Service and parts revenue increased $90.3 million, or 16.8%, from 2005 to 2006. The increase is due to a $48.7 million increase from net dealership acquisitions during the period, coupled with a $41.6 million, or 7.9%, increase in same store revenues. We believe that our service and parts business is being positively impacted by the growth in total retail unit sales at our dealerships in recent years and capacity increases in our service and parts operations resulting from our facility improvement and expansion programs.
Service and parts gross profit increased $52.9 million, or 18.1%, from 2005 to 2006. The increase is due to a $26.5 million increase from net dealership acquisitions during the period coupled with a $26.4 million, or 9.2%, increase in same store gross profit. The same store gross profit increase is due to the $41.6 million, or 7.9%, increase in same store revenues, which increased gross profit by $22.8 million, and a 70 basis point increase in gross margin, which increased gross profit by $3.6 million.
SG&A increased $81.7 million, or 13.7%, from $598.2 million to $679.9 million. The aggregate increase is primarily due to a $49.4 million increase from net dealership acquisitions during the period, coupled with a $32.3 million, or 5.5%, increase in same store SG&A. The increase in same store SG&A is due in large part to a net increase in variable selling expenses, including increases in variable compensation as a result of the 5.3% increase in same store retail gross profit over the prior year, coupled with increased rent and other costs relating to our facility improvement and expansion programs. SG&A expenses in 2005 included a $1.9 million charge for severance. SG&A expenses increased as a percentage of total revenue from 12.0% to 12.2% and increased as a percentage of gross profit from 79.2% to 79.3%.
Depreciation and amortization increased $2.6 million, or 13.4%, from $19.2 million to $21.8 million. The increase is due to a $0.9 million increase from net dealership acquisitions during the period, coupled with a $1.7 million, or 9.1% increase in same store depreciation and amortization. The same store increase is due in large part to our facility improvement and expansion program.
Floor plan interest expense increased $6.7 million, or 26.3%, from $25.4 million to $32.1 million. The increase is due to a $1.9 million increase from net dealership acquisitions during the period, coupled with a $4.8 million, or 18.9%, increase in same store floor plan interest expense. The same store increase is due primarily to a net increase in our weighted average borrowing rate during 2006 compared to 2005.
Other interest expense decreased $0.2 million, or 0.6%, from $23.7 million to $23.5 million. The decrease is due primarily to a decrease in our weighted average borrowing rate during 2006 versus 2005 that resulted from the issuance of $375.0 million of 3.5% Convertible Senior Subordinated Notes on January 31, 2006 and which was used to repay higher-rate debt under our credit agreements, offset in part by an increase in our total outstanding indebtedness in 2006 versus 2005.
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Income Taxes
Income taxes increased $3.8 million, or 11.6%, from $32.9 million to $36.7 million. The increase from 2005 to 2006 is due primarily to our increase in pre-tax income versus the prior year, offset in part by a reduction in our overall effective income tax rate.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital, inventory financing, the acquisition of new dealerships, the improvement and expansion of existing facilities, the construction of new facilities and dividends. 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 or the issuance of equity securities. As of June 30, 2006, we had working capital of $192.9 million, including $25.6 million of cash, available to fund our operations and capital commitments. In addition, we had $555.4 million and £51.0 million ($94.3 million) available for borrowing under our U.S. credit agreement and our U.K. credit agreement, respectively, each of which is discussed below.
We paid dividends of five and one half cents per share on March 1, 2005, June 1, 2005 and August 1, 2005, six cents per share on December 1, 2005 and March 1, 2006 and seven cents per share on June 1, 2006. We have declared a cash dividend on our common stock of seven cents per share payable on September 1, 2006 to shareholders of record on August 10, 2006. Future quarterly or other cash dividends will depend upon our earnings, capital requirements, financial condition, restrictions on any then existing indebtedness and other factors considered relevant by our Board of Directors.
We have grown primarily through the acquisition of automotive dealerships. We believe that cash flow from operations 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. 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 agreements to finance significant additional acquisitions. In certain circumstances, a public equity offering could require the prior approval of certain automobile manufacturers. In connection with any potential significant acquisitions, we may be unable to access the capital markets or increase our borrowing capabilities on terms acceptable to us, if at all.
