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Section 1: 10-Q (10-Q)

PAG Form 10-Q March 31, 2018

Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

 

For the quarterly period ended March 31, 2018

 

or

 

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

 

For the transition period from      to     

 

Commission file number 1-12297

 

Penske Automotive Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

 

22-3086739

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

2555 Telegraph Road

 

 

Bloomfield Hills, Michigan

 

48302-0954

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(248) 648-2500

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No 

 

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

 

 

 

 

 

 

 

 

 

 

Large accelerated filer

 

Accelerated filer

 

Non-accelerated filer

 

Smaller reporting company

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 

 

As of April 23, 2018, there were 84,975,160 shares of voting common stock outstanding.

 

 

 

 

 


 

Table of Contents

TABLE OF CONTENTS

 

 

 

Page

 

 

PART I — FINANCIAL INFORMATION 

 

 

 

Item 1. Financial Statements 

 

 

 

Consolidated Condensed Balance Sheets as of March 31, 2018 and December 31, 2017 

3

 

 

Consolidated Condensed Statements of Income for the three months ended March 31, 2018 and 2017 

4

 

 

Consolidated Condensed Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017 

5

 

 

Consolidated Condensed Statements of Cash Flows for the three months ended March 31, 2018 and 2017 

6

 

 

Consolidated Condensed Statement of Equity for the three months ended March 31, 2018 

7

 

 

Notes to Consolidated Condensed Financial Statements 

8

 

 

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

32

 

 

Item 3. Quantitative & Qualitative Disclosures About Market Risk 

51

 

 

Item 4. Controls and Procedures 

52

 

 

PART II — OTHER INFORMATION 

 

 

 

Item 1. Legal Proceedings 

53

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

53

 

 

Item 6. Exhibits 

54

 

 

2


 

Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

 

    

March 31,

    

December 31,

 

 

 

2018

 

2017

 

 

 

(Unaudited)

 

 

 

(In millions, except share

 

 

 

and per share amounts)

 

ASSETS

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

52.8

 

$

45.7

 

Accounts receivable, net of allowance for doubtful accounts of $5.0 and $5.5

 

 

1,035.4

 

 

954.9

 

Inventories

 

 

3,972.2

 

 

3,944.1

 

Other current assets

 

 

105.0

 

 

81.8

 

Total current assets

 

 

5,165.4

 

 

5,026.5

 

Property and equipment, net

 

 

2,173.5

 

 

2,108.6

 

Goodwill

 

 

1,731.8

 

 

1,660.5

 

Other indefinite-lived intangible assets

 

 

481.4

 

 

474.0

 

Equity method investments

 

 

1,276.2

 

 

1,256.6

 

Other long-term assets

 

 

14.7

 

 

14.4

 

Total assets

 

$

10,843.0

 

$

10,540.6

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

Floor plan notes payable

 

$

2,355.6

 

$

2,343.2

 

Floor plan notes payable — non-trade

 

 

1,413.8

 

 

1,418.6

 

Accounts payable

 

 

720.5

 

 

641.6

 

Accrued expenses

 

 

563.9

 

 

523.5

 

Current portion of long-term debt

 

 

84.3

 

 

72.8

 

Liabilities held for sale

 

 

0.7

 

 

0.7

 

Total current liabilities

 

 

5,138.8

 

 

5,000.4

 

Long-term debt

 

 

2,136.9

 

 

2,090.4

 

Deferred tax liabilities

 

 

505.5

 

 

481.5

 

Other long-term liabilities

 

 

567.4

 

 

540.3

 

Total liabilities

 

 

8,348.6

 

 

8,112.6

 

Commitments and contingent liabilities (Note 9)

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

Penske Automotive Group stockholders’ equity:

 

 

 

 

 

 

 

Preferred Stock, $0.0001 par value; 100,000 shares authorized; none issued and outstanding

 

 

 —

 

 

 —

 

Common Stock, $0.0001 par value, 240,000,000 shares authorized; 84,975,410 shares issued and outstanding at March 31, 2018; 85,787,507 shares issued and outstanding at December 31, 2017

