10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
or
     
o   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 1-12297
Penske Automotive Group, Inc.
(Exact name of registrant as specified in its charter)
     
Delaware   22-3086739
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
2555 Telegraph Road,   48302-0954
Bloomfield Hills, Michigan   (Zip Code)
(Address of principal executive offices)    
Registrant’s telephone number, including area code:
(248) 648-2500
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
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 definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of October 29, 2010, there were 92,096,032 shares of voting common stock outstanding.
 
 

 

 


 

TABLE OF CONTENTS
         
    Page  
 
       
PART I — FINANCIAL INFORMATION
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    25  
 
       
    45  
 
       
    45  
 
       
PART II — OTHER INFORMATION
 
       
    46  
 
       
    46  
 
       
 Exhibit 4.1
 Exhibit 10.1
 Exhibit 12
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

2


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
                 
    September 30,     December 31,  
    2010     2009  
    (Unaudited)  
    (In thousands, except  
    per share amounts)  
ASSETS
               
Cash and cash equivalents
  $ 6,027     $ 13,999  
Accounts receivable, net of allowance for doubtful accounts of $1,619 and $1,689
    367,888       321,226  
Inventories
    1,437,939       1,302,495  
Other current assets
    109,106       95,426  
Assets held for sale
    584       10,625  
 
           
 
               
Total current assets
    1,921,544       1,743,771  
Property and equipment, net
    731,813       726,808  
Goodwill
    813,626       810,047  
Franchise value
    203,507       201,756  
Equity method investments
    290,735       295,473  
Other long-term assets
    14,372       18,152  
 
           
 
               
Total assets
  $ 3,975,597     $ 3,796,007  
 
           
 
               
LIABILITIES AND EQUITY
               
Floor plan notes payable
  $ 907,315     $ 769,657  
Floor plan notes payable — non-trade
    474,805       423,316  
Accounts payable
    210,999       189,989  
Accrued expenses
    231,237       227,294  
Current portion of long-term debt
    15,409       12,442  
Liabilities held for sale
    548       7,675  
 
           
 
               
Total current liabilities
    1,840,313       1,630,373  
Long-term debt
    837,976       933,966  
Deferred tax liabilities
    161,424       157,500  
Other long-term liabilities
    113,103       128,129  
 
           
 
               
Total liabilities
    2,952,816       2,849,968  
Commitments and contingent liabilities
               
Equity
               
Penske Automotive Group stockholders’ equity:
               
Preferred Stock, $0.0001 par value; 100 shares authorized; none issued and outstanding
           
Common Stock, $0.0001 par value, 240,000 shares authorized; 92,090 shares issued and outstanding at September 30, 2010; 91,618 shares issued and outstanding at December 31, 2009
    9       9  
Non-voting Common Stock, $0.0001 par value, 7,125 shares authorized; none issued and outstanding
           
Class C Common Stock, $0.0001 par value, 20,000 shares authorized; none issued and outstanding
           
Additional paid-in-capital
    737,714       737,198  
Retained earnings
    275,977       196,205  
Accumulated other comprehensive income
    5,238       9,049  
 
           
 
               
Total Penske Automotive Group stockholders’ equity
    1,018,938       942,461  
 
               
Non-controlling interest
    3,843       3,578  
 
           
 
               
Total equity
    1,022,781       946,039  
 
           
 
               
Total liabilities and equity
  $ 3,975,597     $ 3,796,007  
 
           
 
               
See Notes to Consolidated Condensed Financial Statements

 

3


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (Unaudited)  
    (In thousands, except per share amounts)  
Revenue:
                               
New vehicle
  $ 1,416,314     $ 1,338,759     $ 4,004,450     $ 3,400,082  
Used vehicle
    765,555       674,228       2,211,892       1,949,514  
Finance and insurance, net
    67,149       60,872       190,141       164,009  
Service and parts
    335,250       335,571       1,001,433       993,580  
Distribution
    15,306       36,451       43,175       169,716  
Fleet and wholesale vehicle
    156,548       142,161       494,398       388,136  
 
                       
Total revenues
    2,756,122       2,588,042       7,945,489       7,065,037  
 
                       
Cost of sales:
                               
New vehicle
    1,304,008       1,225,907       3,679,460       3,129,896  
Used vehicle
    708,593       614,867       2,038,092       1,774,877  
Service and parts
    143,197       150,083       430,472       448,950  
Distribution
    14,481       30,294       39,430       144,310  
Fleet and wholesale
    155,990       144,184       487,810       382,503  
 
                       
Total cost of sales
    2,326,269       2,165,335       6,675,264       5,880,536  
 
                       
Gross profit
    429,853       422,707       1,270,225       1,184,501  
Selling, general and administrative expenses
    355,920       347,550       1,051,611       987,605  
Depreciation
    12,403       14,019       36,831       40,711  
 
                       
Operating income
    61,530       61,138       181,783       156,185  
Floor plan interest expense
    (9,048 )     (9,061 )     (25,890 )     (27,492 )
Other interest expense
    (12,229 )     (13,490 )     (37,491 )     (41,677 )
Debt discount amortization
    (1,647 )     (3,135 )     (6,990 )     (9,908 )
Equity in earnings of affiliates
    7,370       7,536       11,725       11,716  
Gain on debt repurchase
    607             1,634       10,429  
 
                       
Income from continuing operations before income taxes
    46,583       42,988       124,771       99,253  
Income taxes
    (15,279 )     (15,069 )     (43,339 )     (35,143 )
 
                       
Income from continuing operations
    31,304       27,919       81,432       64,110  
Loss from discontinued operations, net of tax
    (1,044 )     (257 )     (1,156 )     (6,079 )
 
                       
Net income
    30,260       27,662       80,276       58,031  
Less: Income attributable to non-controlling interests
    283       239       504       247  
 
                       
Net income attributable to Penske Automotive Group common stockholders
  $ 29,977     $ 27,423     $ 79,772     $ 57,784  
 
                       
Basic earnings per share attributable to Penske Automotive Group common stockholders:
                               
Continuing operations
  $ 0.34     $ 0.30     $ 0.88     $ 0.70  
Discontinued operations
    (0.01 )           (0.01 )     (0.07 )
 
                       
Net income
  $ 0.33     $ 0.30     $ 0.87     $ 0.63  
Shares used in determining basic earnings per share
    92,081       91,528       92,097       91,504  
Diluted earnings per share attributable to Penske Automotive Group common stockholders:
                               
Continuing operations
  $ 0.34     $ 0.30     $ 0.88     $ 0.70  
Discontinued operations
    (0.01 )           (0.01 )     (0.07 )
 
                       
Net income
  $ 0.33     $ 0.30     $ 0.87     $ 0.63  
Shares used in determining diluted earnings per share
    92,141       91,625       92,171       91,563  
Amounts attributable to Penske Automotive Group common stockholders:
                               
Income from continuing operations
  $ 31,304     $ 27,919     $ 81,432     $ 64,110  
Less: Income attributable to non-controlling interests
    283       239       504       247  
 
                       
Income from continuing operations, net of tax
    31,021       27,680       80,928       63,863  
Loss from discontinued operations, net of tax
    (1,044 )     (257 )     (1,156 )     (6,079 )
 
                       
Net income
  $ 29,977     $ 27,423     $ 79,772     $ 57,784  
See Notes to Consolidated Condensed Financial Statements

 

4


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
    (Unaudited)  
    (In thousands)  
Operating Activities:
               
Net income
  $ 80,276     $ 58,031  
Adjustments to reconcile net income to net cash from continuing operating activities:
               
Depreciation
    36,831       40,711  
Debt discount amortization
    6,990       9,908  
Earnings of equity method investments
    (11,725 )     (11,716 )
Loss from discontinued operations, net of tax
    1,156       6,079  
Deferred income taxes
    14,596       33,920  
Gain on debt repurchase
    (1,634 )     (10,733 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (42,196 )     (28,217 )
Inventories
    (107,077 )     427,868  
Floor plan notes payable
    116,033       (255,993 )
Accounts payable and accrued expenses
    27,298       58,606  
Other
    3,768       (14,011 )
 
           
Net cash from continuing operating activities
    124,316       314,453  
 
           
Investing Activities:
               
Purchase of equipment and improvements
    (62,717 )     (70,049 )
Proceeds from sale-leaseback transactions
          2,338  
Dealership acquisitions net, including repayment of sellers’ floor plan notes payable of $7,231 and $5,784, respectively
    (12,261 )     (8,517 )
Other
          11,729  
 
           
Net cash from continuing investing activities
    (74,978 )     (64,499 )
 
           
Financing Activities:
               
Proceeds from borrowings under U.S. credit agreement revolving credit line
    511,500       391,300  
Repayments under U.S. credit agreement revolving credit line
    (475,000 )     (391,300 )
Repayments under U.S. credit agreement term loan
    (10,000 )     (50,000 )
Repurchase of 3.5% senior subordinated convertible notes
    (156,604 )     (51,424 )
Net borrowings of other long-term debt
    19,895       1,113  
Net borrowings (repayments) of floor plan notes payable — non-trade
    51,489       (125,996 )
Proceeds from exercises of options, including excess tax benefit
    403       76  
Repurchases of common stock
    (751 )      
 
           
Net cash from continuing financing activities
    (59,068 )     (226,231 )
 
           
Discontinued operations:
               
Net cash from discontinued operating activities
    (7,498 )     (3,983 )
Net cash from discontinued investing activities
    9,463       (913 )
Net cash from discontinued financing activities
    (207 )     (7,422 )
 
           
Net cash from discontinued operations
    1,758       (12,318 )
 
           
Net change in cash and cash equivalents
    (7,972 )     11,405  
Cash and cash equivalents, beginning of period
    13,999       17,108  
 
           
Cash and cash equivalents, end of period
  $ 6,027     $ 28,513  
 
           
 
               
Supplemental disclosures of cash flow information:
               
Cash paid for:
               
Interest
  $ 56,456     $ 62,017  
Income taxes
    22,839       10,228  
See Notes to Consolidated Condensed Financial Statements

 

5


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
CONSOLIDATED CONDENSED STATEMENT OF EQUITY
                                                                 
                                    Accumulated     Total              
    Common Stock     Additional             Other     Stockholders’ Equity              
    Issued             Paid-in     Retained     Comprehensive     Attributable to Penske     Non-controlling     Total  
    Shares     Amount     Capital     Earnings     Income (Loss)     Automotive Group     Interest     Equity  
    (Unaudited)  
    (Dollars in thousands)  
Balance, January 1, 2010
    91,617,746     $ 9     $ 737,198     $ 196,205     $ 9,049     $ 942,461     $ 3,578     $ 946,039  
Equity compensation
    498,626             8,017                   8,017             8,017  
Exercise of options, Including tax benefit of $121
    42,000             403                   403             403  
Repurchase of common stock
    (68,340 )             (751 )                     (751 )             (751 )
Repurchase of 3.5% senior subordinated convertible notes
                (7,153 )                 (7,153 )           (7,153 )
Distributions to non-controlling interests
                                        (239 )     (239 )
Foreign currency translation
                            (10,909 )     (10,909 )           (10,909 )
Other
                            7,098       7,098             7,098  
Net income
                      79,772             79,772       504       80,276  
 
                                               
Balance, September 30, 2010
    92,090,032     $ 9     $ 737,714     $ 275,977     $ 5,238     $ 1,018,938     $ 3,843     $ 1,022,781  
 
                                               
See Notes to Consolidated Condensed Financial Statements

 

6


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except per share amounts)
1. Interim Financial Statements
Business Overview
Penske Automotive Group, Inc. (the “Company”) is the second largest automotive retailer headquartered in the U.S. as measured by total revenues. As of September 30, 2010, the Company owned and operated 173 franchises in the U.S. and 152 franchises outside of the U.S., primarily in the U.K. Each of the Company’s dealerships offers a wide selection of new and used vehicles for sale. In addition to selling new and used vehicles, the Company generates higher-margin revenue at each of its dealerships through maintenance and repair services and the sale and placement of higher-margin products, such as third party finance and insurance products, third-party extended service contracts and replacement and aftermarket automotive products.
During the nine months ended September 30, 2010, we acquired six franchises, including Volkswagen and Audi franchises in Santa Ana, California and a group of BMW franchises in Augsburg, Germany through the dissolution of a joint venture. We were awarded 15 franchises, including Audi and Mercedes franchises in Chantilly, Virginia, three Mini franchises in the western U.S., a Mitsubishi point in Arkansas, and five Mercedes Sprinter commercial van franchises in the U.S. We also disposed of three franchises, including Toyota/Scion franchises in Warren, Michigan and a Ford franchise in Goodyear, Arizona.
In addition, the Company’s wholly-owned subsidiary, smart USA Distributor, LLC (“smart USA”), is the exclusive distributor of the smart fortwo vehicle in the U.S. and Puerto Rico and the Company holds a 9.0% limited partnership interest in Penske Truck Leasing Co., L.P. (“PTL”), a leading global transportation services provider.
Basis of Presentation
The following unaudited consolidated condensed financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the SEC rules and regulations. The information presented as of September 30, 2010 and December 31, 2009 and for the three and nine month periods ended September 30, 2010 and 2009 is unaudited, but includes all adjustments which the management of the Company believes to be necessary for the fair presentation of results for the periods presented. The consolidated condensed financial statements for prior periods have been revised for entities which have been treated as discontinued operations through September 30, 2010, and the results for interim periods are not necessarily indicative of results to be expected for the year. These consolidated condensed financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2009, which are included as part of the Company’s Annual Report on Form 10-K.
Results for three and nine months ended September 30, 2010 include $607 and $1,634 of pre-tax gain relating to the repurchase of $43,000 and $155,658 aggregate principal amount of the Company’s 3.5% senior subordinated convertible notes (“Convertible Notes”), respectively. Results for the nine months ended September 30, 2009 include $10,429 of pre-tax gain relating to the repurchase of $68,740 aggregate principal amount of the Convertible Notes.
Discontinued Operations
The Company accounts for dispositions as discontinued operations when the operations and cash flows of the business being disposed of will be eliminated from on-going operations and the Company will not have any significant continuing involvement in its operations.

 

7


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
In evaluating whether the cash flows of a dealership in its Retail reportable segment will be eliminated from ongoing operations, the Company considers whether it is likely that customers will migrate to similar franchises that it owns in the same geographic market. The Company’s consideration includes an evaluation of the brands sold at other dealerships it operates in the market and their proximity to the disposed dealership. When the Company disposes of franchises, it typically does not have continuing brand representation in that market. If the franchise being disposed of is located in a complex of Company owned dealerships, the Company does not treat the disposition as a discontinued operation if the Company believes that the cash flows previously generated by the disposed franchise will be replaced by expanded operations of the remaining franchises. The results of operations and net assets of dealerships accounted for as discontinued operations were immaterial for all periods presented.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounts requiring the use of significant estimates include accounts receivable, inventories, income taxes, intangible assets and certain reserves.
Estimated Useful Lives of Assets
The Company changed the useful lives of certain fixed assets during the first quarter of 2010 as part of a review of assumptions related to the expected utilization of those assets by the Company. The Company accounted for the change in useful lives as a change in estimate prospectively effective January 1, 2010, which resulted in a reduction of depreciation expense of $1,410 and $4,230 for the three and nine month periods ended September 30, 2010, respectively.
Fair Value of Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, debt, floor plan notes payable, and interest rate swaps used to hedge future cash flows. Other than our subordinated notes, the carrying amount of all significant financial instruments approximates fair value due either to length of maturity, the existence of variable interest rates that approximate prevailing market rates, or as a result of mark to market accounting. A summary of the fair value of the subordinated notes as of September 30, 2010, based on level one market data follows:
                 
    Carrying Value     Fair Value  
7.75% senior subordinated notes due 2016
  $ 375,000     $ 366,563  
3.5% senior subordinated convertible notes due 2026
    147,236       148,708  
2. Inventories
Inventories consisted of the following:
                 
    September 30,     December 31,  
    2010     2009  
New vehicles
  $ 995,353     $ 898,110  
Used vehicles
    363,710       325,707  
Parts, accessories and other
    78,876       78,678  
 
           
 
               
Total inventories
  $ 1,437,939     $ 1,302,495  
 
           
The Company receives certain non-refundable floor plan interest credits and advertising assistance from certain vehicle manufacturers that reduce cost of sales when the vehicles are sold. These credits amounted to $20,357 and $22,653 during the nine months ended September 30, 2010 and 2009, respectively.

