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EX-32 - EXHIBIT 32.2 - RUSH ENTERPRISES INC \TX\ex32-2.htm
EX-32 - EXHIBIT 32.1 - RUSH ENTERPRISES INC \TX\ex32-1.htm
EX-31 - EXHIBIT 31.1 - RUSH ENTERPRISES INC \TX\ex31-1.htm
EX-31 - EXHIBIT 31.2 - RUSH ENTERPRISES INC \TX\ex31-2.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

(X)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

OR

 

(  )

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___________________________ to ____________________________________________

 

Commission File Number 0-20797

 

 

RUSH ENTERPRISES, INC.

(Exact name of registrant as specified in its charter)

 

Texas

 

74-1733016

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

 incorporation or organization)

 

 

                                                                             

555 I.H. 35 South, Suite 500

New Braunfels, Texas 78130

(Address of principal executive offices)

(Zip Code)

 

(830) 626-5200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]                   No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes [X]                   No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   

 Accelerated filer 

 

 

Non-accelerated filer 

 Smaller reporting company ☐

(Do not check if a smaller reporting company)  

                      

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ]                   No [X]

 

Indicated below is the number of shares outstanding of each of the issuer’s classes of common stock, as of November 1, 2014.

 

Title of Class

 

Number of Shares Outstanding

Class A Common Stock, $.01 Par Value

 

29,850,692
Class B Common Stock, $.01 Par Value

 

10,054,930

 

 
1

 

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

PART I. FINANCIAL INFORMATION

Page

       

 

Item 1.

Financial Statements

 
       

 

 

Consolidated Balance Sheets - September 30, 2014 (unaudited) and December 31, 2013

3

       
   

Consolidated Statements of Income and Comprehensive Income - For the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)

4

       

 

 

Consolidated Statements of Cash Flows - For the Nine Months Ended September 30, 2014 and 2013 (unaudited)

5

       

 

 

Notes to Consolidated Financial Statements (unaudited)

6

       

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

 

 

   
 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

27

       
 

Item 4.

Controls and Procedures

27

       
       
       
       

PART II. OTHER INFORMATION

 
       
 

Item 1.

Legal Proceedings

28

       
 

Item 1A.

Risk Factors

28

       
 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

28

       
 

Item 3.

Defaults Upon Senior Securities

28

       
 

Item 4.

Mine Safety Disclosures

28

       
 

Item 5.

Other Information

28

       
 

Item 6.

Exhibits

29

       

SIGNATURES

30

 

 
2

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements.

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2014 AND DECEMBER 31, 2013

(In Thousands, Except Shares)

 

   

September 30,

   

December 31,

 
   

2014

   

2013

 
   

(Unaudited)

         

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 144,728     $ 217,305  

Accounts receivable, net

    161,315       103,293  

Inventories, net

    928,802       802,220  

Prepaid expenses and other

    8,419       14,341  

Deferred income taxes, net

    16,929       16,277  

Total current assets

    1,260,193       1,153,436  

Investments

    6,812       6,628  

Property and equipment, net

    874,160       739,663  

Goodwill, net

    263,071       215,464  

Other assets, net

    52,376       52,607  

Total assets

  $ 2,456,612     $ 2,167,798  
                 
                 

Liabilities and shareholders’ equity

               

Current liabilities:

               

Floor plan notes payable

  $ 722,148     $ 593,649  

Current maturities of long-term debt

    140,751       97,243  

Current maturities of capital lease obligations

    9,672       10,268  

Trade accounts payable

    126,275       100,375  

Customer deposits

    24,836       58,319  

Accrued expenses

    111,188       69,321  

Total current liabilities

    1,134,870       929,175  

Long-term debt, net of current maturities

    411,161       385,538  

Capital lease obligations, net of current maturities

    34,357       35,199  

Other long-term liabilities

    4,639       4,683  

Deferred income taxes, net

    132,807       147,822  

Shareholders’ equity:

               

Preferred stock, par value $.01 per share; 1,000,000 shares authorized; 0 shares outstanding in 2014 and 2013

 

   

 

Common stock, par value $.01 per share; 60,000,000 class A shares and 20,000,000 class B shares authorized; 29,850,692 class A shares and 10,075,204 class B shares outstanding in 2014; and 28,910,505 class A shares and 10,304,518 class B shares outstanding in 2013

    424       414  

Additional paid-in capital

    269,467       243,154  

Treasury stock, at cost: 2,484,498 class B shares in 2014; and 2,194,519 class B shares in 2013

    (39,639 )     (30,821 )

Retained earnings

    509,166       453,836  

Accumulated other comprehensive loss, net of tax

    (640 )     (1,202 )

Total shareholders’ equity

    738,778       665,381  

Total liabilities and shareholders’ equity

  $ 2,456,612     $ 2,167,798  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
3

 

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In Thousands, Except Per Share Amounts)

(Unaudited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Revenues:

                               

New and used truck sales

  $ 846,256     $ 615,616     $ 2,244,447     $ 1,613,420  

Parts and service

    340,632       257,512       980,588       731,919  

Lease and rental

    45,114       32,668       130,160       94,166  

Finance and insurance

    5,227       4,333       14,559       11,304  

Other

    3,793       2,935       12,396       8,717  

Total revenue

    1,241,022       913,064       3,382,150       2,459,526  

Cost of products sold:

                               

New and used truck sales

    787,952       573,657       2,084,945       1,499,384  

Parts and service

    216,067       161,209       626,786       459,371  

Lease and rental

    38,264       27,886       112,406       78,983  

Total cost of products sold

    1,042,283       762,752       2,824,137       2,037,738  

Gross profit

    198,739       150,312       558,013       421,788  

Selling, general and administrative

    148,238       114,863       431,943       335,597  

Depreciation and amortization

    9,488       7,569       27,483       21,938  

Gain (loss) on sale of assets

    5       (10 )     109       19  

Operating income

    41,018       27,870       98,696       64,272  

Interest expense, net

    2,689       2,781       8,363       7,774  

Income from before taxes

    38,329       25,089       90,333       56,498  

Provision for income taxes

    14,851       9,910       35,003       22,140  

Net income

  $ 23,478     $ 15,179     $ 55,330     $ 34,358  
                                 

Earnings per common share:

                               

Basic

  $ .59     $ .38     $ 1.39     $ .87  

Diluted

  $ .57     $ .37     $ 1.36     $ .85  
                                 

Weighted average shares outstanding:

                               

Basic

    40,008       39,558       39,700       39,411  

Diluted

    41,091       40,623       40,820       40,492  
                                 

Comprehensive income

  $ 23,610     $ 15,280     $ 55,892     $ 34,783  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
4

 

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

   

Nine Months Ended

 
   

September 30,

 
                 
   

2014

   

2013

 
                 

Cash flows from operating activities:

               

Net income

  $ 55,330     $ 34,358  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    90,335       67,815  

Gain on sale of property and equipment

    (109 )     (19 )

Stock-based compensation expense related to stock options and employee stock purchases

    9,127       6,975  

Provision (benefit) for deferred income tax expense

    (16,025 )     8,284  

Excess tax benefits from stock-based compensation

    (5,004 )     (2,183 )

Acquired research and development

    2,000        

Change in accounts receivable, net

    (50,804 )     (22,880 )

Change in inventories

    (67,019 )     (46,446 )

Change in prepaid expenses and other, net

    6,672       3,117  

Change in trade accounts payable

    25,901       20,859  

Draws on floor plan notes payable – trade, net

    26,714       18,298  

Change in customer deposits

    (33,845 )      

Change in accrued expenses

    45,339       (10,378 )

Net cash provided by operating activities

    88,612       77,800  

Cash flows from investing activities:

               

Acquisition of property and equipment

    (182,164 )     (122,999 )

Proceeds from the sale of property and equipment

    342       453  

Business acquisitions

    (147,758 )     (63,188 )

Proceeds from the sale of available for sale securities

    150        

Change in other assets

    1,018       (3,313 )

Net cash used in investing activities

    (328,412 )     (189,047 )

Cash flows from financing activities:

               

Draws on floor plan notes payable – non-trade, net

    101,784       35,553  

Proceeds from long-term debt

    153,369       112,411  

Principal payments on long-term debt

    (84,076 )     (64,911 )

Principal payments on capital lease obligations

    (10,232 )     (10,211 )

Proceeds from issuance of shares relating to employee stock options and employee stock purchases

    11,363       8,092  

Excess tax benefits from stock-based compensation

    5,004       2,183  

Common stock repurchased

    (9,989 )     (4,383 )

Net cash provided by financing activities

    167,223       78,734  

Net decrease in cash and cash equivalents

    (72,577 )     (32,513 )

Cash and cash equivalents, beginning of period

    217,305       198,773  

Cash and cash equivalents, end of period

  $ 144,728     $ 166,260  

Supplemental disclosure of cash flow information:

               

Cash paid during the period for:

               

Interest

  $ 21,833     $ 17,592  

Income taxes, net of refunds

  $ 18,683     $ 6,869  

Noncash investing activities:

               
Common stock issued related to business acquistion   $ 2,000       -  

Assets acquired under capital leases

  $ 8,795     $ 5,872  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
5

 

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1 – Principles of Consolidation and Basis of Presentation

 

The interim consolidated financial statements included herein have been prepared by Rush Enterprises, Inc. and its subsidiaries (collectively referred to as the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). All adjustments have been made to the accompanying interim consolidated financial statements, which, in the opinion of the Company’s management, are necessary for a fair presentation of the Company’s operating results. All adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. It is recommended that these interim consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Results of operations for interim periods are not necessarily indicative of results that may be expected for any other interim periods or the full fiscal year.