 

 

 —

 

 

 —

 

Non-voting Common Stock, $0.0001 par value; 7,125,000 shares authorized; none issued and outstanding

 

 

 —

 

 

 —

 

Class C Common Stock, $0.0001 par value; 20,000,000 shares authorized; none issued and outstanding

 

 

 —

 

 

 —

 

Additional paid-in capital

 

 

485.2

 

 

532.3

 

Retained earnings

 

 

2,094.9

 

 

2,009.4

 

Accumulated other comprehensive income (loss)

 

 

(114.7)

 

 

(146.5)

 

Total Penske Automotive Group stockholders’ equity

 

 

2,465.4

 

 

2,395.2

 

Non-controlling interest

 

 

29.0

 

 

32.8

 

Total equity

 

 

2,494.4

 

 

2,428.0

 

Total liabilities and equity

 

$

10,843.0

 

$

10,540.6

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

    

2017

 

 

 

(Unaudited)

 

 

 

(In millions, except per share amounts)

 

Revenue:

 

 

 

 

 

 

 

Retail automotive dealership

 

$

5,296.0

 

$

4,756.4

 

Retail commercial truck dealership

 

 

292.4

 

 

211.7

 

Commercial vehicle distribution and other

 

 

158.5

 

 

113.0

 

Total revenues

 

 

5,746.9

 

 

5,081.1

 

Cost of sales:

 

 

 

 

 

 

 

Retail automotive dealership

 

 

4,517.7

 

 

4,048.1

 

Retail commercial truck dealership

 

 

245.8

 

 

175.3

 

Commercial vehicle distribution and other

 

 

119.0

 

 

83.4

 

Total cost of sales

 

 

4,882.5

 

 

4,306.8

 

Gross profit

 

 

864.4

 

 

774.3

 

Selling, general and administrative expenses

 

 

663.1

 

 

601.7

 

Depreciation

 

 

25.6

 

 

22.4

 

Operating income

 

 

175.7

 

 

150.2

 

Floor plan interest expense

 

 

(18.9)

 

 

(13.7)

 

Other interest expense

 

 

(29.8)

 

 

(25.0)

 

Equity in earnings of affiliates

 

 

17.3

 

 

13.2

 

Income from continuing operations before income taxes

 

 

144.3

 

 

124.7

 

Income taxes

 

 

(36.6)

 

 

(41.1)

 

Income from continuing operations

 

 

107.7

 

 

83.6

 

Income (loss) from discontinued operations, net of tax

 

 

0.1

 

 

(0.6)

 

Net income

 

 

107.8

 

 

83.0

 

Less: (Loss) income attributable to non-controlling interests

 

 

(0.3)

 

 

0.4

 

Net income attributable to Penske Automotive Group common stockholders

 

$

108.1

 

$

82.6

 

Basic earnings per share attributable to Penske Automotive Group common stockholders:

 

 

 

 

 

 

 

Continuing operations

 

$

1.26

 

$

0.97

 

Discontinued operations

 

 

0.00

 

 

(0.01)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

1.26

 

$

0.96

 

Shares used in determining basic earnings per share

 

 

86.0

 

 

85.6

 

Diluted earnings per share attributable to Penske Automotive Group common stockholders:

 

 

 

 

 

 

 

Continuing operations

 

$

1.26

 

$

0.97

 

Discontinued operations

 

 

0.00

 

 

(0.01)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

1.26

 

$

0.96

 

Shares used in determining diluted earnings per share

 

 

86.0

 

 

85.6

 

Amounts attributable to Penske Automotive Group common stockholders:

 

 

 

 

 

 

 

Income from continuing operations

 

$

107.7

 

$

83.6

 

Less: (Loss) income attributable to non-controlling interests

 

 

(0.3)

 

 

0.4

 

Income from continuing operations, net of tax

 

 

108.0

 

 

83.2

 

Income (loss) from discontinued operations, net of tax

 

 

0.1

 

 

(0.6)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

108.1

 

$

82.6

 

