confirmed commercial-vehicle order backlog was $678.7 million, compared with $277.1 million a year earlier. Management expected delivery during 2012, but orders can be cancelled and backlog is not a guarantee of revenue or earnings.
Management forecast 2012 SG&A at 11%–13% of revenue and an effective tax rate of 37%–39%. Planned 2012 recurring capital expenditures were $10–$12 million, plus approximately $95 million of financed lease-fleet vehicle purchases, depending on demand.
The January 2012 amended GE Capital floor-plan facility increased capacity to $600 million and lowered the rate to LIBOR plus 2.23% on balances up to $500 million; higher balances bear LIBOR plus 2.95%. GE Capital may terminate without cause on 120 days’ notice. The filing reports covenant compliance at year-end.
Interest-rate exposure is significant: a 100-basis-point LIBOR change was estimated to alter annual interest expense by approximately $6.5 million. Variable-rate debt and floor-plan financing are exposed to rate increases; $45 million of interest-rate swaps were designated as cash-flow hedges.
Principal risks include commercial-truck cyclicality, dependence on PACCAR/Peterbilt and other manufacturers, franchise renewal and change-of-control restrictions, floor-plan financing availability, customer exposure to cyclical oil and gas activity, interest rates, competition, goodwill impairment, environmental obligations, and adverse weather or natural disasters.
Rush reported known soil or groundwater contamination at some properties but said it did not believe it had material environmental liabilities. It cautioned that future discoveries, stricter rules, acquisitions or retained liabilities could create material costs. Ordinary-course litigation was not considered likely to materially affect financial position, though outcomes remain uncertain.
The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls were effective as of December 31, 2011.

Important facts for investors to verify

Whether 2012 truck-market, unit-sales and margin assumptions were achieved, particularly given manufacturer production constraints and order-cancellation risk.
How much revenue and earnings growth came from acquisitions versus comparable dealership performance, and whether the acquisitions deliver expected returns.
Inventory levels, floor-plan borrowing capacity and terms, cash conversion, and the sustainability of management’s non-GAAP adjusted operating cash-flow measure.
The effect of the vehicle-heavy sales mix on gross margins and whether aftermarket growth continues to offset truck-market cyclicality.
Liquidity and valuation developments for the illiquid auction-rate securities, plus any material environmental, tax or litigation developments.
Renewal and change-of-control terms for key manufacturer franchises, especially Peterbilt, and the company’s ongoing reliance on PACCAR.