 

2 –Other Assets

 

The capitalized costs, including capitalized interest, of the SAP enterprise software and SAP dealership management system of $39.1 million are recorded on the Consolidated Balance Sheet in Other Assets at September 30, 2014. These capitalized costs are net of accumulated amortization of $9.5 million. The SAP software is being amortized over a period of 15 years. The Company is currently operating 83 Rush Truck Centers and all of its leasing operations on the SAP enterprise software and SAP dealership management system, which represent approximately 70% of the Company’s total revenue for the nine months ended September 30, 2014. The Company plans to convert all of its existing Rush Truck Centers to the SAP enterprise software and SAP dealership management system by the end of the second quarter of 2015.

 

Amortization expense relating to the SAP software, which is recognized in depreciation and amortization expense in the Consolidated Statement of Income, was $0.8 million for the three months ended September 30, 2014, and $0.7 million for the three months ended September 30, 2013, and $2.4 million for the nine months ended September 30, 2014, and $2.2 million for the nine months ended September 30, 2013. The Company estimates that amortization expense relating to the SAP software will be approximately $3.3 million for each of the next five succeeding years.

 

The Company’s only significant identifiable intangible assets, other than goodwill, are rights under franchise agreements with manufacturers. The fair value of the franchise right is determined at the acquisition date by discounting the projected cash flows specific to each acquisition. The carrying value of the Company’s manufacturer franchise rights was $4.5 million at September 30, 2014, and December 31, 2013, and is included in Other Assets on the accompanying consolidated balance sheets. The Company has determined that manufacturer franchise rights have an indefinite life as there are no economic or other factors that limit their useful lives and they are expected to generate cash flows indefinitely due to the historically long lives of the manufacturers’ brand names. Furthermore, to the extent that any agreements evidencing manufacturer franchise rights have expiration dates, the Company expects that it will be able to renew those agreements in the ordinary course of business. Accordingly, the Company does not amortize manufacturer franchise rights.

 

Due to the fact that manufacturer franchise rights are specific to geographic region, the Company has determined that the geographic region is the appropriate level for purposes of testing franchise rights for impairment. Management reviews indefinite-lived manufacturer franchise rights for impairment annually during the fourth quarter, or more often if events or circumstances indicate that an impairment may have occurred. The Company is subject to financial statement risk to the extent that manufacturer franchise rights become impaired due to decreases in the fair market value of its individual franchises.

 

The significant estimates and assumptions used by management in assessing the recoverability of manufacturer franchise rights include estimated future cash flows, present value discount rate, and other factors. Any changes in these estimates or assumptions could result in an impairment charge. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s subjective judgment. Depending on the assumptions and estimates used, the estimated future cash flows projected in the evaluations of manufacturer franchise rights can vary within a range of outcomes.

 

No impairment write down was required in the fourth quarter of 2013. The Company cannot predict the occurrence of certain events that might adversely affect the reported value of manufacturer franchise rights in the future. However, no facts or circumstances were noted during the nine months ended September 30, 2014 that would indicate impairment.

 

 
6

 

 

3 – Commitments and Contingencies

 

From time to time, the Company is involved in litigation arising out of its operations in the ordinary course of business. The Company maintains liability insurance, including product liability coverage, in amounts deemed adequate by management. To date, aggregate costs to us for claims, including product liability actions, have not been material. However, an uninsured or partially insured claim, or claim for which indemnification is not available, could have a material adverse effect on the Company’s financial condition or results of operations. The Company believes that there are no claims or litigation pending, the outcome of which could have a material adverse effect on its financial position or results of operations. However, due to the inherent uncertainty of litigation, there can be no assurance that the resolution of any particular claim or proceeding would not have a material adverse effect on the Company’s financial condition or results of operations for the fiscal period in which such resolution occurred.

 

In May 2013, the Company entered into a Retirement and Transition Agreement with the Company’s former Chairman, W. Marvin Rush, which resulted in the recognition of $10.8 million in retirement pay and benefits recorded in selling, general and administrative expense on the Consolidated Statements of Income and Comprehensive Income for the nine months ended September 30, 2013.

 

4 – Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share information):

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Numerator:

                               

Numerator for basic and diluted earnings per share – Net income available to common shareholders

  $ 23,478     $ 15,179     $ 55,330     $ 34,358  
                                 

Denominator–

                               

Denominator for basic earnings per share – weighted average shares outstanding

    40,008       39,558       39,700       39,411  

Effect of dilutive securities–

                               

Employee and director stock options and restricted share awards

    1,083       1,065       1,120       1,081  

Denominator for diluted earnings per share – adjusted weighted average shares outstanding and assumed conversions

    41,091       40,623       40,820       40,492  
                                 

Basic earnings per common share

  $ .59     $ .38     $ 1.36     $ .87  

Diluted earnings per common share and common share equivalents

  $ .57     $ .37     $ 1.39     $ .85  

 

Options to purchase shares of common stock that were outstanding for the three months and nine months ended September 30, 2014 and 2013 that were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive are as follows (in thousands):

 

   

Three Months Ended

September 30,

   

Nine months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Anti-dilutive options

    395       865       516       865  

 

5 Stock Options and Restricted Stock Awards

 

Valuation and Expense Information

 

The Company accounts for stock-based compensation in accordance with Accounting Standards Codification (“ASC”) 718-10, “Compensation – Stock Compensation,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including employee stock options, restricted share awards, restricted stock unit awards and employee stock purchases related to the Employee Stock Purchase Plan based on estimated fair values. Stock-based compensation expense, calculated using the Black-Scholes option-pricing model and included in selling, general and administrative expense, was $2.0 million for the three months ended September 30, 2014, and $1.5 million for the three months ended September 30, 2013. Stock-based compensation expense, included in selling, general and administrative expense, for the nine months ended September 30, 2014, was $9.1 million and for the nine months ended September 30, 2013, was $7.0 million. As of September 30, 2014, there was $17.9 million of total unrecognized compensation expense related to non-vested, share-based compensation arrangements to be recognized over a weighted-average period of 2.8 years.

 

 
7

 

 

6 – Financial Instruments and Fair Value

 

The Company measures certain financial assets and liabilities at fair value on a recurring basis. Financial instruments consist primarily of cash, accounts receivable, accounts payable and floor plan notes payable. The carrying values of the Company’s financial instruments approximate fair value due either to their short-term nature or the existence of variable interest rates, which approximate market rates. Certain methods and assumptions were used by the Company in estimating the fair value of financial instruments at September 30, 2014 and 2013. The carrying value of current assets and current liabilities approximates the fair value due to the short maturity of these items.

 

The fair value of the Company’s long-term debt is based on secondary market indicators. Because the Company’s debt is not quoted, estimates are based on each obligation’s characteristics, including remaining maturities, interest rate, credit rating, collateral and liquidity. Accordingly, the Company concluded that the valuation measurement inputs of its long-term debt represent, at its lowest level, current market interest rates available to the Company for similar debt and the Company’s current credit standing, and has categorized such debt within Level 2 of the hierarchy framework. The carrying amount approximates fair value.

 

If investments are deemed to be impaired, the Company determines whether the impairment is temporary or other than temporary. If the impairment is deemed to be temporary, the Company records an unrealized loss in other comprehensive income. If the impairment is deemed other than temporary, the Company records the impairment in the Company’s consolidated statement of income.

 

In prior years, the Company invested in interest-bearing, short-term investments, primarily consisting of investment-grade auction rate securities classified as available-for-sale and reported at fair value. These types of investments were designed to provide liquidity through an auction process that reset the applicable interest rates at predetermined periods ranging from 1 to 35 days. This reset mechanism was intended to allow existing investors to continue to own their respective interest in the auction rate security or to gain immediate liquidity by selling their interests at par.

 

Auctions for investment grade securities held by the Company have failed. However, a failed auction does not represent a default by the issuer. The auction rate securities continue to pay interest in accordance with the terms of the underlying security; however, liquidity will be limited until there is a successful auction or until such time as other markets for these investments develop. The Company has the intent and ability to hold these auction rate securities until liquidity returns to the market. The Company does not believe that the lack of liquidity relating to its auction rate securities will have a material impact on its ability to fund operations.

 

As of September 30, 2014, the Company held auction rate securities with underlying tax-exempt municipal bonds that mature in 2030 and have a fair value of $6.8 million and a cost basis of $7.4 million. The Company sold $150,000 of the auction rate securities during the second quarter of 2014. These bonds have credit wrap insurance and a credit rating of A by a major credit rating agency.

 

The Company valued the auction rate securities at September 30, 2014, using a discounted cash flow model based on the characteristics of the individual securities, which the Company believes yields the best estimate of fair value. The first step in the valuation included a credit analysis of the security which considered various factors including the credit quality of the issuer, the instrument’s position within the capital structure of the issuing authority, and the composition of the authority’s assets including the effect of insurance and/or government guarantees. Next, the future cash flows of the instruments were projected based on certain assumptions regarding the auction rate market significant to the valuation including the auction rate market will remain illiquid and auctions will continue to fail causing the interest rate to be the maximum applicable rate. This assumption resulted in discounted cash flow analysis being performed through 2019, the point at which the Company estimates the securities will be redeemed by the municipality. The projected cash flows were then discounted using the applicable yield curve plus a 225 basis point liquidity premium added to the applicable discount rate.

 

The Company recorded a pre-tax impairment charge of $1.0 million on these auction rate securities in 2011 and a subsequent pre-tax increase in fair value of $184,000 in the second quarter of 2014. The Company believes that the impairment is temporary and has included the impairment in accumulated other comprehensive loss.