Cash dividends per share

 

$

0.34

 

$

0.30

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

    

2017

 

 

 

(Unaudited)

 

 

 

(In millions)

 

Net income

 

$

107.8

 

$

83.0

 

Other comprehensive income:

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

30.7

 

 

24.7

 

Other adjustments to comprehensive income, net

 

 

1.1

 

 

1.4

 

Other comprehensive income, net of tax

 

 

31.8

 

 

26.1

 

Comprehensive income

 

 

139.6

 

 

109.1

 

Less: Comprehensive (loss) income attributable to non-controlling interests

 

 

(0.3)

 

 

0.8

 

Comprehensive income attributable to Penske Automotive Group common stockholders

 

$

139.9

 

$

108.3

 

 

See Notes to Consolidated Condensed Financial Statements

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Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

    

2018

    

2017

 

 

 

(Unaudited)

 

 

 

(In millions)

 

Operating Activities:

 

 

 

 

 

 

 

Net income

 

$

107.8

 

$

83.0

 

Adjustments to reconcile net income to net cash from continuing operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

25.6

 

 

22.4

 

Earnings of equity method investments

 

 

(17.3)

 

 

(13.2)

 

(Income) loss from discontinued operations, net of tax

 

 

(0.1)

 

 

0.6

 

Deferred income taxes

 

 

23.7

 

 

42.5

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(76.7)

 

 

33.5

 

Inventories

 

 

9.2

 

 

(52.5)

 

Floor plan notes payable

 

 

20.9

 

 

20.4

 

Accounts payable and accrued expenses

 

 

108.8

 

 

86.0

 

Other

 

 

(27.1)

 

 

(24.1)

 

Net cash provided by continuing operating activities

 

 

174.8

 

 

198.6

 

Investing Activities:

 

 

 

 

 

 

 

Purchase of equipment and improvements

 

 

(64.7)

 

 

(36.9)

 

Proceeds from sale of dealerships

 

 

58.4

 

 

9.0

 

Acquisitions net, including repayment of sellers’ floor plan notes payable of $25.8 and $81.2, respectively

 

 

(156.5)

 

 

(314.2)

 

Other

 

 

(6.3)

 

 

 —

 

Net cash used in continuing investing activities

 

 

(169.1)

 

 

(342.1)

 

Financing Activities:

 

 

 

 

 

 

 

Proceeds from borrowings under U.S. credit agreement revolving credit line

 

 

396.0

 

 

523.0

 

Repayments under U.S. credit agreement revolving credit line

 

 

(440.0)

 

 

(476.0)

 

Net borrowings of other long-term debt

 

 

128.6

 

 

106.1

 

Net (repayments) borrowings of floor plan notes payable — non-trade

 

 

(4.8)

 

 

63.0

 

Repurchases of common stock

 

 

(50.0)

 

 

(2.7)

 

Dividends

 

 

(29.2)

 

 

(25.6)

 

Net cash provided by continuing financing activities

 

 

0.6

 

 

187.8

 

Discontinued operations:

 

 

 

 

 

 

 

Net cash provided by (used in) discontinued operating activities

 

 

0.1

 

 

(7.0)

 

Net cash provided by discontinued investing activities

 

 

 —

 

 

9.7

 

Net cash used in discontinued financing activities

 

 

 —

 

 

(0.2)

 

Net cash provided by discontinued operations

 

 

0.1

 

 

2.5

 

Effect of exchange rate changes on cash and cash equivalents

 

 

0.7

 

 

1.4

 

Net change in cash and cash equivalents

 

 

7.1

 

 

48.2

 

Cash and cash equivalents, beginning of period

 

 

45.7

 

 

24.0

 

Cash and cash equivalents, end of period

 

$

52.8

 

$

72.2

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid (received) for:

 

 

 

 

 

 

 

Interest

 

$

32.4

 

$

20.3

 

Income taxes

 

 

6.4

 

 

(8.4)

 

Seller financed/assumed debt

 

 

 —

 

 

3.8

 

Non cash activities:

 

 

 

 

 

 