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. In the U.S., the floor plan arrangements are due on demand; however, we are generally not required to make loan principal repayments prior to the sale of the vehicles that have been financed. We typically make monthly interest payments on the amount financed. In the U.K., 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 grant a security interest in substantially all of the assets of our dealership subsidiaries. Interest rates under the floor plan arrangements are variable and increase or decrease based on changes in the prime rate or defined LIBOR. 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.
U.S. Credit Agreement
Our credit agreement with DaimlerChrysler Services Americas LLC and Toyota Motor Credit Corporation, as amended, provides for up to $600.0 million in revolving loans for working capital, acquisitions, capital expenditures, investments and for other general corporate purposes, and for an additional $50.0 million of availability for letters of credit, through September 30, 2008. The revolving loans bear interest between defined LIBOR plus 2.50% and defined LIBOR plus 3.50%.
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, 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, a ratio of debt to earnings before income taxes, depreciation and amortization, (“EBITDA”), a ratio of domestic debt to domestic EBITDA, and a measurement of stockholders’ equity. 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 the amounts owed. As of June 30, 2006 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 foreseeable future. In making such determination, we have considered our current margin of compliance with the covenants and expected future results of operations, working capital requirements, acquisitions, capital expenditures and investments in the U.S. 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 not pledged as security under floor plan arrangements are subject to security interests granted to lenders under the U.S. credit agreement. As of June 30, 2006, outstanding borrowings and letters of credit under the U.S. credit agreement amounted to $32.0 million and $12.6 million, respectively.
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U.K. Credit Agreement
Our subsidiaries in the U.K. (the “U.K. Subsidiaries”), are party to a credit agreement with the Royal Bank of Scotland, as amended, which provides for up to £55.0 million in revolving loans to be used for acquisitions, working capital, and general corporate purposes through March 31, 2008. Revolving loans under the U.K. credit agreement have an original maturity of 90 days or less and bear interest between defined LIBOR plus 0.85% and defined LIBOR plus 1.25%. The U.K. credit agreement also provides for an additional seasonally adjusted overdraft line of credit up to a maximum of £15.0 million.
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 measurement of net worth, a debt to capital ratio, an EBITDA to interest expense ratio, a measurement of maximum capital expenditures, a debt to EBITDA ratio, and a fixed charge coverage ratio. 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 the amounts owed. As of June 30, 2006, we were in compliance with all covenants under the U.K. credit agreement, and we believe that we will remain in compliance with such covenants for the foreseeable future. In making such determination, we have considered the current margin of compliance with the covenants and the expected future results of operations, working capital requirements, acquisitions, capital expenditures and investments in the U.K.
The U.K. credit agreement also contains typical events of default, including change of control and non-payment of obligations. Substantially all of our U.K. Subsidiaries’ assets not pledged as security under floor plan arrangements are subject to security interests granted to lenders under the U.K. credit agreement. The U.K. credit agreement also has cross-default provisions that trigger a default in the event of an uncured default under other material indebtedness of our U.K. Subsidiaries. As of June 30, 2006, outstanding borrowings under the U.K. credit agreement amounted to £4.0 million ($7.4 million).
Senior Subordinated Notes
We have outstanding $300.0 million aggregate principal amount of 9.625% senior subordinated notes due 2012, referred to as the 9.625% Notes. The 9.625% Notes are unsecured senior subordinated notes and are subordinate to all existing and future senior debt, including debt under our credit agreements and obligations under our floor plan arrangements. The 9.625% Notes are guaranteed by substantially all domestic subsidiaries on a senior subordinated basis. We can redeem all or some of the 9.625% Notes at our option beginning in 2007 at specified redemption prices. Upon a change of control, each holder of 9.625% Notes will be able to require us to repurchase all or some of the 9.625% Notes at a redemption price of 101% of their principal amount. The 9.625% Notes also contain customary negative covenants and events of default. As of June 30, 2006, we were in compliance with all negative covenants and there were no events of default.
