UNITED STATES
Form 10-Q
Commission file number 1-12297
United Auto Group, Inc.
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
As of November 12, 2002, there were 38,839,026 shares of voting common stock outstanding and 1,758,784 shares of non-voting common stock outstanding.
TABLE OF CONTENTS
1
UNITED AUTO GROUP, INC.
See Notes to Consolidated Condensed Financial Statements
2
3
4
[Additional columns below]
[Continued from above table, first column(s) repeated]
5
1. Basis of Presentation
The information presented as of September 30, 2002 and 2001 and for the three and nine month periods then ended is unaudited, but includes all adjustments (consisting only of normal recurring accruals) which the management of United Auto Group, Inc. (the “Company”) believes to be necessary for the fair presentation of results for the periods presented. The results for the 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, 2001, which were included as part of the Company’s Annual Report on Form 10-K. In order to maintain consistency and comparability of financial information between periods presented, certain reclassifications have been made to the Company’s prior year consolidated condensed financial statements to conform to the current year presentation.
2. Inventories
Inventories consisted of the following:
3. Business Combinations
During 2002 and 2001, the Company completed a number of acquisitions. Each of these acquisitions has been accounted for using the purchase method of accounting. As a result, the Company’s financial statements include the results of operations of the acquired dealerships only from the date of acquisition.
During the nine months ended September 30, 2002, the Company acquired 69 automobile dealership franchises. The aggregate consideration paid in connection with such acquisitions amounted to $182,030 in cash. The consolidated condensed balance sheets include preliminary allocations of the purchase price relating to these acquisitions, which are subject to final adjustment pending the final implementation by the Company of Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangibles (“SFAS No. 142”). Such allocations resulted in recording approximately $183,930 of intangibles.
The following unaudited consolidated pro forma results of operations of the Company for the nine month periods ended September 30, 2002 and 2001 give effect to acquisitions consummated subsequent to January 1, 2001 as if they had occurred on January 1, 2001.
6
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)
4. Capital Stock
In February 2002, affiliates of Penske Corporation exercised warrants to acquire voting and non-voting common stock of the Company. The warrants were issued in connection with such affiliates’ investment in the Company in 1999. As a result, the Company issued 3,916 shares of voting common stock and 1,106 shares of non-voting common stock in exchange for $62,520. In March 2002, the Company completed the sale of 3,000 shares of voting common stock to the public in an underwritten registered offering at $22.00 per share. Net proceeds of the two equity transactions totaled approximately $123,393, which was used to repay indebtedness under the Company’s credit agreement.
In September 2002, the Company repurchased 1,009 shares of common stock from Combined Specialty Insurance Company, a wholly owned subsidiary of Aon Corporation, for $15.85 per share with funds obtained from borrowings under the Company’s credit agreement.
5. Discontinued Operations
During 2002, the Company has sold or has entered into definitive agreements to sell five dealerships which qualify for treatment as discontinued operations in accordance with Statement of Financial Accounting Standards No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. Combined financial information of the dealerships follows:
6. Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142. As a result, the Company no longer amortizes goodwill. The Company completed the intangible impairment assessment required by SFAS No. 142 and determined that no adjustment to the carrying value of goodwill is required. The following
7
income statement information is presented as if the Company stopped amortizing goodwill as of January 1, 2001:
7. Earnings Per Share
Income available to common shareholders used in the computation of basic earnings per share data is based on net income, adjusted to reflect accrued dividends relating to outstanding preferred stock. Basic earnings per share data is computed using the weighted average number of common shares outstanding. Diluted earnings per share data is based on the weighted average number of common shares outstanding, adjusted for the dilutive effect of stock options, preferred stock and warrants. For the three and nine months ended September 30, 2002, 884 and 82 shares issuable upon the exercise of outstanding options were excluded from the calculation of diluted earnings per share because the effect of such securities was antidilutive. For the three and nine months ended September 30, 2001, 218 and 978 shares issuable upon the exercise of outstanding options were excluded from the calculation of diluted earnings per share because the effect of such securities was antidilutive. A reconciliation of the number of shares used in the calculation of basic and dilutive earnings per share for the three and nine month periods ended September 30, 2002 and 2001 follows:
8
8. Supplemental Cash Flow Information
The following table presents certain supplementary information to the consolidated condensed statements of cash flows:
9. Sale-Leaseback Transactions
The Company finances a portion of its dealership expansion program through sale-leaseback transactions with Automotive Group Realty, LLC (“AGR”), a wholly-owned subsidiary of Penske Corporation. Sales of real property are valued at a price that was either independently confirmed by a third party appraiser, or for the price paid by the Company to an independent third party. Improvements are sold for the Company’s cost. All sale-leaseback transactions with AGR have been consummated at the Company’s net book value, and the resulting leases are being accounted for as operating leases. To date during 2002, the Company has entered into sale-leaseback transactions for $80,000 of properties and related improvements.
10. Senior Subordinated Notes
In March 2002, the Company completed the sale of $300,000 aggregate principal amount of 9.625% Senior Subordinated Notes due 2012. The sale of the notes was exempt from registration pursuant to Rule 144A and Regulation S under the Securities Act, as amended. The notes are unsecured senior subordinated notes and rank behind all existing and future senior debt, including debt under our credit agreement. The notes are guaranteed by substantially all of our domestic subsidiaries on a senior subordinated basis. We can redeem all or some of the notes at our option beginning in 2007 at specified redemption prices. In addition, until 2005 we are allowed to redeem up to 35% of the notes with the net cash proceeds from specified public equity offerings. Upon a change of control each holder of notes will be able to require us to repurchase all or some of the notes at a redemption price of 101% of the principal amount of the notes. The notes also contain customary negative covenants and events of default. Net proceeds from the offering amounted to approximately $292,200, which was used to repay indebtedness under the Company’s credit agreement.