 

Deferred consideration

 

$

12.0

 

$

 —

 

Consideration transferred through common stock issuance

 

 

 —

 

 

32.4

 

Contingent consideration

 

 

 —

 

 

20.0

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENT OF EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

Total

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional

 

 

 

 

Other

 

Penske

 

 

 

 

 

 

 

 

 

Issued

 

 

 

 

Paid-in

 

Retained

 

Comprehensive

 

Automotive Group

 

Non-controlling

 

Total

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income (Loss)

 

Stockholders’ Equity

 

Interest

 

Equity

 

 

 

(Unaudited)

 

 

 

(Dollars in millions)

 

Balance, December 31, 2017

    

85,787,507

    

$

 —

    

$

532.3

    

$

2,009.4

    

$

(146.5)

    

$

2,395.2

    

$

32.8

    

$

2,428.0

 

Adoption of ASC 606 (Note 1)

 

 —

 

 

 —

 

 

 —

 

 

6.6

 

 

 —

 

 

6.6

 

 

 —

 

 

6.6

 

Equity compensation

 

320,919

 

 

 —

 

 

4.5

 

 

 —

 

 

 —

 

 

4.5

 

 

 —

 

 

4.5

 

Repurchases of common stock

 

(1,133,016)

 

 

 —

 

 

(50.0)

 

 

 —

 

 

 —

 

 

(50.0)

 

 

 —

 

 

(50.0)

 

Dividends

 

 —

 

 

 —

 

 

 —

 

 

(29.2)

 

 

 —

 

 

(29.2)

 

 

 —

 

 

(29.2)

 

Purchase of subsidiary shares from non-controlling interest

 

 —

 

 

 —

 

 

(1.4)

 

 

 —

 

 

 —

 

 

(1.4)

 

 

(3.1)

 

 

(4.5)

 

Distributions to non-controlling interest

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(0.1)

 

 

(0.1)

 

Foreign currency translation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

30.7

 

 

30.7

 

 

 —

 

 

30.7

 

Other

 

 —

 

 

 —

 

 

(0.2)

 

 

 —

 

 

1.1

 

 

0.9

 

 

(0.3)

 

 

0.6

 

Net income

 

 —

 

 

 —

 

 

 —

 

 

108.1

 

 

 —

 

 

108.1

 

 

(0.3)

 

 

107.8

 

Balance, March 31, 2018

 

84,975,410

 

$

 —

 

$

485.2

 

$

2,094.9

 

$

(114.7)

 

$

2,465.4

 

$

29.0

 

$

2,494.4

 

 

See Notes to Consolidated Condensed Financial Statements

 

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PENSKE AUTOMOTIVE GROUP, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)
(In millions, except share and per share amounts)

 

1. Interim Financial Statements

 

Business Overview

 

Unless the context otherwise requires, the use of the terms “PAG,” “we,” “us,” and “our” in these Notes to the Consolidated Condensed Financial Statements refers to Penske Automotive Group, Inc. and its consolidated subsidiaries.

 

We are a diversified international transportation services company that operates automotive and commercial truck dealerships principally in the United States, Canada and Western Europe, and distributes commercial vehicles, diesel engines, gas engines, power systems and related parts and services principally in Australia and New Zealand.

 

Retail Automotive Dealership. We believe we are the second largest automotive retailer headquartered in the U.S. as measured by the $19.8 billion in total retail automotive dealership revenue we generated in 2017. As of March 31, 2018, we operated 342 retail automotive franchises, of which 151 franchises are located in the U.S. and 191 franchises are located outside of the U.S. The franchises outside the U.S. are located primarily in the U.K. In the three months ended March 31, 2018, we retailed and wholesaled more than 162,000 vehicles. We are diversified geographically, with 52% of our total retail automotive dealership revenues in the three months ended March 31, 2018 generated in the U.S. and Puerto Rico and 48% generated outside the U.S. We offer over 40 vehicle brands, with 70% of our retail automotive dealership revenue in the three months ended March 31, 2018 generated from premium brands, such as Audi, BMW, Mercedes-Benz and Porsche. Each of our franchised dealerships offers a wide selection of new and used vehicles for sale. In addition to selling new and used vehicles, we generate higher-margin revenue at each of our dealerships through maintenance and repair services and the sale and placement of third-party finance and insurance products, third-party extended service and maintenance contracts and replacement and aftermarket automotive products. We operate our franchised dealerships under franchise agreements with a number of automotive manufacturers and distributors that are subject to certain rights and restrictions typical of the industry.