Senior Subordinated Convertible Notes
On January 31, 2006, we issued $375.0 million of 3.50% senior subordinated convertible notes due 2026 (the “Convertible Notes”) in a private offering (the “Offering”), to qualified institutional buyers under Rule 144A of the Securities Act of 1933.The Convertible Notes mature on April 1, 2026, unless earlier converted, redeemed or purchased by us. The Convertible Notes are our unsecured senior subordinated obligations and are guaranteed on an unsecured senior subordinated basis by our wholly owned domestic subsidiaries. The Convertible Notes also contain customary negative covenants and events of default. As of June 30, 2006 we were in compliance with all negative covenants and there were no events of default.
Holders may convert based on a conversion rate of 42.2052 shares of our common stock per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $23.69 per share), subject to adjustment, only under the following circumstances: (1) if the closing price of our common stock reaches, or the trading price of the Convertible Notes falls below, specific thresholds, (2) if the Convertible Notes are called for redemption, (3) if specified distributions to holders of our common stock are made or specified corporate transactions occur, (4) if a fundamental change occurs, or (5) 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, in lieu of shares of our common stock, equal to the lesser of (i) $1,000 or (ii) the conversion value, determined in the manner set forth in the related indenture, of the number of shares of our 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. If a holder elects to convert its Convertible Notes in connection with certain events that constitute a change of control on or before April 6, 2011, we will pay, to the extent described in the related indenture, a make-whole premium by increasing the conversion rate applicable to such Convertible Notes.
In addition, we will pay contingent interest in cash, commencing with any six-month period beginning on April 1, 2011, if the average trading price of a Convertible Note for the five trading days ending on the third trading day immediately preceding the first day of that six-month period equals 120% or more of the principal amount of the Convertible Note.
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 each of April 1, 2011, April 1, 2016 and 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. In addition, if we experience certain fundamental change events specified in the related indenture, holders of the Convertible Notes will have the option to require us to purchase for cash all or a portion of their Convertible Notes, subject to specified exceptions, at a price equal to 100% of the principal amount of the Convertible Notes, plus accrued and unpaid interest, if any, to the fundamental change purchase date.
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Share Repurchase
In connection with the Offering, we repurchased 1,000,000 shares of our outstanding common stock on January 26, 2006 for $18.96 million, or $18.955 per share.
Interest Rate Swaps
We are party to an interest rate swap agreement through January 2008 pursuant to which a notional $200.0 million of our U.S. floating rate debt was exchanged for fixed rate debt. The swap was designated as a cash flow hedge of future interest payments of LIBOR-based U.S. floor plan borrowings. As of June 30, 2006, we expected approximately $1.3 million associated with the swap to be recognized as a reduction of interest expense over the next twelve months.
Other Financing Arrangements
We expect to enter into significant sale-leaseback transactions to finance certain property acquisitions and capital expenditures, pursuant to which we sell property and/or leasehold improvements to a third-party and agree to lease those assets back for a certain period of time. Such sales generate proceeds which vary from period to period.
Off-Balance Sheet Arrangements
We are not party to any off-balance sheet arrangements.
Cash Flows
We have restated our 2005 consolidated statement of cash flows to reflect the repayment of floor plan obligations in connection with acquisitions and dispositions as cash transactions to comply with guidance under SFAS No. 95, “Statement of Cash Flows.” More specifically, with respect to acquisitions, we restated our consolidated statement of cash flows to reflect the repayment of seller floor plan notes payable obligations by our floor plan lender as additional cost of dealership acquisitions with corresponding borrowings of floor plan notes payable-non-trade. Similarly, with respect to dispositions, we restated our consolidated statement of cash flows to reflect the repayment of our floor plan notes payable by the purchaser’s floor plan lender as additional transaction proceeds with corresponding repayments of floor plan notes payable trade or non-trade, as appropriate. Previously, all such activity was treated as a non-cash acquisition or disposition of inventory and floor plan notes payable. As a result, the consolidated condensed statement of cash flows for the six months ended June 30, 2005 has been restated. A summary of the significant effects of the restatement follows:
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| | | Six Months Ended | |
| | | June 30, | |
| | | 2005 | |
| Net cash from continuing operating activities as previously reported | $ | 103,123 | |
| Discontinued operations | | (13,449 | ) |
| Recognition of floorplan balances as cash transactions | | 30,444 | |
| Net cash from continuing operating activities, as restated | $ | 120,118 | |
| | | | |
| Net cash from continuing investing activities as previously reported | $ | (96,306 | ) |
| Discontinued operations | | (1,422 | ) |
| Recognition of floorplan balances as cash transactions | | (32,092 | ) |
| Net cash from continuing investing activities, as restated | $ | (129,820 | ) |
| |
| Net cash from continuing financing activities as previously reported | $ | (26,889 | ) |
| Discontinued operations | | 12,849 | |
| Recognition of floorplan balances as cash transactions | | 1,648 | |
| Net cash from continuing financing activities, as restated | $ | (12,392 | ) |
Cash and cash equivalents increased by $16.2 million and decreased by $9.5 million during the six months ended June 30, 2006 and 2005, respectively. The major components of these changes are discussed below.