 

8


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
3. Business Combinations
The Company acquired three and five franchises during the nine months ended September 30, 2010 and 2009, respectively, in its retail operations (not including the German operations noted below). The Company’s financial statements include the results of operations of the acquired dealerships from the date of acquisition. The fair value of the assets acquired and liabilities assumed have been recorded in the Company’s consolidated condensed financial statements, and may be subject to adjustment pending completion of final valuation. A summary of the aggregate consideration paid and the aggregate amounts of the assets acquired and liabilities assumed in the nine months ended September 30, 2010 and 2009 follows:
                 
    September 30,  
    2010     2009  
Inventory
  $ 8,595     $ 2,935  
Other current assets
    17       129  
Property and equipment
    187       3,250  
Goodwill
    3,494       2,402  
Current liabilities
    (32 )     (199 )
 
           
Cash used in dealership acquisitions
  $ 12,261     $ 8,517  
 
           
In the first quarter of 2010, the Company exited one of its German joint ventures by exchanging its 50% interest in the joint venture for 100% ownership in three BMW franchises previously held by the joint venture. The Company recorded $13,331 of intangible assets in connection with this transaction.
4. Intangible Assets
The following is a summary of the changes in the carrying amount of goodwill and franchise value during the nine months ended September 30, 2010:
                 
            Franchise  
    Goodwill     Value  
Balance, January 1, 2010
  $ 810,047     $ 201,756  
Additions
    13,034       3,703  
Foreign currency translation
    (9,455 )     (1,952 )
 
           
Balance, September 30, 2010
  $ 813,626     $ 203,507  
 
           
5. Floor Plan Notes Payable — Trade and Non-trade
The Company finances substantially all of its new and a portion of its used vehicle inventories under revolving floor plan arrangements with various lenders, including a majority through captive finance companies associated with automotive manufacturers. In the U.S., the floor plan arrangements are due on demand; however, the Company has not historically been required to repay floor plan advances prior to the sale of the vehicles that have been financed. The Company typically makes monthly interest payments on the amount financed. Outside the U.S., substantially all of the floor plan arrangements are payable on demand or have an original maturity of 90 days or less, and the Company is generally required to repay floor plan advances at the earlier of the sale of the vehicles that have been financed or the stated maturity.
The floor plan agreements typically grant a security interest in substantially all of the assets of the Company’s dealership subsidiaries, and in the U.S. are guaranteed by the Company. Interest rates under the floor plan arrangements are variable and increase or decrease based on changes in the prime rate, defined London Interbank Offered Rate (“LIBOR”), Finance House Base Rate, or Euro Interbank Offered Rate. The Company classifies floor plan notes payable to a party other than the manufacturer of a particular new vehicle, and all floor plan notes payable relating to pre-owned vehicles, as floor plan notes payable — non-trade on its consolidated condensed balance sheets, and classifies related cash flows as a financing activity on its consolidated condensed statements of cash flows.

 

9


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
6. Earnings Per Share
Basic earnings per share is computed using net income attributable to Penske Automotive Group common stockholders and the number of weighted average shares of voting common stock outstanding, including outstanding unvested restricted stock awards which contain non-forfeitable rights to dividends. Diluted earnings per share is computed using net income attributable to Penske Automotive Group common stockholders and the number of weighted average shares of voting common stock outstanding, adjusted for the dilutive effect of non-participatory equity compensation. A reconciliation of the number of shares used in the calculation of basic and diluted earnings per share for the three and nine months ended September 30, 2010 and 2009 follows:
                                 
    September 30,     September 30,  
    2010     2009     2010     2009  
Weighted average number of common shares outstanding
    92,081       91,528       92,097       91,504  
Effect of non-participatory equity compensation
    60       97       74       59  
 
                       
Weighted average number of common shares outstanding, including effect of dilutive securities
    92,141       91,625       92,171       91,563  
 
                       
The Company has senior subordinated convertible notes outstanding which, under certain circumstances discussed in Note 7, may be converted to voting common stock. As of September 30, 2010 and 2009, no shares related to the senior subordinated convertible notes were included in the calculation of diluted earnings per share because the effect of such securities was anti-dilutive and there were no anti-dilutive stock options outstanding during the three and nine months ended September 30, 2010 and 2009.
7. Long-Term Debt
Long-term debt consisted of the following:
                 
    September 30,     December 31,  
    2010     2009  
U.S. credit agreement — revolving credit line
  $ 36,500     $  
U.S. credit agreement — term loan
    139,000       149,000  
U.K. credit agreement — revolving credit line
    80,126       59,803  
U.K. credit agreement — term loan
    8,317       17,115  
U.K. credit agreement — overdraft line of credit
    12,368       12,048  
7.75% senior subordinated notes due 2016
    375,000       375,000  
3.5% senior subordinated convertible notes due 2026, net of debt discount
    147,236       289,344  
Mortgage facilities
    46,330       41,358  
Other
    8,508       2,740  
 
           
Total long-term debt
    853,385       946,408  
Less: current portion
    (15,409 )     (12,442 )
 
           
Net long-term debt
  $ 837,976     $ 933,966  
 
           

 

10


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
U.S. Credit Agreement
The Company is party to a credit agreement with DCFS USA LLC and Toyota Motor Credit Corporation, as amended (the “U.S. Credit Agreement”), which provides for up to $300,000 in revolving loans for working capital, acquisitions, capital expenditures, investments and other general corporate purposes, a non-amortizing term loan with a remaining balance of $139,000, and for an additional $10,000 of availability for letters of credit. The term of the credit agreement was extended on September 15, 2010, by one year through September 30, 2013. The revolving loans bear interest at a defined LIBOR plus 2.75%, subject to an incremental 0.75% for uncollateralized borrowings in excess of a defined borrowing base. The term loan, which bears interest at defined LIBOR plus 2.50%, may be prepaid at any time, but then may not be re-borrowed. The Company repaid $10,000 of this term loan in the third quarter of 2010.
The U.S. Credit Agreement is fully and unconditionally guaranteed on a joint and several basis by the Company’s domestic subsidiaries and contains a number of significant covenants that, among other things, restrict the Company’s ability to dispose of assets, incur additional indebtedness, repay other indebtedness, pay dividends, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. The Company is also required to comply with specified financial and other tests and ratios, each as defined in the U.S. Credit Agreement, including: a ratio of current assets to current liabilities, a fixed charge coverage ratio, a ratio of debt to stockholders’ equity and a ratio of debt to EBITDA. A breach of these requirements would give rise to certain remedies under the agreement, the most severe of which is the termination of the agreement and acceleration of any amounts owed. As of September 30, 2010, the Company was in compliance with all covenants under the U.S. Credit Agreement.
The U.S. Credit Agreement also contains typical events of default, including change of control, non-payment of obligations and cross-defaults to the Company’s other material indebtedness. Substantially all of the Company’s domestic assets are subject to security interests granted to lenders under the U.S. Credit Agreement. As of September 30, 2010, $139,000 of term loans, $1,250 of letters of credit, and $36,500 of revolver borrowings were outstanding under the U.S. Credit Agreement.
U.K. Credit Agreement
The Company’s subsidiaries in the U.K. (the “U.K. Subsidiaries”) are party to an agreement with the Royal Bank of Scotland plc, as agent for National Westminster Bank plc, which provides for a funded term loan, a revolving credit agreement, and a demand overdraft line of credit (collectively, the “U.K. Credit Agreement”) to be used for working capital, acquisitions, capital expenditures, investments and general corporate purposes. During the third quarter of 2010, the agreement was amended in connection with a reorganization of our European operations pursuant to which the maximum revolving borrowing capacity was reduced from £100,000 to £86,600, which maximum will be increased in the future by amounts equal to the required term loan repayments.
As amended, the U.K. Credit Agreement includes (1) up to £86,600 in revolving loans through August 31, 2013, which bears interest between a defined LIBOR plus 1.1% and defined LIBOR plus 3.0%, (2) a term loan which bears interest between 6.39% and 8.29% and is payable ratably in quarterly intervals until fully repaid on June 30, 2011, and (3) a demand overdraft line of credit for up to £10,000 that bears interest at the Bank of England Base Rate plus 1.75%.
The U.K. Credit Agreement is fully and unconditionally guaranteed on a joint and several basis by our U.K. Subsidiaries, and contains a number of significant covenants that, among other things, restrict the ability of the U.K. Subsidiaries to pay dividends, dispose of assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. In addition, the U.K. Subsidiaries are required to comply with specified ratios and tests, each as defined in the U.K. Credit Agreement, including: a ratio of EBITDAR to interest plus rental payments (as defined), a measurement of maximum capital expenditures, and a debt to EBITDA ratio (as defined). A breach of these requirements would give rise to certain remedies under the agreement, the most severe of which is the termination of the agreement and acceleration of any amounts owed. As of September 30, 2010, our U.K. subsidiaries were in compliance with all covenants under the U.K. Credit Agreement.
The U.K. Credit Agreement also contains typical events of default, including change of control and non-payment of obligations and cross-defaults to other material indebtedness of our U.K. Subsidiaries. Substantially all of the U.K. Subsidiaries’ assets are subject to security interests granted to lenders under the U.K. Credit Agreement. As of September 30, 2010, outstanding loans under the U.K. Credit Agreement amounted to £64,166 ($100,811), including £5,294 ($8,317) under the term loan.

 

11


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
7.75% Senior Subordinated Notes
In December 2006, the Company issued $375,000 aggregate principal amount of 7.75% senior subordinated notes due 2016 (the “7.75% Notes”). The 7.75% Notes are unsecured senior subordinated notes and are subordinate to all existing and future senior debt, including debt under the Company’s credit agreements, mortgages and floor plan indebtedness. The 7.75% Notes are guaranteed by substantially all of the Company’s wholly-owned domestic subsidiaries on an unsecured senior subordinated basis. Those guarantees are full and unconditional and joint and several. The Company can redeem all or some of the 7.75% Notes at its option beginning in December 2011 at specified redemption prices, or prior to December 2011 at 100% of the principal amount of the notes plus an applicable “make-whole” premium, as defined. Upon certain sales of assets or specific kinds of changes of control, the Company is required to make an offer to purchase the 7.75% Notes. The 7.75% Notes also contain customary negative covenants and events of default. As of September 30, 2010, the Company was in compliance with all negative covenants and there were no events of default.
Senior Subordinated Convertible Notes
In January 2006, the Company issued $375,000 aggregate principal amount of 3.50% senior subordinated convertible notes due 2026 (the “Convertible Notes”), of which $150,602 were outstanding at September 30, 2010. The Convertible Notes mature on April 1, 2026, unless earlier converted, redeemed or purchased by the Company, as discussed below. The Convertible Notes are unsecured senior subordinated obligations and are subordinate to all future and existing senior debt, including debt under the Company’s credit agreements, mortgages and floor plan indebtedness. The Convertible Notes are guaranteed on an unsecured senior subordinated basis by substantially all of the Company’s wholly-owned domestic subsidiaries. Those guarantees are full and unconditional and joint and several. The Convertible Notes also contain customary negative covenants and events of default. As of September 30, 2010, the Company was in compliance with all negative covenants and there were no events of default.
Holders of the Convertible Notes may convert them based on a conversion rate of 42.7796 shares of common stock per $1,000 principal amount of the Convertible Notes (which is equal to a conversion price of approximately $23.38 per share), subject to adjustment, only under the following circumstances: (1) in any quarterly period, if the closing price of the common stock for twenty of the last thirty trading days in the prior quarter exceeds $28.05 (subject to adjustment), (2) for specified periods, if the trading price of the Convertible Notes falls below specific thresholds, (3) if the Convertible Notes are called for redemption, (4) if specified distributions to holders of common stock are made or specified corporate transactions occur, (5) if a fundamental change (as defined) occurs, or (6) during the ten trading days prior to, but excluding, the maturity date.
Upon conversion of the Convertible Notes, for each $1,000 principal amount of the Convertible Notes, a holder will receive an amount in cash, equal to the lesser of (i) $1,000 or (ii) the conversion value, determined in the manner set forth in the related indenture covering the Convertible Notes, of the number of shares of common stock equal to the conversion rate. If the conversion value exceeds $1,000, the Company will also deliver, at its election, cash, common stock or a combination of cash and common stock with respect to the remaining value deliverable upon conversion.
In the event of a conversion due to a change of control on or before April 6, 2011, the Company will, in certain circumstances, pay a make-whole premium by increasing the conversion rate used in that conversion. In addition, the Company will pay additional cash interest, commencing with six-month periods beginning on April 1, 2011, if the average trading price of a Convertible Note for certain periods in the prior six-month period equals 120% or more of the principal amount of the Convertible Notes. On or after April 6, 2011, the Company may redeem the Convertible Notes, in whole at any time or in part from time to time, for cash at a redemption price of 100% of the principal amount of the Convertible Notes to be redeemed, plus any accrued and unpaid interest to the applicable redemption date.
Holders of the Convertible Notes may require the Company to purchase all or a portion of their Convertible Notes for cash on each of April 1, 2011, April 1, 2016 or April 1, 2021 at a purchase price equal to 100% of the principal amount of the Convertible Notes to be purchased, plus accrued and unpaid interest, if any, to the applicable purchase date. The Company expects to be required to redeem the Convertible Notes in April 2011. The Company currently expects to utilize cash flow from operations, working capital and availability under the U.S. Credit Agreement to redeem the Convertible Notes. Based on the ability and intent to refinance the redemption of the Convertible Notes, the Company has classified them as long-term in the Consolidated Condensed Balance Sheet as of September 30, 2010.

 

12


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
In the third quarter of 2010, the Company repurchased $43,000 principal amount of its outstanding Convertible Notes which had a book value, net of debt discount, of $41,570 for $43,323. The Company allocated $2,519 of the total consideration to the reacquisition of the equity component of the Convertible Notes. In connection with the transaction, the Company wrote off $158 of unamortized deferred financing costs. As a result, the Company recorded $607 of pre-tax gain. During the first nine months of 2010, the Company repurchased $155,658 principal amount of its outstanding Convertible Notes, which had a book value, net of debt discount, of $149,100 for $156,604. The Company allocated $10,186 of the total consideration to the reacquisition of the equity component of the Convertible Notes. In connection with these transactions, the Company wrote off $725 of unamortized deferred financing costs. As a result, the Company recorded $1,634 of pre-tax gain.
During the first nine months of 2009, the Company repurchased $68,740 principal amount of its outstanding Convertible Notes, which had a book value, net of debt discount, of $62,831 for $51,424. In connection with the transaction, the Company wrote off $672 of unamortized deferred financing costs and incurred $305 of transaction costs. No element of the consideration was allocated to the reacquisition of the equity component because the consideration paid was less than the fair value of the liability component prior to extinguishment. As a result, the Company recorded $10,429 of pre-tax gain.
The liability and equity components related to the Convertible Notes consist of the following:
                 
    September 30,     December 31,  
    2010     2009  
Carrying amount of the equity component
  $ 35,940     $ 43,093  
 
           
 
               
Principal amount of the liability component
  $ 150,602     $ 306,260  
Unamortized debt discount
    3,366       16,916  
 
           
 
               
Net carrying amount of the liability component
  $ 147,236     $ 289,344  
 
           
The unamortized debt discount will be amortized as additional interest expense through April 1, 2011, the date the Company expects to be required to redeem the Convertible Notes. The annual effective interest rate on the liability component is 8.25%.
Mortgage Facilities
The Company is party to several mortgages which bear interest at defined rates and require monthly principal and interest payments. These mortgage facilities also contain typical events of default, including non-payment of obligations, cross-defaults to the Company’s other material indebtedness, certain change of control events, and the loss or sale of certain franchises operated at the properties. Substantially all of the buildings and improvements on the properties financed pursuant to the mortgage facilities are subject to security interests granted to the lender. As of September 30, 2010, we owed $46,330 of principal under our mortgage facilities.
8. Interest Rate Swaps
The Company uses interest rate swaps to manage interest rate risk associated with the Company’s variable rate floor plan debt. The Company is party to interest rate swap agreements through January 2011, pursuant to which the LIBOR portion of $300,000 of the Company’s floating rate floor plan debt was fixed at 3.67%. We may terminate these arrangements at any time, subject to the settlement of the then current fair value of the swap arrangements.
The Company designated $290,000 of the swap agreements as cash flow hedges of future interest payments of LIBOR based U.S. floor plan borrowings. Any gain or loss related to changes in the fair value of that $290,000 of the swap agreements is reported as a component of other comprehensive income and will be reclassified into earnings when the hedged transaction affects earnings. Settlements and changes in the fair value related to the remaining $10,000 of the swap agreements are recorded as realized and unrealized gains/losses within interest expense.