11. Condensed Consolidating Financial Information
The following tables include condensed consolidating financial information as of September 30, 2002 and December 31, 2001 and for the three and nine month periods ended September 30, 2002 and 2001 for United Auto Group, Inc. (as the issuer), wholly-owned subsidiary guarantors, non-wholly owned guarantors, 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 and cash flows of these entities on a stand-alone basis.
9
10
CONDENSED CONSOLIDATING BALANCE SHEETS — (Continued)
11
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
12
CONDENSED CONSOLIDATING STATEMENTS OF INCOME — (Continued)
13
14
15
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
16
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS — (Continued)
17
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.
General
We are the second largest publicly-held automotive retailer in the United States as measured by total revenues. As of September 30, 2002, we owned and operated 126 franchises in the United States and 71 franchises internationally, primarily in the United Kingdom. As an integral part of our dealership operations, we retail new and used automobiles and light trucks, operate service and parts departments, operate collision repair centers and sell various aftermarket products, including finance, warranty, extended service and other insurance contracts.
New vehicle revenues include sales to retail customers and to leasing companies providing consumer automobile leasing. Used vehicle revenues include amounts received for used vehicles sold to retail customers, leasing companies providing consumer leasing and other dealers. We generate finance and insurance revenues from sales of warranty policies, extended service contracts, other insurance policies, and accessories, as well as from fees for placing finance and lease contracts. Service and parts revenues include fees paid for repair and maintenance service, the sale of replacement parts and body shop repairs.
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, and service and parts services. Our gross profit generally varies across product lines, with new vehicle sales usually resulting in lower gross profit margins and our other products resulting in higher gross profit margins. Factors such as seasonality, weather, cyclicality and manufacturers’ advertising and incentives may impact the mix of our revenues, and therefore influence our gross profit margin.
Our selling expenses consist of advertising and compensation for sales department personnel, including commissions and related bonuses. General and administrative expenses include compensation for administration, finance, legal and general management personnel, depreciation, amortization, rent, insurance, utilities and other outside services. A significant portion of our selling expenses are variable, and 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 floor plan financing. Other interest expense consists of interest charges on all of our interest-bearing debt, other than interest relating to floor plan financing.
We have made a number of dealership acquisitions in 2002 and 2001. Each of these acquisitions has been accounted for using the purchase method of accounting. As a result, our financial statements include the results of operations of the acquired dealerships from the date of acquisition.
Critical Accounting Policies
The preparation of financial statements in accordance with accounting standards generally accepted in the United States of America requires the application of accounting policies that often involve a significant amount of judgment. Such judgments influence the reported amounts of the assets, liabilities, revenues and expenses in the Company’s consolidated financial statements. Management, on an ongoing basis, reviews estimates and assumptions. If management determines, as a result of its consideration of facts and circumstances, that modifications in assumptions and estimates are appropriate, results of operations and financial position as reported in the consolidated financial statements may change significantly.
Following is a summary of the accounting policies applied in the preparation of our consolidated financial statements that management believes are most dependent upon the use of estimates and assumptions.
18
Finance and Insurance Revenue Recognition
The Company arranges financing for customers through various financial institutions and receives a commission from the lender equal to the difference between the interest rates charged to customers over the predetermined interest rates set by the financing institution. The Company also receives commissions from the sale of various insurance products to customers, including credit, life, and health insurance policies and extended service contracts. The Company receives fee income from the placement of these contracts at the time the customer enters into the contract. The Company is not the obligor under any of these contracts. In the case of finance contracts, a customer may prepay, or fail to pay, thereby terminating the contract. Customers may also terminate extended warranty contracts with the underlying warranty provider, which are fully paid at purchase, and become eligible for refunds of unused premiums. If the customer terminates a retail finance contract or cancels an extended warranty or other insurance product prior to scheduled maturity, a portion of these fees may be charged back to us based on the relevant terms of the contracts. The revenue we record relating to these fees is net of an estimate of the ultimate amount of chargebacks we will be required to pay. Such estimate of ultimate chargeback exposure is based on our historical chargeback expense arising from similar contracts, including the impact of refinance and default rates on retail finance contracts and cancellation rates on extended warranty contracts and other insurance products.
Results of Operations
Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001
Revenues. Retail revenues, which exclude revenues relating to fleet and wholesale transactions, increased by $517.9 million, or 37.5%, from $1.4 billion to $1.9 billion. The overall increase in retail revenues is due primarily to (1) a $100.2 million, or 7.4%, increase in retail revenues at dealerships owned prior to July 1, 2001, and (2) a $435.0 million increase at dealerships acquired subsequent to July 1, 2001. The overall increase in retail revenues at dealerships owned prior to July 1, 2001 reflects 9.2%, 1.9%, 10.3% and 6.3% increases in new retail vehicle, used retail vehicle, finance and insurance and service and parts revenues, respectively. Revenues of $163.8 million from fleet and wholesale transactions represent a 27.8% increase versus the prior year. The increase in fleet and wholesale revenues is due to $41.7 million from acquisitions subsequent to July 1, 2001, offset by a $4.5 million, or 3.6%, decrease at stores owned prior to July 1, 2001.
