UNITED STATES SECURITIES AND EXCHANGE COMMISSION
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
Indicate by check mark whether the registrant is an accelerated filer (as defined Rule 12b-2 of the Exchange Act) Yes þ No o
As of May 12, 2003, there were 40,611,310 shares of voting common stock outstanding.
TABLE OF CONTENTS
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UNITED AUTO GROUP, INC.
See Notes to Consolidated Condensed Financial Statements
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1. Interim Financial Statements
The information presented as of March 31, 2003 and 2002 and for the three month periods then ended is unaudited, but includes all adjustments (consisting only of normal and recurring adjustments) 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, 2002, 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.
During 2002, the Company sold certain dealerships which qualified for treatment as discontinued operations in accordance with Statement of Financial Accounting Standard No. 144 “Accounting for the Impairment of Disposal of Long-Lived Assets”. Consequently, such dealerships have been reported as discontinued operations. Combined financial information of these dealerships is as follows:
In March 2003, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) finalized Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor” (“EITF 02-16”). EITF 02-16 addresses the accounting treatment for vendor allowances and provides that cash consideration received from a vendor should be presumed to be a reduction of the prices of the vendors’ product and should therefore be shown as a reduction in the purchase price of the merchandise. To the extent that the cash consideration represents a reimbursement of a specific, incremental and identifiable cost, then those vendor allowances should be used to offset such costs. Historically, the company recorded non-refundable floor plan credits and certain other non-refundable credits when received. As a result of the EITF, these credits are now presumed to be reductions in the cost of purchased inventory and are deferred until the related vehicle is sold. In accordance with EITF 02-16, the Company recorded a cumulative effect of accounting change as of January 1, 2003, the date of adoption, that decreased net income for 2002 by $3.1 million, net of tax, or $0.07 per diluted share.
Statement of Financial Accounting Standards No. 146, “Accounting 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. The adoption of SFAS No. 146 did not have a material impact on the Company’s results of operations, financial position or cash flows.
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Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”) was issued in November 2002. FIN 45 requires the recognition of a liability for certain guarantee obligations issued or modified after December 31, 2002. FIN 45 also clarifies disclosure requirements to be made by a guarantor for certain guarantees. The adoption of FIN 45 did not have a material impact on the Company’s results of operations, financial position or cash flows.
FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of APB No. 50” (“FIN 46”) was issued in January 2003. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not currently participate in any variable interest entities.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual result could differ from those estimates. The accounts requiring the use of significant estimates include accounts receivable, inventories, income taxes, intangible assets and certain reserves.
Intangible assets in the consolidated condensed balance sheets include goodwill and franchise value. Goodwill represents the excess of cost over the fair value of tangible and identified intangible assets acquired arising in connection with purchase business combinations. Franchise value represents the estimated value of franchises acquired in business combinations. Goodwill and franchise value are deemed to have indefinite lives and are not amortized, but are subject to, at a minimum, an annual impairment test. If the carrying value of goodwill, franchise value or other intangible assets exceeds its fair market value, an impairment loss would be recorded. The Company uses a discounted cash flow model to determine the fair market value of the Company’s reporting units.
Following is a summary of the changes in the carrying amount of goodwill and franchise value:
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2. Inventories
Inventories consisted of the following:
3. Business Combinations
During the three months ended March 31, 2002, the Company acquired 62 automobile dealership franchises. The aggregate consideration paid in connection with such acquisitions amounted to $144,832 in cash. The Company’s financial statements include the results of operations of the acquired dealerships only from the date of acquisition.
The following unaudited consolidated pro forma results of operations of the Company for the three month period ended March 31, 2002 give effect to acquisitions consummated subsequent to January 1, 2002 as if they had occurred on January 1, 2002.
4. Stock-Based Compensation
Full-time employees of the Company and its subsidiaries and affiliates are eligible to receive stock options pursuant to the terms of the Company’s Stock Option Plan. Options granted under the Stock Option Plan have a ten year life and typically vest on a pro-rata basis over three or five years. The aggregate number of shares of Common Stock for which stock options may be granted under the Stock Option Plan is 3,001,000. As of March 31, 2003, 150,000 shares of Common Stock were available for the grant of options under the Stock Option Plan.
Pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, the Company accounts for stock-based employee compensation arrangements using the intrinsic value method. Accordingly, no compensation expense has been recorded in the Consolidated Financial Statements with respect to option grants. The Company has adopted the disclosure only provisions of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock Based Compensation”, as amended by Financial Accounting Standards Board Statement No. 148, “Accounting for Stock Based Compensation — Transition and Disclosure, an Amendment of FASB Statement No. 123”.
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Had the Company elected to recognize compensation expense for stock-based compensation using the fair value method, net income, basic net income per common share and net income per diluted common share would have been as follows (unaudited):
The weighted average fair value of the Company’s stock options was calculated using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2002: no dividend yield; expected volatility of 60.8%; risk-free interest rate of 4% and expected lives of five years. There were no option grants in the first quarter of 2003. The weighted average fair value of options granted during the period ended March 31, 2002 was $11.67.
The Company has proposed that stockholders approve the United Auto Group, Inc. 2002 Equity Compensation Plan (the “Plan”) at its annual meeting of stockholders in May 2003. The Plan would include 2,100,000 shares available for future issuance of awards including; stock options, stock appreciation rights, restricted stock and restricted stock units, performance shares and other awards to key employees, outside directors, consultants and advisors of the Company.
5. Earnings Per Share
Basic earnings per common share is computed using the weighted average number of common shares outstanding. Diluted earnings per common share is based on the weighted average number of common shares outstanding, adjusted for the dilutive effect of stock options, preferred stock, warrants and stock price guarantees. For the three months ended March 31, 2003 and 2002, 969,087 and 150,000 shares issuable upon the exercise of outstanding options were excluded from the calculation of diluted earnings per common share
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because the effect of such securities was antidilutive. A reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share is as follows:
6. Supplemental Cash Flow Information
The following table presents certain supplementary information to the consolidated condensed statements of cash flow:
7. Long Term Debt
Long-term debt consisted of the following:
Undrawn, available capacity under the Company’s credit facilities amounted to approximately $344,000 as of March 31, 2003.
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The Company is party to a credit agreement with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation, dated as of August 3, 1999, as amended and restated (the “U.S. Credit Agreement”), which provides for up to $700,000 in revolving loans to be used for acquisitions, working capital, the repurchase of common stock and general corporate purposes, as well as a $50,000 standby letter of credit facility. Revolving loans mature on August 3, 2005. Loans under the U.S. Credit Agreement bear interest between U.S. LIBOR plus 2.00% and U.S. LIBOR plus 3.00%. The U.S. Credit Agreement is fully and unconditionally guaranteed on a joint and several basis by the Company’s domestic automotive dealership subsidiaries and contains a number of significant covenants that, among other things, restrict the ability of the Company 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 maintain specified ratios and tests as defined in the U.S. Credit Agreement. The U.S. Credit Agreement also contains typical events of default including change of control and non-payment of obligations. Availability under the revolving portion of the U.S. Credit Agreement is subject to a collateral-based borrowing limitation, which is determined based on certain of our allowable tangible assets (which does not include foreign assets). Substantially all of the Company’s domestic assets are subject to security interests granted to lenders under the U.S. Credit Agreement. Our U.S. Credit Agreement, the subordinated notes discussed below and borrowings under floor plan financing arrangements have cross-default provisions that trigger a default in the event of an uncured default under other material indebtedness. As of March 31, 2003 and December 31, 2002, outstanding letters of credit under the U.S. Credit Agreement amounted to $42,500. As of March 31, 2003 the Company was in compliance with all financial covenants under the U.S. Credit Agreement.