 

13


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The Company used Level 2 inputs to estimate the fair value of the interest rate swap agreements. As of September 30, 2010, the fair value of the swaps designated as hedging instruments was estimated to be a liability of $3,515, which is recorded in accrued expenses and the fair value of the swaps not designated as hedging instruments was estimated to be a liability of $121, which is recorded in accrued expenses. As of December 31, 2009, the fair value of the swaps designated as hedging instruments was estimated to be a liability of $9,963, of which $9,250 and $713 were recorded in accrued expenses and other long-term liabilities, respectively, and the fair value of the swaps not designated as hedging instruments was estimated to be a liability of $344, of which $319 and $25 were recorded in accrued expenses and other long-term liabilities, respectively.
During the nine months ended September 30, 2010, the Company recognized a net gain in accumulated other comprehensive income of $3,643 related to the effective portion of the interest rate swap agreements designated as hedging instruments, and reclassified $6,482 of the existing derivative losses from accumulated other comprehensive income into floor plan interest expense. During the nine months ended September 30, 2009, the Company recognized a net gain in accumulated other comprehensive income of $1,929 related to the effective portion of the interest rate swap agreements designated as hedging instruments, and reclassified $8,549 of existing derivative losses from accumulated other comprehensive income into floor plan interest expense. The Company expects approximately $2,278 associated with the swaps to be recognized as an increase of interest expense as the hedged interest payments become due through the swap agreement’s maturity in January 2011. During the nine months ended September 30, 2010 and 2009, the swaps increased the weighted average interest rate on the Company’s floor plan borrowings by approximately 0.8% and 0.6%, respectively.
9. Commitments and Contingent Liabilities
The Company is involved from time-to-time in litigation which may relate to claims brought by governmental authorities, issues with customers and employment related matters, including class action claims and purported class action claims. As of September 30, 2010, the Company is not party to any legal proceedings, including class action lawsuits, that individually or in the aggregate, are reasonably expected to have a material adverse effect on the Company’s results of operations, financial condition or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on the Company’s results of operations, financial condition or cash flows.
The Company has historically structured its operations so as to minimize ownership of real property. As a result, the Company leases or subleases substantially all of its facilities. These leases are generally for a period between five and 20 years, and are typically structured to include renewal options at the Company’s election. Pursuant to the leases for some of the Company’s larger facilities, the Company is required to comply with specified financial ratios, including a “rent coverage” ratio and a debt to EBITDA ratio, each as defined. For these leases, non-compliance with the ratios may require the Company to post collateral in the form of a letter of credit. A breach of the other lease covenants give rise to certain remedies by the landlord, the most severe of which include the termination of the applicable lease and acceleration of the total rent payments due under the lease. As of September 30, 2010, the Company was in compliance with all covenants under these leases.
The Company has sold a number of dealerships to third parties and, as a condition to certain of those sales, remains liable for the lease payments relating to the properties on which those businesses operate in the event of non-payment by the buyer. The Company is also party to lease agreements on properties that it no longer uses in its retail operations that it has sublet to third parties. The Company relies on subtenants to pay the associated rent and maintain the property at these locations. In the event the subtenant does not perform as expected, the Company may not be able to recover amounts owed to it and the Company could be required to fulfill these obligations.
The Company is potentially subject to additional purchase commitments pursuant to its smart distribution agreement, smart franchise agreement and state franchise laws in the event of franchise terminations, none of which have historically had a material adverse effect on its results of operations, financial condition or cash flows. The Company does not anticipate that the purchase commitments will have a material adverse effect on its future results of operations, financial condition or cash flows, although such an outcome is possible.
The Company has $20,266 of letters of credit outstanding as of September 30, 2010, and has posted $14,384 of surety bonds in the ordinary course of business.

 

14


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
10. Equity
Comprehensive income (loss)
Other comprehensive income (loss) includes foreign currency translation gains and losses, as well as changes relating to other immaterial items, including certain defined benefit plans in the U.K. and changes in the fair value of interest rate swap agreements, each of which has been excluded from net income and reflected in equity. Total comprehensive income (loss) is summarized as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Attributable to Penske Automotive Group:
                               
Net income
  $ 29,977     $ 27,423     $ 79,772     $ 57,784  
Other comprehensive income (loss):
                               
Foreign currency translation
    31,922       (9,167 )     (10,909 )     45,398  
Other
    (117 )     1,284       7,098       2,919  
 
                       
 
                               
Total attributable to Penske Automotive Group
    61,782       19,540       75,961       106,101  
 
                               
Attributable to the non-controlling interest:
                               
Net income
    283       239       504       247  
 
                       
 
                               
Total comprehensive income
  $ 62,065     $ 19,779     $ 76,465     $ 106,348  
 
                       
During the third quarter of 2010, the Company repurchased 68 shares at an average price of $10.97 for a total of $751.
11. Segment Information
The Company’s operations are organized by management into operating segments by line of business and geography. The Company has determined it has three reportable segments as defined in general accounting principles for segment reporting, including: (i) Retail, consisting of our automotive retail operations, (ii) Distribution, consisting of our distribution of the smart fortwo vehicle, parts and accessories in the U.S. and Puerto Rico and (iii) PAG Investments, consisting of our investments in non-retail automotive operations. The Retail reportable segment includes all automotive dealerships and all departments relevant to the operation of the dealerships and the retail automotive joint ventures. The individual dealership operations included in the Retail reportable segment have been grouped into four geographic operating segments, which have been aggregated into one reportable segment as their operations (A) have similar economic characteristics (all are automotive dealerships having similar margins), (B) offer similar products and services (all sell new and used vehicles, service, parts and third-party finance and insurance products), (C) have similar target markets and customers (generally individuals) and (D) have similar distribution and marketing practices (all distribute products and services through dealership facilities that market to customers in similar fashions).

 

15


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The following table summarizes revenues and income from continuing operations before certain non-recurring items and income taxes, which is the measure by which management allocates resources to its segments, and which we refer to as adjusted segment income, for each of our reportable segments. Adjusted segment income excludes the item in the table below in order to enhance the comparability of segment income from period to period.
Three Months Ended September 30
                                         
                    PAG     Intersegment        
    Retail     Distribution     Investments     Elimination     Total  
Revenues
                                       
2010
  $ 2,741,035     $ 19,523     $     $ (4,436 )   $ 2,756,122  
2009
    2,551,588       44,904             (8,450 )     2,588,042  
Adjusted segment income
                                       
2010
    45,190       (6,074 )     6,765       95       45,976  
2009
    42,353       (5,896 )     6,464       67       42,988  
Nine Months Ended September 30
                                         
                    PAG     Intersegment        
    Retail     Distribution     Investments     Elimination     Total  
Revenues
                                       
2010
  $ 7,903,158     $ 66,710     $     $ (24,379 )   $ 7,945,489  
2009
    6,895,400       192,413             (22,776 )     7,065,037  
Adjusted segment income
                                       
2010
    128,220       (15,276 )     10,362       (169 )     123,137  
2009
    78,013       1,376       9,590       (155 )     88,824  
The following table reconciles total adjusted segment income to consolidated income from continuing operations before income taxes for the three and nine month periods ended September 30, 2010 and 2009.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Adjusted segment income
  $ 45,976     $ 42,988     $ 123,137     $ 88,824  
Gain on debt repurchase
    607             1,634       10,429  
 
                       
 
                               
Income from continuing operations before income taxes
  $ 46,583     $ 42,988     $ 124,771     $ 99,253  
 
                       

 

16


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
12. Consolidating Condensed Financial Information
The following tables include consolidating condensed financial information as of September 30, 2010 and December 31, 2009 and for the three and nine month periods ended September 30, 2010 and 2009 for Penske Automotive Group, Inc. (as the issuer of the Convertible Notes and the 7.75% Notes), guarantor subsidiaries and non-guarantor subsidiaries (primarily representing foreign entities). The condensed consolidating financial information includes certain allocations of balance sheet, income statement and cash flow items which are not necessarily indicative of the financial position, results of operations or cash flows of these entities on a stand-alone basis.
CONSOLIDATING CONDENSED BALANCE SHEET
September 30, 2010
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Cash and cash equivalents
  $ 6,027     $     $     $ 5,029     $ 998  
Accounts receivable, net
    367,888       (260,301 )     260,301       186,838       181,050  
Inventories
    1,437,939                   881,349       556,590  
Other current assets
    109,106             863       65,467       42,776  
Assets held for sale
    584                   584        
 
                             
 
                                       
Total current assets
    1,921,544       (260,301 )     261,164       1,139,267       781,414  
Property and equipment, net
    731,813             4,809       458,854       268,150  
Intangible assets
    1,017,133                   490,895       526,238  
Equity method investments
    290,735             236,678             54,057  
Other long-term assets
    14,372       (1,237,203 )     1,240,473       8,962       2,140  
 
                             
 
                                       
Total assets
  $ 3,975,597     $ (1,497,504 )   $ 1,743,124     $ 2,097,978     $ 1,631,999  
 
                             
 
                                       
Floor plan notes payable
  $ 907,315     $     $     $ 533,269     $ 374,046  
Floor plan notes payable — non-trade
    474,805             20,300       262,925       191,580  
Accounts payable
    210,999             1,864       81,799       127,336  
Accrued expenses
    231,237       (260,301 )     442       131,250       359,846  
Current portion of long-term debt
    15,409                   1,249       14,160  
Liabilities held for sale
    548                   548        
 
                             
 
                                       
Total current liabilities
    1,840,313       (260,301 )     22,606       1,011,040       1,066,968  
Long-term debt
    837,976       (76,798 )     697,737       47,743       169,294  
Deferred tax liabilities
    161,424                   149,934       11,490  
Other long-term liabilities
    113,103                   97,337       15,766  
 
                             
 
                                       
Total liabilities
    2,952,816       (337,099 )     720,343       1,306,054       1,263,518  
Total equity
    1,022,781       (1,160,405 )     1,022,781       791,924       368,481  
 
                             
 
                                       
Total liabilities and equity
  $ 3,975,597     $ (1,497,504 )   $ 1,743,124     $ 2,097,978     $ 1,631,999  
 
                             

 

17


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED BALANCE SHEET
December 31, 2009
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Cash and cash equivalents
  $ 13,999     $     $     $ 12,344     $ 1,655  
Accounts receivable, net
    321,226       (230,299 )     230,299       195,748       125,478  
Inventories
    1,302,495                   776,887       525,608  
Other current assets
    95,426             1,725       61,640       32,061  
Assets held for sale
    10,625                   10,625        
 
                             
 
                                       
Total current assets
    1,743,771       (230,299 )     232,024       1,057,244       684,802  
Property and equipment, net
    726,808             6,007       450,116       270,685  
Intangible assets
    1,011,803                   570,282       441,521  
Equity method investments
    295,473             231,897             63,576  
Other long-term assets
    18,152       (1,287,938 )     1,293,067       10,848       2,175  
 
                             
 
                                       
Total assets
  $ 3,796,007     $ (1,518,237 )   $ 1,762,995     $ 2,088,490     $ 1,462,759  
 
                             
 
                                       
Floor plan notes payable
  $ 769,657     $     $     $ 448,069     $ 321,588  
Floor plan notes payable — non-trade
    423,316                   254,807       168,509  
Accounts payable
    189,989             3,268       74,610       112,111  
Accrued expenses
    227,294       (230,299 )     344       111,800       345,449  
Current portion of long-term debt
    12,442                   1,033       11,409  
Liabilities held for sale
    7,675                   7,675        
 
                             
 
                                       
Total current liabilities
    1,630,373       (230,299 )     3,612       897,994       959,066  
Long-term debt
    933,966       (59,706 )     813,344       43,066       137,262  
Deferred tax liabilities
    157,500                   145,551       11,949  
Other long-term liabilities
    128,129                   123,154       4,975  
 
                             
 
                                       
Total liabilities
    2,849,968       (290,005 )     816,956       1,209,765       1,113,252  
Total equity
    946,039       (1,228,232 )     946,039       878,725       349,507  
 
                             
 
                                       
Total liabilities and equity
  $ 3,796,007     $ (1,518,237 )   $ 1,762,995     $ 2,088,490     $ 1,462,759  
 
                             

 

18


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF INCOME
Three Months Ended September 30, 2010
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Revenues
  $ 2,756,122     $     $     $ 1,605,210     $ 1,150,912  
Cost of sales
    2,326,269                   1,340,958       985,311  
 
                             
 
                                       
Gross profit
    429,853                   264,252       165,601  
Selling, general, and administrative expenses
    355,920             4,547       219,476       131,897  
Depreciation
    12,403             241       7,073       5,089  
 
                             
 
                                       
Operating income (loss)
    61,530             (4,788 )     37,703       28,615  
Floor plan interest expense
    (9,048 )           (380 )     (6,218 )     (2,450 )
Other interest expense
    (12,229 )           (7,471 )     (558 )     (4,200 )
Debt discount amortization
    (1,647 )           (1,647 )            
Equity in earnings of affiliates
    7,370             6,441             929  
Gain on debt repurchase
    607             607              
Equity in earnings of subsidiaries
          (53,538 )     53,538              
 
                             
 
                                       
Income from continuing operations before income taxes
    46,583       (53,538 )     46,300       30,927       22,894  
Income taxes
    (15,279 )     17,668       (15,279 )     (11,046 )     (6,622 )
 
                             
 
                                       
Income from continuing operations
    31,304       (35,870 )     31,021       19,881       16,272  
Loss from discontinued operations, net of tax
    (1,044 )     1,044       (1,044 )     (1,044 )      
 
                             
 
                                       
Net income
    30,260       (34,826 )     29,977       18,837       16,272  
Less: Income attributable to the non-controlling interests
    283                         283  
 
                             
 
                                       
Net income attributable to Penske Automotive Group common stockholders
  $ 29,977     $ (34,826 )   $ 29,977     $ 18,837     $ 15,989  
 
                             

 

19


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF INCOME
Three Months Ended September 30, 2009
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Revenues
  $ 2,588,042     $     $     $ 1,520,833     $ 1,067,209  
Cost of sales
    2,165,335                   1,265,713       899,622  
 
                             
 
                                       
Gross profit
    422,707                   255,120       167,587  
Selling, general, and administrative expenses
    347,550             3,980       213,334       130,236  
Depreciation
    14,019             290       8,632       5,097  
 
                             
 
                                       
Operating income (loss)
    61,138             (4,270 )     33,154       32,254  
Floor plan interest expense
    (9,061 )                 (6,826 )     (2,235 )
Other interest expense
    (13,490 )           (9,614 )     (33 )     (3,843 )
Debt discount amortization
    (3,135 )           (3,135 )            
Equity in earnings of affiliates
    7,536             6,392             1,144  
Equity in earnings of subsidiaries
          (53,376 )     53,376              
 
                             
 
                                       
Income from continuing operations before income taxes
    42,988       (53,376 )     42,749       26,295       27,320  
Income taxes
    (15,069 )     18,820       (15,069 )     (11,132 )     (7,688 )
 
                             
 
                                       
Income from continuing operations
    27,919       (34,556 )     27,680       15,163       19,632  
Loss from discontinued operations, net of tax
    (257 )     257       (257 )     (598 )     341  
 
                             
 
                                       
Net income
    27,662       (34,299 )     27,423       14,565       19,973  
Less: Income attributable to the non- controlling interests
    239                         239  
 
                             
 
                                       
Net income attributable to Penske Automotive Group common stockholders
  $ 27,423     $ (34,299 )   $ 27,423     $ 14,565     $ 19,734  
 
                             

 