 

 
8

 

 

The table below presents disclosures about the auction rate securities measured at fair value on a recurring basis in the Company’s financial statements as follows (in thousands):

 

 

   

At September 30, 2014

   

At December 31, 2013

 
   

Level 1
Inputs

   

Level 2
Inputs

   

Level 3
Inputs

   

Level 1
Inputs

   

Level 2

Inputs

   

Level 3

Inputs

 

Investment in auction rate securities

  $     $     $ 6,812     $     $     $ 6,628  

 

 

   

Cost Basis
Amount

   

Gross Unrealized

(Gain) Loss In

Accumulated

OCI

   

Fair Value

 

September 30, 2014

                       

Investment in auction rate securities

  $ 7,425     $ 613     $ 6,812  
                         

December 31, 2013

                       

Investment in auction rate securities

  $ 7,575     $ 947     $ 6,628  

 

Interest Rate Swap Agreements

 

The Company has entered into swap agreements to hedge against the potential impact of increases in interest rates on its floating-rate debt instruments.  Swap agreements that hedge exposures to changes in interest rates expose us to credit risk and market risk.  Credit risk is the potential failure of the counterparty to perform under the terms of the swap agreement.  The Company attempts to minimize this risk by entering into transactions with high-quality counterparties.  Market risk is the potential adverse effect on the value of the swap agreement that results from a decline in interest rates.  The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

 

At September 30, 2014, the Company had an aggregate $35.8 million notional amount of interest rate swap contracts, which have been designated as cash flow hedges, to pay fixed rates of interest and receive a floating interest rate based on LIBOR. The fixed interest rates specified in the interest rate swap contracts became effective on or about January 1, 2012. The Company’s interest rate swaps qualify for cash flow hedge accounting treatment.  Unrealized gains or losses are recorded in accumulated other comprehensive income. Realized gains and losses will be recognized in interest expense, if they occur. Amounts to be received or paid under the contracts will be recognized as interest expense over the life of the contracts. There was no ineffectiveness for these swaps during the three months ended September 30, 2014 and 2013.

 

The fair value of cash flow hedges is calculated as the present value of expected future cash flows, determined on the basis of forward interest rates and present value factors. As such, the carrying amounts for these swaps are designated to be Level 2 fair values and totaled a liability of $0.4 million as of September 30, 2014. The carrying value of these swaps is included in Other Long-Term Liabilities on the accompanying Consolidated Balance Sheet as of September 30, 2014.

 

As of September 30, 2014, the Company was a party to derivative financial instruments, as described in the following table (in thousands):

 

Agreement

 

Notional Amount

   

Fixed Interest Rate

 

Underlying Rate

 

Expiration Date

 

Fair Value

 

Interest Rate Swap

  $ 1,749       5.075 %

3 month LIBOR

 

July 1, 2015

  $ (26 )

Interest Rate Swap

    3,612       5.075 %

3 month LIBOR

 

July 1, 2015

    (54 )

Interest Rate Swap

    6,237       5.39 %

1 month LIBOR

 

December 31, 2014

    (34 )

Interest Rate Swap

    1,206       5.39 %

1 month LIBOR

 

December 31, 2014

    (6 )

Interest Rate Swap

    2,146       5.39 %

1 month LIBOR

 

December 31, 2014

    (12 )

Interest Rate Swap

    4,856       5.39 %

1 month LIBOR

 

December 31, 2014

    (26 )

Interest Rate Swap

    4,472       5.38 %

1 month LIBOR

 

June 29, 2015

    (80 )

Interest Rate Swap

    688       5.29 %

1 month LIBOR

 

June 30, 2015

    (12 )

Interest Rate Swap

    1,319       5.29 %

1 month LIBOR

 

June 30, 2015

    (23 )

Interest Rate Swap

    6,650       5.29 %

1 month LIBOR

 

June 30, 2015

    (114 )

Interest Rate Swap

    573       5.29 %

1 month LIBOR

 

June 30, 2015

    (10 )

Interest Rate Swap

    2,305       5.29 %

1 month LIBOR

 

June 30, 2015

    (40 )

  

 
9

 

 

Fair values of derivative instruments are on the accompanying Consolidated Balance Sheet (in thousands):

 

       

Fair Value at

 

Derivative Liabilities Designated as Hedging Instruments

 

Balance Sheet Location

 

September 30, 2014

   

December 31, 2013

 

Interest Rate Swaps

 

Other Long-Term Liabilities

  $ 437     $ 1,024  

 

(in thousands)

 

Gain Recognized in
OCI on Derivatives
(Effective Portion)
during the
Three Months Ended

 

Location of Loss

 

Loss Reclassified
from Accumulated
OCI into Income
(Effective Portion)
during the
Three Months Ended

 
   

September 30,
2014

   

September 30,
2013

 

Reclassified into
Income

 

September 30,
2014

   

September 30,
2013

 

Interest rate swaps

  $ 216     $ 165  

Interest Expense

  $ (55 )   $ (60 )

 

(in thousands)

 

Gain Recognized in
OCI on Derivatives
(Effective Portion)
during the
Nine Months Ended

 

Location of Loss

 

Loss Reclassified
from Accumulated
OCI into Income
(Effective Portion)
during the
Nine Months Ended

 
   

September 30,
2014

   

September 30,
2013

 

Reclassified into
Income

 

September 30,
2014

   

September 30,
2013

 

Interest rate swaps

  $ 587     $ 691  

Interest Expense

  $ (166 )   $ (231 )

 

7 – Segment Information

 

The Company currently has one reportable business segment, the Truck Segment. The Truck Segment includes the Company’s operation of a network of commercial vehicle dealerships that provide an integrated one-stop source for the commercial vehicle needs of its customers, including retail sales of new and used commercial vehicles; aftermarket parts, service and body shop facilities; and a wide array of financial services, including the financing of new and used commercial vehicle purchases, insurance products and truck leasing and rentals. The commercial vehicle dealerships are deemed a single reporting unit because they have similar economic characteristics. The Company’s chief operating decision maker considers the entire Truck Segment, not individual dealerships, when making decisions about resources to be allocated to the segment and assess its performance.

 

The Company also has revenues attributable to three other operating segments. These segments include a retail tire company, an insurance agency and a guest ranch operation and are included in the All Other column below. None of these segments has ever met any of the quantitative thresholds for determining reportable segments.

 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on income before income taxes, not including extraordinary items.

 

The following table contains summarized information about reportable segment revenue, segment income or loss and segment assets for the periods ended September 30, 2014 and 2013 (in thousands):

 

   

Truck Segment

   

All Other

   

Totals

 
                         

As of and for the three months ended September 30, 2014

                       
                         

Revenues from external customers

  $ 1,236,101     $ 4,921     $ 1,241,022  

Segment income (loss) before taxes

    38,366       (37 )     38,329  

Segment assets

    2,426,368       30,244       2,456,612  
                         

For the nine months ended September 30, 2014

                       
                         

Revenues from external customers

  $ 3,368,037     $ 14,113     $ 3,382,150  

Segment income (loss) before taxes

    90,459       (126 )     90,333  
                         

As of and for the three months ended September 30, 2013

                       
                         

Revenues from external customers

  $ 907,903     $ 5,161     $ 913,064  

Segment income (loss) before taxes

    25,149       (60 )     25,089  

Segment assets

    2,016,725       28,806       2,045,530  
                         

For the nine months ended September 30, 2013

                       
                         

Revenues from external customers

  $ 2,445,151     $ 14,375     $ 2,459,526  

Segment income (loss) before taxes

    56,685       (187 )     56,498  

  

 
10

 

 

8 – Income Taxes

 

The Company included accruals for unrecognized income tax benefits totaling $1.5 million as a component of accrued liabilities as of September 30, 2014, and $1.4 million as of September 30, 2013. The unrecognized tax benefits, if recognized, would impact the Company’s effective tax rate. An unfavorable settlement would require a charge to income tax expense and a favorable resolution would be recognized as a reduction to income tax expense. The Company records interest and penalties related to unrecognized income tax benefits in income tax expense. The Company had accrued interest of $81,000 at September 30, 2014, and December 31, 2013, related to unrecognized tax benefits. No amounts were accrued for penalties.

 

The Company does not anticipate a significant change in the amount of unrecognized tax benefits in the next 12 months. As of September 30, 2014, the tax years ended December 31, 2010 through 2013, remained subject to audit by federal tax authorities and the tax years ended December 31, 2009 through 2013, remained subject to audit by state tax authorities.