On February 28, 2003, the Company entered into a new credit facility with the Royal Bank of Scotland (the “U.K. Credit Facility”), which provides for up to £45,000 in revolving loans to be used for acquisitions, working capital, and general corporate purposes and a seasonally adjusted overdraft line of credit up to a maximum of £10,000. Loans under the U.K. Credit Facility bear interest between U.K. LIBOR plus 0.85% and U.K. LIBOR plus 1.25%. The Company’s borrowing capacity under the U.K. Credit Facility will be reduced by £2,000 every six months, with the first reduction occurring on January 1, 2004. The remaining £35,000 of revolving loans mature on January 31, 2006. The U.K. Credit Facility is fully and unconditionally guaranteed on a joint and several basis by the Company’s automotive dealership subsidiaries in the U.K. (the “U.K. Subsidiaries”), and contains a number of significant covenants that, among other things, restrict the ability of the U.K. Subsidiaries to pay dividends, dispose of assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. In addition, the U.K. Subsidiaries are required to comply with specified ratios and tests, as defined in the U.K. Credit Facility. The U.K. Credit Facility also contains typical events of default, including change of control and non-payment of obligations. Substantially all of the U.K. Subsidiaries’ assets are subject to security interests granted to lenders under the U.K. Credit Facility and the U.K. Credit Facility has cross-default provisions that trigger a default in the event of an uncured default under other material indebtedness of the U.K. Subsidiaries. As of March 31, 2003, outstanding borrowings under the U.K. Credit Facility amounted to approximately £23,800. As of March 31, 2003, the Company was in compliance with all financial covenants under the U.K. Credit Facility.
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 of 1933, as amended. Net proceeds from the offering were approximately $291,900, and were used to repay indebtedness outstanding under the U.S. Credit
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Agreement. In February 2003, the Company exchanged the notes in a registered offering for $300,000 of new notes (the “Notes”) with identical terms. The Notes are unsecured senior subordinated notes and rank behind all existing and future senior debt, including debt under our credit agreements and floor plan indebtedness. 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.
8. Interest Rate Swaps
During January 2000, the Company entered into a swap agreement of five years duration pursuant to which a notional $200,000 of our floating rate debt was exchanged for fixed rate debt. The fixed rate interest to be paid by us was based on U.S. LIBOR and amounted to 7.15%. In October 2002, the terms of this swap were amended pursuant to which the interest rate to be paid by the Company was reduced to 5.86% and the term of the agreement was extended for an additional three years. During March 2003, the Company entered into a swap agreement of five years duration pursuant to which a notional $350,000 of floating rate debt was exchanged for fixed rate debt. The fixed rate interest to be paid by the Company of 3.15% is based on U.S. LIBOR. These swaps have been designated as cash flow hedges of future interest payments of the Company’s LIBOR based floor plan borrowings.
9. Subsequent Events
In April 2003, the Company acquired nine automobile dealership franchises. The aggregate consideration paid in connection with such acquisitions amounted to approximately $62.7 million in cash.
In April 2003, an entity controlled by one of our directors, Lucio A. Noto (the “Investor”), paid approximately $1.8 million (including approximately $800,000 credited from prior earnings retroactive to March 1, 2001) for a 6.5% interest in one of the Company’s subsidiaries, UAG Connecticut I, LLC, which entitles the Investor to 20% of the operating profits of UAG Connecticut I. In addition, the Investor has an option to purchase up to a 20% interest in UAG Connecticut I for specified amounts. The Investor has also guaranteed 20% of UAG Connecticut I’s lease obligation to Automotive Group Realty, LLC (“AGR”), our landlord of the facility at which the dealership operates and a wholly owned subsidiary of Penske Corporation. In exchange for that guarantee, the Investor will be entitled to 20% of any appreciation of the property, which appreciation would otherwise accrue to AGR at the time of sale, and the Investor is responsible to AGR for any corresponding depreciation of the property at the time of sale, which obligation shall be secured solely by the Investor’s ownership interest in UAG Connecticut I, LLC.
In April 2003, we formed a joint venture to own and operate three BMW dealerships in and around Munich, Germany. Our joint venture partner in Germany is Mr. Peter Reisacher. We contributed approximately $5.0 million for a 50% interest and Mr. Reisacher contributed approximately $5.0 million for a 50% interest in the joint venture.
10. Condensed Consolidating Financial Information
The following tables include condensed consolidating financial information as of March 31, 2003 and December 31, 2002 and for the three month periods ended March 31, 2003 and 2002 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.
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CONDENSED CONSOLIDATING BALANCE SHEET
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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
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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 March 31, 2003, we owned and operated 129 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. Floor plan financing represents indebtedness incurred in connection with the acquisition of new and used vehicle inventories. 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 each year since our inception. 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.