Retail sales of new vehicles increased by $312.5 million, or 34.2%, from $914.6 million to $1.2 billion. The increase is due primarily to (1) an $82.4 million, or 9.2%, increase at dealerships owned prior to July 1, 2001 and (2) a $241.5 million increase at dealerships acquired subsequent to July 1, 2001. The increase at dealerships owned prior to July 1, 2001, is due primarily to a 6.2% increase in new retail unit sales, which increased revenue by $57.3 million, and a 2.8% increase in comparative average selling prices per vehicle, which increased revenue by $25.1 million. The Company believes that this increase is due in part to its favorable brand mix, which includes a higher concentration of foreign nameplates which have been steadily increasing market share in the US, coupled with aggressive incentive programs being offered by domestic nameplate manufacturers. Approximately 78% of the increase in new retail unit sales at dealerships owned prior to July 1, 2001 results from sales of these foreign nameplates. Aggregate retail unit sales of new vehicles increased by 25.7%, due principally to: (1) the net increase at dealerships owned prior to July 1, 2001 and (2) a 7,388 increase in new vehicle retail unit sales at dealerships acquired subsequent to July 1, 2001. We retailed 44,432 new vehicles (68.1% of total retail vehicle sales) during the three months ended September 30, 2002, compared with 35,351 new vehicles (67.8% of total retail vehicle sales) during the three months ended September 30, 2001.
Retail sales of used vehicles increased by $138.4 million, or 50.7%, from $272.8 million to $411.2 million. The increase is due primarily to (1) a $5.0 million, or 1.9%, increase at dealerships owned prior to July 1, 2001 and (2) a $138.5 million increase at dealerships acquired subsequent to July 1, 2001. The increase at dealerships owned prior to July 1, 2001 is due primarily to a 0.3% increase in used retail unit sales which increased revenue by $0.8 million, and a 1.6% increase in comparative average selling prices per vehicle which increased revenue by $4.2 million. The Company believes the relative affordability of new vehicles resulting from manufacturer incentive programs has negatively impacted used vehicles sales growth during the three
19
Finance and insurance revenues increased by $11.6 million, or 30.3%, from $38.3 million to $49.9 million. The increase is due primarily to: (1) a $3.5 million, or 10.3%, increase at dealerships owned prior to July 1, 2001 and (2) a $7.3 million increase at dealerships acquired subsequent to July 1, 2001. The increase at dealerships owned prior to July 1, 2001 is primarily due to a revenue increase of $38 per retail vehicle sold, which increased revenue by $1.9 million, and a 4.3% increase in retail vehicles sold, which increased revenue by $1.6 million.
Service and parts revenues increased by $55.3 million, or 36.3%, from $152.2 million to $207.6 million. The increase is due primarily to (1) an $9.4 million, or 6.3%, increase at dealerships owned prior to July 1, 2001 and (2) a $47.8 million increase at dealerships acquired subsequent to July 1, 2001. The Company believes that its service and parts business is being positively impacted by the complexity of today’s vehicles, manufacturers’ warranty programs for both new and certified used vehicles, increases in retail unit sales at our dealerships and capacity increases in our service and parts operations resulting from capital construction projects.
Fleet revenues decreased $4.5 million, or 12.1%, versus the comparable prior year period. The decrease in fleet revenues is due primarily to a $6.3 million, or 17.0%, decrease in fleet sales revenues at dealerships owned prior to July 1, 2001, partially offset by a $1.8 million increase at stores acquired subsequent to July 1, 2001. The Company has elected to de-emphasize the low margin fleet business and expects fleet sales volumes to remain lower in the future.
Wholesale revenues increased $40.2 million, or 44.1%, versus the comparable prior year period. The increase in wholesale revenues is due primarily to (1) a $1.8 million, or 2.0%, increase at dealerships owned prior to July 1, 2001 and (2) a $39.9 million increase at dealerships acquired subsequent to July 1, 2001. The Company believes the increase at dealerships owned prior to July 1, 2001 is due in part to the relative strength of the new car market, resulting in an increase in the number of cars taken in on trade, versus the relative weakness of the used car market.
Gross Profit. Retail gross profit, which excludes gross profit on fleet and wholesale transactions, increased $76.5 million, or 36.0%, from $212.4 million to $288.9 million. The increase in gross profit is due to: (1) a $12.4 million, or 6.1%, increase in retail gross profit at stores owned prior to July 1, 2001 and (2) a $65.4 million increase at dealerships acquired subsequent to July 1, 2001. Retail gross profit as a percentage of revenues from retail transactions decreased from 15.4% to 15.2%. Gross profit as a percentage of revenues for new vehicle retail, used vehicle retail, finance and insurance and service and parts revenues was 8.2%, 9.7%, 100.0%, and 47.3%, respectively, compared with 8.4%, 10.7%, 100.0% and 44.8% in the comparable prior year period. The decrease in retail gross profit as a percentage of revenues from retail transactions is primarily attributable to (1) decreased margins on the sale of used vehicle, which relate primarily to the lower margins realized on used vehicle sales in the UK, (2) decreased margins on the sale of new vehicles, which are due primarily to margin compression in the US, offset in part by higher margins realized on new vehicle sales in the UK, and (3) a decrease in the percentage of higher margin finance and insurance revenues to total retail revenues, offset in part by (1) increased gross profit margins on service and parts revenues, which result from the realization of higher margins in the US and UK, and (2) an increase in the relative proportion of used vehicle retail sales to total vehicle sales. Aggregate gross profit on fleet and wholesale transactions decreased by $0.9 million to a loss of $1.2 million.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $58.4 million, or 34.1%, from $171.4 million to $229.8 million. Such expenses decreased as a percentage of total revenue from 11.4% to 11.2%, and decreased as a percentage of gross profit from 80.8% to 79.9%. The aggregate increase in selling, general and administrative expenses is due principally to: (1) a $16.1 million, or 10.3%, increase at dealerships owned prior to July 1, 2001, and (2) a $51.2 million increase at dealerships
20
Floor Plan Interest Expense. Floor plan interest expense increased by $0.1 million, or 0.9%, from $9.0 million to $9.1 million. The increase in floor plan interest expense is due to a $1.7 million, or 19.0%, decrease at stores owned prior to July 1, 2001, partially offset by a $1.9 million increase at dealerships acquired subsequent to July 1, 2001. The decrease at stores owned prior to July 1, 2001 is due primarily to a decrease in inventory at those dealerships, coupled with a decrease in our weighted average borrowing rate on floor plan indebtedness during 2002.