20


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF INCOME
Nine Months Ended September 30, 2010
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Revenues
  $ 7,945,489     $     $     $ 4,612,163     $ 3,333,326  
Cost of sales
    6,675,264                   3,835,553       2,839,711  
 
                             
 
                                       
Gross profit
    1,270,225                   776,610       493,615  
Selling, general, and administrative expenses
    1,051,611             12,634       652,582       386,395  
Depreciation
    36,831             831       21,017       14,983  
 
                             
 
                                       
Operating income (loss)
    181,783             (13,465 )     103,011       92,237  
Floor plan interest expense
    (25,890 )           (380 )     (18,446 )     (7,064 )
Other interest expense
    (37,491 )           (23,861 )     (1,147 )     (12,483 )
Debt discount amortization
    (6,990 )           (6,990 )            
Equity in earnings of affiliates
    11,725             10,724             1,001  
Gain on debt repurchase
    1,634             1,634              
Equity in earnings of subsidiaries
          (156,605 )     156,605              
 
                             
 
                                       
Income from continuing operations before income taxes
    124,771       (156,605 )     124,267       83,418       73,691  
Income taxes
    (43,339 )     54,617       (43,339 )     (33,850 )     (20,767 )
 
                             
 
                                       
Income from continuing operations
    81,432       (101,988 )     80,928       49,568       52,924  
Loss from discontinued operations, net of tax
    (1,156 )     1,156       (1,156 )     (1,156 )      
 
                             
 
                                       
Net income
    80,276       (100,832 )     79,772       48,412       52,924  
Less: Income attributable to the non-controlling interests
    504                         504  
 
                             
 
                                       
Net income attributable to Penske Automotive Group common stockholders
  $ 79,772     $ (100,832 )   $ 79,772     $ 48,412     $ 52,420  
 
                             

 

21


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF INCOME
Nine Months Ended September 30, 2009
                                         
                    Penske              
    Total             Automotive     Guarantor     Non-Guarantor  
    Company     Eliminations     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
                                       
Revenues
  $ 7,065,037     $     $     $ 4,166,592     $ 2,898,445  
Cost of sales
    5,880,536                   3,445,538       2,434,998  
 
                             
 
                                       
Gross profit
    1,184,501                   721,054       463,447  
Selling, general, and administrative expenses
    987,605             13,527       611,724       362,354  
Depreciation
    40,711             870       25,556       14,285  
 
                             
 
                                       
Operating income (loss)
    156,185             (14,397 )     83,774       86,808  
Floor plan interest expense
    (27,492 )                 (19,297 )     (8,195 )
Other interest expense
    (41,677 )           (31,840 )     (97 )     (9,740 )
Debt discount amortization
    (9,908 )           (9,908 )            
Equity in earnings of affiliates
    11,716             9,356             2,360  
Gain on debt repurchase
    10,429             10,429              
Equity in earnings of subsidiaries
          (135,366 )     135,366              
 
                             
 
                                       
Income from continuing operations before income taxes
    99,253       (135,366 )     99,006       64,380       71,233  
Income taxes
    (35,143 )     48,067       (35,143 )     (28,085 )     (19,982 )
 
                             
 
                                       
Income from continuing operations
    64,110       (87,299 )     63,863       36,295       51,251  
Loss from discontinued operations, net of tax
    (6,079 )     6,079       (6,079 )     (4,065 )     (2,014 )
 
                             
 
                                       
Net income
    58,031       (81,220 )     57,784       32,230       49,237  
Less: Income attributable to the non-controlling interests
    247                         247  
 
                             
 
                                       
Net income attributable to Penske Automotive Group common stockholders
  $ 57,784     $ (81,220 )   $ 57,784     $ 32,230     $ 48,990  
 
                             

 

22


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2010
                                 
            Penske              
    Total     Automotive     Guarantor     Non-Guarantor  
    Company     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
Net cash from continuing operating activities
  $ 124,316     $ 109,785     $ 43,004     $ (28,473 )
 
                       
 
                               
Investing activities:
                               
Purchase of property and equipment
    (62,717 )     367       (44,975 )     (18,109 )
Dealership acquisitions, net
    (12,261 )           (12,261 )      
Other
                83       (83 )
 
                       
 
                               
Net cash from continuing investing activities
    (74,978 )     367       (57,153 )     (18,192 )
 
                       
 
                               
Financing activities:
                               
Repayment under U.S. credit agreement term loan
    (10,000 )     (10,000 )            
Repurchase 3.5% senior subordinated convertible notes
    (156,604 )     (156,604 )            
Net borrowings (repayments) of long-term debt
    56,395       36,500       (12,520 )     32,415  
Net (repayments) borrowings of floor plan notes payable — non-trade
    51,489       20,300       16,642       14,547  
Proceeds from exercises of options, including excess tax benefit
    403       403              
Repurchase of common stock
    (751 )     (751 )            
Distributions from (to) parent
                954       (954 )
 
                       
 
                               
Net cash from continuing financing activities
    (59,068 )     (110,152 )     5,076       46,008  
 
                               
Net cash from discontinued operations
    1,758             1,758        
 
                       
 
                               
Net change in cash and cash equivalents
    (7,972 )           (7,315 )     (657 )
Cash and cash equivalents, beginning of period
    13,999             12,344       1,655  
 
                       
 
                               
Cash and cash equivalents, end of period
  $ 6,027     $     $ 5,029     $ 998  
 
                       

 

23


Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2009
                                 
            Penske              
    Total     Automotive     Guarantor     Non-Guarantor  
    Company     Group     Subsidiaries     Subsidiaries  
    (In thousands)  
 
Net cash from continuing operating activities
  $ 314,453     $ 32,544     $ 126,351     $ 155,558  
 
                       
 
                               
Investing activities:
                               
Purchase of property and equipment
    (70,049 )     14       (53,983 )     (16,080 )
Proceeds from sale-leaseback transactions
    2,338             2,338        
Dealership acquisitions, net
    (8,517 )           (597 )     (7,920 )
Other
    11,729       11,485             244  
 
                       
 
                               
Net cash from continuing investing activities
    (64,499 )     11,499       (52,242 )     (23,756 )
 
                       
 
                               
Financing activities:
                               
Repayment under U.S. credit agreement term loan
    (50,000 )     (50,000 )            
Repurchase 3.5% senior subordinated convertible notes
    (51,424 )     (51,424 )            
Net borrowings (repayments) of long-term debt
    1,113       57,305       (6,013 )     (50,179 )
Net repayments of floor plan notes payable — non-trade
    (125,996 )           (47,785 )     (78,211 )
Proceeds from exercises of options, including excess tax benefit
    76       76              
Distributions from (to) parent
                430       (430 )
 
                       
 
                               
Net cash from continuing financing activities
    (226,231 )     (44,043 )     (53,368 )     (128,820 )
 
                               
Net cash from discontinued operations
    (12,318 )           (7,246 )     (5,072 )
 
                       
 
                               
Net change in cash and cash equivalents
    11,405             13,495       (2,090 )
Cash and cash equivalents, beginning of period
    17,108             14,126       2,982  
 
                       
 
                               
Cash and cash equivalents, end of period
  $ 28,513     $     $ 27,621     $ 892  
 
                       

 

24


Table of Contents

Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those discussed in “Forward Looking Statements.” We have acquired and initiated a number of businesses during the periods presented and addressed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. Our financial statements include the results of operations of those businesses from the date acquired or when they commenced operations. This Management’s Discussion and Analysis of Financial Condition and Results of Operations has also been updated to reflect the revision of our financial statements for entities which have been treated as discontinued operations through September 30, 2010.
Overview
We are the second largest automotive retailer headquartered in the U.S. as measured by total revenues. As of September 30, 2010, we owned and operated 173 franchises in the U.S. and 152 franchises outside of the U.S., primarily in the U.K. We offer a full range of vehicle brands with 96% of our total retail revenue in 2010 generated from brands of non-U.S. based manufacturers, and 65% generated from premium brands, such as Audi, BMW, Cadillac, Mercedes-Benz and Porsche. Each of our dealerships offers a wide selection of new and used vehicles for sale. In addition to selling new and used vehicles, we generate higher-margin revenue at each of our dealerships through maintenance and repair services and the sale and placement of higher-margin products, such as third party finance and insurance products, third-party extended service contracts and replacement and aftermarket automotive products. We are also diversified geographically, with 63% of our total revenues in 2010 generated by operations in the U.S. and Puerto Rico and 37% generated from our operations outside the U.S.
smart USA. We are also, through smart USA Distributor, LLC (“smart USA”), a wholly-owned subsidiary, the exclusive distributor of the smart fortwo vehicle in the U.S. and Puerto Rico. The smart fortwo is manufactured by Mercedes-Benz Cars and is a Daimler brand. This technologically advanced vehicle achieves more than 40 miles per gallon on the highway and is an ultra-low emissions vehicle as certified by the State of California Air Resources Board. As of September 30, 2010, smart USA has certified a network of more than 75 smart dealerships, ten of which are owned and operated by us. The smart fortwo offers five different versions, the pure, passion coupe, passion cabriolet, BRABUS coupe and BRABUS cabriolet, with base retail prices currently ranging from $11,990 to $20,990. smart USA wholesaled 4,161 and 12,774 smart fortwo vehicles during the nine months ended September 30, 2010 and 2009, respectively.
During the third quarter of 2010, smart USA entered into a Memorandum of Understanding with Nissan Motor Co., Ltd. relating to the right to procure a vehicle from Nissan for distribution through the smart USA dealer network. Completion of the transaction is subject to customary conditions, including the completion of definitive agreements.
Penske Truck Leasing. We also hold a 9.0% limited partnership interest in Penske Truck Leasing Co., L.P. (“PTL”), a leading global transportation services provider. PTL operates and maintains more than 200,000 vehicles and serves customers in North America, South America, Europe and Asia. Product lines include full-service leasing, contract maintenance, commercial and consumer truck rental and logistics services, including, transportation and distribution center management and supply chain management. The general partner of PTL is Penske Truck Leasing Corporation, a wholly-owned subsidiary of Penske Corporation, which together with other wholly-owned subsidiaries of Penske Corporation, owns 41.1% of PTL. The remaining 49.9% of PTL is owned by GE Capital.
Outlook
Since September 2008, general economic conditions have impacted consumer traffic, vehicle sales and vehicle service work at our dealerships. While we have experienced increased sales in the nine months ended September 30 compared with the prior year, volumes are still below historical levels. We believe general economic conditions, while improving, will continue to impact traffic and sales in the markets in which we operate throughout 2010 and in 2011.
Operating Overview
New and used vehicle revenues include sales to retail customers and to leasing companies providing consumer automobile leasing. We generate finance and insurance revenues from sales of third-party extended service contracts, sales of third-party insurance policies, commissions relating to the sale of finance and lease contracts to third parties and the sales of certain other products. Service and parts revenues include fees paid for repair, maintenance and collision services, and the sale of replacement parts and other aftermarket accessories.

 

25


Table of Contents

During the nine months ended September 30, 2010, we experienced year over year increases in same store new and used retail unit sales, resulting in retail revenue growth, including finance and insurance revenues. Our same store service and parts business declined 1.3% during the nine months ended September 30, 2010 despite a benefit relating to Toyota recall activity in the U.S.
Our gross profit tends to vary with the mix of revenues we derive from the sale of new vehicles, used vehicles, finance and insurance products, service and parts transactions, and the distribution of the smart fortwo. Our gross profit varies across product lines, with vehicle sales usually resulting in lower gross profit margins and our other revenues resulting in higher gross profit margins. Factors such as inventory and vehicle availability, customer demand, consumer confidence, unemployment, general economic conditions, seasonality, weather, credit availability, fuel prices and manufacturers’ advertising and incentives also impact the mix of our revenues, and therefore influence our gross profit margin. Aggregate gross profit increased $85.7 million, or 7.2%, during the nine month period ended September 30, 2010 compared to the same period in prior year. The increase in gross profit is largely attributable to the increases in new and used unit sales. Our retail gross margin percentage declined from 17.7% during the nine months ended September 30, 2009 to 17.0% during the nine months ended September 30, 2010, due primarily to an increase in the percentage of our revenues generated by lower margin vehicle sales.
Our selling expenses consist of advertising and compensation for sales personnel, including commissions and related bonuses. General and administrative expenses include compensation for administration, finance, legal and general management personnel, rent, insurance, utilities, costs associated with the design and development of a new vehicle for smart USA and other outside services. A significant portion of our selling expenses are variable, and we believe a significant portion of our general and administrative expenses are subject to our control, allowing us to adjust them over time to reflect economic trends.
Floor plan interest expense relates to financing incurred in connection with the acquisition of new and used vehicle inventories that is secured by those vehicles. Other interest expense consists of interest charges on all of our interest-bearing debt, other than interest relating to floor plan financing. The cost of our variable rate indebtedness is based on the prime rate, defined London Interbank Offered Rate (“LIBOR”), the Bank of England Base Rate, the Finance House Base Rate, or the Euro Interbank Offered Rate. Our floor plan interest expense has decreased in the nine month period ended September 30, 2010 as a result of decreases in average floor plan balances outstanding and lower applicable interest rates. Our other interest expense has decreased during the three and nine months ended September 30, 2010 due to term loan repayments and repurchases of our 3.5% senior subordinated convertible notes.
Equity in earnings of affiliates represents our share of the earnings from our investments in joint ventures and other non-consolidated investments, including PTL. It is our expectation that operating conditions as outlined above in the Outlook section will similarly impact these businesses throughout 2010.
The future success of our business will likely be dependent on, among other things, general economic and industry conditions, our ability to consummate and integrate acquisitions, the level of vehicle sales in the markets where we operate, our ability to increase sales of higher margin products, especially service and parts services, our ability to realize returns on our significant capital investment in new and upgraded dealership facilities, the success of our smart USA distribution business, and the return realized from our investments in various joint ventures and other non-consolidated investments. See “Forward-Looking Statements.”
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires the application of accounting policies that often involve making estimates and employing judgments. Such judgments influence the assets, liabilities, revenues and expenses recognized in our financial statements. Management, on an ongoing basis, reviews these estimates and assumptions. Management may determine that modifications in assumptions and estimates are required, which may result in a material change in our results of operations or financial position.
The following are the accounting policies applied in the preparation of our financial statements that management believes are most dependent upon the use of estimates and assumptions.

 

26


Table of Contents

Revenue Recognition
Vehicle, Parts and Service Sales
We record revenue when vehicles are delivered and title has passed to the customer, when vehicle service or repair work is completed and when parts are delivered to our customers. Sales promotions that we offer to customers are accounted for as a reduction of revenues at the time of sale. Rebates and other incentives offered directly to us by manufacturers are recognized as a reduction of cost of sales. Reimbursements of qualified advertising expenses are treated as a reduction of selling, general and administrative expenses. The amounts received under certain manufacturer rebate and incentive programs are based on the attainment of program objectives, and such earnings are recognized either upon the sale of the vehicle for which the award was received, or upon attainment of the particular program goals if not associated with individual vehicles. During the nine months ended September 30, 2010 and 2009, we earned $261.4 million and $235.0 million, respectively, of rebates, incentives and reimbursements from manufacturers, of which $254.7 million and $231.3 million was recorded as a reduction of cost of sales.
Finance and Insurance Sales
Subsequent to the sale of a vehicle to a customer, we sell installment sale contracts to various financial institutions on a non-recourse basis (with specified exceptions) to mitigate the risk of default. We receive a commission from the lender equal to either the difference between the interest rate charged to the customer and the interest rate set by the financing institution or a flat fee. We also receive commissions for facilitating the sale of various third-party insurance products to customers, including credit and life insurance policies and extended service contracts. These commissions are recorded as revenue at the time the customer enters into the contract.
Impairment Testing
Franchise value impairment is assessed as of October 1 every year and upon the occurrence of an indicator of impairment through a comparison of its carrying amount and estimated fair value. An indicator of impairment exists if the carrying value of a franchise exceeds its estimated fair value and an impairment loss may be recognized up to that excess. The fair value of franchise value is determined using a discounted cash flow approach, which includes assumptions that include revenue and profitability growth, franchise profit margins, and our cost of capital. We also evaluate our franchise agreements in connection with the annual impairment testing to determine whether events and circumstances continue to support our assessment that the franchise agreements have an indefinite life.
Goodwill impairment is assessed at the reporting unit level as of October 1 every year and upon the occurrence of an indicator of impairment. We have determined that the dealerships in each of our operating segments within the Retail reportable segment are components that are aggregated into four geographical reporting units for the purpose of goodwill impairment testing, as they (A) have similar economic characteristics (all are automotive dealerships having similar margins), (B) offer similar products and services (all sell new and used vehicles, service, parts and third-party finance and insurance products), (C) have similar target markets and customers (generally individuals) and (D) have similar distribution and marketing practices (all distribute products and services through dealership facilities that market to customers in similar fashions). There is no goodwill recorded in our Distribution or PAG Investments reportable segments. An indicator of goodwill impairment exists if the carrying amount of the reporting unit, including goodwill, is determined to exceed its estimated fair value. The fair value of goodwill is determined using a discounted cash flow approach, which includes assumptions that include revenue and profitability growth, franchise profit margins, residual values and our cost of capital. If an indication of goodwill impairment exists, an analysis reflecting the allocation of the fair value of the reporting unit to all assets and liabilities, including previously unrecognized intangible assets, is performed. The impairment is measured by comparing the implied fair value of the reporting unit goodwill with its carrying amount and an impairment loss may be recognized up to any excess of the carrying value over the implied fair value.
Investments
We account for each of our investments under the equity method, pursuant to which we record our proportionate share of the investee’s income each period. The net book value of our investments was $290.7 million and $295.5 million as of September 30, 2010 and December 31, 2009, respectively. Investments for which there is not a liquid, actively traded market are reviewed periodically by management for indicators of impairment. If an indicator of impairment is identified, management estimates the fair value of the investment using a discounted cash flow approach, which includes assumptions relating to revenue and profitability growth, profit margins, residual values and our cost of capital. Declines in investment values that are deemed to be other than temporary may result in an impairment charge reducing the investments’ carrying value to fair value.