 

9Accumulated Other Comprehensive Income

 

The following table shows the components of accumulated other comprehensive loss, net of tax, (in thousands):

 

   

Three Months Ended September 30, 2014

 
   

Cash Flow Swaps

   

Available for Sale Securities

   

Total

 

Balance at June 30, 2014

  $ (398 )   $ (374 )   $ (772 )

Change in fair value

    216             216  

Income tax deferred

    (84 )           (84 )

Balance at September 30, 2014

  $ (266 )   $ (374 )   $ (640 )

 

   

Three Months Ended September 30, 2013

 
   

Cash Flow Swaps

   

Available for Sale Securities

   

Total

 

Balance at June 30, 2013

  $ (854 )   $ (578 )   $ (1,432 )

Change in fair value

    165             165  

Income tax deferred

    (64 )           (64 )

Balance at September 30, 2013

  $ (753 )   $ (578 )   $ (1,331 )

 

   

Nine Months Ended September 30, 2014

 
   

Cash Flow Swaps

   

Available for Sale Securities

   

Total

 

Balance at December 31, 2013

  $ (624 )   $ (578 )   $ (1,202 )

Change in fair value

    587       184       771  

Sale of available for sale securities

          150       150  

Income tax deferred

    (229 )     (130 )     (359 )

Balance at September 30, 2014

  $ (266 )   $ (374 )   $ (640 )

  

   

Nine Months Ended September 30, 2013

 
   

Cash Flow Swaps

   

Available for Sale Securities

   

Total

 

Balance at December 31, 2012

  $ (1,178 )   $ (578 )   $ (1,756 )

Change in fair value

    691             691  

Income tax deferred

    (266 )           (266 )

Balance at September 30, 2013

  $ (753 )   $ (578 )   $ (1,331 )

 

 
11

 

 

The following table shows the amount of loss reclassified from accumulated other comprehensive loss into earnings (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30, 2014

   

September 30, 2013

   

September 30, 2014

   

September 30, 2013

 

Losses on cash flow swaps to:

                               

Interest expense

  $ (55 )   $ (60 )   $ (166 )   $ (231 )

Income tax benefit

    21       23       65       89  

Total reclassifications

  $ (34 )   $ (37 )   $ (101 )   $ (142 )

 

The following table shows the reconciliation of net income to comprehensive income (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30, 2014

   

September 30, 2013

   

September 30, 2014

   

September 30, 2013

 
                                 

Net Income

  $ 23,478     $ 15,179     $ 55,330     $ 34,358  

Other comprehensive income, before tax:

                               

Change in fair value of interest rate swaps

    216       165       587       691  

Change in fair value of available-for-sale securities

                184        

Unrealized gain on available-for-sale securities

                150        

Other comprehensive income, before tax

    216       165       921       691  

Income tax expense related to components of other comprehensive income

    84       64       359       266  

Other comprehensive income, net of tax

    132       101       562       425  

Comprehensive income

  $ 23,610     $ 15,280     $ 55,892     $ 34,783  

 

10 – Acquisitions

 

On July 1, 2014, the Company acquired certain assets of Truck Parts Depot, Inc. which included a commercial parts and service facility in Gainsville, Georgia. The Gainsville location is operating as a full-service Rush Truck Center and offers commercial vehicles manufactured by International. The transaction was valued at approximately $0.5 million, with the purchase price paid in cash.

 

On June 25, 2014, a joint venture was established to further expand the Company’s used commercial vehicle sales network. As a result, the Company owns 50% of Central California Truck and Trailer Sales, LLC (“CCTTS”), which has locations in Fresno and Stockton, California that sell used trucks. In connection with the formation of this joint venture, the Company contributed $2.2 million. CCTTS is accounted for using the equity method of accounting in accordance with ASC 323, “Investments-Equity Method and Joint Venture,” and is recorded on the Consolidated Balance Sheet in Other Assets.

 

In May 2014, the Company announced an agreement with 3M to pursue the design, manufacture and installation of a portfolio of compressed natural gas (“CNG”) fuel systems for use in Class 6 through 8 vehicles. The Agreement allows the Company to engineer, assemble and install CNG fuel systems utilizing 3M’s CNG tanks, as well as provide market distribution and aftermarket support. In addition to the initial $2.0 million investment for research and development, which was recorded in selling, general and administrative expense, the Company will continue to incur expenses to bring its CNG fuel system to market. The transaction did not qualify as a business combination in accordance with ASC 805, “Business Combinations.”

 

 
12

 

 

On January 13, 2014, the Company acquired certain assets of CIT, Inc., which did business as Chicago International Trucks, Mcgrenho L.L.C., which did business as Indy Truck Sales, and Indiana Mack Leasing, LLC; and the membership interests of Idealease of Chicago, LLC. The acquisition included International commercial truck dealerships and Idealease commercial vehicle rental and leasing businesses in Carol Stream, Chicago, Grayslake, Huntley, Joliet, Kankakee and Ottawa, Illinois, and Brazil, Gary and Indianapolis, Indiana.

 

The purchase price for the assets, membership interests, goodwill and dealership properties was approximately $145.1 million, which was paid in cash and 83,091 shares of the Company’s Class B Common Stock with a total value of $2.0 million on the date of acquisition. The operations of CIT, Inc. are included in the accompanying consolidated financial statements from the date of the acquisition. The preliminary purchase price was allocated based on the fair values of the assets at the date of acquisition as follows (in thousands):

 

Property and equipment

  $ 60,066  

Goodwill

    47,326  

Inventory

    31,048  

Accounts receivable

    7,175  

Prepaid expenses

    750  

Other

    23  

Accrued expenses

    (1,325 )
         

Total

  $ 145,063  

 

As the value of certain assets and liabilities are preliminary in nature, they are subject to adjustment as additional information is obtained about the facts and circumstances that existed at the acquisition date. Pro forma information is not included in accordance with ASC 805, “Business Combinations,” because the acquisition was not considered material.

 

 
13

 

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Certain statements contained in this Form 10-Q (or otherwise made by the Company or on the Company’s behalf from time to time in other reports, filings with the Securities and Exchange Commission, news releases, conferences, website postings or otherwise) that are not statements of historical fact constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended (the “Exchange Act”), notwithstanding that such statements are not specifically identified. Forward-looking statements include statements about the Company’s financial position, business strategy and plans and objectives of management of the Company for future operations. These forward-looking statements reflect the best judgments of the Company about the future events and trends based on the beliefs of the Company’s management as well as assumptions made by and information currently available to the Company’s management. Use of the words “may,” “should,” “continue,” “plan,” “potential,” “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements reflect the current view of the Company with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those in such statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those set forth under Item 1A—Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as well as future growth rates and margins for certain of our products and services, future supply and demand for our products and services, competitive factors, general economic conditions, cyclicality, market conditions in the new and used commercial vehicle markets, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, technological change, changes in industry practices, one-time events and other factors described herein and in the Company’s quarterly and other reports filed with the Securities and Exchange Commission (collectively, “Cautionary Statements”). Although the Company believes that its expectations are reasonable, it can give no assurance that such expectations will prove to be correct. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the applicable Cautionary Statements. All forward-looking statements speak only as of the date on which they are made and the Company undertakes no duty to update or revise any forward-looking statements.

 

The following comments should be read in conjunction with the Company’s consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

 

Note Regarding Trademarks Commonly Used in the Company’s Filings

 

Peterbilt® is a registered trademark of Peterbilt Motors Company. PACCAR® is a registered trademark of PACCAR, Inc. PacLease® is a registered trademark of PACCAR Leasing Corporation. Navistar® is a registered trademark of Navistar International Corporation. International® is a registered trademark of Navistar International Transportation Corp. Idealease is a registered trademark of Idealease, Inc. aka Idealease of North America, Inc. Blue Bird® is a registered trademark of Blue Bird Investment Corporation. IC Bus® is a registered trademark of IC Bus, LLC. Fuso® is a registered trademark of Mitsubishi Fuso Truck and Bus Corporation. Hino® is a registered trademark of Hino Motors, Ltd. Isuzu® is a registered trademark of Isuzu Motors Limited. Ford Motor Credit Company® is a registered trademark of Ford Motor Company. Mack® is a registered trademark of Mack Trucks, Inc. Ford® is a registered trademark of Ford Motor Company. SAP® is a registered trademark of SAP Aktiengesellschaft.

 

General

 

Rush Enterprises, Inc. was incorporated in Texas in 1965 and consists of one reportable segment, the Truck Segment and conducts business through its subsidiaries. Its principal offices are located at 555 IH 35 South, Suite 500, New Braunfels, Texas 78130.

 

The Company is a full-service, integrated retailer of commercial vehicles and related services. The Truck Segment includes the Company’s operation of a regional network of commercial vehicle dealerships under the name “Rush Truck Centers.” Rush Truck Centers primarily sell commercial vehicles manufactured by Peterbilt, International, Hino, Ford, Isuzu, Mitsubishi Fuso, IC Bus or Blue Bird. Through its strategically located network of Rush Truck Centers, the Company provides one-stop service for the needs of its commercial vehicle customers, including retail sales of new and used commercial vehicles, aftermarket parts sales, service and repair facilities, financing, leasing and rental, and insurance products.

 

 
14

 

 

The Company’s Rush Truck Centers are principally located in high traffic areas throughout the United States. Since commencing operations as a Peterbilt heavy-duty truck dealer in 1966, the Company has grown to operate 107 Rush Truck Centers in 20 states.

 

Our business strategy consists of providing our customers with competitively priced products supported with timely and reliable service through our integrated dealer network. We intend to continue to implement our business strategy, reinforce customer loyalty and remain a market leader by continuing to develop our Rush Truck Centers as we extend our geographic focus through strategic acquisitions of new locations and expansions of our existing facilities and product lines.

 

Critical Accounting Policies and Estimates

 

The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. The Company believes the following accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Inventories

 

Inventories are stated at the lower of cost or market value. Cost is determined by specific identification of new and used commercial vehicles inventory and by the first-in, first-out method for tires, parts and accessories. As the market value of our inventory typically declines over time, reserves are established based on historical loss experience and market trends. These reserves are charged to cost of sales and reduce the carrying value of our inventory on hand. An allowance is provided when it is anticipated that cost will exceed net realizable value plus a reasonable profit margin.

 

Goodwill

 

Goodwill is tested for impairment by reporting unit utilizing a two-step process at least annually, or more frequently when events or changes in circumstances indicate that the asset might be impaired. The first step requires the Company to compare the fair value of the reporting unit, which is the same as the segment, to the respective carrying value. The Company considers its Truck Segment to be a reporting unit for purposes of this analysis. If the fair value of the reporting unit exceeds its carrying value, the goodwill is not considered impaired. If the carrying value is greater than the fair value, there is an indication that impairment may exist and a second step is required. In the second step of the analysis, the implied fair value of the goodwill is calculated as the excess of the fair value of a reporting unit over the fair values assigned to its assets and liabilities. If the implied fair value of goodwill is less than the carrying value of the reporting unit’s goodwill, the difference is recognized as an impairment loss.