Other Interest Expense. Other interest expense increased by $2.0 million, or 25.0%, from $8.0 million to $10.0 million. The increase is due primarily to increased acquisition related indebtedness, including approximately $140.0 million borrowed in connection with the acquisition of the Sytner Group plc in March 2002, offset in part by (1) a decrease in our weighted average borrowing rate during 2002 and (2) the pay-down of indebtedness with proceeds from equity offerings subsequent to December 31, 2001.
Income Taxes. Income taxes increased by $5.4 million from $10.3 million to $15.7 million. The increase is due to an increase in pre-tax income compared with 2001, partially offset by a decrease in our estimated effective annual tax rate.
Discontinued Operations. Income (loss) from discontinued operations, consisting of the results of operations which have been or will be divested or closed, decreased by $0.8 million from $0.2 million to a loss of $0.6 million. The current year results include an after-tax gain on disposal of $0.5 million.
Revenues. Retail revenues, which exclude revenues relating to fleet and wholesale transactions, increased by $1.1 billion, or 28.8%, from $4.0 billion to $5.1 billion. The overall increase in retail revenues is due primarily to: (1) a $200.0 million, or 5.6%, increase in retail revenues at dealerships owned prior to January 1, 2001, and (2) a $1.0 billion increase at dealerships acquired subsequent to January 1, 2001. The overall increase in retail revenues at dealerships owned prior to January 1, 2001 reflects 7.0%, 9.9% and 6.2% increases in new retail vehicle, finance and insurance and service and parts revenues, respectively. Revenues of $448.8 million from fleet and wholesale transactions represent a 17.3% increase versus the prior year. The increase in fleet and wholesale revenues is due to $97.1 million from acquisitions subsequent to January 1, 2001, offset by a $23.2 million, or 6.7%, decrease at stores owned prior to January 1, 2001.
Retail sales of new vehicles increased by $685.6 million, or 26.2%, from $2.6 billion to $3.3 billion. The increase is due primarily to: (1) a $166. million, or 7.0%, increase at dealerships owned prior to January 1, 2001 and (2) a $561.2 million increase at dealerships acquired subsequent to January 1, 2001. The increase at dealerships owned prior to January 1, 2001, is due primarily to a 4.4% increase in new retail unit sales, which increased revenue by $106.9 million, and a 2.5% increase in comparative average selling prices per vehicle, which increased revenue by $59.1 million. The Company believes that this increase is due in part to its favorable brand mix, which includes a higher concentration of foreign nameplates which have been steadily increasing market share in the US, coupled with aggressive incentive programs being offered by domestic nameplate manufacturers. Approximately 89% of the increase in new retail unit sales at dealerships owned prior to January 1, 2001 results from sales of these foreign nameplates. Aggregate retail unit sales of new vehicles increased by 19.9%, due principally to: (1) the net increase at dealerships owned prior to January 1, 2001 and (2) a 17,617 increase in new vehicle retail unit sales at dealerships acquired subsequent to January 1, 2001. We retailed 119,662 new vehicles (67.4% of total retail vehicle sales) during the nine months ended September 30, 2002, compared with 100,016 new vehicles (67.0% of total retail vehicle sales) during the nine months ended September 30, 2001.
21
Retail sales of used vehicles increased by $299.3 million, or 37.1%, from $807.3 million to $1.1 billion. The increase is due primarily to a $323.9 million increase at dealerships acquired subsequent to January 1, 2001. Retail sales of used vehicles at dealerships owned prior to January 1, 2001 were consistent with the prior year. The Company believes the relative affordability of new vehicles resulting from manufacturer incentive programs has negatively impacted used vehicles sales growth during the nine months ended September 30, 2002. Aggregate retail unit sales of used vehicles increased by 17.9%, due principally to a 10,738 increase in used vehicle retail unit sales at dealerships acquired subsequent to January 1, 2001. We retailed 58,092 used vehicles (32.6% of total retail vehicle sales) during the nine months ended September 30, 2002, compared with 49,278 used vehicles (33.0% of total retail vehicle sales) during the nine months ended September 30, 2001.
Finance and insurance revenues increased by $26.6 million, or 24.9%, from $106.7 million to $133.3 million. The increase is due primarily to: (1) an $8.8 million, or 9.9%, increase at dealerships owned prior to January 1, 2001 and (2) a $16.5 million increase at dealerships acquired subsequent to January 1, 2001. The increase at dealerships owned prior to January 1, 2001 is primarily due to a revenue increase of $46 per retail vehicle sold, which increased revenue by $6.2 million, and a 2.7% increase in retail vehicles sold, which increased revenue by $2.6 million.