 

We operate fourteen stand-alone used vehicle dealerships in the U.S. and the U.K. We acquired CarSense in the U.S. and CarShop in the U.K. in the first quarter of 2017 and acquired The Car People in the U.K. in January 2018. Our CarSense operations in the U.S. consist of five locations operating in the Philadelphia and Pittsburgh, Pennsylvania market areas, including southern New Jersey. Our CarShop operations in the U.K. consist of five retail locations and a vehicle preparation center operating principally throughout Southern England. The Car People operations in the U.K. consist of four retail locations operating across Northern England, which complements CarShop’s locations principally in Southern England.

 

During the three months ended March 31, 2018, we acquired four retail automotive franchises and disposed of five retail automotive franchises. The four retail automotive franchises acquired are located in Italy and represent the Mercedes-Benz and smart brands.

 

Retail Commercial Truck Dealership. We operate a heavy and medium-duty truck dealership group known as Premier Truck Group (“PTG”) with locations in Texas, Oklahoma, Tennessee, Georgia, and Canada. As of March 31, 2018, PTG operated twenty locations, including fourteen full-service dealerships and six collision centers, offering primarily Freightliner and Western Star branded trucks. PTG also offers a full range of used trucks available for sale as well as service and parts departments, providing a full range of maintenance and repair services.

 

Commercial Vehicle Distribution. We are the exclusive importer and distributor of Western Star heavy-duty trucks (a Daimler brand), MAN heavy and medium-duty trucks and buses (a VW Group brand), and Dennis Eagle refuse collection vehicles, together with associated parts, across Australia, New Zealand and portions of the Pacific. This business, known as Penske Commercial Vehicles Australia (“PCV Australia”), distributes commercial vehicles and parts

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to a network of more than 70 dealership locations, including eight company-owned retail commercial vehicle dealerships.

 

We are also a leading distributor of diesel and gas engines and power systems, principally representing MTU, Detroit Diesel, Allison Transmission and MTU Onsite Energy. This business, known as Penske Power Systems (“PPS”), offers products across the on- and off-highway markets in Australia, New Zealand and portions of the Pacific and supports full parts and aftersales service through a network of branches, field locations and dealers across the region. The on-highway portion of this business complements our PCV Australia distribution business, including integrated operations at retail locations selling PCV brands.

 

Penske Truck Leasing. We currently hold a 28.9% ownership interest in Penske Truck Leasing Co., L.P. (“PTL”), a leading provider of transportation services and supply chain management. PTL is capable of meeting customers’ needs across the supply chain with a broad product offering that includes full-service truck leasing, truck rental and contract maintenance, along with logistic services such as dedicated contract carriage, distribution center management, transportation management and lead logistics provider. On September 7, 2017, we acquired an additional 5.5% ownership interest in PTL from subsidiaries of GE Capital Global Holdings, LLC (collectively, “GE Capital”) for approximately $239.1 million in cash. Prior to this acquisition, we held a 23.4% ownership interest in PTL. PTL is currently owned 41.1% by Penske Corporation, 28.9% by us, and 30.0% by Mitsui & Co., Ltd. (“Mitsui”). GE Capital no longer owns any ownership interests in PTL. We account for our investment in PTL under the equity method, and we therefore record our share of PTL’s earnings on our statements of income under the caption “Equity in earnings of affiliates,” which also includes the results of our other equity method investments.