In March 2003, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) finalized Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor” (“EITF 02-16”). EITF 02-16 addresses the accounting treatment for vendor allowances and provides that cash consideration received from a vendor should be presumed to be a reduction of the prices of the vendors’ product and should therefore be shown as a reduction in the purchase price of the merchandise. To the extent that the cash consideration represents a reimbursement of a specific, incremental and identifiable cost, then those vendor allowances should be used to offset such costs. Historically, the company recorded non-refundable floor plan credits and certain other non-refundable credits when received. As a result of the EITF, these credits are now presumed to be reductions in the cost of purchased inventory and are deferred until the related vehicle is sold. In accordance with EITF 02-16, the
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Results of Operations
Retail revenues, which exclude revenues relating to fleet and wholesale transactions, increased by $379.4 million, or 26.2%, from $1.446 billion to $1.826 billion. The overall increase in retail revenues is due primarily to: (1) a $45.2 million, or 3.4%, increase in retail revenues at dealerships owned prior to January 1, 2002, and (2) dealership acquisitions made subsequent to January 1, 2002, partially offset by a decrease in revenues resulting from the divestiture of certain dealerships. The overall increase in retail revenues at dealerships owned prior to January 1, 2002 reflects 2.4%, 4.2%, 6.2% and 11.6% increases in new retail vehicle, used retail vehicle, service and parts and finance and insurance revenues, respectively. Aggregate retail unit sales increased by 17.0%, due principally to: (1) the net increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. We retailed 60,835 retail vehicles during the three months ended March 31, 2003, compared with 51,987 retail vehicles during the three months ended March 31, 2002.
Retail sales of new vehicles increased by $170.4 million, or 18.0%, from $946.3 million to $1.117 billion. The increase is due primarily to: (1) a $20.7 million, or 2.4%, increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. The increase at dealerships owned prior to January 1, 2002, is due primarily to a 0.4% increase in new retail unit sales and a 1.9% increase in comparative average selling prices per vehicle. Aggregate retail unit sales of new vehicles increased by 12.3%, due principally to: (1) the net increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. We retailed 38,958 new vehicles (64.0% of total retail vehicle sales) during the three months ended March 31, 2003, compared with 34,689 new vehicles (66.7% of total retail vehicle sales) during the three months ended March 31, 2002.
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Retail sales of used vehicles increased by $145.8 million, or 48.6%, from $299.9 million to $445.7 million. The increase is due primarily to: (1) an $11.3 million, or 4.2%, increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. The increase at dealerships owned prior to January 1, 2002 is due primarily to a 6.1% increase in used retail unit sales, offset slightly by a 1.8% decrease in comparative average selling prices per vehicle. Aggregate retail unit sales of used vehicles increased by 26.5%, due principally to: (1) the net increase at dealerships owned prior to January 1, 2002, and (2) acquisitions made subsequent to January 1, 2002. We retailed 21,877 used vehicles (36.0% of total retail vehicle sales) during the three months ended March 31, 2003, compared with 17,298 used vehicles (33.3% of total retail vehicle sales) during the three months ended March 31, 2002.
Finance and insurance revenues increased by $11.1 million, or 29.5%, from $37.7 million to $48.8 million. The increase is due primarily to: (1) a $3.7 million, or 11.6%, increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. The increase at dealerships owned prior to January 1, 2002 is primarily due to a finance and insurance revenue increase of $60 per retail vehicle sold, which increased revenue by $3.0 million, and a 2.3% increase in retail vehicles sold which increased revenue by $0.7 million.
Service and parts revenues increased by $52.2 million, or 32.1%, from $162.5 million to $214.7 million. The increase is due primarily to: (1) a $9.4 million, or 6.2%, increase at dealerships owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. The Company believes that its service and parts business is being positively impacted by the complexity of today’s 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 $1.9 million, or 6.1%, versus the comparable prior year period. The decrease in fleet revenues is due entirely to a decrease in fleet sales revenues at dealerships owned prior to January 1, 2002.
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Wholesale revenues increased $24.5 million, or 25.2%, versus the comparable prior year period. The increase in wholesale revenues is due primarily to acquisitions made subsequent to January 1, 2002, partially offset by a $5.2 million, or 5.9%, decrease at dealerships owned prior to January 1, 2002. The Company believes that wholesale sales levels are decreasing as a result of the relative strength of the company’s used vehicle sales, coupled with the relative weakness of the new car market, resulting in the ability to dispose of older vehicles received on trade through retail channels rather than through the auction process.