Service and parts revenues increased by $129.6 million, or 29.8%, from $435.6 million to $565.2 million. The increase is due primarily to: (1) a $24.8 million, or 6.2%, increase at dealerships owned prior to January 1, 2001 and (2) a $111.5 million increase at dealerships acquired subsequent to January 1, 2001. The Company believes that its service and parts business is being positively impacted by the complexity of today’s vehicles, manufacturers’ warranty programs for both new and certified used vehicles, increases in retail unit sales at our dealerships and capacity increases in our service and parts operations resulting from capital construction projects.
Fleet revenues decreased $25.7 million, or 21.6%, versus the comparable prior year period. The decrease in fleet revenues is due primarily to a $28.8 million, or 26.8%, decrease in fleet sales revenues at dealerships owned prior to January 1, 2001, partially offset by a $4.0 million increase at stores acquired subsequent to January 1, 2001. The Company has elected to de-emphasize the low margin fleet business and expects fleet sales volumes to remain lower in the future.
Wholesale revenues increased $92.0 million, or 34.9%, versus the comparable prior year period. The increase in wholesale revenues is due primarily to: (1) a $5.6 million, or 2.4%, increase at dealerships owned prior to January 1, 2001 and (2) a $93.2 million increase at dealerships acquired subsequent to January 1, 2001. The Company believes the increase at dealerships owned prior to July 1, 2001 is due in part to the relative strength of the new car market, resulting in an increase in the number of cars taken in on trade, versus the relative weakness of the used car market.
Gross Profit. Retail gross profit, which excludes gross profit on fleet and wholesale transactions, increased $185.9 million, or 30.7%, from $604.7 million to $790.6 million. The increase in gross profit is due to: (1) a $38.4 million, or 7.1%, increase in retail gross profit at stores owned prior to January 1, 2001 and (2) a $154.3 million increase at dealerships acquired subsequent to January 1, 2001. Retail gross profit as a percentage of revenues from retail transactions increased from 15.2% to 15.5%. Gross profit as a percentage of revenues for new vehicle retail, used vehicle retail, finance and insurance and service and parts revenues was 8.5%, 10.2%, 100.0%, and 46.9%, respectively, compared with 8.3%, 10.6%, 100.0% and 44.7% in the comparable prior year period. The increase in retail gross profit as a percentage of revenues from retail transactions is primarily attributable to (1) increased gross profit margins on service and parts revenues, which result from the realization of higher margins in the US and UK, (2) an increase in the relative proportion of service and parts sales to total retail sales, (3) an increase in the relative proportion of used vehicle retail sales to total vehicle sales and (4) an increase in margins on the sale of new vehicles, which is due primarily to higher margins realized on new vehicle sales in the UK, offset in part by decreased margins on the sale of used vehicles, which relate primarily to the lower margins realized on used vehicle sales in the UK, offset in part by higher margins on used vehicle sales in the US. Aggregate gross profit on fleet and wholesale transactions decreased by $1.1 million to a loss of $0.8 million.
22
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $144.2 million, or 29.6%, from $487.4 million to $631.6 million. Such expenses increased as a percentage of total revenue from 11.2% to 11.4%, and decreased as a percentage of gross profit from 80.6% to 80.0%. The aggregate increase in selling, general and administrative expenses is due principally to: (1) a $43.5 million, or 10.5%, increase at dealerships owned prior to January 1, 2001 and (2) a $122.4 million increase at dealerships acquired subsequent to January 1, 2001, partially offset by a $14.6 million decrease in goodwill amortization due to the adoption of SFAS No. 142. The increase in selling, general and administrative expenses at stores owned prior to January 1, 2001 is due in large part to increased selling expenses, including increases in variable compensation as a result of the 7.1% increase in retail gross profit over the prior year, depreciation, healthcare costs, and other insurance costs versus the prior year.
Floor Plan Interest Expense. Floor plan interest expense decreased by $5.6 million, or 17.6%, from $31.6 million to $26.0 million. The decrease in floor plan interest expense is due to an $8.2 million, or 28.1%, decrease at stores owned prior to January 1, 2001, partially offset by a $3.5 million increase at dealerships acquired subsequent to January 1, 2001. The decrease at stores owned prior to January 1, 2001 is due primarily to a decrease in inventory at those dealerships, coupled with a decrease in our weighted average borrowing rate on floor plan indebtedness during 2002.
Other Interest Expense. Other interest expense increased by $0.6 million, or 2.3%, from $27.2 million to $27.8 million. The increase is due primarily to increased acquisition related indebtedness, including approximately $140.0 million borrowed in connection with the acquisition of the Sytner Group plc in March 2002, offset in part by (1) a decrease in our weighted average borrowing rate during 2002 and (2) the pay-down of indebtedness with proceeds from equity offerings subsequent to December 31, 2001.
Discontinued Operations. Income (loss) from discontinued operations, consisting of the results of operations which have been or will be divested or closed, increased by $0.1 million from $0.6 million to $0.7 million. The current year results include an after-tax gain on disposal of $1.7 million.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital, the acquisition of new dealerships, the improvement and expansion of existing facilities and the construction of new facilities. Historically, these cash requirements have been met through borrowings under our credit agreement, the issuance of debt securities, including floor plan notes payable, sale-leaseback transactions, the issuance of equity securities and cash flow from operations. As of September 30, 2002, we had working capital of $125.3 million.
We finance the majority of our new and a portion of our used vehicle inventory under revolving floor plan financing arrangements into which our subsidiaries have entered with various lenders. We make monthly interest payments on the amount financed, but are generally not required to make loan principal repayments prior to the sale of the new and used vehicles we have financed. The floor plan agreements grant a security interest in substantially all of the assets of our automotive dealership subsidiaries. Interest rates on the floor plan arrangements are variable and increase or decrease based on movements in the prime rate or LIBOR. As of September 30, 2002, our outstanding borrowings under floor plan arrangements amounted to $790.9 million.