 

The Company determines the fair value of its reporting unit using the discounted cash flow method. The discounted cash flow method uses various assumptions and estimates regarding revenue growth rates, future gross margins, future selling, general and administrative expenses and an estimated weighted average cost of capital. The analysis is based upon available information regarding expected future cash flows of each reporting unit discounted at rates consistent with the cost of capital specific to the reporting unit. This type of analysis contains uncertainties because it requires the Company to make assumptions and to apply judgment regarding its knowledge of its industry, information provided by industry analysts, and its current business strategy in light of present industry and economic conditions. If any of these assumptions change, or fail to materialize, the resulting decline in its estimated fair value could result in a material impairment charge to the goodwill associated with the reporting unit.

 

The Company does not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions it used to test for impairment losses on goodwill. However, if actual results are not consistent with our estimates or assumptions, or certain events occur that might adversely affect the reported value of goodwill in the future, the Company may be exposed to an impairment charge that could be material. Such events may include, but are not limited to, strategic decisions made in response to economic and competitive conditions or the impact of the current economic environment.

 

Goodwill was tested for impairment during the fourth quarter of 2013 and no impairment was required. The fair value of our reporting unit exceeded the carrying value of its net assets. As a result, we were not required to conduct the second step of the impairment test. The Company does not believe its reporting unit is at risk of failing step one of the impairment test. No facts or circumstances were noted during the nine months ended September 30, 2014 that would indicate impairment.

 

 
15

 

 

Insurance Accruals

 

The Company is partially self-insured for a portion of the claims related to its property and casualty insurance programs, requiring it to make estimates regarding expected losses to be incurred. The Company engages a third-party administrator to assess any open claims and the Company adjusts its accrual accordingly on an annual basis. The Company is also partially self-insured for a portion of the claims related to its workers’ compensation and medical insurance programs. The Company uses actuarial information provided from third-party administrators to calculate an accrual for claims incurred, but not reported, and for the remaining portion of claims that have been reported.

 

Changes in the frequency, severity, and development of existing claims could influence the Company’s reserve for claims and financial position, results of operations and cash flows. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions it used to calculate its self-insured liabilities. However, if actual results are not consistent with our estimates or assumptions, the Company may be exposed to losses or gains that could be material.

 

Accounting for Income Taxes

 

Management’s judgment is required to determine the provisions for income taxes and to determine whether deferred tax assets will be realized in full or in part. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When it is more likely than not that all or some portion of specific deferred income tax assets will not be realized, a valuation allowance must be established for the amount of deferred income tax assets that are determined not to be realizable. Accordingly, the facts and financial circumstances impacting state deferred income tax assets are reviewed quarterly and management’s judgment is applied to determine the amount of valuation allowance required, if any, in any given period.

 

The Company’s income tax returns are periodically audited by tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions. In evaluating the exposures associated with the Company’s various tax filing positions, the Company adjusts its liability for unrecognized tax benefits and income tax provision in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position, or when more information becomes available.

 

The Company’s liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with its various filing positions. The Company’s effective income tax rate is also affected by changes in tax law, the level of earnings and the results of tax audits. Although the Company believes that the judgments and estimates are reasonable, actual results could differ, and the Company may be exposed to losses or gains that could be material. An unfavorable tax settlement generally would require use of the Company’s cash and result in an increase in its effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in the Company’s effective income tax rate in the period of resolution. The Company’s income tax expense includes the impact of reserve provisions and changes to reserves that it considers appropriate, as well as related interest.

 

Stock-Based Compensation Expense

 

The Company applies the provisions of ASC 718-10, “Compensation – Stock Compensation,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including grants of employee stock options and restricted stock and employee stock purchases under the Employee Stock Purchase Plan based on estimated fair values.

 

The Company uses the Black-Scholes option-pricing model to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Income.

 

Derivative Instruments and Hedging Activities

 

The Company utilizes derivative financial instruments to manage its interest rate risk. The types of risks hedged are those relating to the variability of cash flows and changes in the fair value of the Company’s financial instruments caused by movements in interest rates. The Company assesses hedge effectiveness at the inception and during the term of each hedge. Derivatives are reported at fair value on the accompanying Consolidated Balance Sheets.

 

The effective portion of the gain or loss on the Company’s cash flow hedges are reported as a component of accumulated other comprehensive loss. Hedge effectiveness is assessed quarterly by comparing the changes in cumulative gain or loss from the interest rate swap with the cumulative changes in the present value of the expected future cash flows of the interest rate swap that are attributable to changes in the LIBOR rate. If the interest rate swaps become ineffective, portions of these interest rate swaps would be reported as a component of interest expense in the accompanying Consolidated Statements of Income.

 

 
16

 

 

Results of Operations

 

The following discussion and analysis includes the Company’s historical results of operations for the three months and nine months ended September 30, 2014 and 2013.

 

The following table sets forth for the periods indicated certain financial data as a percentage of total revenues:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Revenue

                               

New and used commercial vehicle sales

    68.2

%

    67.4

%

    66.4

%

    65.6

%

Parts and service sales

    27.5       28.2       29.0       29.8  

Lease and rental

    3.6       3.6       3.8       3.8  

Finance and insurance

    0.4       0.5       0.4       0.5  

Other

    0.3       0.3       0.4       0.3  

Total revenues

    100.0       100.0       100.0       100.0  

Cost of products sold

                               

New and used commercial vehicle sales

    63.5       62.8       61.7       61.0  

Parts and service sales

    17.4       17.7       18.5       18.7  

Lease and rental

    3.1       3.0       3.3       3.2  

Total cost of products sold

    84.0       83.5       83.5       82.9  

Gross profit

    16.0       16.5       16.5       17.1  

Selling, general and administrative

    11.9       12.6       12.8       13.6  

Depreciation and amortization

    0.8       0.8       0.8       0.9  

Gain on sale of assets

    0.0       0.0       0.0       0.0  

Operating income

    3.3       3.1       2.9       2.6  

Interest expense, net

    0.2       0.3       0.2       0.3  

Income before income taxes

    3.1       2.8       2.7       2.3  

Provision for income taxes

    1.2       1.1       1.0       0.9  

Net income

    1.9

%

    1.7

%

    1.7

%

    1.4

%

 

The following table sets forth for the periods indicated the percent of gross profit by revenue source:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Gross Profit:

                               

New and used commercial vehicle sales

    29.3

%

    27.9

%

    28.6

%

    27.0

%

Parts and service sales

    62.7       64.1       63.4       64.6  

Lease and rental

    3.5       3.2       3.2       3.6  

Finance and insurance

    2.6       2.9       2.6       2.7  

Other

    1.9       1.9       2.2       2.1  

Total gross profit

    100.0

%

    100.0

%

    100.0

%

    100.0

%

  

 
17

 

 

The following table sets forth the unit sales and revenue for new heavy-duty, new medium-duty, new light-duty and used commercial vehicles and the absorption ratio (revenue in millions):

 

   

Three Months Ended

September 30,

           

Nine Months Ended

September 30,

         
   

2014

   

2013

   

% Change

   

2014

   

2013

   

% Change

 

Vehicle unit sales:

                                               

New heavy-duty vehicles

    4,384       2,605       68.3 %     10,714       6,758       58.5 %

New medium-duty vehicles

    2,587       2,421       6.9 %     7,529       6,376       18.1 %

New light-duty vehicles

    377       515       -26.8 %     1,352       1,444       -6.4 %

Total new vehicle unit sales

    7,348       5,541       32.6 %     19,595       14,578       34.4 %
                                                 

Used vehicles

    1,956       1,635       19.6 %     5,680       4,567       24.4 %
                                                 

Vehicle revenue:

                                               

New heavy-duty vehicles

  $ 561.6     $ 348.2       61.3 %   $ 1,421.9     $ 928.0       53.2 %

New medium-duty vehicles

    185.4       181.2       2.3 %     532.9       451.5       18.0 %

New light-duty vehicles

    14.9       17.2       13.4 %     45.6       45.8       -.04 %

Total new vehicle revenue

  $ 761.9     $ 546.6       39.4 %   $ 2,000.4     $ 1,425.3       40.3 %
                                                 

Used vehicle revenue

  $ 82.1     $ 64.4       27.5 %   $ 233.7     $ 178.0       31.3 %
                                                 

Other vehicle revenue:(1)

  $ 2.3     $ 4.6       -50.0 %   $ 10.3     $ 10.1       2.0 %
                                                 

Absorption rate:

    120.2 %     114.6 %     5.2 %     117.2 %     113.8 %     3.2 %

 

(1) Includes sales of truck bodies, trailers and other new equipment.

 

Key Performance Indicator

 

Absorption Ratio

 

Management uses several performance metrics to evaluate the performance of its commercial vehicle dealerships, and considers Rush Truck Centers’ “absorption ratio” to be of critical importance. Absorption ratio is calculated by dividing the gross profit from the parts, service and body shop (collectively, “Aftermarket Services”) departments by the overhead expenses of all of a dealership’s departments, except for the selling expenses of the new and used commercial vehicle departments and carrying costs of new and used commercial vehicle inventory. When 100% absorption is achieved, all of the gross profit from the sale of a commercial vehicle, after sales commissions and inventory carrying costs, directly impacts operating profit. In 1999, the Company’s commercial vehicle dealerships’ absorption ratio was approximately 80%. The Company has made a concerted effort to increase its absorption ratio since 1999. The Company’s truck dealerships achieved a 120.2% absorption ratio for the third quarter of 2014 compared to a 114.6% absorption ratio for the third quarter of 2013.