 

Basis of Presentation

 

The accompanying unaudited consolidated condensed financial statements of PAG have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in our annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC rules and regulations. The information presented as of March 31, 2018 and December 31, 2017 and for the three month periods ended March 31, 2018 and 2017 is unaudited, but includes all adjustments which our management believes to be necessary for the fair presentation of results for the periods presented. Results for interim periods are not necessarily indicative of results to be expected for the year. These consolidated condensed financial statements should be read in conjunction with our audited financial statements for the year ended December 31, 2017, which are included as part of our Annual Report on Form 10-K.

 

Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounts requiring the use of significant estimates include accounts receivable, inventories, income taxes, intangible assets and certain reserves.

 

Fair Value of Financial Instruments

 

Accounting standards define fair value as the price that would be received from selling an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accounting standards establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and also establishes the following three levels of inputs that may be used to measure fair value:

 

 

 

 

Level 1

 

Quoted prices in active markets for identical assets or liabilities

 

 

 

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Level 2

 

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted market prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

 

 

 

Level 3

 

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

 

Our financial instruments consist of cash and cash equivalents, debt, floor plan notes payable, and forward exchange contracts used to hedge future cash flows. Other than our fixed rate debt, the carrying amount of all significant financial instruments approximates fair value due either to length of maturity, the existence of variable interest rates that approximate prevailing market rates, or as a result of mark to market accounting.

 

Our fixed rate debt consists of amounts outstanding under our senior subordinated notes and mortgage facilities. We estimate the fair value of our senior unsecured notes using quoted prices for the identical liability (Level 2), and we estimate the fair value of our mortgage facilities using a present value technique based on current market interest rates for similar types of financial instruments (Level 2). A summary of the carrying values and fair values of our 5.75% senior subordinated notes, 5.375% senior subordinated notes, 5.50% senior subordinated notes, 3.75% senior subordinated notes, and our fixed rate mortgage facilities are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

 

  

Carrying Value

  

Fair Value

  

Carrying Value

  

Fair Value

 

5.75% senior subordinated notes due 2022

 

$

546.2

 

$

561.2

 

$

545.9

 

$

562.3

 

5.375% senior subordinated notes due 2024

 

 

297.3

 

 

298.1

 

 

297.2

 

 

300.2

 

5.50% senior subordinated notes due 2026

 

 

494.6

 

 

484.6

 

 

494.4

 

 

505.0

 

3.75% senior subordinated notes due 2020

 

 

296.8

 

 

295.1

 

 

296.5

 

 

301.7

 

Mortgage facilities

 

 

214.4

 

 

210.0

 

 

235.5

 

 

233.4

 

 

 

 

 

 

Assets Held for Sale and Discontinued Operations

 

We had no entities newly classified as held for sale during the three months ended March 31, 2018 or 2017 that met the criteria to be classified as discontinued operations. The financial information for entities that were classified as discontinued operations prior to adoption of Accounting Standards Update No. 2014-08 are included in “Income (loss) from discontinued operations” in the accompanying consolidated condensed statements of income and “Liabilities held for sale” in the accompanying consolidated condensed balance sheets for all periods presented.

 

 Disposals

 

During the three months ended March 31, 2018, we disposed of five retail automotive franchises. The results of operations for these businesses are included within continuing operations for the three months ended March 31, 2018 and 2017, as these franchises did not meet the criteria to be classified as held for sale and treated as discontinued operations.

 

Income Taxes

 

Tax regulations may require items to be included in our tax returns at different times than the items are reflected in our financial statements. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as the timing of depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that will be used as a tax deduction or credit in our tax returns in future years which we have already recorded in our financial statements. Deferred tax liabilities generally represent deductions taken on our tax returns that have not yet been recognized as expense in our financial statements. We establish valuation allowances for our deferred tax assets if the amount of expected future taxable income is not likely to allow for the use of the deduction or credit.

 

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The U.S. Tax Cuts and Jobs Act (the “Act”) was signed into law on December 22, 2017. The Act modifies several provisions of the Internal Revenue Code related to corporations, including a permanent corporate income tax rate reduction from 35% to 21%, effective January 1, 2018. The Act also significantly changes international tax laws for tax years beginning after December 31, 2017 and requires a one-time mandatory deemed repatriation of all cumulative post-1986 foreign earnings and profits of a U.S. shareholder’s foreign subsidiaries, which we recognized in 2017, the year of enactment. 