Our credit agreement with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation provides for revolving loans to be used for acquisitions, working capital, the repurchase of common stock and general corporate purposes. Our borrowing capacity under the revolving portion of the credit agreement is $700.0 million and, in addition, we have use of a standby letter of credit facility in the amount of $50.0 million. Our credit agreement also provided for a term loan of $161.0 million, all of which was used during 1999 and 2000 to repurchase our 11.0% senior subordinated notes. Loans under the credit agreement bear interest between LIBOR plus 2.00% and LIBOR plus 3.00%. The credit agreement is fully and unconditionally guaranteed on a joint and several basis by our domestic automotive dealership subsidiaries (and will be guaranteed by domestic automotive dealership subsidiaries acquired or established by us in the future) and contains a number of significant covenants that, among other things, restrict our ability to dispose of assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. Under the terms of our credit agreement, we are required
23
During 2000, we entered into a swap agreement of five years duration pursuant to which a notional $200.0 million of our floating rate debt was exchanged for fixed rate debt for five years. The fixed rate interest paid by us is based on LIBOR and amounted to approximately 7.1%. In October 2002, we extended the term of this swap to January 2008. In connection with the extension of the term of the swap, the fixed rate interest rate to be paid by us was reduced to 5.86%.
In March 2002, we issued $300.0 million of 9.625% senior subordinated notes due 2012 pursuant to Rule 144A and Regulation S under the Securities Act, as amended. Proceeds from the offering of $292.2 million were used to repay borrowings under the Company’s credit agreement. The notes are unsecured senior subordinated notes and rank behind all of our existing and future senior debt, including debt under our credit agreement. The notes are guaranteed by substantially all of our domestic subsidiaries on a senior subordinated basis. We can redeem all or some of the notes at our option beginning in 2007 at specified redemption prices. In addition, until 2005 we are allowed to redeem up to 35% of the notes with the net cash proceeds from specified public equity offerings. Upon a change of control each holder of notes will be able to require us to repurchase all or some of the notes at a redemption price of 101% of the principal amount of the notes. The notes also contain customary negative covenants and events of default. We are obligated to use our best efforts to complete a registered exchange offer for the notes or to register resales of the notes under the Securities Act, but we cannot assure that such a registration will be completed or that any trading market will develop after completion of such a registration.
In March 2002, we completed an offering of 6,000,000 shares of our common stock for $22.00 per share pursuant to an underwritten registered offering, of which 3,000,000 shares were sold by the Company and 3,000,000 were sold by selling stockholders. Proceeds to the Company from the offering of $61.5 million were used to repay borrowings under the Company’s credit agreement.
On April 12, 1999, we entered into a securities purchase agreement with International Motor Cars Group I, L.L.C. and International Motor Cars Group II, L.L.C., Delaware limited liability companies controlled by Penske Capital Partners, L.L.C. (together, the “PCP Entities”), pursuant to which the PCP Entities agreed to purchase (1) an aggregate of 7,903.124 shares of our Series A convertible preferred stock, par value $0.0001 per share, (2) an aggregate of 396.876 shares of our Series B convertible preferred stock, par value $0.0001 per share, and (3) warrants to purchase (a) 3,898,665 shares of common stock and (b) 1,101,335 shares of our non-voting common stock, par value $0.0001 per share, for $83.0 million. The shares of Series A preferred stock and Series B preferred stock entitled the PCP Entities to dividends at a rate of 6.5% per year. The dividends were payable in kind for the first two years after issuance, after which they were payable in cash. The Series A preferred stock was converted into 7,033,031 shares of our voting common stock in May 2002. The Series B preferred stock was converted into 652,452 shares of our non-voting common stock in August 2002.
The warrants, as originally issued to the PCP Entities, were exercisable at a price of $12.50 per share until February 3, 2002, and $15.50 per share thereafter until May 2, 2004. Pursuant to the anti-dilution provisions of the warrants and as a result of the sale of equity to Mitsui & Co. in 2001, (a) the number of warrants to purchase common stock was increased from 3,898,665 shares to 3,915,580 shares, (b) the number of warrants
24
In September 2001, we announced that our board of directors authorized the repurchase of up to three million shares of our outstanding common stock. Pursuant to that authorization, we repurchased 1,009,463 shares in a negotiated transaction at an aggregate cost of $16.0 million during 2002. As of November 12, 2002, we have repurchased 1,396,555 shares under the program announced in September 2001. The share repurchase program remains open and the Company continually evaluates market conditions and internal financing considerations when contemplating purchasing shares.
In March 2002, we acquired Sytner Group plc, a publicly traded automotive retailer operating in excess of 60 franchises in the United Kingdom, pursuant to an all cash tender offer for approximately £95.3 million in cash. In addition, we assumed approximately £15.8 million of Sytner’s debt. As an alternative to receiving all or any part of the £95.3 million of the cash consideration receivable under the offer, Sytner shareholders could elect to receive £1 of loan notes in lieu of every £1 of consideration otherwise receivable under the offer. A total of £26.4 million of such loan notes were issued pursuant to this election. The loan notes bear interest at approximately 3.9% and mature in July 2003. The funds to be used to repay these notes are being held in escrow by the Royal Bank of Scotland for the benefit of the noteholders.