 

27


Table of Contents

Self-Insurance
We retain risk relating to certain of our general liability insurance, workers’ compensation insurance, auto physical damage insurance, property insurance, employment practices liability insurance, directors and officers insurance and employee medical benefits in the U.S. As a result, we are likely to be responsible for a significant portion of the claims and losses incurred under these programs. The amount of risk we retain varies by program, and, for certain exposures, we have pre-determined maximum loss limits for certain individual claims and/or insurance periods. Losses, if any, above the pre-determined loss limits are paid by third-party insurance carriers. Our estimate of future losses is prepared by management using our historical loss experience and industry-based development factors. Aggregate reserves relating to retained risk were $24.7 million and $21.5 million as of September 30, 2010 and December 31, 2009, respectively. Changes in the reserve estimate during 2010 relate primarily to current year activity in our general liability and workers compensation programs.
Income Taxes
Tax regulations may require items to be included in our tax returns at different times than the items are reflected in our financial statements. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as the timing of depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that will be used as a tax deduction or credit in our tax returns in future years which we have already recorded in our financial statements. Deferred tax liabilities generally represent deductions taken on our tax returns that have not yet been recognized as expense in our financial statements. We establish valuation allowances for our deferred tax assets if the amount of expected future taxable income is not likely to allow for the use of the deduction or credit.
Classification of Franchises in Continuing and Discontinued Operations
We classify the results of our operations in our consolidated financial statements based on general accounting principles relating to discontinued operations, which requires judgment in determining whether a franchise will be reported within continuing or discontinued operations. Such judgments include whether a franchise will be divested, the period required to complete the divestiture, and the likelihood of changes to the divestiture plans. If we determine that a franchise should be either reclassified from continuing operations to discontinued operations or from discontinued operations to continuing operations, our consolidated financial statements for prior periods are revised to reflect such reclassification.
Results of Operations
The following tables present comparative financial data relating to our operating performance in the aggregate and on a “same store” basis. Dealership results are only included in same store comparisons when we have consolidated the acquired entity during the entirety of both periods being compared. As an example, if a dealership was acquired on January 15, 2008, the results of the acquired entity would be included in annual same store comparisons beginning with the year ended December 31, 2010 and in quarterly same store comparisons beginning with the quarter ended September 30, 2009.
Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009
Our results for the three months ended September 30, 2009 include charges of $5.2 million ($3.4 million after-tax), or $0.04 per share, relating to costs associated with the termination of the acquisition of the Saturn brand, our election to close three franchises in the U.S. and charges relating to certain interest rate hedges.

 

28


Table of Contents

Retail unit sales of new vehicles during the three months ended September 30, 2009 include units sold under government incentive programs in each of the markets where we have retail operations.
New Vehicle Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
New retail unit sales
    40,504       41,574       (1,070 )     -2.6 %
Same store new retail unit sales
    38,907       41,544       (2,637 )     -6.3 %
New retail sales revenue
  $ 1,416.3     $ 1,338.8       77.5       5.8 %
Same store new retail sales revenue
  $ 1,362.4     $ 1,336.8       25.6       1.9 %
New retail sales revenue per unit
  $ 34,967     $ 32,202       2,765       8.6 %
Same store new retail sales revenue per unit
  $ 35,018     $ 32,179       2,839       8.8 %
Gross profit — new
  $ 112.3     $ 112.8       (0.5 )     -0.4 %
Same store gross profit — new
  $ 108.1     $ 112.6       (4.5 )     -4.0 %
Average gross profit per new vehicle retailed
  $ 2,773     $ 2,714       59       2.2 %
Same store average gross profit per new vehicle retailed
  $ 2,777     $ 2,711       66       2.4 %
Gross margin % — new
    7.9 %     8.4 %     -0.5 %     -6.0 %
Same store gross margin % — new
    7.9 %     8.4 %     -0.5 %     -6.0 %
Units
Retail unit sales of new vehicles decreased 1,070 units, or 2.6%, from 2009 to 2010. The decrease is due to a 2,637 unit, or 6.3%, decrease in same store retail unit sales during the period, offset by a 1,567 unit increase from net dealership acquisitions. The same store decrease was due primarily to unit sales decreases in our volume foreign brand stores in the U.S. and, to a lesser extent, in the U.K. Prior year sales were influenced by the various government incentive programs designed to spur sales activity.
Revenues
New vehicle retail sales revenue increased $77.5 million, or 5.8%, from 2009 to 2010. The increase is due to a $51.9 million increase from net dealership acquisitions, coupled with a $25.6 million, or 1.9%, increase in same store revenues. The same store revenue increase is due primarily to a $2,839, or 8.8%, increase in average selling prices per unit which increased revenue by $110.5 million, offset by the 6.3% decrease in retail unit sales, which decreased revenue by $84.9 million.
Gross Profit
Retail gross profit from new vehicle sales decreased $0.5 million, or 0.4%, from 2009 to 2010. The decrease is due to a $4.5 million, or 4.0%, decrease in same store gross profit, offset by a $4.0 million increase from net dealership acquisitions. The same store decrease is due primarily to the 6.3% decrease in retail unit sales, which decreased gross profit by $7.1 million, offset by a $66, or 2.4%, increase in the average gross profit per new vehicle retailed, which increased gross profit by $2.6 million.
Used Vehicle Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Used retail unit sales
    29,975       25,723       4,252       16.5 %
Same store used retail unit sales
    28,985       25,682       3,303       12.9 %
Used retail sales revenue
  $ 765.6     $ 674.2       91.4       13.6 %
Same store used retail sales revenue
  $ 744.0     $ 673.0       71.0       10.6 %
Used retail sales revenue per unit
  $ 25,540     $ 26,211       (671 )     -2.6 %
Same store used retail sales revenue per unit
  $ 25,669     $ 26,203       (534 )     -2.0 %
Gross profit — used
  $ 57.0     $ 59.4       (2.4 )     -4.0 %
Same store gross profit — used
  $ 55.9     $ 59.3       (3.4 )     -5.7 %
Average gross profit per used vehicle retailed
  $ 1,900     $ 2,308       (408 )     -17.7 %
Same store average gross profit per used vehicle retailed
  $ 1,930     $ 2,308       (378 )     -16.4 %
Gross margin % — used
    7.4 %     8.8 %     -1.4 %     -15.9 %
Same store gross margin % — used
    7.5 %     8.8 %     -1.3 %     -14.8 %

 

29


Table of Contents

Units
Retail unit sales of used vehicles increased 4,252 units, or 16.5%, from 2009 to 2010. The increase is due to a 3,303 unit, or 12.9%, increase in same store retail unit sales, coupled with a 949 unit increase from net dealership acquisitions. The same store increase was due primarily to unit sales increases in premium and volume foreign brand stores in the U.S., and reflect our effort to bolster used vehicle sales activity in light of the challenging new vehicle market.
Revenues
Used vehicle retail sales revenue increased $91.4 million, or 13.6%, from 2009 to 2010. The increase is due to a $71.0 million, or 10.6%, increase in same store revenues, coupled with a $20.4 million increase from net dealership acquisitions. The same store revenue increase is due to the 12.9% increase in same store retail unit sales which increased revenue by $84.8 million, offset by a $534, or 2.0%, decrease in comparative average selling prices per unit, which decreased revenue by $13.8 million.
Gross Profit
Retail gross profit from used vehicle sales decreased $2.4 million, or 4.0%, from 2009 to 2010. The decrease is due to a $3.4 million, or 5.7%, decrease in same store gross profit, offset by a $1.0 million increase from net dealership acquisitions. The decrease in same store gross profit is due to a $378, or 16.4%, decrease in average gross profit per used vehicle retailed, which decreased retail gross profit by $9.7 million, offset by the 12.9% increase in used retail unit sales, which increased gross profit by $6.3 million.
Finance and Insurance Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Finance and insurance revenue
  $ 67.1     $ 60.9     $ 6.2       10.2 %
Same store finance and insurance revenue
  $ 65.5     $ 60.8     $ 4.7       7.7 %
Finance and insurance revenue per unit
  $ 953     $ 905     $ 48       5.3 %
Same store finance and insurance revenue per unit
  $ 965     $ 905     $ 60       6.6 %
Finance and insurance revenue increased $6.2 million, or 10.2%, from 2009 to 2010. The increase is due to a $4.7 million, or 7.7%, increase in same store revenues during the period, coupled with a $1.5 million increase from net dealership acquisitions. The same store revenue increase is due to a $60, or 6.6%, increase in comparative average finance and insurance revenue per unit which increased revenue by $4.0 million, coupled with a 1.0% increase in total retail unit sales, which increased revenue by $0.7 million.
Service and Parts Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Service and parts revenue
  $ 335.3     $ 335.6       (0.3 )     -0.1 %
Same store service and parts revenue
  $ 324.2     $ 334.0       (9.8 )     -2.9 %
Gross profit
  $ 192.1     $ 185.5       6.6       3.6 %
Same store gross profit
  $ 185.9     $ 184.7       1.2       0.6 %
Gross margin
    57.3 %     55.3 %     2.0 %     3.6 %
Same store gross margin
    57.4 %     55.3 %     2.1 %     3.8 %
Revenues
Service and parts revenue decreased $0.3 million, or 0.1%, from 2009 to 2010. The decrease is due to a $9.8 million, or 2.9%, decrease in same store revenues during the period, offset by a $9.5 million increase from net dealership acquisitions. We believe the same store decline is due in large part to a decline in vehicle sales over the last several years compared to historical levels in addition to a decrease in warranty due to the improvement in the quality of vehicles being produced today, offset somewhat by the significant Toyota recall actions in the U.S. in 2010.

 

30


Table of Contents

Gross Profit
Service and parts gross profit increased $6.6 million, or 3.6%, from 2009 to 2010. The increase is due to a $5.4 million increase from net dealership acquisitions, coupled with a $1.2 million, or 0.6%, increase in same store gross profit during the period. The same store gross profit increase is due to a 3.8% increase in gross margin, which increased gross profit by $6.8 million, offset by the $9.8 million, or 2.9%, decrease in same store revenues, which decreased gross profit by $5.6 million. Service and parts margin in 2010 has been positively impacted by the significant Toyota recall actions in the U.S.
Distribution
Distribution units wholesaled during the quarter decreased 2,236 units, or 65.7%, from 3,401 in 2009 to 1,165 in 2010. During the three months ended September 30, 2010, smart USA recorded $1.4 million of incentives which decreased gross profit. Distribution segment revenue decreased $25.4 million, or 56.6%, to $19.5 million in 2010 due largely to the reduction in wholesale unit sales. As a result, segment gross profit decreased $5.4 million, or 88.5%, to $0.7 million in 2010. During 2010, the distribution segment recorded $1.6 million in pre-production costs related to its efforts to procure a vehicle from Nissan for distribution through smart USA. In total, the distribution segment generated a loss of $6.1 million in 2010 compared with a loss of $5.9 million in 2009.
Selling, General and Administrative
Selling, general and administrative expenses (“SG&A”) increased $8.3 million, or 2.4%, from $347.6 million to $355.9 million. The aggregate increase is due primarily to a $10.3 million increase from net dealership acquisitions, offset by a $2.0 million, or 0.6%, decrease in same store SG&A. The decrease in same store SG&A is due to a net decrease in variable selling expenses, including decreases in variable compensation, as a result of the 0.5% decrease in same store retail gross profit versus the prior year, somewhat offset by increased rent, the costs associated with the development of the new smart USA vehicle, and certain other costs. SG&A expenses increased as a percentage of gross profit from 82.2% to 82.8%.
Depreciation
Depreciation decreased $1.6 million, or 11.5%, from $14.0 million to $12.4 million. The decrease is due to a $1.9 million, or 13.6%, decrease in same store depreciation, offset by a $0.3 million increase from net dealership acquisitions. The same store decrease was primarily due to a change in the estimated useful lives of certain fixed assets effective January 1, 2010.
Floor Plan Interest Expense
Floor plan interest expense, including the impact of swap transactions, decreased $0.1 million, or 0.1%, from $9.1 million to $9.0 million due to a decrease in same store floor plan interest expense. The same store decrease is due primarily to decreases in applicable interest rates.
Other Interest Expense
Other interest expense decreased $1.3 million, or 9.3%, from $13.5 million to $12.2 million. The decrease is due primarily to the repurchase of $155.7 million aggregate principal amount of our 3.5% senior subordinated convertible notes during the nine months ended September 30, 2010.
Debt Discount Amortization
Debt discount amortization decreased $1.5 million, from $3.1 million to $1.6 million, due primarily to the repurchase of a portion of our outstanding 3.5% senior subordinated convertible notes.
Equity in Earnings of Affiliates
Equity in earnings of affiliates decreased $0.1 million, from $7.5 million to $7.4 million reflecting the consistent operating performance of those businesses.