 

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013

 

The positive impact of continued freight growth and economic improvement in the third quarter contributed to the Company achieving another quarter of record performance in total revenues, net income, Class 8 new truck sales and market share, aftermarket sales and its absorption ratio. The Company continued to focus on asset management, process standardization and customer service consistency, while expanding its portfolio of solutions to help drive efficiencies for its customers.

 

Aftermarket Services revenue was driven by continued repair and maintenance needs of aged vehicles, increased activity in pre-delivery inspection and vehicle modifications resulting from new truck sales, and service support for a broad range of market segments. The Company expects aftermarket sales to remain strong through the remainder of 2014 and into 2015; however, continued low oil prices could adversely impact the Company if such lower prices lead to reduced activity in the energy sector.

 

Demand for new Class 8 trucks remained strong in the third quarter. Large fleets continued to replace aged vehicles to improve uptime, capitalize on gains in fuel efficiency, and appeal to a wider range of potential drivers. Demand for vehicles from small and mid-size vocational customers increased in the third quarter. Our third quarter Class 4-7 truck sales accounted for the second largest quarterly sales volume in the Company’s history. The Company believes that this was a direct result of our investment in a large inventory of work-ready equipment, which allows it to meet the immediate demands of vocational customers, particularly those in construction.

 

The Company continues to implement its accelerated business system rollout as planned and expand its investments in new facility construction and renovations. The Company is currently constructing new dealerships in San Antonio, Texas; Cleveland and Cincinnati, Ohio; and will begin construction soon on new dealerships in Denver, Colorado; Odessa, Texas; and Twin Falls, Idaho.

 

 
18

 

 

Revenues

 

Revenues increased $328.0 million, or 35.9%, in the third quarter of 2014, compared to the third quarter of 2013.

 

Aftermarket Services revenues increased $83.1 million, or 32.3%, in the third quarter of 2014, compared to the third quarter of 2013. This increase is due primarily to the effect of the acquisitions that occurred since the second quarter of 2013, but is also impacted by strong demand for maintenance and repair of aged vehicles. The Company expects Aftermarket Services revenues to continue to remain strong through 2014 and remains focused on expanding aftermarket product and service offerings.

 

Revenues from sales of new and used commercial vehicles increased $230.6 million, or 37.5%, in the third quarter of 2014 compared to the third quarter of 2013.

 

The Company sold 4,384 heavy-duty trucks in the third quarter of 2014, a 68.3% increase compared to 2,605 heavy-duty trucks in the third quarter of 2013. This increase is due primarily to a stronger heavy-duty truck market and the effect of the acquisitions that occurred since the second quarter of 2013. According to A.C.T. Research Co., LLC (“A.C.T. Research”), a truck industry data and forecasting service provider, the U.S. Class 8 truck market increased 20% in the third quarter of 2014 compared to the third quarter of 2013. A.C.T. Research currently predicts U.S. retail sales of Class 8 trucks of approximately 227,100 units in 2014, 240,000 units in 2015, and 220,000 units in 2016, compared to approximately 188,000 units in 2013. The Company’s share of the U.S. Class 8 truck sales market was approximately 5.1% in 2013, and 6.6% in the first nine months of 2014. The Company expects its market share to range between 6.5% and 7.0% of U.S. Class 8 truck sales in 2014. Based on A.C.T. Research’s estimate of U.S. retail sales of 227,100 units, this market share percentage would result in the sale of approximately 14,800 to 15,900 of Class 8 trucks in 2014.

 

The Company sold 2,587 medium-duty commercial vehicles, including 435 buses, in the third quarter of 2014, a 6.9% increase compared to 2,421 medium-duty commercial vehicles, including 626 buses, in 2013. A.C.T. Research estimates that unit sales of Class 4 through 7 commercial vehicles in the U.S. increased approximately 20% in the third quarter of 2014, compared to the third quarter of 2013. A.C.T. Research currently predicts U.S. retail sales of Class 4 through 7 medium-duty commercial vehicles of approximately 196,300 units in 2014, 204,300 units in 2015, and 212,300 in 2016. The Company’s share of the U.S. Class 4 through 7 commercial vehicle sales market in the U.S. in 2013 was 4.7%, and 5.1% in the first nine months of 2014. The Company expects its market share to range between 4.9% and 5.3% of U.S. Class 4 through 7 commercial vehicle sales in 2014. Based on A.C.T. Research’s current U.S. retail sales estimates of 196,300 units, this market share percentage would result in the sale of approximately 9,600 to 10,400 of Class 4 through 7 commercial vehicles in 2014.

 

The Company sold 377 light-duty vehicles in the third quarter of 2014, a 26.8% decrease compared to 515 light-duty vehicles sold in the third quarter of 2013. This decrease was primarily attributable to the relocation of the Orlando dealership during the third quarter of 2014 which resulted in a temporary closure during the move. The Company expects to sell approximately 2,000 light-duty vehicles in 2014.

 

The Company sold 1,956 used commercial vehicles in the third quarter of 2014, a 19.6% increase compared to 1,635 used commercial vehicles in the third quarter of 2013. This increase was primarily the result of acquisitions that occurred since the second quarter of 2013. The Company expects to sell 7,500 to 8,500 used commercial vehicles in 2014. The volume of used commercial vehicle sales will be largely dependent upon our ability to acquire quality used commercial vehicles and maintain an adequate used commercial vehicle inventory throughout 2014.

 

Truck lease and rental revenues increased $12.4 million, or 38.1%, in the third quarter of 2014, compared to the third quarter of 2013. The increase in lease and rental revenue is primarily due to acquisitions that occurred in the second half of 2013 and the first quarter of 2014. The Company expects lease and rental revenue to increase 38% to 40% during 2014, compared to 2013.

 

Finance and insurance revenues increased $0.9 million, or 20.6%, in the third quarter of 2014, compared to the third quarter of 2013. The Company expects finance and insurance revenue to fluctuate proportionately with the Company’s new and used commercial vehicle sales for the remainder of the year. Finance and insurance revenues have limited direct costs and, therefore, contribute a disproportionate share of the Company’s operating profits.

 

 
19

 

 

Gross Profit

 

Gross profit increased $48.5 million, or 32.3%, in the third quarter of 2014, compared to the third quarter of 2013. Gross profit as a percentage of sales decreased to 16.0% in the third quarter of 2014, from 16.5% in the third quarter of 2013. This decrease in gross profit as a percentage of sales is a result of a change in our product sales mix. Commercial vehicle sales, a lower margin revenue item, increased as a percentage of total revenue to 68.2% in 2014, from 67.4% in 2013. Aftermarket Services revenues, a higher margin revenue item, decreased as a percentage of total revenue to 27.4% in 2014, from 28.2% in 2013.

 

Gross margins from the Company’s Aftermarket Services operations decreased to 36.6% in the third quarter of 2014, from 37.4% in the third quarter of 2013. Gross profit for the Aftermarket Services departments increased to $124.6 million in the third quarter of 2014, from $96.3 million in the third quarter of 2013. Historically, parts operations gross margins range from 27% to 28% and service and body shop operations range from 67% to 68%. Gross profits from parts sales represented 55% of total gross profit for Aftermarket Services operations in both the third quarter of 2014 and 2013. Service and body shop operations represented 45% of total gross profit for Aftermarket Services operations in both the third quarter of 2014 and 2013. The Company expects blended gross margins on Aftermarket Services operations to range from 35.5% to 36.5% in 2014.

 

Gross margins on Class 8 truck sales increased to 6.9% in the third quarter of 2014, from 6.7% in the third quarter of 2013. In 2014, the Company expects overall gross margins from Class 8 truck sales of approximately 6.9% to 7.5%.

 

Gross margins on medium-duty commercial vehicle sales increased to 5.8% in the third quarter of 2014, from 5.3% in the third quarter of 2013. It is difficult to accurately forecast gross margins on medium-duty commercial vehicles because gross margins vary significantly depending upon the mix of fleet and non-fleet purchasers and types of medium-duty commercial vehicles sold. For 2014, the Company expects overall gross margins from medium-duty commercial vehicle sales of approximately 5.3% to 5.9%, but this will largely depend upon the mix of purchasers and types of vehicles sold.

 

Gross margins on used commercial vehicle sales increased to 10.3% in the third quarter of 2014, from 9.0% in the third quarter of 2013. The Company expects margins on used commercial vehicles to range between 9.8% and 10.5% during 2014, depending upon general economic conditions and the availability of quality used vehicles.

 

Gross margins from truck lease and rental sales increased to 15.2% in the third quarter of 2014, from 14.6% in the third quarter of 2013. The Company expects gross margins from lease and rental sales of approximately 13.3% to 14.0% during 2014, as it expects to continue to grow its lease and rental fleet. The Company’s policy is to depreciate its lease and rental fleet using a straight line method over the customer’s contractual lease term. The lease unit is depreciated to a residual value that approximates fair value at the expiration of the lease term. This policy results in the Company realizing reasonable gross margins while the unit is in service and a corresponding gain or loss on sale when the unit is sold at the end of the lease term.

 

Finance and insurance revenues and other income, as described above, have limited direct costs and, therefore, contribute a disproportionate share of gross profit.