Cash Flows from Continuing Operating Activities
Cash provided by continuing operating activities was $181.1 million and $120.1 million during the six months ended June 30, 2006 and 2005, respectively. Cash flows from operating activities include net income 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 arrangements with various lenders. We report all cash flows arising in connection with floor plan arrangements with the manufacturer of a particular new vehicle as an operating activity and all cash flows arising in connection with floor plan arrangements with 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.
We believe that changes in aggregate floor plan liabilities are linked to changes in vehicle inventory and, therefore, are an integral part of understanding changes in our working capital and operating cash flow. Consequently, we have provided below a reconciliation of cash flow from operating activities as reported in our condensed consolidated statement of cash flows to cash flows from operating activities on the basis that all changes in vehicle floor plan were classified as an operating activity:
| | | Six Months Ended June 30, | |
| | | 2006 | | 2005 | |
| | | | |
| Net cash from operating activities as reported | $ | 181,130 | $ | 120,118 | |
| Floor plan notes payable - non-trade as reported | | 18,155 | | (33,837 | ) |
| Net cash from operating activities including all floor plan notes payable | $ | 199,285 | $ | 86,281 | |
Cash Flows from Continuing Investing Activities
Cash used in continuing investing activities was $313.5 million and $129.8 million during the six months ended June 30, 2006 and 2005, respectively. Cash flows from investing activities consist primarily of cash used for capital expenditures, proceeds from sale-leaseback transactions and net expenditures for dealership acquisitions. Capital expenditures were $109.8 million and $102.8 million during the six months ended June 30, 2006 and 2005, respectively. Capital expenditures relate primarily to improvements to our existing dealership facilities and the construction of new facilities. Proceeds from sale-leaseback transactions were $21.4 million and $53.3 million during the six months ended June 30, 2006 and 2005, respectively. Cash used in business acquisitions, net of cash acquired, was $225.2 million and $80.3 million during the six months ended June 30, 2006 and 2005, respectively, and included cash used to repay sellers’ floorplan liabilities in such business acquisitions of $86.9 million and $32.1 million during the six months ended June 30, 2006 and 2005, respectively.
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Cash Flows from Continuing Financing Activities
Cash provided by continuing financing activities was $132.3 million during the six months ended June 30, 2006. Cash used in continuing financing activities was $12.4 million during the six months ended June 30, 2005. Cash flows from financing activities include net borrowings or repayments of long-term debt, net borrowings or repayments of floor plan notes payable non-trade, payments of deferred financing costs, proceeds from the issuance of common stock, including proceeds from the exercise of stock options, repurchases of common stock and dividends. We had net borrowings of long-term debt of $139.5 million and $29.4 million during the six months ended June 30, 2006 and 2005, respectively. We had net borrowings of floor plan notes payable non-trade of $18.2 million during the six months ended June 30, 2006 and net repayments of floor plan notes payable non-trade of $33.8 million during the six months ended June 30, 2005. During the six months ended June 30, 2006, we paid $11.8 million of deferred financing costs related to our issuance of the Convertible Notes. During the six months ended June 30, 2006 and 2005, we received proceeds of $17.5 million and $2.2 million, respectively, from the issuance of common stock including excess tax benefits. In connection with the issuance of the Convertible Notes, we repurchased 1,000,000 shares of our outstanding common stock on January 26, 2006 for $19.0 million. During the six months ended June 30, 2006 and 2005, we paid $12.1 million and $10.2 million, respectively, of cash dividends to our stockholders.