 

31


Table of Contents

Gain on Debt Repurchase
During the three months ended September 30, 2010, we repurchased $43.0 million principal amount of our Convertible Notes, which had a book value, net of debt discount, of $41.6 million for $43.3 million. We allocated $2.5 million of the total consideration to the reacquisition of the equity component of the Convertible Notes. In connection with the transactions, we wrote off $0.2 million of unamortized deferred financing costs. As a result, we recorded $0.6 million of pre-tax gain in connection with the repurchase.
Income Taxes
Income taxes increased $0.2 million, or 1.4%, from $15.1 million to $15.3 million. The increase from 2009 to 2010 is due to an increase in our pre-tax income versus the prior year, slightly offset by a decrease in our overall effective income tax rate resulting from the relative strength of our operations in foreign markets with lower tax rates.
Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009
Our results for the nine months ended September 30, 2009 include a gain of $10.4 million ($6.5 million after-tax), or $0.07 per share, relating to the repurchase of $68.7 million aggregate principal amount of our 3.5% senior subordinated convertible notes and include charges of $5.2 million ($3.4 million after-tax), or $0.04 per share, relating to costs associated with the termination of the acquisition of the Saturn brand, our election to close three franchises in the U.S. and charges relating to certain interest rate hedges.
Retail unit sales of new vehicles during the nine months ended September 30, 2009 include units sold under government incentive programs in each of the markets we serve where we have retail operations.
New Vehicle Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
New retail unit sales
    116,319       105,485       10,834       10.3 %
Same store new retail unit sales
    112,210       105,116       7,094       6.7 %
New retail sales revenue
  $ 4,004.5     $ 3,400.1       604.4       17.8 %
Same store new retail sales revenue
  $ 3,846.9     $ 3,376.3       470.6       13.9 %
New retail sales revenue per unit
  $ 34,426     $ 32,233       2,193       6.8 %
Same store new retail sales revenue per unit
  $ 34,283     $ 32,120       2,163       6.7 %
Gross profit — new
  $ 325.0     $ 270.2       54.8       20.3 %
Same store gross profit — new
  $ 310.7     $ 267.4       43.3       16.2 %
Average gross profit per new vehicle retailed
  $ 2,794     $ 2,561       233       9.1 %
Same store average gross profit per new vehicle retailed
  $ 2,768     $ 2,544       224       8.8 %
Gross margin % — new
    8.1 %     7.9 %     0.2 %     2.5 %
Same store gross margin % — new
    8.1 %     7.9 %     0.2 %     2.5 %
Units
Retail unit sales of new vehicles increased 10,834 units, or 10.3%, from 2009 to 2010. The increase is due a 7,094 unit, or 6.7%, increase in same store retail unit sales during the period, coupled with a 3,740 unit increase from net dealership acquisitions. The same store increase was due primarily to unit sales increases in our volume foreign brand stores in the U.S. and premium brand stores in the U.S. and U.K., and reflect the improved consumer confidence levels and credit availability in 2010 compared to the prior year.
Revenues
New vehicle retail sales revenue increased $604.4 million, or 17.8%, from 2009 to 2010. The increase is due to a $470.6 million, or 13.9%, increase in same store revenues, coupled with a $133.8 million increase from net dealership acquisitions. The same store revenue increase is due primarily to the 6.7% increase in retail unit sales, which increased revenue by $243.2 million, coupled with a $2,163, or 6.7%, increase in average selling prices per unit which increased revenue by $227.4 million.

 

32


Table of Contents

Gross Profit
Retail gross profit from new vehicle sales increased $54.8 million, or 20.3%, from 2009 to 2010. The increase is due to a $43.3 million, or 16.2%, increase in same store gross profit, coupled with an $11.5 million increase from net dealership acquisitions. The same store increase is due primarily to a $224, or 8.8%, increase in the average gross profit per new vehicle retailed which increased gross profit by $23.6 million, coupled with the 6.7% increase in retail unit sales, which increased gross profit by $19.7 million.
Used Vehicle Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Used retail unit sales
    85,971       78,813       7,158       9.1 %
Same store used retail unit sales
    83,324       78,380       4,944       6.3 %
Used retail sales revenue
  $ 2,211.9     $ 1,949.5       262.4       13.5 %
Same store used retail sales revenue
  $ 2,128.8     $ 1,924.3       204.5       10.6 %
Used retail sales revenue per unit
  $ 25,728     $ 24,736       992       4.0 %
Same store used retail sales revenue per unit
  $ 25,549     $ 24,551       998       4.1 %
Gross profit — used
  $ 173.8     $ 174.6       (0.8 )     -0.5 %
Same store gross profit — used
  $ 169.5     $ 172.7       (3.2 )     -1.9 %
Average gross profit per used vehicle retailed
  $ 2,022     $ 2,216       (194 )     -8.8 %
Same store average gross profit per used vehicle retailed
  $ 2,034     $ 2,204       (170 )     -7.7 %
Gross margin % — used
    7.9 %     9.0 %     -1.1 %     -12.2 %
Same store gross margin % — used
    8.0 %     9.0 %     -1.0 %     -11.1 %
Units
Retail unit sales of used vehicles increased 7,158 units, or 9.1%, from 2009 to 2010. The increase is due to a 4,944 unit, or 6.3%, increase in same store retail unit sales, coupled with a 2,214 unit increase from net dealership acquisitions. The same store increase was due primarily to unit sales increases in premium and volume foreign brand stores in the U.S., and reflect our effort to bolster used vehicle sales activity in light of the challenging new vehicle market.
Revenues
Used vehicle retail sales revenue increased $262.4 million, or 13.5%, from 2009 to 2010. The increase is due to a $204.5 million, or 10.6%, increase in same store revenues, coupled with a $57.9 million increase from net dealership acquisitions. The same store revenue increase is due to the 6.3% increase in same store retail unit sales which increased revenue by $126.3 million, coupled with a $998, or 4.1%, increase in comparative average selling prices per unit, which increased revenue by $78.2 million.
Gross Profit
Retail gross profit from used vehicle sales decreased $0.8 million, or 0.5%, from 2009 to 2010. The decrease is due to a $3.2 million, or 1.9%, decrease in same store gross profit, offset by a $2.4 million increase from net dealership acquisitions. The decrease in same store gross profit is due to a $170, or 7.7%, decrease in average gross profit per used vehicle retailed, which decreased retail gross profit by $13.3 million, offset by the 6.3% increase in used retail unit sales which increased gross profit by $10.1 million.

 

33


Table of Contents

Finance and Insurance Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Finance and insurance revenue
  $ 190.1     $ 164.0     $ 26.1       15.9 %
Same store finance and insurance revenue
  $ 184.7     $ 163.0     $ 21.7       13.3 %
Finance and insurance revenue per unit
  $ 940     $ 890     $ 50       5.6 %
Same store finance and insurance revenue per unit
  $ 945     $ 888     $ 57       6.4 %
Finance and insurance revenue increased $26.1 million, or 15.9%, from 2009 to 2010. The increase is due to a $21.7 million, or 13.3%, increase in same store revenues during the period, coupled with a $4.4 million increase from net dealership acquisitions. The same store revenue increase is due to a 6.6% increase in total retail unit sales, which increased revenue by $11.4 million, coupled with a $57, or 6.4%, increase in comparative average finance and insurance revenue per unit which increased revenue by $10.3 million.
Service and Parts Data
                                 
                    2010 vs. 2009  
Dollars in millions, except per unit amounts   2010     2009     Change     % Change  
Service and parts revenue
  $ 1,001.4     $ 993.6       7.8       0.8 %
Same store service and parts revenue
  $ 972.2     $ 984.7       (12.5 )     -1.3 %
Gross profit
  $ 571.0     $ 544.6       26.4       4.8 %
Same store gross profit
  $ 554.5     $ 540.1       14.4       2.7 %
Gross margin
    57.0 %     54.8 %     2.2 %     4.0 %
Same store gross margin
    57.0 %     54.8 %     2.2 %     4.0 %
Revenues
Service and parts revenue increased $7.8 million, or 0.8%, from 2009 to 2010. The increase is due to a $20.3 million increase from net dealership acquisitions, offset by a $12.5 million, or 1.3%, decrease in same store revenues during the period. We believe the same store decline is due in large part to a decline in vehicle sales over the last several years compared to historical levels in addition to a decrease in warranty due to the improvement in the quality of vehicles being produced today, offset somewhat by the significant Toyota recall actions in the U.S. in 2010.
Gross Profit
Service and parts gross profit increased $26.4 million, or 4.8%, from 2009 to 2010. The increase is due to a $14.4 million, or 2.7%, increase in same store gross profit during the period, coupled with a $12.0 million increase from net dealership acquisitions. The same store gross profit increase is due to a 2.2% increase in gross margin, which increased gross profit by $21.6 million, offset by the $12.5 million, or 1.3%, decrease in same store revenues, which decreased gross profit by $7.2 million. Service and parts margin in 2010 has been positively impacted by the significant Toyota recall actions in the U.S.
Distribution
Distribution units wholesaled decreased 8,613 units, or 67.4%, from 12,774 in 2009 to 4,161 in 2010. During the nine months ended September 30, 2010, smart USA recorded $2.9 million of incentives which decreased gross profit. Distribution segment revenue decreased $125.7 million, or 65.3%, to $66.7 million in 2010 due largely to the reduction in wholesale unit sales. As a result, segment gross profit decreased $21.7 million, or 85.1%, to $3.8 million in 2010. In total, the distribution segment generated a loss of $15.3 million in 2010 compared with income of $1.4 million in 2009.

 

34


Table of Contents

Selling, General and Administrative
Selling, general and administrative expenses (“SG&A”) increased $64.0 million, or 6.5%, from $987.6 million to $1,051.6 million. The aggregate increase is due primarily to a $37.9 million, or 3.9%, increase in same store SG&A, coupled with a $26.1 million increase from net dealership acquisitions. The increase in same store SG&A is due to a net increase in variable selling expenses, including increases in variable compensation, as a result of a 6.7% increase in same store retail gross profit versus the prior year, increased rent, the costs associated with the development of the new smart USA vehicle, and certain other costs. SG&A expenses decreased as a percentage of gross profit from 83.4% to 82.8%.
Depreciation
Depreciation decreased $3.9 million, or 9.5%, from $40.7 million to $36.8 million. The decrease is due to a $4.6 million, or 11.4%, decrease in same store depreciation, offset by a $0.7 million increase from net dealership acquisitions. The same store decrease was primarily due to a change in the estimated useful lives of certain fixed assets effective January 1, 2010.
Floor Plan Interest Expense
Floor plan interest expense, including the impact of swap transactions, decreased $1.6 million, or 5.8%, from $27.5 million to $25.9 million. The decrease is due to a $2.0 million, or 7.4%, decrease in same store floor plan interest expense, offset by a $0.4 million increase from net dealership acquisitions. The same store decrease is due in large part to decreases in average outstanding floor plan balances and lower applicable rates.
Other Interest Expense
Other interest expense decreased $4.2 million, or 10.0%, from $41.7 million to $37.5 million. The decrease is due primarily to the repurchases of $155.7 million aggregate principal amount of Convertible Notes during the nine months ended September 30, 2010.
Debt Discount Amortization
Debt discount amortization decreased $2.9 million, from $9.9 million to $7.0 million, due primarily to the repurchase of a portion of Convertible Notes.
Gain on Debt Repurchase
During 2010, we repurchased $155.7 million principal amount of Convertible Notes, which had a book value, net of debt discount, of $149.1 million for $156.6 million. We allocated $10.2 million of the total consideration to the reacquisition of the equity component of the Convertible Notes. In connection with the transactions, we wrote off $0.7 million of unamortized deferred financing costs. As a result, we recorded $1.6 million of pre-tax gains in connection with the repurchases.
In 2009, we repurchased $68.7 million principal amount of Convertible Notes, which had a book value, net of debt discount, of $62.8 million for $51.4 million. In connection with the transaction, we wrote off $0.7 million of unamortized deferred financing costs and incurred $0.3 million of transaction costs. No element of the consideration was allocated to the reacquisition of the equity component of the Convertible Notes because the consideration paid was less than the fair value of the liability component prior to extinguishment. As a result, we recorded $10.4 million of pre-tax gain in connection with the repurchase.
Income Taxes
Income taxes increased $8.2 million, or 23.3%, from $35.1 million to $43.3 million. The increase from 2009 to 2010 is due to the increase in our pre-tax income versus the prior year. Our effective tax rate was 34.7% for the nine months ended September 30, 2010 and 35.4% for the nine months ended September 30, 2009.

 

35


Table of Contents

Liquidity and Capital Resources
Our cash requirements are primarily for working capital, inventory financing, the acquisition of new businesses, the improvement and expansion of existing facilities, the construction of new facilities, the design and development of a new vehicle for smart USA, debt service and repayments, and potentially for dividends and repurchases of our outstanding securities under the program discussed below. Historically, these cash requirements have been met through cash flow from operations, borrowings under our credit agreements and floor plan arrangements, the issuance of debt securities, sale-leaseback transactions, mortgages, dividends from joint venture investments or the issuance of equity securities.
We have historically expanded our retail automotive operations through organic growth and the acquisition of retail automotive dealerships. In addition, one of our subsidiaries, smart USA, is the exclusive distributor of smart fortwo vehicles in the U.S. and Puerto Rico. smart USA has entered into a Memorandum of Understanding with Nissan Motor Co., Ltd. relating to the right to procure a vehicle from Nissan for distribution through the smart USA dealer network. We estimate that smart USA will incur approximately $25 million of development, engineering and tooling costs to bring the new vehicle to market. We believe that cash flow from operations, dividends from our joint venture investments and our existing capital resources, including the liquidity provided by our credit agreements and floor plan financing arrangements, will be sufficient to fund our operations and commitments for at least the next twelve months.
In the event we pursue additional significant acquisitions, other expansion opportunities, significant repurchases of our outstanding securities; reinstate our quarterly cash dividends; or refinance or repay existing debt (including the Convertible Notes), we may need to raise additional capital either through the public or private issuance of equity or debt securities or through additional borrowings, which sources of funds may not necessarily be available on terms acceptable to us, if at all. In addition, our liquidity could be negatively impacted in the event we fail to comply with the covenants under our various financing and operating agreements or in the event our floor plan financing is withdrawn. For a discussion of these possible events, see the discussion below with respect to our financing agreements.
As of September 30, 2010, we had working capital of $81.2 million, including $6.0 million of cash, available to fund our operations and capital commitments. In addition, we had $263.5 million and £37.7 million ($59.3 million) available for borrowing under our U.S. credit agreement and our U.K. credit agreement, respectively, each of which is discussed below. We had $150.6 million of Convertible Notes outstanding as of September 30, 2010. We currently expect to utilize cash flow from operations, working capital and available capacity under the U.S. credit agreement to redeem the Convertible Notes in April 2011. See “Forward Looking Statements.”
Securities Repurchases
From time to time, our Board of Directors has authorized securities repurchase programs pursuant to which we may, from time to time and as market conditions warrant, purchase our outstanding common stock, debt or convertible debt on the open market, in privately negotiated transactions, via a tender offer, or a pre-arranged trading plan. We have historically funded any such repurchases through cash flow from operations and borrowings under our U.S. credit facility. The decision to make repurchases will be based on factors such as the market price of the relevant security versus our view of its intrinsic value, the potential impact of such repurchases on our capital structure, and alternative uses of capital, such as for strategic investments in our current businesses, as well as any then-existing limits imposed by our finance agreements and securities trading policy. During the nine months ended September 30, 2010, we repurchased a total of $155.7 million aggregate principal amount of Convertible Notes for $156.6 million and 68 thousand shares of our common stock at an average price of $10.97 per share. Subsequent to these purchases, our Board of Directors increased our authorized repurchase authority to $150.0 million.
Dividends
In February 2009, we announced the suspension of our quarterly cash dividend. Future quarterly or other cash dividends will depend upon a variety of factors considered relevant by our Board of Directors which may include our earnings, capital requirements, restrictions on any then existing indebtedness, financial condition, our ability to fund the expected April 2011 redemption of our $150.6 million of Convertible Notes, and other factors.