During 2002, net cash provided by operations amounted to $44.3 million. Net cash used in investing activities during 2002 totaled $251.7 million, including $140.0 million related to capital expenditures and $191.6 million for acquisitions (which includes approximately $140.0 million relating to the acquisition of Sytner), offset by $80.0 million in proceeds from sale-leaseback transactions. Net cash provided by financing activities during 2002 totaled $190.9 million, relating to: (1) borrowings of $332.8 million for capital expenditures and acquisitions, (2) borrowings of $300.0 million in connection with the issuance of the senior subordinated notes due 2012 and (3) $135.3 million relating to the issuance of voting common stock, offset by (1) $561.2 million used to repay borrowings under the Company’s credit agreement and (2) $16.0 million to repurchase common stock.
We have a number of capital projects planned or underway relating to the expansion and renovation of our retail automotive operations. Gross cash expenditures during 2002 relating to such projects are estimated to aggregate to $150.0 million, a substantial portion of which has already been spent. Historically, we have financed such capital expenditures with borrowings under our credit agreement and cash flow from operations. In the past, we have also entered into sale-leaseback transactions with Automotive Group Realty, LLC (“AGR”), a wholly owned subsidiary of Penske Corporation. We sold certain properties to AGR in 2002 for consideration of $80.0 million and made lease payments to AGR totaling $8.9 million during the nine months ended September 30, 2002, which payments relate to the properties we lease from AGR. We believe we will continue to finance certain capital expenditures in this fashion during 2002. As a result, we anticipate that the net cash we will fund for capital expenditures will amount to approximately $70.0 million. Funding for such capital expenditures is expected to come from cash flow from operations, supplemented by borrowings under our credit agreement.
The Company agreed to make a contingent payment in cash to the extent the 841,476 shares of common stock issued in connection with an acquisition completed in October 2000 are sold subsequent to the fifth anniversary of the transaction and have a market value at the time of sale of less than $12.00 per share. The Company will be forever released from this guarantee in the event the average daily closing price of the Company’s common stock for any 90 day period subsequent to the fifth anniversary of the transaction exceeds $12.00 per share. The Company has further granted the seller a put option pursuant to which the Company may be required to repurchase no more than 108,333 shares for $12.00 per share in cash on each of the first five anniversary dates of the transaction. As of September 30, 2002, the maximum of future cumulative cash payments the Company may be required to make in connection with the put option amounted to $5.2 million. As of November 12, 2002, such maximum cash payments amounted to $3.9 million. To date, no payments have been made by the Company relating to the put option.
25
In connection with an acquisition of dealerships in October 1997, we agreed that if the acquired companies achieved aggregate specified base earnings levels in any of the five years beginning with the year ending December 31, 1999, we would pay to the sellers for each year in which the acquired companies exceeded base earnings an amount equal to $0.7 million plus defined percentages of the amounts earned in excess of such base earnings for any such year. The total amount of payments to be made pursuant to this agreement is limited to $7.0 million. To date we have paid $2.0 million relating to this agreement. The amount of additional payments, if any, will be determined based upon the financial performance of the acquired business in 2002 and 2003. We also have obligations with respect to past transactions totaling $32.7 million over the next four years.
As of September 30, 2002, we had approximately $0.7 million of cash available to fund operations and future acquisitions. In addition, $355.7 million was available for borrowing under our credit agreement as of November 12, 2002, which availability is subject to a maximum actual borrowing limit of $329.6 million due to the credit agreement’s borrowing base collateral limitation (in general, the borrowing base equals certain of our allowable tangible assets plus $300.0 million). Borrowings used to finance the cost of acquisitions and capital construction projects will typically increase tangible assets, allowing the Company to access borrowing capacity which is currently not available due to the base collateral limitation.
We are a holding company whose assets consist primarily of the direct or indirect ownership of the capital stock of our operating subsidiaries. Consequently, our ability to pay dividends is dependent upon the earnings of our subsidiaries and their ability to distribute earnings and other advances and payments to us. The minimum working capital requirement under our franchise agreements could in some cases restrict the ability of our subsidiaries to make distributions, although to date we have not faced any such restrictions.
Our principal source of growth has come from acquisitions of automotive dealerships. We believe that our existing capital resources, including the liquidity provided by our credit agreement and floor plan financing, will be sufficient to fund our current operations and commitments for the next twelve months. To the extent we pursue additional significant acquisitions, we may need to raise additional capital either through the public or private issuance of equity or debt securities or through additional bank borrowings. We may not have sufficient availability under our credit agreement to finance significant additional acquisitions. In certain circumstances, a public equity offering could require the prior approval of several automobile manufacturers. There is no assurance that we would be able to access the capital markets or increase our borrowing capabilities on terms acceptable to us, if at all.
Joint Ventures
From time to time we enter into joint venture arrangements in the ordinary course of business, pursuant to which we acquire dealerships together with a minority investor.
In January 1998, we entered into a joint venture agreement with a third party to manage and acquire dealerships in Illinois, Ohio, North Carolina and South Carolina. With respect to any joint venture established pursuant to this agreement, we are required to buy out the other party at the end of the five-year period following the date of the acquisition. Pursuant to this arrangement, in 1998 we entered into a joint venture with respect to the Citrus Chrysler dealership. We are required to buy out our partner in this dealership in May 2003. We expect this payment to be approximately $3.0 million.
In November 1999 we formed a joint venture to own and operate certain dealerships in Brazil. Our joint venture partners in Brazil are Roger S. Penske, Jr. and Andre Ribeiro Holdings, Ltda. We contributed approximately $3.6 million for a 90.6% interest in United Auto do Brasil, Ltda. and Mr. Penske, Jr. and Mr. Ribeiro each contributed approximately $0.2 million for a 4.7% interest.