Commitments
We have entered into an agreement with a third-party to jointly acquire and manage dealerships in Indiana, Illinois, Ohio, North Carolina and South Carolina. With respect to any joint venture relationship established pursuant to this agreement, we are required to repurchase our partner’s interest at the end of the five-year period following the date of formation of the joint venture relationship. Pursuant to this arrangement, we entered into a joint venture agreement with respect to our Honda of Mentor dealership in Ohio. We are required to repurchase our partner’s interest in this joint venture in July 2008. We expect this payment to be approximately $2.7 million.
Related Party Transactions
Stockholders Agreement
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 41% of our outstanding common stock. Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (collectively, “Mitsui”) own approximately 15% 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.
Other Related Party Interests
Roger S. Penske is also a managing member of Penske Capital Partners and Transportation Resource Partners, organizations that undertake investments in transportation-related industries. Richard J. Peters, one of our directors, is a director of Penske Corporation and a managing director of Transportation Resource Partners. Eustace W. Mita and Lucio A. Noto (two of our directors) are investors in Transportation Resource Partners. One of our directors, Hiroshi Ishikawa, serves as our Executive Vice President — International Business Development and serves in a similar capacity for Penske Corporation. Robert H. Kurnick, Jr., our Vice Chairman, is also the President and a director of Penske Corporation and Paul F. Walters, our Executive Vice President — Human Resources serves in a similar human resources capacity for Penske Corporation.
Other Transactions
We are currently a tenant under a number of non-cancelable lease agreements with Automotive Group Realty, LLC and its subsidiaries (together “AGR”), which are subsidiaries of Penske Corporation. From time to time, we may sell AGR real property and improvements that are subsequently leased by AGR to us. In addition, we may purchase real property or improvements from AGR which, in some instances, occur via the purchase of the equity interest of a corporate entity. Each of these transactions is valued at a price that is independently confirmed by a third party appraiser. During the three months ended June 30, 2006, we purchased $20.0 million of real property and improvements from AGR.
We sometimes pay to and/or receive fees from Penske Corporation and its affiliates for services rendered in the normal course of business, or to reimburse payments made to third parties on each others’ behalf. These transactions and those relating to AGR mentioned above, are reviewed periodically by our Audit Committee and reflect the provider’s cost or an amount mutually agreed upon by both parties, which we believe represent terms at least as favorable as those that could be obtained from an unaffiliated third party negotiated on an arm’s length basis.
We and Penske Corporation have entered into a joint insurance agreement which provides that with respect to our joint insurance policies (which includes our property policy), available coverage with respect to a loss shall be paid to each party as stipulated in the policies. In the event of losses by us and Penske Corporation in excess of the limit of any policy during a policy period, the total policy proceeds shall be allocated (and re-allocated) based on the ratio of premiums paid.
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We have entered into joint ventures with certain related parties as more fully discussed below.
Joint Venture Relationships
From time to time, we enter into joint venture relationships in the ordinary course of business, through which we acquire 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 June 30, 2006, our joint venture relationships were as follows:
Location | | Dealerships | |
Ownership|
Interest
|
| | | | | |
Fairfield, Connecticut | | | Audi, Mercedes-Benz, Porsche | | | 91.70% | (A)(B) |
Edison, New Jersey | | | Ferrari | | | 70.00% | (B) |
Tysons Corner, Virginia | | | Mercedes-Benz, Maybach, | | | 90.00% | (B)(C) |
| | | Aston Martin, Audi, Porsche | | | | |
Las Vegas, Nevada | | | Ferrari, Maserati | | | 50.00% | (D) |
Mentor, Ohio | | | Honda | | | 75.00% | (B) |
Munich, Germany | | | BMW, MINI | | | 50.00% | (D) |
Frankfurt, Germany | | | Lexus, Toyota | | | 50.00% | (D) |
Achen, Germany | | | Audi, Volkswagen, Lexus, Toyota | | | 50.00% | (D) |
Mexico | | | Toyota | | | 48.70% | (D) |
Mexico | | | Toyota | | | 45.00% | (D) |
____________________
| | |
(A) | | An entity controlled by one of our directors, Lucio A. Noto (the “Investor”), owns an 8.3% interest in this joint venture, which entitles the Investor to 20% of the operating profits of the dealerships owned by the joint venture. 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) | | Roger S. Penske, Jr. owns a 10% interest in this joint venture. |
| |
(D) | | Entity is accounted for using the equity method of accounting. |
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, 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 severe winters. The greatest U.S. seasonality exists at the dealerships we operate in northeastern and upper mid-western states, for which the second and third quarters are the strongest with respect to vehicle-related sales. 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. The service and parts business at all dealerships experiences relatively modest seasonal fluctuations.