 

36


Table of Contents

Inventory Financing
We finance substantially all of our new and a portion of our used vehicle inventories under revolving floor plan arrangements with various lenders, including a majority through captive finance companies associated with automotive manufacturers. In the U.S., the floor plan arrangements are due on demand; however, we have not historically been required to repay floor plan advances prior to the sale of the vehicles that have been financed. We typically make monthly interest payments on the amount financed. Outside of the U.S., substantially all of our floor plan arrangements are payable on demand or have an original maturity of 90 days or less and we are generally required to repay floor plan advances at the earlier of the sale of the vehicles that have been financed or the stated maturity.
The floor plan agreements typically grant a security interest in substantially all of the assets of our dealership subsidiaries, and in the U.S. are guaranteed by us. Interest rates under the floor plan arrangements are variable and increase or decrease based on changes in the prime rate, defined LIBOR, Finance House Base Rate, or Euro Interbank Offered Rate. We receive non-refundable credits from certain of our vehicle manufacturers, which are treated as a reduction of cost of sales as vehicles are sold. To date, we have not experienced any material limitation with respect to the amount or availability of financing from any institution providing us vehicle financing.
U.S. Credit Agreement
We are party to a credit agreement with DCFS USA LLC and Toyota Motor Credit Corporation, as amended (the “U.S. credit agreement”), which, provides for up to $300.0 million in revolving loans for working capital, acquisitions, capital expenditures, investments and other general corporate purposes, a non-amortizing term loan with a remaining balance of $139.0 million, and for an additional $10.0 million of availability for letters of credit. The term of the credit agreement was extended on September 15, 2010, by one year through September 30, 2013. The revolving loans bear interest at a defined LIBOR plus 2.75%, subject to an incremental 0.75% for uncollateralized borrowings in excess of a defined borrowing base. The term loan, which bears interest at defined LIBOR plus 2.50%, may be prepaid at any time, but then may not be re-borrowed. We repaid $10.0 million of the term loan in the third quarter of 2010.
The U.S. credit agreement is fully and unconditionally guaranteed on a joint and several basis by our domestic subsidiaries and contains a number of significant covenants that, among other things, restrict our ability to dispose of assets, incur additional indebtedness, repay other indebtedness, pay dividends, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. We are also required to comply with specified financial and other tests and ratios, each as defined in the U.S. credit agreement, including: a ratio of current assets to current liabilities, a fixed charge coverage ratio, a ratio of debt to stockholders’ equity and a ratio of debt to EBITDA. A breach of these requirements would give rise to certain remedies under the agreement, the most severe of which is the termination of the agreement and acceleration of any amounts owed. As of September 30, 2010, we were in compliance with all covenants under the U.S. credit agreement, and we believe we will remain in compliance with such covenants for the next twelve months. In making such determination, we have considered the current margin of compliance with the covenants and our expected future results of operations, working capital requirements, acquisitions, capital expenditures and investments. See “Forward Looking Statements”.
The U.S. credit agreement also contains typical events of default, including change of control, non-payment of obligations and cross-defaults to our other material indebtedness. Substantially all of our domestic assets are subject to security interests granted to lenders under the U.S. credit agreement. As of September 30, 2010, $139.0 of term loans, $36.5 million of borrowings under our revolving credit agreement and $1.3 million of letters of credit were outstanding under the U.S. credit agreement.
U.K. Credit Agreement
Our subsidiaries in the U.K. (the “U.K. subsidiaries”) are party to an agreement with the Royal Bank of Scotland plc, as agent for National Westminster Bank plc, which provides for a funded term loan, a revolving credit agreement, and a demand overdraft line of credit (collectively, the “U.K. Credit Agreement”) to be used for working capital, acquisitions, capital expenditures, investments and general corporate purposes. During the third quarter of 2010, the agreement was amended in connection with a reorganization of our European operations pursuant to which the maximum revolving borrowing capacity was reduced from £100.0 million to £86.6 million, which maximum will be increased in the future by amounts equal to the required term loan repayments.
As amended, the U.K. Credit Agreement includes (1) up to £86.6 million in revolving loans through August 31, 2013, which bears interest between a defined LIBOR plus 1.1% and defined LIBOR plus 3.0%, (2) a term loan which bears interest between 6.39% and 8.29% and is payable ratably in quarterly intervals until fully repaid on June 30, 2011, and (3) a demand overdraft line of credit for up to £10.0 million that bears interest at the Bank of England Base Rate plus 1.75%.

 

37


Table of Contents

The U.K. credit agreement is fully and unconditionally guaranteed on a joint and several basis by our U.K. subsidiaries, and contains a number of significant covenants that, among other things, restrict the ability of our U.K. subsidiaries to pay dividends, dispose of assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. In addition, our U.K. subsidiaries are required to comply with specified ratios and tests, each as defined in the U.K. Credit Agreement, including: a ratio of EBITDAR to interest plus rental payments (as defined), a measurement of maximum capital expenditures, and a debt to EBITDA ratio (as defined). A breach of these requirements would give rise to certain remedies under the agreement, the most severe of which is the termination of the agreement and acceleration of any amounts owed. As of September 30, 2010, our U.K. subsidiaries were in compliance with all covenants under the U.K. credit agreement and we believe they will remain in compliance with such covenants for the next twelve months. In making such determination, we have considered the current margin of compliance with the covenants and our expected future results of operations, working capital requirements, acquisitions, capital expenditures and investments in the U.K. See “Forward Looking Statements”.
The U.K. credit agreement also contains typical events of default, including change of control and non-payment of obligations and cross-defaults to other material indebtedness of our U.K. subsidiaries. Substantially all of our U.K. subsidiaries’ assets are subject to security interests granted to lenders under the U.K. Credit Agreement. As of September 30, 2010, outstanding loans under the U.K. Credit Agreement amounted to £64.2 million ($100.8 million), including £5.3 million ($8.3 million) under the term loan.
7.75% Senior Subordinated Notes
In December 2006 we issued $375.0 million aggregate principal amount of 7.75% senior subordinated notes due 2016 (the “7.75% Notes”). The 7.75% Notes are unsecured senior subordinated notes and are subordinate to all existing and future senior debt, including debt under our credit agreements, mortgages and floor plan indebtedness. The 7.75% Notes are guaranteed by substantially all of our wholly-owned domestic subsidiaries on an unsecured senior subordinated basis. Those guarantees are full and unconditional and joint and several. We can redeem all or some of the 7.75% Notes at our option beginning in December 2011 at specified redemption prices, or prior to December 2011 at 100% of the principal amount of the notes plus an applicable “make-whole” premium, as defined. Upon certain sales of assets or specific kinds of changes of control, we are required to make an offer to purchase the 7.75% Notes. The 7.75% Notes also contain customary negative covenants and events of default. As of September 30, 2010, we were in compliance with all negative covenants and there were no events of default.
Senior Subordinated Convertible Notes
In January 2006, we issued $375.0 million aggregate principal amount of 3.50% senior subordinated convertible notes due 2026 (the “Convertible Notes”), of which $150.6 million were outstanding at September 30, 2010. The Convertible Notes mature on April 1, 2026, unless earlier converted, redeemed or purchased by us, as discussed below. The Convertible Notes are unsecured senior subordinated obligations and are subordinate to all future and existing debt under our credit agreements, mortgages and floor plan indebtedness. The Convertible Notes are guaranteed on an unsecured senior subordinated basis by substantially all of our wholly-owned domestic subsidiaries. The guarantees are full and unconditional and joint and several. The Convertible Notes also contain customary negative covenants and events of default. As of September 30, 2010, we were in compliance with all negative covenants and there were no events of default.
Holders of the Convertible Notes may convert them based on a conversion rate of 42.7796 shares of our common stock per $1,000 principal amount of the Convertible Notes (which is equal to a conversion price of approximately $23.38 per share), subject to adjustment, only under the following circumstances: (1) in any quarterly period, if the closing price of our common stock for twenty of the last thirty trading days in the prior quarter exceeds $28.05 (subject to adjustment), (2) for specified periods, if the trading price of the Convertible Notes falls below specific thresholds, (3) if the Convertible Notes are called for redemption, (4) if specified distributions to holders of our common stock are made or specified corporate transactions occur, (5) if a fundamental change (as defined) occurs, or (6) during the ten trading days prior to, but excluding, the maturity date.
Upon conversion of the Convertible Notes, for each $1,000 principal amount of the Convertible Notes, a holder will receive an amount in cash, equal to the lesser of (i) $1,000 or (ii) the conversion value, determined in the manner set forth in the indenture covering the Convertible Notes, of the number of shares of common stock equal to the conversion rate. If the conversion value exceeds $1,000, we will also deliver, at our election, cash, common stock or a combination of cash and common stock with respect to the remaining value deliverable upon conversion.

 

38


Table of Contents

In the event of a conversion due to a change of control on or before April 6, 2011, we will, in certain circumstances, pay a make-whole premium by increasing the conversion rate used in that conversion. In addition, we will pay additional cash interest commencing with six-month periods beginning on April 1, 2011, if the average trading price of a Convertible Note for certain periods in the prior six-month period equals 120% or more of the principal amount of the Convertible Notes. On or after April 6, 2011, we may redeem the Convertible Notes, in whole at any time or in part from time to time, for cash at a redemption price of 100% of the principal amount of the Convertible Notes to be redeemed, plus any accrued and unpaid interest to the applicable redemption date.
Holders of the Convertible Notes may require us to purchase all or a portion of their Convertible Notes for cash on April 1, 2011, April 1, 2016 or April 1, 2021 at a purchase price equal to 100% of the principal amount of the Convertible Notes to be purchased, plus accrued and unpaid interest, if any, to the applicable purchase date. We expect to be required to redeem the Convertible Notes in April 2011. We currently expect to utilize cash flow from operations, working capital and availability under the U.S. credit agreement to redeem the Convertible Notes. See “Forward Looking Statements”.
In the third quarter of 2010, we repurchased $43.0 million principal amount of its outstanding Convertible Notes for $43.3 million. During the first nine months of 2010, we repurchased an aggregate $155.7 million principal amount of our outstanding Convertible Notes for $156.6 million.
Mortgage Facilities
We are party to several mortgages, which bear interest at defined rates and require monthly principal and interest payments. These mortgage facilities also contain typical events of default, including non-payment of obligations, cross-defaults to our other material indebtedness, certain change of control events, and loss or sale of certain franchises operated at the properties. Substantially all of the buildings and improvements on the properties financed pursuant to the mortgage facilities are subject to security interests granted to the lender. As of September 30, 2010, we owed $46.3 million of principal under our mortgage facilities.
Short-term Borrowings
We have three principal sources of short-term borrowing: the revolving portion of the U.S. Credit Agreement, the revolving portion of the U.K. Credit agreement, and the floor plan agreements in place that we utilize to finance our vehicle inventories. All of the cash generated in our operations is initially used to pay down our floor plan indebtedness. Over time, we are able to access availability under the floor plan agreements to fund our cash needs, including payments made relating to our higher interest rate revolving credit agreements.
During the third quarter of 2010, outstanding revolving commitments varied between no balance and $110.5 million under the U.S. Credit Agreement’s revolving credit line and between £17.0 million and £55.0 million under the U.K. Credit Agreement’s revolving credit line (excluding overdraft facility), and the amounts outstanding under our floor plan agreements varied based on the timing of the receipt and expenditure of cash in our operations, driven principally by the levels of our vehicle inventories.
Interest Rate Swaps
We use interest rate swaps to manage interest rate risk associated with our variable rate floor plan debt. We are party to interest rate swap agreements through January 2011 pursuant to which the LIBOR portion of $300.0 million of our floating rate floor plan debt was fixed at 3.67%. We may terminate these arrangements at any time, subject to the settlement of the then current fair value of the swap arrangements. During the nine months ended September 30, 2010 and 2009, the swaps increased the weighted average interest rate on floor plan borrowings by approximately 0.8% and 0.6%, respectively.
PTL Dividends
We own a 9.0% limited partnership interest in Penske Truck Leasing. During the nine months ended September 30, 2010 and 2009, respectively, we received $8.8 million and $20.0 million of pro rata cash dividends relating to this investment. We currently expect to continue to receive future dividends from PTL subject in amount and timing on its performance.

 

39


Table of Contents

Operating Leases
We have historically structured our operations so as to minimize our ownership of real property. As a result, we lease or sublease substantially all of our facilities. These leases are generally for a period between five and 20 years, and are typically structured to include renewal options at our election. Pursuant to the leases for some of our larger facilities, we are required to comply with specified financial ratios, including a “rent coverage” ratio and a debt to EBITDA ratio, each as defined. For these leases, non-compliance with the ratios may require us to post collateral in the form of a letter of credit. A breach of our other lease covenants give rise to certain remedies by the landlord, the most severe of which include the termination of the applicable lease and acceleration of the total rent payments due under the lease. As of September 30, 2010, we were in compliance with all covenants under these leases, and we believe we will remain in compliance with such covenants for the next twelve months.
Sale/Leaseback Arrangements
We have in the past and expect in the future to enter into sale-leaseback transactions to finance certain property acquisitions and capital expenditures, pursuant to which we sell property and/or leasehold improvements to third parties and agree to lease those assets back for a certain period of time. Such sales generate proceeds which vary from period to period. In light of current market conditions, this financing option has become more expensive and thus we may utilize these arrangements less in the near term.
Off-Balance Sheet Arrangements
We have sold a number of dealerships to third parties and, as a condition to certain of those sales, remain liable for the lease payments relating to the properties on which those businesses operate in the event of non-payment by the buyer. We are also party to lease agreements on properties that we no longer use in our retail operations that we have sublet to third parties. We rely on subtenants to pay the rent and maintain the property at these locations. In the event a subtenant does not perform as expected, we may not be able to recover amounts owed to us and we could be required to fulfill these obligations.
smart USA
We are subject to purchase commitments pursuant to the smart distribution agreement, which requires us to purchase a number of vehicles to be negotiated on an ongoing basis. In addition, we are potentially subject to a purchase commitment with respect to unsold inventories and other items pursuant to the smart franchise agreement and state franchise laws in the event of franchise terminations.
Cash Flows
Cash and cash equivalents decreased by $8.0 million and increased by $11.4 million during the nine months ended September 30, 2010 and 2009, respectively. The major components of these changes are discussed below.
Cash Flows from Continuing Operating Activities
Cash provided by operating activities was $124.3 million and $314.5 million during the nine months ended September 30, 2010 and 2009, respectively. Cash flows from continuing operating activities include net income, as adjusted for non-cash items, and the effects of changes in working capital.
We finance substantially all of our new and a portion of our used vehicle inventories under revolving floor plan notes payable with various lenders. We retain the right to select which, if any, financing source to utilize in connection with the procurement of vehicles. Many vehicle manufacturers provide vehicle financing for the dealers representing their brands, however, it is not a requirement that dealers utilize this financing. Historically, our floor plan finance source has been based on aggregate pricing considerations.
In accordance with general accounting principles relating to the statement of cash flows, we report all cash flows arising in connection with floor plan notes payable with the manufacturer of a particular new vehicle as an operating activity in our statement of cash flows, and all cash flows arising in connection with floor plan notes payable to a party other than the manufacturer of a particular new vehicle and all floor plan notes payable relating to pre-owned vehicles as a financing activity in our statement of cash flows.

 

40


Table of Contents

We believe that changes in aggregate floor plan liabilities are typically linked to changes in vehicle inventory and, therefore, are an integral part of understanding changes in our working capital and operating cash flow. As a result, we present the following reconciliation of cash flow from operating activities as reported in our condensed consolidated statement of cash flows as if all changes in vehicle floor plan were classified as an operating activity for informational purposes:
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
    (In thousands)  
Net cash from continuing operating activities as reported
  $ 124,316     $ 314,453  
Floor plan notes payable — non-trade as reported
    51,489       (125,996 )
 
           
 
               
Net cash from continuing operating activities, adjusted to include all floor plan notes payable
  $ 175,805     $ 188,457  
 
           
Cash Flows from Continuing Investing Activities
Cash used in continuing investing activities was $75.0 million and $64.5 million during the nine months ended September 30, 2010 and 2009, respectively. Cash flows from continuing investing activities consist primarily of cash used for capital expenditures, proceeds from sale-leaseback transactions, and net expenditures for acquisitions and other investments. Capital expenditures were $62.7 million and $70.1 million during the nine months ended September 30, 2010 and 2009, respectively. Capital expenditures relate primarily to improvements to our existing dealership facilities and the construction of new facilities. As of September 30, 2010, we do not have material commitments related to our planned or ongoing capital projects. We currently expect to finance our capital expenditures with operating cash flows or borrowings under our U.S. or U.K. credit facilities. Cash used in acquisitions and other investments, net of cash acquired, was $12.3 million and $8.5 million during the nine months ended September 30, 2010 and 2009, respectively, and included cash used to repay sellers floor plan liabilities in such business acquisitions of $7.2 million and $5.8 million, respectively. The nine months ended September 30, 2009 include $11.7 million of proceeds from other investing activities.
Cash Flows from Continuing Financing Activities
Cash used in continuing financing activities was $59.1 million and $226.2 million during the nine months ended September 30, 2010 and 2009, respectively. Cash flows from continuing financing activities include net borrowings or repayments of long-term debt, repurchases of securities, net borrowings or repayments of floor plan notes payable non-trade and the exercise of stock options. We had net borrowings of other long-term debt of $9.9 million for the nine months ended September 30, 2010, and net repayments of other long-term debt of $48.9 million during the nine months ended September 30, 2009, which included repayments of $10.0 million and $50.0 million on our U.S. credit agreement term loan, respectively. We used $156.6 million to repurchase $155.7 million aggregate principal amount of Convertible Notes during the nine months ended September 30, 2010 and used $51.4 million to repurchase $68.7 million aggregate principal amount of Convertible Notes during the nine months ended September 30, 2009. We had net borrowings of floor plan notes payable non-trade of $51.5 million and repayments of $126.0 million during the nine months ended September 30, 2010 and 2009, respectively. During the nine months ended September 30, 2010 and 2009, we received proceeds of $0.4 million and $0.1 million, respectively, from the exercise of stock options.
Cash Flows from Discontinued Operations
Cash flows relating to discontinued operations are not currently considered, nor are they expected to be, material to our liquidity or our capital resources.
Related Party Transactions
Stockholders Agreement
Several of our directors and officers are affiliated with Penske Corporation or related entities. Roger S. Penske, our Chairman of the Board and Chief Executive Officer, is also Chairman of the Board and Chief Executive Officer of Penske Corporation, and through entities affiliated with Penske Corporation, our largest stockholder owning approximately 35% of our outstanding common stock. Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (collectively, “Mitsui”) own approximately 17% of our outstanding common stock. Mitsui, Penske Corporation and certain other affiliates of Penske Corporation are parties to a stockholders agreement pursuant to which the Penske affiliated companies agreed to vote their shares for one director who is a representative of Mitsui. In turn, Mitsui agreed to vote their shares for up to fourteen directors voted for by the Penske affiliated companies. This agreement terminates in March 2014, upon the mutual consent of the parties, or when either party no longer owns any of our common stock.