 

On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. SAB 118 provides a measurement period that should not extend beyond one year from the Act enactment date for companies to complete such income tax accounting under ASC 740. In accordance with SAB 118, we have analyzed and computed the U.S. tax impact of the Act to the best of our ability with the information available at this time and consider our conclusions to be reasonable estimates. Additional information gathering and analysis will be required to refine our detailed computations, primarily related to the earnings and profits and related foreign tax credits for the most recent tax year ended December 31, 2017. Any subsequent adjustments to our provisional estimates will be recorded to current tax expense or deferred tax expense (for foreign tax credit carryovers) in the quarter of 2018 when our analysis is considered final and complete. No adjustments were recorded during the first quarter of 2018. 

 

We have considered and analyzed the applicability of the global intangible low-taxed income (“GILTI”) provisions of the Act beginning in 2018 and its effect on our annualized effective tax rate for 2018. The effect of the GILTI inclusions on the 2018 annualized effective tax rate was not material. We have adopted the method of accounting for GILTI inclusions as a period expense and therefore have not accrued any deferred taxes in relation to this provision in the first quarter of 2018 or in the 2017 consolidated financial statements.

 

 

Recent Accounting Pronouncements

 

Revenue Recognition

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” The FASB also issued additional ASUs containing various updates to Topic 606 which are to be adopted along with ASU 2014-09 (collectively, “the new revenue recognition standard,” “ASC 606”). ASC 606 supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition.” In accordance with the new revenue recognition standard, an entity recognizes revenue when it transfers promised goods or services to customers using a five-step model that requires entities to exercise judgment when considering the terms of contracts with customers. For public companies, the new revenue recognition standard is effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Entities may adopt the new guidance retrospectively to each prior reporting period presented under a full retrospective approach, or as a cumulative-effect adjustment as of the date of adoption under a modified retrospective approach. We adopted ASC 606 on January 1, 2018 using the modified retrospective approach to contracts not completed as of the date of adoption, with no restatement of comparative periods, and a cumulative-effect adjustment to retained earnings recognized as of the date of adoption.

 

As part of the adoption of ASC 606, we performed an assessment of the impact the new revenue recognition standard would have on our consolidated financial statements. Our assessment also considered required changes in internal controls resulting from the adoption of the new revenue recognition standard. Although new controls have been implemented as a result of the adoption, such changes were not deemed material. A summary of the impact of the adoption of ASC 606 on our consolidated financial statements is included below.

 

For our Retail Automotive and Retail Commercial Truck reportable segments, under legacy guidance we recognized revenues at a point in time upon meeting relevant revenue recognition criteria. Under ASC 606, the timing of revenue recognition for our service, parts and collision revenue stream changed, as we concluded that performance obligations for service and collision work are satisfied over time under the new revenue recognition standard. All other revenue

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streams for these businesses continue to be recognized at a point in time, and our performance obligations and revenue recognition timing and practices are substantially similar to how revenues were recorded under legacy guidance.

 

For our Other reportable segment consisting primarily of our businesses in Australia and New Zealand, Penske Commercial Vehicles Australia and Penske Power Systems, under legacy guidance we recognized revenues for vehicles, engines, parts, and services at a point in time upon meeting relevant revenue recognition criteria. For our long-term power generation contracts at Penske Power Systems, we recognized revenues using the percentage of completion method in accordance with contract milestones. Under ASC 606, the timing of revenue recognition for the service and parts revenue stream for PCV Australia and PPS changed, as we concluded that performance obligations for service work are satisfied over time under the new revenue recognition standard. For revenues previously recognized using the percentage of completion method, these revenues are recognized as performance obligations are satisfied over time, consistent with the timing of recognition under legacy guidance, but are now recognized using an output method, which measures the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised. All other revenue streams for these businesses continue to be recognized at a point in time, and our performance obligations and revenue recognition timing and practices are substantially similar to how revenues were recorded under legacy guidance.

