Group 1 Automotive, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. The filing reports unaudited results for the quarter and six months ended June 30, 2014. Group 1 operates franchised dealerships, collision centers and related finance, insurance, parts and service businesses in the U.S., U.K. and Brazil. At quarter-end it reported 193 franchises at 151 dealership locations and 37 collision centers. Results are seasonal and include acquired businesses.
Financial performance
| Metric | Three months ended June 30, 2014 | Six months ended June 30, 2014 |
|---|---|---|
| Revenue | $2.512 billion, up 7.6% | $4.773 billion, up 11.0% |
| Gross profit | $369.1 million, up 8.2% | $707.3 million, up 10.2% |
| Income from operations | $84.7 million, up 5.1% | $155.3 million, up 11.5% |
| Income before taxes | $38.2 million, down 36.5% | $87.4 million, down 12.1% |
| Net income | $16.9 million, down 54.9% | $48.2 million, down 19.1% |
| Diluted EPS | $0.62, down from $1.43 | $1.80, down from $2.32 |
| Operating cash flow, GAAP | Not separately stated here | $130.9 million, versus $87.3 million |
| Adjusted operating cash flow, non-GAAP | Not separately stated here | $87.2 million, versus $154.6 million |
Q2 gross margin was 14.7%, compared with 14.6%; operating margin was 3.4%, versus 3.5%; and pretax margin was 1.5%, versus 2.6%. For the first half, gross margin was 14.8%, versus 14.9%; operating margin was 3.3%, versus 3.2%; and pretax margin was 1.8%, versus 2.3%. Q2 SG&A was 73.7% of gross profit, essentially unchanged from 73.6%; first-half SG&A ratio improved to 74.9% from 75.5%.
Q2 retail new-vehicle units rose 2.2% and used-vehicle units rose 4.2%; parts and service revenue grew 8.5%, and finance and insurance revenue grew 12.9%. New-vehicle gross margin declined to 5.5% from 5.8%; total used-vehicle margin was 7.0% versus 7.1%. Parts and service margin improved to 53.4% from 52.5%. First-half trends were similar: new-vehicle retail units increased 7.5%, used-vehicle units 9.7%, parts and service revenue 10.8%, and finance and insurance revenue 15.9%.
Balance sheet, debt and liquidity
- At June 30, 2014, cash was $21.3 million, total assets $3.977 billion, and working capital $211.2 million.
- Current liabilities were $1.813 billion. Floorplan notes payable were $1.122 billion under credit facilities and $298.7 million to manufacturer affiliates, partly offset by a $64.6 million floorplan offset account.
- Long-term debt, including current maturities, totaled $969.1 million; long-term debt net of current maturities was $938.6 million. Total stockholders’ equity was $967.1 million.
- The $1.7 billion revolving credit facility had $558.4 million of reported availability across its floorplan and acquisition lines; the separate $300 million Ford floorplan facility had $125.3 million available. The company reported compliance with debt covenants.
- Variable-rate borrowings totaled $1.514 billion. Management estimated that a 100-basis-point rate increase would raise annual interest expense by about $10.6 million after swaps. Brazil vehicle-financing rates were 15.10%–19.56%.
GAAP investing cash outflow was $194.4 million for the first half, including $129.3 million paid for acquisitions and $68.7 million for property and equipment, including real estate. Financing cash inflow was $63.4 million; cash increased $1.1 million to $21.3 million. Adjusted cash-flow measures are non-GAAP and reclassify certain floorplan-related flows; adjusted operating cash flow fell 43.6% year over year.
Material changes and unusual items
- Revenue and gross profit grew, but net income fell primarily because the company recorded a $23.6 million loss on its June tender-offer purchase of $92.5 million principal of 3.00% convertible notes for $210.4 million. The remaining principal was $22.6 million.
- On June 2, the company issued $350 million of 5.00% senior notes due 2022. Proceeds partly funded the convertible-note purchase. Other interest expense rose 31.3% in Q2 and 22.7% for the first half.
- The effective tax rate was 55.9% for Q2 and 44.9% for the first half, elevated by the note-purchase accounting/tax difference, Brazil deferred-tax valuation allowances and earnings mix. Management expected an approximately 38% rate for the remainder of 2014.
- The company acquired four U.S. dealerships, received one U.S. franchise and opened a dealership in Brazil in the first half; it sold two U.S. dealerships in Q2. It classified $90.0 million of assets as held for sale at June 30.
- Severe U.S. winter weather caused store closures and added costs in Q1. Vehicle recalls and stop-sale orders affected sales and inventory carrying costs; management expected recalls to benefit warranty parts and service through at least Q4, while brand and sales effects remained uncertain.
- The company disclosed an immaterial cash-flow statement error for Q1 2014: operating cash flow and the exchange-rate effect had each been overstated by $12.5 million. The corrected Q1 operating cash flow was $120.7 million.
Outlook, risks and contingencies
Management cited improving U.S. demand and U.K. conditions, but continuing weakness in Brazil: Brazilian registrations fell 7.3% in the first half, and management expected the market to be flat to down for the remainder of 2014. Management saw opportunities in vehicle sales, higher-margin parts and service, efficiency and acquisitions, and forecast 2014 capital spending below $95 million. It believed operating cash flow and borrowing capacity would fund operations, capital spending and acquisitions for the rest of 2014, subject to economic conditions and plans.
Key risks include consumer demand and credit availability, manufacturer incentives and vehicle supply, recalls and brand reputation, interest rates, foreign currency movements, acquisition integration, debt covenants and access to financing, and regulatory or litigation exposure. The company reported no legal proceedings expected to have a material adverse effect and no material change in its previously disclosed risk factors. It stated that it had no known material environmental commitments or contingencies.
Subsequent to quarter-end, the company notified holders that it would redeem all outstanding 2.25% convertible notes on September 4, 2014. This is a post-period event, not reflected as a completed redemption at June 30.
Most important facts for investors to verify
- How much of the earnings decline reflects the $23.6 million note-purchase loss and unusually high tax rate, and what earnings level is sustainable after these effects?
- Whether adjusted operating cash flow, which excludes/reclassifies floorplan-related items, provides a useful view alongside GAAP cash flow and working-capital movements.
- The full funding and dilution implications of the 2.25% note redemption, the remaining 3.00% notes, and associated options and warrants.
- Whether the stated borrowing availability remains accessible under facility borrowing bases and covenants, and how debt and interest costs evolve after the 5.00% notes issuance.
- Whether Brazil’s sales and profitability stabilize, and whether recall-related service gains offset any damage to vehicle sales or manufacturer brands.
- The resolution and proceeds from the $90.0 million held-for-sale asset group, and execution and returns on acquisitions and planned capital spending.