 

41


Table of Contents

Other Related Party Interests and Transactions
Roger S. Penske is also a managing member of Transportation Resource Partners, an organization that invests in transportation-related industries. Richard J. Peters, one of our directors, is a managing director of Transportation Resource Partners and is a director of Penske Corporation. Robert H. Kurnick, Jr., our President and a director, is also the President and a director of Penske Corporation.
We sometimes pay to and/or receive fees from Penske Corporation, its subsidiaries, and its affiliates for services rendered in the normal course of business, or to reimburse payments made to third parties on each other’s behalf. These transactions are reviewed periodically by our Audit Committee and reflect the provider’s cost or an amount mutually agreed upon by both parties.
We are a 9.0% limited partner of PTL, a leading global transportation services provider. PTL operates and maintains more than 200,000 vehicles and serves customers in North America, South America, Europe and Asia. Product lines include full-service leasing, contract maintenance, commercial and consumer truck rental and logistics services, including, transportation and distribution center management and supply chain management. The general partner of PTL is Penske Truck Leasing Corporation, a wholly-owned subsidiary of Penske Corporation, which together with other wholly-owned subsidiaries of Penske Corporation, owns 41.1% of PTL. The remaining 49.9% of PTL is owned by GE Capital. Among other things, the partnership agreement provides us with specified partner distribution and governance rights and restricts our ability to transfer our interests. We have also entered into other joint ventures with certain related parties as more fully discussed below.
Joint Venture Relationships
We are party to a number of joint ventures pursuant to which we own and operate automotive dealerships together with other investors. We may provide these dealerships with working capital and other debt financing at costs that are based on our incremental borrowing rate. As of September 30, 2010, our automotive retail joint venture relationships were as follows:
             
        Ownership  
Location   Dealerships   Interest  
Fairfield, Connecticut
  Audi, Mercedes-Benz, Porsche, smart     87.95 %(A)(B)
Edison, New Jersey
  Ferrari, Maserati     70.00 %(B)
Las Vegas, Nevada
  Ferrari, Maserati     50.00 %(C)
Frankfurt, Germany
  Lexus, Toyota     50.00 %(C)
Aachen, Germany
  Audi, Lexus, Skoda, Toyota, Volkswagen     50.00 %(C)
     
(A)  
An entity controlled by one of our directors, Lucio A. Noto (the “Investor”), owns a 12.05% interest in this joint venture which entitles the Investor to 20% of the joint venture’s operating profits. In addition, the Investor has an option to purchase up to a 20% interest in the joint venture for specified amounts.
 
(B)  
Entity is consolidated in our financial statements.
 
(C)  
Entity is accounted for using the equity method of accounting.
In the first quarter of 2010, the Company exited one of its German joint ventures by exchanging its 50% interest in the joint venture for 100% ownership in three BMW franchises previously held by the joint venture.
Cyclicality
Unit sales of motor vehicles, particularly new vehicles, historically have been cyclical, fluctuating with general economic cycles. During economic downturns, the automotive retailing industry tends to experience periods of decline and recession similar to those experienced by the general economy. We believe that the industry is influenced by general economic conditions and particularly by consumer confidence, the level of personal discretionary spending, fuel prices, interest rates and credit availability.
Seasonality
Our business is modestly seasonal overall. Our U.S. operations generally experience higher volumes of vehicle sales in the second and third quarters of each year due in part to consumer buying trends and the introduction of new vehicle models. Also, vehicle demand, and to a lesser extent demand for service and parts, is generally lower during the winter months than in other seasons, particularly in regions of the U.S. where dealerships may be subject to severe winters. Our U.K. operations generally experience higher volumes of vehicle sales in the first and third quarters of each year, due primarily to vehicle registration practices in the U.K.

 

42


Table of Contents

Effects of Inflation
We believe that inflation rates over the last few years have not had a significant impact on revenues or profitability. We do not expect inflation to have any near-term material effects on the sale of our products and services; however, we cannot be sure there will be no such effect in the future. We finance substantially all of our inventory through various revolving floor plan arrangements with interest rates that vary based on various benchmarks. Such rates have historically increased during periods of increasing inflation.
Forward Looking Statements
This quarterly report on Form 10-Q contains “forward-looking statements” which generally can be identified by the use of terms such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “intend,” “plan,” “estimate,” “predict,” “potential,” “forecast,” “continue” or variations of such terms, or the use of these terms in the negative. Forward-looking statements include statements regarding our current plans, forecasts, estimates, beliefs or expectations, including, without limitation, statements with respect to:
   
our future financial and operating performance;
 
   
future acquisitions;
 
   
future potential capital expenditures and securities repurchases;
 
   
our ability to realize cost savings and synergies;
 
   
our ability to respond to economic cycles;
 
   
trends in the automotive retail industry and in the general economy in the various countries in which we operate;
 
   
our ability to access the remaining availability under our credit agreements;
 
   
our liquidity, including our ability to refinance our outstanding senior subordinated convertible notes;
 
   
future foreign exchange rates;
 
   
trends affecting our future financial condition or results of operations; and
 
   
our business strategy.
Forward-looking statements involve known and unknown risks and uncertainties and are not assurances of future performance. Actual results may differ materially from anticipated results due to a variety of factors, including the factors identified in our 2009 annual report on Form 10-K filed February 24, 2010. Important factors that could cause actual results to differ materially from our expectations include the following:
   
our business and the automotive retail industry in general are susceptible to adverse economic conditions, including changes in interest rates, foreign exchange rates, consumer demand, consumer confidence, fuel prices, unemployment rates and credit availability;
 
   
the number of new and used vehicles sold in our markets;
 
   
automobile manufacturers exercise significant control over our operations, and we depend on them in order to operate our business;
 
   
we depend on the success and popularity of the brands we sell, and adverse conditions affecting one or more automobile manufacturers, such as the recent Toyota recalls, may negatively impact our revenues and profitability;
 
   
a restructuring of any significant automotive manufacturers, as well as the automotive sector as a whole;
 
   
we may not be able to satisfy our capital requirements for acquisitions, dealership renovation projects, financing the purchase of our inventory, or refinancing of our debt when it becomes due (including our $150.6 million of outstanding senior subordinated convertible notes expected to be repaid in April 2011);

 

43


Table of Contents

   
our failure to meet a manufacturer’s consumer satisfaction requirements may adversely affect our ability to acquire new dealerships, our ability to obtain incentive payments from manufacturers;
 
   
although we typically purchase vehicles and parts in the local functional currency, changes in foreign exchange rates may impact manufacturers, as many of the component parts of vehicles are manufactured in foreign markets, which could lead to an increase in our costs which we may not be able to pass on to the consumer;
 
   
changes in tax, financial or regulatory rules or requirements;
 
   
with respect to PTL, changes in the financial health of its customers, labor strikes or work stoppages by its employees, a reduction in PTL’s asset utilization rates and industry competition;
 
   
if we lose key personnel, especially our Chief Executive Officer, or are unable to attract additional qualified personnel;
 
   
import product restrictions and foreign trade risks that may impair our ability to sell foreign vehicles profitably;
 
   
new or enhanced regulations relating to automobile dealerships;
 
   
if state dealer laws in the U.S. are repealed or weakened, our automotive dealerships may be subject to increased competition and may be more susceptible to termination, non-renewal or renegotiation of their franchise agreements;
 
   
non-compliance with the financial ratios and other covenants under our credit agreements and operating leases;
 
   
our distribution of the smart fortwo vehicle is dependent upon continued availability of and customer demand for the smart fortwo;
 
   
actual results of our efforts to procure a new vehicle for distribution through the smart USA dealer network are subject to completion of binding documentation, performance by certain vendors and suppliers, and other conditions many of which may be outside of our control.
 
   
our dealership operations may be affected by severe weather or other periodic business interruptions;
 
   
some of our directors and officers may have conflicts of interest with respect to certain related party transactions and other business interests;
 
   
our level of indebtedness may limit our ability to obtain financing generally and may require that a significant portion of our cash flow be used for debt service;
 
   
we may be involved in legal proceedings that could have a material adverse effect on our business; and
 
   
our operations outside of the U.S. subject our profitability to fluctuations relating to changes in foreign currency valuations.
In addition:
   
the price of our common stock is subject to substantial fluctuation, which may be unrelated to our performance; and
   
shares eligible for future sale, or issuable under the terms of our convertible notes, may cause the market price of our common stock to drop significantly, even if our business is doing well.

 

44


Table of Contents

We urge you to carefully consider these risk factors in evaluating all forward-looking statements regarding our business. Readers of this report are cautioned not to place undue reliance on the forward-looking statements contained in this report. All forward-looking statements attributable to us are qualified in their entirety by this cautionary statement. Except to the extent required by the federal securities laws and Securities and Exchange Commission rules and regulations, we have no intention or obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
Interest Rates. We are exposed to market risk from changes in the interest rates on a significant portion of our outstanding debt. Outstanding revolving balances under our credit agreements bear interest at variable rates based on a margin over defined LIBOR or the Bank of England Base Rate. Based on the amount outstanding under these facilities as of September 30, 2010, a 100 basis point change in interest rates would result in an approximate $2.7 million change to our annual other interest expense. Similarly, amounts outstanding under floor plan financing arrangements bear interest at a variable rate based on a margin over the prime rate, defined LIBOR, the Finance House Base Rate, or the Euro Interbank Offered Rate. We are currently party to swap agreements pursuant to which a notional $300.0 million of our floating rate floor plan debt was exchanged for fixed rate debt through January 2011. Based on an average of the aggregate amounts outstanding under our floor plan financing arrangements subject to variable interest payments during the trailing twelve months ended September 30, 2010, adjusted to exclude the notional value of the hedged swap agreements, a 100 basis point change in interest rates would result in an approximate $9.9 million change to our annual floor plan interest expense.
We evaluate our exposure to interest rate fluctuations and follow established policies and procedures to implement strategies designed to manage the amount of variable rate indebtedness outstanding at any point in time in an effort to mitigate the effect of interest rate fluctuations on our earnings and cash flows. These policies include:
   
the maintenance of our overall debt portfolio with targeted fixed and variable rate components;
 
   
the use of authorized derivative instruments;
 
   
the prohibition of using derivatives for trading or other speculative purposes; and
 
   
the prohibition of highly leveraged derivatives or derivatives which we are unable to reliably value, or for which we are unable to obtain a market quotation.
Interest rate fluctuations affect the fair market value of our fixed rate debt, including our swaps, mortgages, the 7.75% Notes, the Convertible Notes, and certain seller financed promissory notes, but, with respect to such fixed rate debt instruments, do not impact our earnings or cash flows.
Foreign Currency Exchange Rates. As of September 30, 2010, we had dealership operations in the U.K. and Germany. In each of these markets, the local currency is the functional currency. Due to our intent to remain permanently invested in these foreign markets, we do not hedge against foreign currency fluctuations. In the event we change our intent with respect to the investment in any of our international operations, we would expect to implement strategies designed to manage those risks in an effort to mitigate the effect of foreign currency fluctuations on our earnings and cash flows. A ten percent change in average exchange rates versus the U.S. Dollar would have resulted in an approximate $294.6 million change to our revenues for the nine months ended September 30, 2010.
In common with other automotive retailers, we purchase certain of our new vehicle and parts inventories from foreign manufacturers. Although we purchase the majority of our inventories in the local functional currency, our business is subject to certain risks, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility which may influence such manufacturers’ ability to provide their products at competitive prices in the local jurisdictions. Our future results could be materially and adversely impacted by changes in these or other factors.
Item 4.  
Controls and Procedures
Under the supervision and with the participation of our management, including the principal executive and financial officers, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our principal executive and financial officers, to allow timely discussions regarding required disclosure.

 

45


Table of Contents

Based upon this evaluation, the Company’s principal executive and financial officers concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, we maintain internal controls designed to provide us with the information required for accounting and financial reporting purposes. There were no changes in our internal control over financial reporting that occurred during the most recent quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1.  
Legal Proceedings
We are involved from time-to-time in litigation which may relate to claims brought by governmental authorities, issues with customers, and employment related matters, including class action claims and purported class action claims. As of September 30, 2010, we are not party to any legal proceedings, including class action lawsuits, that, individually or in the aggregate, are reasonably expected to have a material adverse effect on our results of operations, financial condition or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our results of operations, financial condition or cash flows.
Item 6.  
Exhibits
         
  4.1    
Amendment dated September 22, 2010 to multi-option credit agreement and fixed rate credit agreement each dated August 31, 2006 between Sytner Group Limited and The Royal Bank of Scotland, plc, as agent for National Westminster Bank Plc.
  10.1    
Amendment No. 2 dated September 20, 2010 to the Amended and Restated Penske Automotive Group 401(k) Savings and Retirement Plan.
  12    
Computation of Ratio of Earnings to Fixed Charges
  31.1    
Rule 13(a)-14(a)/15(d)-14(a) Certification.
  31.2    
Rule 13(a)-14(a)/15(d)-14(a) Certification.
  32    
Section 1350 Certification.
  101    
The following materials from Penske Automotive Group’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Condensed Balance Sheets as of September 30, 2010 and December 31, 2009, (ii) the Consolidated Condensed Statements of Income for the three and nine months ended September 30, 2010 and 2009, (iii) the Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2010 and 2009, (iv) the Consolidated Condensed Statement of Equity for the nine months ended September 30, 2010, and (v) the Notes to Consolidated Condensed Financial Statements, tagged as blocks of text.*
     
*  
Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

46


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
             
    PENSKE AUTOMOTIVE GROUP, INC.    
 
           
 
  By:   /s/ Roger S. Penske
 
Roger S. Penske
   
Date: November 4, 2010
      Chief Executive Officer    
 
           
 
  By:   /s/ Robert T. O’Shaughnessy
 
Robert T. O’Shaughnessy
   
Date: November 4, 2010
      Chief Financial Officer    

 

47


Table of Contents

EXHIBIT INDEX
         
Exhibit    
No.   Description
       
 
  4.1    
Amendment dated September 22, 2010 to multi-option credit agreement and fixed rate credit agreement each dated August 31, 2006 between Sytner Group Limited and The Royal Bank of Scotland, plc, as agent for National Westminster Bank Plc.
  10.1    
Amendment No. 2 dated September 20, 2010 to the Amended and Restated Penske Automotive Group 401(k) Savings and Retirement Plan.
  12    
Computation of Ratio of Earnings to Fixed Charges
  31.1    
Rule 13(a)-14(a)/15(d)-14(a) Certification.
  31.2    
Rule 13(a)-14(a)/15(d)-14(a) Certification.
  32    
Section 1350 Certification.
  101    
The following materials from Penske Automotive Group’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Balance Sheets as of September 30, 2010 and December 31, 2009, (ii) the Condensed Statements of Income for the three and nine months ended September 30, 2010 and 2009, (iii) the Condensed Statements of Cash Flows for the nine months ended September 30, 2010 and 2009, (iv) the Consolidated Condensed Statement of Equity for the nine months ended September 30, 2010, and (v) the Notes to Consolidated Condensed Financial Statements, tagged as blocks of text*.
     
*  
Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

48