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 the prime rate or LIBOR. Such rates have historically increased during periods of increasing inflation.
Forward-Looking Statements
This quarterly report on 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:
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| • | our future financial performance; |
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| • | future acquisitions; |
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| • | future capital expenditures; |
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| • | our ability to obtain cost savings and synergies; |
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| • | our ability to respond to economic cycles; |
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| • | trends in the automotive retail industry and in the general economy in the various countries in which we operate dealerships; |
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| • | our ability to access the remaining availability under our credit agreements; |
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| • | our liquidity; |
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| • | interest rates; |
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| • | trends affecting our future financial condition or results of operations; and |
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| • | 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 filings with the SEC. Important factors that could cause actual results to differ materially from our expectations include the following:
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| • | the ability of automobile manufacturers to exercise significant control over our operations, since we depend on them in order to operate our business; |
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| • | because we depend on the success and popularity of the brands we sell, adverse conditions affecting one or more automobile manufacturers may negatively impact our revenues and profitability; |
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| • | we may not be able to satisfy our capital requirements for making acquisitions, dealership renovation projects or financing the purchase of our inventory; |
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| • | 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 and our profitability; |
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| • | automobile manufacturers may impose limits on our ability to issue additional equity and on the ownership of our common stock by third parties, which may hamper our ability to meet our financing needs; |
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| • | our business and the automotive retail industry in general are susceptible to adverse economic conditions, including changes in interest rates, consumer confidence, fuel prices and credit availability; |
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| • | substantial competition in automotive sales and services may adversely affect our profitability; |
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| • | if we lose key personnel, especially our Chief Executive Officer, or are unable to attract additional qualified personnel, our business could be adversely affected; |
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| • | our quarterly operating results may fluctuate due to seasonality in the automotive retail business and other factors; |
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| • | because most customers finance the cost of purchasing a vehicle, increased interest rates may adversely affect our vehicle sales; |
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| • | our business may be adversely affected by import product restrictions and foreign trade risks that may impair our ability to sell foreign vehicles profitably; |
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| • | our automobile dealerships are subject to substantial regulations which may adversely affect our profitability; |
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| • | if state dealer laws in the United States 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; |
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| • | our U.K. dealerships are not afforded the same legal franchise protections as those in the U.S. so we could be subject to additional competition from other local dealerships in the U.K.; |
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| • | our automotive dealerships are subject to environmental regulations that may result in claims and liabilities; |
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| • | our dealership operations may be affected by severe weather or other periodic business interruptions; |
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| • | our principal stockholders have substantial influence over us and may make decisions with which other stockholders may disagree; |
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| • | some of our directors and officers may have conflicts of interest with respect to certain related party transactions and other business interests; |
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| • | our level of indebtedness may limit our ability to obtain financing for acquisitions and may require that a significant portion of our cash flow be used for debt service; |
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| • | due to the nature of the automotive retailing business, we may be involved in legal proceedings that could have a material adverse effect on our business; |
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| • | our operations outside of the United States subject our profitability to fluctuations relating to changes in foreign currency valuations; |
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| • | we are a holding company and, as a result, rely on the receipt of payments from our subsidiaries in order to meet our cash needs and service our indebtedness; |
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| • | the price of our common stock is subject to substantial fluctuation, which may be unrelated to our performance; and |
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| • | shares eligible for future sale may cause the market price of our common stock to drop significantly, even if our business is doing well. |
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 SEC 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.
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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 U.S. and U.K. credit agreements bear interest at variable rates based on a margin over defined LIBOR. Based on the amount outstanding as of June 30, 2006, a 100 basis point change in interest rates would result in an approximate $0.4 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. We continually 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. We are currently party to a swap agreement pursuant to which a notional $200.0 million of our floating rate floor plan debt was exchanged for fixed rate debt through January 2008. Based on an average of the aggregate amounts outstanding under our floor plan financing arrangements subject to variable interest payments during the six months ended June 30, 2006, a 100 basis point change in interest rates would result in an approximate $10.6 million change to our annual interest expense.