 

Selling, General and Administrative Expenses

 

Selling, General and Administrative (“SG&A”) expenses increased $33.4 million, or 29.1%, in the third quarter of 2014, compared to the third quarter of 2013. SG&A expenses as a percentage of total revenue decreased to 11.9% in the second quarter of 2014, from 12.6% in the second quarter of 2013. SG&A expenses as a percentage of total revenue have historically ranged from 10.0% to 15.0%. For 2014, the Company expects SG&A expenses as a percentage of total revenue to range from 12.5% to 13.5% and the selling portion of SG&A expenses to be approximately 25% to 30% of new and used commercial vehicle gross profit. In 2014, the Company expects the general and administrative portion of SG&A expenses to increase by approximately 25% to 30% compared to 2013, due primarily to the full year effect of the acquisitions that occurred since the first quarter of 2013, the addition of personnel and technology to integrate the Company’s network of dealerships and the start-up of the Company’s natural gas fuel systems business.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased $1.9 million, or 25.4%, in the third quarter of 2014, compared to the third quarter of 2013. This increase is primarily due to acquisitions that occurred since the second quarter of 2013, the construction of new dealerships and dealership renovations and expansions.

 

 
20

 

 

Interest Expense, Net

 

Net interest expense remained unchanged compared to the third quarter of 2013. Net interest expense in 2014 will depend on inventory levels and the amount of cash available to make prepayments on the Company’s floor plan agreement with GE Capital Commercial, Inc. (“GE Capital”).

 

Income before Income Taxes

 

As a result of the factors described above, income before income taxes increased $13.2 million, or 52.8%, in the third quarter of 2014, compared to the third quarter of 2013.

 

Income Taxes

 

Income taxes increased $4.9 million, or 49.9%, in the third quarter of 2014, compared to the third quarter of 2013. The Company provided for taxes at a 38.75% effective rate in the third quarter of 2014, compared to an effective rate of 39.5% in the third quarter of 2013. The Company expects its effective tax rate to be approximately 38% to 39% of pretax income in 2014.

 

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

 

Unless otherwise stated below, the Company’s variance explanations and future expectations with regard to the items discussed in this section are set forth in the discussion of the “Three Months Ended September 30, 2014, Compared to Three Months Ended September 30, 2013.”

 

Revenues

 

Revenues increased $922.6 million, or 37.5%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Aftermarket Services sales increased $248.7 million, or 34.0%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Revenues from sales of new and used commercial vehicles increased $631.0 million, or 39.1%, in the first nine months of 2014, compared to the first nine months of 2013.

 

The Company sold 10,714 heavy-duty trucks in the first nine months of 2014, a 58.5% increase compared to 6,758 heavy-duty trucks in the first nine months of 2013. According to A.C.T. Research, the U.S. Class 8 truck market increased 20% in the first nine months of 2014, compared to the first nine months of 2013.

 

The Company sold 7,529 medium-duty commercial vehicles, including 1,242 buses, in the first nine months of 2014, an 18.1% increase compared to 6,376 medium-duty commercial vehicles, including 1,092 buses, in the first nine months of 2013. A.C.T. Research estimates that unit sales of Class 4 through 7 commercial vehicles, including buses, in the U.S increased approximately 13% in the first nine months of 2014, compared to the first nine months of 2013.

 

The Company sold 1,352 light-duty commercial vehicles in the first nine months of 2014, a 6.4% decrease compared to 1,444 light-duty commercial vehicles in the first nine months of 2013.

 

The Company sold 5,680 used commercial vehicles in the first nine months of 2014, a 24.4% increase compared to 4,567 used commercial vehicles in the first nine months of 2013.

 

Truck lease and rental revenues increased $36.0 million, or 38.2%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Finance and insurance revenues increased $3.3 million, or 28.8%, in the first nine months of 2014, compared to the first nine months of 2013.

 

 
21

 

 

Gross Profit

 

Gross profit increased $136.3 million, or 32.3%, in the first nine months of 2014, compared to the first nine months of 2013. Gross profit as a percentage of sales decreased to 16.5% in the first nine months of 2014, from 17.1% in the first nine months of 2013. This decrease in gross profit as a percentage of sales is a result of a change in our product sales mix. Commercial vehicle sales, a lower margin revenue item, increased as a percentage of total revenue to 66.4% in 2014, from 65.6% in 2013. Aftermarket Services revenues, a higher margin revenue item, decreased as a percentage of total revenue to 29.0% in 2014, from 29.8% in 2013.

 

Gross margins from the Company’s Aftermarket Services operations decreased to 36.1% in the first nine months of 2014, from 37.2% in the first nine months of 2013. Gross profit for the Aftermarket Services departments was $353.9 million in the first nine months of 2014, compared to $272.5 million in the first nine months of 2013. Gross profits from parts sales represented 55% of total gross profit for Aftermarket Services operations in the first nine months of 2014 and the first nine months of 2013. Service and body shop operations represented 45% of total gross profit for Aftermarket Services operations in the first nine months of 2014 and the first nine months of 2013.

 

Gross margins on Class 8 truck sales increased to 7.3% in the first nine months of 2014, from 6.9% in the first nine months of 2013.

 

Gross margins on medium-duty commercial vehicle sales increased to 5.7% in the first nine months of 2014, from 5.3% in the first nine months of 2013.

 

Gross margins on used commercial vehicle sales increased to 10.2% in the first nine months of 2014, from 9.8% in the first nine months of 2013.

 

Gross margins from truck lease and rental sales decreased to 13.6% in the first nine months of 2014, from 16.1% in the first nine months of 2013. The decrease in gross margins is primarily due to the acquisitions in Illinois and Indiana.

 

Selling, General and Administrative Expenses

 

SG&A expenses increased $96.3 million, or 28.7%, in the first nine months of 2014, compared to the first nine months of 2013. SG&A expenses as a percentage of sales were 12.8% in the first nine months of 2014 and 13.6% in the first nine months of 2013.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased $5.5 million, or 25.3%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Interest Expense, Net

 

Net interest expense increased $0.6 million, or 7.6%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Income before Income Taxes

 

Income before income taxes increased $33.8 million, or 59.9%, in the first nine months of 2014, compared to the first nine months of 2013.

 

Provision for Income Taxes

 

Income taxes increased $12.9 million, or 58.1% in the first nine months of 2014, compared to the first nine months of 2013. The Company provided for taxes at a 38.75% rate in the first nine months of 2014, compared to a rate of 39.2% in the first nine months of 2013.

 

Liquidity and Capital Resources

 

The Company’s short-term cash requirements are primarily for working capital, inventory financing, the renovation and expansion of existing facilities and the construction or purchase of new facilities. Historically, these cash requirements have been met through the retention of profits, borrowings under our floor plan arrangements and bank financings. As of September 30, 2014, the Company had working capital of approximately $125.3 million, including $144.7 million in cash available to fund our operations. The Company believes that these funds are sufficient to meet its operating requirements for at least the next twelve months. From time to time, the Company utilizes its excess cash on hand to pay down its outstanding borrowings under its credit agreement with GE Capital, and the resulting interest earned is recognized as an offset to the Company’s gross interest expense under the credit agreement.

 

 
22

 

 

The Company has a secured line of credit that provides for a maximum borrowing of $15.0 million. There were no advances outstanding under this secured line of credit at September 30, 2014; however, $11.5 million was pledged to secure various letters of credit related to self-insurance products, leaving $3.5 million available for future borrowings as of September 30, 2014.

 

The Company’s long-term real estate debt agreements and floor plan financing arrangements require the Company to satisfy various financial ratios such as the debt-to-worth ratio, leverage ratio and the fixed charge coverage ratio and certain requirements for tangible net worth and GAAP net worth. As of September 30, 2014, the Company was in compliance with all debt covenants related to debt secured by real estate and lease and rental units and its floor plan credit agreement. The Company does not anticipate any breach of the covenants in the foreseeable future.

 

The Company expects to purchase or lease trucks worth approximately $170.0 million for its leasing operations during 2014, depending on customer demand, all of which will be financed. The Company expects to make capital expenditures for recurring items such as computers, shop equipment and vehicles of approximately $4.0 million to $6.0 million during the remainder of 2014.

 

The Company is currently under contracts to construct dealership facilities or remodel existing dealership facilities in San Antonio, Texas, at an estimated cost of $12.0 million, Dallas, Texas at an estimated cost of $2.6 million, Odessa, Texas at an estimated cost of $10.9 million, Cleveland, Ohio at an estimated cost of $8.4 million, Chicago, Illinois at an estimated cost of $2.4 million, and Cincinnati, Ohio at an estimated cost of $12.7 million. These construction projects are estimated to continue through the second quarter of 2015.

 

The Company anticipates funding its capital expenditures relating to the improvement and expansion of existing facilities and recurring expenses through its operating cash flow. The Company expects to fund the construction or purchase of new facilities through either its operating cash flow or by financing 70% to 80% of the appraised value of such facility.

 

On February 4, 2014, the Company announced that its Board of Directors approved a new stock repurchase program authorizing the Company to repurchase, from time to time, up to an aggregate of $40.0 million shares of Class A Common Stock and/or Class B Common Stock. The new stock repurchase program replaces the previous $40 million stock repurchase program that was set to expire on February 11, 2014. Repurchases will be made at times and in amounts as the Company deems appropriate and will be made through open market transactions, privately negotiated transactions and other lawful means. The manner, timing and amount of any repurchases will be determined by the Company based on an evaluation of market conditions, stock price and other factors. The stock repurchase program expires on February 3, 2015, and may be suspended or discontinued at any time. While the stock repurchase program does not obligate the Company to acquire any particular amount or class of common stock, the Company anticipates that it will be repurchasing primarily shares of its Class B Common Stock. As of September 30, 2014, the Company had repurchased $9.4 million of its Class B Common Stock under the stock repurchase program announced on February 4, 2014.