Retail gross profit, which excludes gross profit on fleet and wholesale transactions, increased $60.3 million, or 26.5%, from $227.4 million to $287.7 million. The increase in gross profit is due to: (1) an $8.1 million, or 3.9%, increase in retail gross profit at stores owned prior to January 1, 2002, and (2) acquisitions made subsequent to January 1, 2002. The increase in gross profit at stores owned prior to January 1, 2002 is due to (1) an increase in the relative proportion of service and parts sales to total retail sales attributable largely to our capacity expansion programs and (2) an increase in gross profit margins on service and parts revenues. Additionally, finance and insurance revenues per unit increased by $60. These factors were offset by decreased gross profit margins on the sale of new, fleet and wholesale vehicles.
Retail gross profit as a percentage of revenues on retail transactions increased from 15.7% to 15.8%. Gross profit as a percentage of revenues for new vehicle retail, used vehicle retail, finance and insurance and service and parts revenues was 8.4%, 9.5%, 100.0%, and 47.8%, respectively, compared with 8.6%, 11.2%, 100.0% and 46.0% in the comparable prior year period.
Selling, general and administrative expenses increased by $53.6 million, or 28.9%, from $185.7 million to $239.3 million. Such expenses increased as a percentage of total revenue from 11.8% to 12.1%, and increased as a percentage of gross profit from 81.4% to 83.3%. The aggregate increase in selling, general and administrative expenses is due principally to: (1) a $15.6 million, or 9.4%, increase at dealerships owned prior to January 1, 2002, and (2) acquisitions made subsequent to January 1, 2002, offset in part by a decrease of approximately $7.0 million related to reduced legal expenses, employee costs, and insurance expense as a result of favorable experience. The increase in selling, general and administrative expenses at stores owned prior to January 1, 2002 is due in large part to increased selling expenses, including increases in variable compensation as a result of the 3.9% increase in retail gross profit over the prior year coupled with increased occupancy, depreciation and utility costs of approximately $6.4 million associated with the Company’s facility improvement and expansion program.
Floor plan interest expense increased by $0.8 million, or 9.6%, from $8.3 million to $9.1 million. The increase in floor plan interest expense is due to (1) a $0.6 million, or 7.6%, decrease at stores owned prior to January 1, 2002 and (2) acquisitions made subsequent to January 1, 2002. The decrease at stores owned prior
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Other interest expense increased by $2.5 million, or 31.6%, from $7.9 million to $10.4 million. The increase is due primarily to (1) increased acquisition related indebtedness, including approximately $140.0 million borrowed in connection with the acquisition of the Sytner Group plc in March 2002 and (2) a full quarter of interest expense related to our $300 million senior subordinated notes offered in March 2002, offset slightly by (1) a decrease in our weighted average borrowing rate during 2003 and (2) the pay down of certain debt with proceeds of equity transactions in the first quarter of 2002.
Income taxes increased by $0.8 million from $10.4 million to $11.2 million. The increase is due to an increase in pre-tax income compared with 2002 offset by a reduction in our effective rate due to an increase in the relative proportion of taxable income from our U.K. operations, which are taxed at a lower rate.
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 agreements, the issuance of debt securities, including floor plan notes payable, sale-leaseback transactions, the issuance of equity securities and cash flow from operations. At March 31, 2003, we had working capital of $164.1 million.
We finance the majority of our new and a portion of our used vehicle inventory under revolving floor plan financing arrangements between our subsidiaries and various lenders. In the U.S., 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. In the U.K., we pay interest only for 60 days, after which we repay the floor plan indebtedness with cash flow from operations or borrowings under available credit facilities. 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. Outstanding borrowings under floor plan arrangements amounted to $1.0 billion as of March 31, 2003, of which $175.4 million relates to inventory held by our U.K. subsidiaries.