Interest rate fluctuations affect the fair market value of our swaps and fixed rate debt, including the 9.625% 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 June 30, 2006, 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. Other than the U.K., our foreign operations are not significant. 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 $169.3 million change to our revenues for the three months ended June 30, 2006.
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.
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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 June 30, 2006. 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.
Based upon this evaluation, the Company’s principal executive and financial officers concluded that our disclosure controls and procedures were effective as of June 30, 2006. 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 our second quarter of 2006 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 4. | Submission of Matters to a Vote of Security Holders |
Our Annual Meeting of Stockholders (the “Annual Meeting”) was held on May 3, 2006. Proxies for the Annual Meeting were solicited pursuant to regulation 14A under the Securities Exchange Act of 1934, as amended. There were no solicitations in opposition to the nominees or proposals listed in the proxy statement. Each of the twelve nominees listed in the proxy statement was elected. The results of the voting at the Annual Meeting is as follows, adjusted to give effect to our recent stock split.
Nominee | For | Withheld |
John Barr | 88,842,832 | 2,005,878 |
Michael R. Eisenson | 88,933,876 | 1,914,834 |
Hiroshi Ishikawa | 76,839,468 | 14,009,242 |
Robert H. Kurnick, Jr. | 77,267,482 | 13,581,228 |
William Lovejoy | 90,313,926 | 531,184 |
Kimberly J. McWaters | 90,302,404 | 546,306 |
Eustace W. Mita | 75,892,372 | 14,956,338 |
Lucio A. Noto | 77,079,236 | 13,769,474 |
Roger S. Penske | 77,125,080 | 13,723,630 |
Richard J. Peters | 77,083,502 | 13,765,208 |
Ronald G. Steinhart | 89,142,396 | 1,706,314 |
H. Brian Thompson | 81,447,112 | 9,401,598 |
2. | Amendment to our certificate of incorporation to increase the number of authorized shares of voting common stock to 240,000,000 : |
For | Against | Abstain | Non-Vote |
72,635,034 | 18,187,898 | 25,778 | -0- |
On August 7, 2006, we and Penske Corporation entered into a joint insurance agreement, filed as exhibit 10.1 to this quarterly report on Form 10-Q, and incorporated into this Item 5. This agreement provides that with respect to our joint insurance policies (which includes our property policy), available benefits with respect to a loss shall be paid to each party as stipulated in the policies, however, in the event of losses by us and Penske Corporation in excess of the limit of any policy during a policy period, the total policy proceeds shall be allocated (and re-allocated) based on the ratio of premiums paid.
| Item 6. | Exhibits | |
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| 4.1 | | Third Amendment dated August 8, 2006 to the Second Amended and Restated Credit Agreement dated September 8, 2004 by and among, United Auto Group, Inc., DaimlerChrysler Financial Services Americas LLC and Toyota Motor Credit Corporation |
| 10.1 | | Joint Insurance Agreement dated August 7, 2006 between us and Penske Corporation. |
| 12 | | Computation of Ratio of Earnings to Fixed Charges |
| 31 | | Rule 13a-14(a)/15(d)-14(a) Certifications |
| 32 | | Section 1350 Certifications |
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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.
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| By: | /s/ Roger S. Penske |
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| Roger S. Penske |
| Chief Executive Officer |
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Date: August 9, 2006
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| By: | /s/ James R. Davidson |
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| James R. Davidson |
| Executive Vice President — Finance |
| (Principal Financial Officer) |
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Date: August 9, 2006
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EXHIBIT INDEX
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Exhibits | | |
Number: | | Description |
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| | 4.1 | | Third Amendment dated August 8, 2006 to the Second Amended and Restated Credit Agreement dated September 8, 2004 by and among, United Auto Group, Inc., DaimlerChrysler Financial Services Americas LLC and Toyota Motor Credit Corporation |
| | 10.1 | | Joint Insurance Agreement dated August 7, 2006 between us and Penske Corporation. |
| | 12 | | Computation of Ratio of Earnings to Fixed Charges |
| | 31 | | Rule 13a-14(a)/15(d)-14(a) Certifications |
| | 32 | | Section 1350 Certifications |
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