In October 2000, we purchased the operating assets of certain dealerships in Fairfield, Connecticut for approximately $26.8 million. We are contractually committed to sell 20% of this venture to Lucio A. Noto and other investors upon receipt of approval for the transfer of ownership by the manufacturers represented at the Fairfield location and the completion of other conditions. Upon completion of these conditions, the closing will occur as of March 1, 2001. The selling price is approximately $5.4 million, representing 20% of the
26
In December 2000 we formed a joint venture with Roger S. Penske, Jr. to own and operate certain Mercedes-Benz, Audi and Porsche dealerships. We contributed $65.1 million for a 90% interest in HBL, LLC and Mr. Penske, Jr. contributed $7.2 million for the remaining 10% interest.
In July 2001 we invested in the Tulsa Auto Collection, a group of dealerships in Tulsa, Oklahoma. The Tulsa Auto Collection consists of seven dealerships representing the Ford, Lincoln-Mercury, Jaguar and Mazda brands. In addition, through the Tulsa Auto Collection, we operate two automotive care service centers and two used vehicle facilities in the Tulsa market.
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 similar periods of decline and recession as 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 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, demand for cars and light trucks is generally lower during the winter months than in other seasons, particularly in regions of the United States where dealerships may be subject to harsh winters. Accordingly, we expect our revenues and profitability to be generally lower in our first and fourth quarters as compared to our second and third quarters. The greatest seasonalities exist with the dealerships we operate in the northeastern and upper mid-western United States, for which the second and third quarters are the strongest with respect to vehicle-related sales. The service and parts business at all dealerships experiences relatively modest seasonal fluctuations.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 146Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”) was issued in June 2002 and is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 addresses the timing of the recognition of exit costs associated with restructuring activities. Under the new standard, certain exit costs will be recognized over the period in which the restructuring activities occur, rather than at the point in time the Company commits to the restructuring plan. SFAS No. 146 is not expected to have a material impact on the Company’s results of operations.
Effects of Inflation
We believe that the relatively moderate rates of inflation 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, there can be no assurance that 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 the prime rate or LIBOR. Such rates have historically increased during periods of increasing inflation. We do not believe that we would be placed at a competitive disadvantage should interest rates increase due to increased inflation since most other automotive dealerships have similar floating rate borrowing arrangements.
27
Forward Looking Statements
This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements 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:
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 the reports and our other periodic filings with the SEC. Important factors that could cause actual results to differ materially from our expectations include the following:
28
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 indebtedness. Outstanding balances under our credit agreements bear interest at a variable rate based on a margin over LIBOR, as defined. Based on the amount outstanding as of September 30, 2002, a 100 basis point change in interest rates would result in an approximate $3.6 million change to our annual interest expense. Similarly, amounts outstanding under floor plan financing arrangements bear interest at a variable rate based on a margin over defined LIBOR or Prime rates. Based on an average of the aggregate amounts outstanding under our floor plan financing arrangements, a 100 basis point change in interest rates would result in an approximate $5.9 million change to our annual floor plan interest expense.
29
The Company continually evaluates its exposure to interest rate fluctuations and follows 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 reduce the effect of interest rate fluctuations on the Company’s earnings and cash flows. The Company is currently party to a swap agreement pursuant to which a notional $200.0 million of our floating rate debt was exchanged for fixed rate debt through January 2008. The fixed rate interest paid by us is based on LIBOR and amounts to approximately 5.86%.
Interest rate fluctuations effect the fair market value of our fixed rate debt, including the senior subordinated notes, certain seller financed promissory notes and obligations under certain capital leases, but do not impact our earnings or cash flows.
Foreign Currency Exchange Rates. The Company currently has operations in the United Kingdom, Germany, Mexico and Brazil. In each of these markets, the local currency is the functional currency. Due to the Company’s intent to remain permanently invested in these foreign markets, we do not hedge against foreign currency fluctuations. Other than the United Kingdom, the Company’s foreign operations are not significant. In the event we enter into transactions that expose the Company to foreign exchange fluctuations, or change our intent with respect to the investment in any of our international operations, the Company would expect to implement strategies designed to manage those risks in an effort to reduce the effect of foreign currency fluctuations on the Company’s earnings and cash flows.
In common with other automotive retailers, we purchase certain of our new vehicle and parts inventories from foreign manufacturers. Although we purchase all 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
a) As of a date within 90 days prior to the filing of this report (the “Evaluation Date”), the Chief Executive Officer (the “CEO”) and the Chief Financial Officer (the “CFO”), with the participation of other members of the Company’s management, performed an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon this evaluation, the CEO and the CFO have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective to ensure that material information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is made known to the CEO and CFO within the time periods specified in the Securities and Exchange Commission rules and forms.
b) There were no significant changes in the registrant’s internal controls or other factors that could significantly affect these controls subsequent to the Evaluation Date.
30
The Company and its subsidiaries are involved in litigation that has arisen in the ordinary course of business. None of these matters, either individually or in the aggregate, are expected to have a material adverse effect on the Company’s results of operations or financial condition.
(a) Exhibits
(b) Reports on Form 8-K.
The Company filed the following Current Reports on Form 8-K and amendments to Form 8-K during the quarter ended September 30, 2002:
31
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.
Date: November 12, 2002
32
Certification
I, Roger S. Penske, certify that:
33
CERTIFICATIONS PURSUANT TO SECTION 302 OF THE
I, James R. Davidson, certify that:
34