The Company is party to an amended and restated credit agreement with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation, dated as of December 22, 2002 (the “U.S. Credit Agreement”), which provides for up to $700.0 million in revolving loans to be used for acquisitions, working capital, the repurchase of common stock and general corporate purposes, as well as a $50.0 million standby letter of credit facility. Revolving loans mature on August 3, 2005. Loans under the U.S. Credit Agreement bear interest between U.S. LIBOR plus 2.00% and U.S. LIBOR plus 3.00%. The U.S. Credit Agreement is fully and unconditionally guaranteed on a joint and several basis by the Company’s domestic automotive dealership subsidiaries and contains a number of significant covenants that, among other things, restrict the ability of the Company 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 maintain specified ratios and tests as defined in the U.S. Credit Agreement. The U.S. Credit Agreement also contains typical events of default including change of control and non-payment of obligations. Availability under the revolving portion of the U.S. Credit Agreement is subject to a collateral-based
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On February 28, 2003, the Company entered into a new credit facility with the Royal Bank of Scotland (the “U.K. Credit Facility”), which provides for up to £45.0 million in revolving loans to be used for acquisitions, working capital, and general corporate purposes and a seasonally adjusted overdraft line of credit up to a maximum of £10.0 million. Loans under the U.K. Credit Facility bear interest between U.K. LIBOR plus 0.85% and U.K. LIBOR plus 1.25%. The Company’s borrowing capacity under the U.K. Credit Facility will be reduced by £2.0 million every six months, with the first reduction occurring on January 1, 2004. The remaining £35.0 million of revolving loans mature on January 31, 2006. The U.K. Credit Facility is fully and unconditionally guaranteed on a joint and several basis by the Company’s automotive dealership subsidiaries in the U.K. (the “U.K. Subsidiaries”), and contains a number of significant covenants that, among other things, restrict the ability of the U.K. Subsidiaries to pay dividends, dispose of assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make investments or acquisitions and engage in mergers or consolidations. In addition, the U.K. Subsidiaries are required to comply with specified ratios and tests as defined in the U.K. Credit facility. The U.K. Credit Facility also contains typical events of default, including change of control and non-payment of obligations. Substantially all of the U.K. Subsidiaries’ assets are subject to security interests granted to lenders under the U.K. Credit Facility and the U.K. Credit Facility has cross-default provisions that trigger a default in the event of an uncured default under other material indebtedness of the U.K. Subsidiaries. As of March 31, 2003, outstanding borrowings under the U.K. Credit Facility amounted to approximately £23.8 million. As of March 31, 2003, the Company was in compliance with all financial covenants under the U.K. Credit Facility.
In March 2002, the Company completed the sale of $300.0 million 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 of 1933, as amended. Net proceeds from the offering were approximately $291.9 million, and were used to repay indebtedness outstanding under the U.S. Credit Agreement. In February 2003, the Company exchanged the notes in a registered offering for $300.0 million of new notes (the “Notes”) with identical terms. The Notes are unsecured senior subordinated notes and rank behind all existing and future senior debt, including debt under our credit agreements and floor plan indebtedness. 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.
During January 2000, the Company 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. The fixed rate interest to be paid by us was based on U.S. LIBOR and amounted to 7.15%. In October 2002, the terms of this swap were amended pursuant to which the interest rate to be paid by us was reduced to 5.86% and the term of the agreement was extended for an additional three years. During March 2003, the Company entered into a
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As of March 31, 2003, we had approximately $11.5 million of cash available to fund operations and future acquisitions. In addition, as of March 31, 2003, $344.0 million was available for borrowing under our credit agreements. Availability under the U.S. Credit Agreement is not currently limited by 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 domestic acquisitions and domestic capital construction projects will typically increase tangible assets, allowing the Company to access borrowing capacity that may not otherwise be available due to the base collateral limitation in the U.S. Credit Agreement.
In March 2002, pursuant to an all cash tender offer, we acquired Sytner Group plc, a publicly traded automotive retailer operating in excess of 60 franchises in the United Kingdom. Total consideration for Sytner amounted to approximately $140.0 million. In addition, we assumed approximately $22.4 million of Sytner’s debt. As an alternative to receiving all or any part of the cash consideration receivable under the offer, Sytner shareholders could elect to receive loan notes in lieu of cash. Approximately $40.0 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 note holders.
During the quarter ended March 31, 2003, net cash used in operations amounted to $1.5 million. Net cash used in investing activities during the quarter ended March 31, 2003 totaled $44.8 million, including $42.0 million related to capital expenditures. Net cash provided by financing activities during the quarter ended March 31, 2003 totaled $49.7 million.