 

The Company has no other material commitments for capital expenditures as of September 30, 2014, except that the Company will continue to purchase vehicles for its lease and rental division and authorize capital expenditures for improvement and expansion of its existing dealership facilities and construction or purchase of new facilities based on market opportunities.

 

Cash Flows

 

Cash and cash equivalents decreased by $72.6 million during the nine months ended September 30, 2014, and decreased by $32.5 million during the nine months ended September 30, 2013. The major components of these changes are discussed below.

 

Cash Flows from Operating Activities

 

Cash flows from operating activities include net income adjusted for non-cash items and the effects of changes in working capital. During the first nine months of 2014, operating activities resulted in net cash provided by operations of $88.6 million. Cash provided by operating activities was primarily impacted by the increase in accounts payable, the increase in accrued liabilities and draws on floor plan notes payable – trade, which was offset by the increase in inventories and accounts receivable.

 

 
23

 

 

During the first nine months of 2013, operating activities resulted in net cash provided by operations of $77.8 million. Cash provided by operating activities was primarily impacted by the increase in accounts payable and draws on floor plan notes payable – trade, which was offset by the increase in inventories and accounts receivable and the decrease in accrued liabilities.

 

In June 2012, the Company entered into a wholesale financing agreement with Ford Motor Credit Company that provides for the financing of, and is collateralized by, the Company’s Ford new vehicle inventory. This wholesale financing agreement bears interest at a rate of Prime plus 150 basis points minus certain incentives and rebates; however, the prime rate is defined to be a minimum of 3.75%. As of September 30, 2014, the interest rate on the wholesale financing agreement was 5.25% before considering the applicable incentives. As of September 30, 2014, the Company had an outstanding balance of $61.2 million under the Ford Motor Credit Company wholesale financing agreement.

 

Cash Flows from Investing Activities

 

Cash flows used in investing activities primarily consist of cash used for capital expenditures and business acquisitions. During the first nine months of 2014, cash used in investing activities was $328.4 million. Capital expenditures consisted of purchases of property and equipment and improvements to our existing dealership facilities of $182.2 million. Property and equipment purchases during the first nine months of 2014 included $120.7 million for additional units for rental and leasing operations, which will be directly offset by borrowings of long-term debt. The Company expects to purchase or lease trucks worth approximately $170.0 million for its leasing operations in 2014, depending on customer demand, all of which will be financed. Cash used in business acquisitions was $147.8 million during the first nine months of 2014, which was partially offset by borrowings of long-term debt and floor plan notes payable. See Note 10 of the Notes to Consolidated Financial Statements for a detailed discussion of the business acquisitions. The Company expects to make capital expenditures for recurring items such as computers, shop equipment and vehicles of approximately $4.0 million to $6.0 million during the remainder of 2014.

 

During the first nine months of 2013, cash used in investing activities was $189.0 million. Capital expenditures consisted of purchases of property and equipment and improvements to our existing dealership facilities of $123.0 million. Property and equipment purchases, during the first nine months of 2013 included $73.0 million for additional units for rental and leasing operations, which will be directly offset by borrowings of long-term debt.

 

Cash Flows from Financing Activities

 

Cash flows from financing activities include borrowings and repayments of long-term debt and net proceeds of floor plan notes payable – non-trade. Cash provided by financing activities was $167.2 million during the first nine months of 2014. The Company had borrowings of long-term debt of $153.4 million, primarily related to units for the lease and rental operations, and repayments of long-term debt and capital lease obligations of $94.3 million during the first nine months of 2014. The Company had net draws on floor plan notes payable – non-trade of $101.8 million during the first nine months of 2014. Cash flows from financing activities also included proceeds from the issuance of shares relating to equity award plans, excess tax benefits from stock-based compensation and common stock repurchased.

 

Cash provided by financing activities was $78.7 million during the first nine months of 2013. The Company had borrowings of long-term debt of $112.4 million, primarily related to units for the lease and rental operations, and repayments of long-term debt and capital lease obligations of $75.1 million during the first nine months of 2013. The Company had net draws on floor plan notes payable – non-trade of $35.6 million during the first nine months of 2013. Cash flows from financing activities also included proceeds from the issuance of shares relating to equity award plans, excess tax benefits from stock-based compensation and common stock repurchased.

 

Most of the Company’s commercial vehicle purchases are made on terms requiring payment to the manufacturer within 15 days or less from the date the commercial vehicles are invoiced from the factory. On July 11, 2013, the Company entered into the third amendment to its credit agreement with GE Capital. The amendment increased the aggregate loan commitment to $750.0 million. Borrowings under the amended credit agreement will now bear interest per annum, payable monthly, at the three month LIBOR rate, determined on the last day of the prior month, plus 2.03%.  In addition, the Company is required to pay the lenders a monthly working capital fee equal to 0.35% per annum multiplied by the amount of voluntary prepayments of new and used inventory loans. Loans under the credit agreement for the purchase of used inventory are limited to $150.0 million. Pursuant to the third amendment, the credit agreement expires July 11, 2016, although GE Capital has the right to terminate the credit agreement at any time upon 120 days’ written notice. The Company may terminate the credit agreement at any time, although if it does so it must pay the lenders a prepayment processing fee of (i) $15,000,000 if it terminates on or prior to January 11, 2015, (ii) $7,500,000 if it terminates after January 11, 2015, but on or prior to July 11, 2015 and (iii) $300,000 if it terminates thereafter, subject in each case to specified limited exceptions. On September 30, 2014, the Company had approximately $660.9 million outstanding under its credit agreement with GE Capital. The average daily outstanding borrowings under the credit agreement with GE Capital were $533.6 million during the nine months ended September 30, 2014. From time to time, the Company utilizes its excess cash on hand to pay down its outstanding borrowings under its credit agreement with GE Capital, and the resulting interest earned is recognized as an offset to the Company’s gross interest expense under the credit agreement.

 

 
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Navistar Financial Corporation and Peterbilt offer trade terms that provide an interest-free inventory stocking period for certain new commercial vehicles.  If the commercial vehicle is not sold within the interest-free period, the Company then finances the commercial vehicle under the GE Capital credit agreement. 

 

Backlog

 

On September 30, 2014, the Company’s backlog of commercial vehicle orders was approximately $1,437.7 million, compared to a backlog of commercial vehicle orders of approximately $666.5 million on September 30, 2013. The Company includes only confirmed orders in its backlog. The delivery time for a custom-ordered commercial vehicle varies depending on the truck specifications and demand for the particular model ordered, however, the Company expects to fill the majority of its backlog orders during 2014 and 2015. The Company sells the majority of its new heavy-duty commercial vehicles by customer special order. The Company sells the majority of its medium- and light-duty commercial vehicles out of inventory. Orders from a number of the Company’s major fleet customers are included in the Company’s backlog as of September 30, 2014.

 

Seasonality

 

The Company’s business is moderately seasonal. Seasonal effects on new commercial vehicle sales related to the seasonal purchasing patterns of any single customer type are mitigated by the diverse geographic locations of the Company’s dealerships and its diverse customer base, including regional and national fleets, local governments, corporations and owner operators. However, Aftermarket Services operations historically have experienced higher sales volumes in the second and third quarters.

 

Cyclicality

 

The Company’s business is dependent on a number of factors relating to general economic conditions, including fuel prices, interest rate fluctuations, credit availability, economic recessions, environmental and other government regulations and customer business cycles. Unit sales of new commercial vehicles have historically been subject to substantial cyclical variation based on these general economic conditions. According to data published by A.C.T. Research, in recent years total U.S. retail sales of new Class 8 trucks have ranged from a low of approximately 97,000 in 2009, to a high of approximately 291,000 in 2006. Through geographic expansion, concentration on higher margin parts and service operations and diversification of its customer base, the Company believes that it is in a better position to reduce the negative impact on the Company’s earnings of adverse general economic conditions or cyclical trends affecting the heavy-duty truck industry.

 

Off-Balance Sheet Arrangements

 

Other than operating leases, the Company does not have any obligation under any transaction, agreement or other contractual arrangement to which an entity unconsolidated with the Company is a party, that has or is reasonably likely to have a material effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

Environmental Standards and Other Governmental Regulations

 

The Company is subject to a wide range of federal, state and local environmental laws and regulations, including those governing discharges into the air and water; the operation and removal of underground and aboveground storage tanks; the use, handling, storage and disposal of hazardous substances, petroleum and other materials; and the investigation and remediation of environmental impacts. As with commercial vehicle dealerships generally, and Aftermarket Services operations in particular, our business involves the generation, use, storage, handling and contracting for recycling or disposal of hazardous materials or wastes and other environmentally sensitive materials. The Company has incurred, and will continue to incur, capital and operating expenditures and other costs in complying with such laws and regulations.

 

 
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Our operations involving the use, handling, storage and disposal of hazardous and nonhazardous materials are subject to the requirements of the federal Resource Conservation and Recovery Act, or RCRA, and comparable state statutes. Pursuant to these laws, federal and state environmental agencies have established approved methods for handling, storage, treatment, transportation and disposal of regulated substances and wastes with which the Company must comply. Our business also involves the operation and use of aboveground and underground storage tanks. These storage tanks are subject to periodic testing, containment, upgrading and removal under RCRA and comparable state statutes. Furthermore, investigation or remediation may be necessary in the event of leaks or other discharges from current or former underground or aboveground storage tanks.

 

The Company may also have liability in connection with materials that were sent to third-party recycling, treatment, or disposal facilities under the federal Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, and comparable state statutes. These statutes impose liability for investigation and remediation of environmental impacts without regard to fault or the legality of the conduct that