We have a number of capital projects planned or underway relating to the expansion and renovation of our retail automotive operations. Historically, we have financed such capital expenditures with cash flow from operations and borrowings under our credit agreements. 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 made lease payments to AGR totaling $1.3 million during the period ended March 31, 2003, which payments relate to the properties we lease from AGR. We believe we will continue to finance certain capital expenditures in this fashion in the future. Funding for such capital expenditures is expected to come from cash flow from operations, supplemented by borrowings under our credit agreements.
In connection with an acquisition of dealerships completed in October 2000, the Company agreed to make a contingent payment in cash to the extent 841,476 shares of common stock issued as consideration in connection with that acquisition are sold subsequent to the fifth anniversary of the transaction and have a market value of less than $12.00 per share at the time of sale. 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. In the event the Company is required to make a payment relating to this guarantee, such payment would result in the revaluation of the common stock issued in the transaction, resulting in a reduction of additional paid-in-capital. 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 on each of the first five anniversary dates of the transaction. To
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In connection with an acquisition of dealerships completed in October 1997, the Company 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 2003. Payments relating to this earnings contingency are recorded as additional cost of the acquired dealerships, resulting in an increase in goodwill.
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 cash flow provided by operating activities and our 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 April 2003, we formed a joint venture to own and operate three BMW dealerships in and around Munich, Germany. Our joint venture partner in Germany is Peter Reisacher. We contributed approximately $5.0 million for a 50% interest and Mr. Reisacher contributed approximately $5.0 million for a 50% interest in the joint venture.
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In March 2002, we formed a joint venture to own and operate Lexus and Toyota dealerships in and around Frankfurt, Germany. Our joint venture partner in Germany is Mr. Werner Nix. We contributed $4.7 million for a 50.0% interest and Mr. Nix contributed $4.7 million for a 50.0% interest, respectively, in the joint venture.
In March 2002, we formed a joint venture to own and operate a Toyota dealership in Monterrey Mexico. Our joint venture partners in Mexico are Mr. Mario Padilla and Mr. Bernard Wolfe. We contributed $2.4 million for a 48.7% interest, Mr. Padilla contributed $2.5 million for a 49.8% interest, and Mr. Wolfe contributed approximately eighty thousand dollars for a 1.5% interest, respectively, in the joint venture.
In December 2001, 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 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 January 1998, we entered into an agreement with a third party to jointly acquire and manage dealerships in Illinois, Ohio, North Carolina and South Carolina. With respect to any joint venture 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 the acquisition. Pursuant to this arrangement, we entered into a joint venture with respect to the Citrus Chrysler dealership acquired in 1998. We are required to repurchase our partner’s interest in this joint venture in November 2003. We expect this payment to be approximately $3.0 million.
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 in the northeastern 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
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FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of APB No. 50” (“FIN 46”) was issued in January 2003. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not currently participate in any variable interest entities.
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.
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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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:
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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.
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 a variable rate based on a margin over LIBOR, as defined. Based on the amount outstanding as of March 31, 2003, a 100 basis point change in interest rates would result in an approximate $3.9 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 $6.7 million change to our annual floor plan interest expense.
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 swap agreements pursuant to which a notional $200.0 million of our floating rate debt was exchanged for 5.86% fixed rate debt through January 2008 and a notional $350.0 million of our floating rate debt was exchanged for 3.155% fixed rate debt through March 2008.
Interest rate fluctuations effect the fair market value of our fixed rate debt, including the Notes and certain seller financed promissory notes, but do not impact our earnings or cash flows.
Foreign Currency Exchange Rates.The Company currently has operations in the U.K. and Brazil and has investments in Germany and Mexico. 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 U.K., the Company’s foreign operations are not significant. In the event we 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 the majority of our inventories in the local functional currency, including the U.S. Dollar, 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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We maintain a set of disclosure controls and procedures designed to ensure that material information related to the Company, including our consolidated subsidiaries, is made known to our principal executive officer and principal financial officer on a regular basis, in particular during the period in which the quarterly and annual reports are being prepared. As required, we continue to evaluate the effectiveness of these disclosure controls and procedures. Based on the most recent evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to our most recent evaluation.
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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 during the quarter ended March 31, 2003:
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CERTIFICATIONS PURSUANT TO SECTION 302 OF THE
Certification
I, Roger S. Penske, certify that:
1. I have reviewed this quarterly report on Form 10-Q of United Auto Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements and other financial information included in this quarterly report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant and we have:
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
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I, James R. Davidson, certify that:
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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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