 

See Note 2 “Revenues” for additional disclosures in accordance with the new revenue recognition standard.

 

The adoption of the new revenue recognition standard resulted in a net, after-tax cumulative effect adjustment to retained earnings of approximately $6.6 million as of January 1, 2018. The details of this adjustment are summarized below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at

 

Adjustments Due

 

Balance at

  

 

  

December 31, 2017

    

to ASC 606

    

January 1, 2018

 

Assets

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

$

954.9

 

$

22.4

 

$

977.3

 

Inventories

 

 

3,944.1

 

 

(13.4)

 

 

3,930.7

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Equity

 

 

 

 

 

 

 

 

 

 

Accrued expenses

 

$

523.5

 

$

0.1

 

$

523.6

 

Deferred tax liabilities

 

 

481.5

 

 

2.3

 

 

483.8

 

Retained earnings

 

 

2,009.4

 

 

6.6

 

 

2,016.0

 

 

The following tables summarize the impact of the adoption of ASC 606 on our consolidated condensed statement of income and consolidated condensed balance sheet for the three months ended and as of March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31, 2018

 

Statement of Income

 

As

 

Without Adoption

 

Impact of Adoption

 

 

  

Reported

    

of ASC 606

    

of ASC 606

 

Revenue:

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

$

5,296.0

 

$

5,295.5

 

$

0.5

 

Retail commercial truck dealership

 

 

292.4

 

 

291.5

 

 

0.9

 

Commercial vehicle distribution and other

 

 

158.5

 

 

157.0

 

 

1.5

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

 

4,517.7

 

 

4,517.1

 

 

0.6

 

Retail commercial truck dealership

 

 

245.8

 

 

245.3

 

 

0.5

 

Commercial vehicle distribution and other

 

 

119.0

 

 

117.8

 

 

1.2

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

864.4

 

 

863.8

 

 

0.6

 

Income taxes

 

 

(36.6)

 

 

(36.4)

 

 

0.2

 

Net income

 

 

107.8

 

 

107.4

 

 

0.4

 

 

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March 31, 2018

 

Balance Sheet

 

As

 

Without Adoption

 

Impact of ASC 606

 

 

  

Reported

    

of ASC 606

    

Adoption

 

Assets

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

$

1,035.4

 

$

1,010.1

 

$

25.3

 

Inventories

 

 

3,972.2

 

 

3,987.9

 

 

(15.7)

 

 

 

 

 

 

 

 

 

 

 

  

Liabilities and Equity

 

 

 

 

 

 

 

 

 

 

Accrued expenses

 

$

563.9

 

$

563.8

 

$

0.1

 

Deferred tax liabilities

 

 

505.5

 

 

503.0

 

 

2.5

 

Retained earnings

 

 

2,094.9

 

 

2,087.9

 

 

7.0

 

 

Accounting for Leases

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Under this new guidance, a company will now recognize most leases on its balance sheet as lease liabilities with corresponding right-of-use assets. For public companies, this ASU is effective for financial statements issued for annual periods beginning after December 15, 2018, and interim periods within those annual periods, with early adoption permitted. We intend to adopt this ASU on January 1, 2019. The amendments from this update are to be applied using a modified retrospective approach. The adoption of this ASU will result in a significant increase to our consolidated balance sheets for lease liabilities and right-of-use assets. We believe our current off-balance sheet leasing commitments are reflected in our credit rating. We are currently evaluating the other impacts the adoption of this accounting standard update will have on our consolidated financial statements. We are also in the process of evaluating and documenting any changes in controls and procedures that may be necessary as part of the adoption.

 

Classification of Certain Cash Receipts and Cash Payments

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) — Classification of Certain Cash Receipts and Cash Payments.” This ASU provides new guidance on eight specific cash flow issues related to how such cash receipts and cash payments should be presented in a statement of cash flows. For public companies, this ASU is effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within those annual periods, with early adoption permitted. The amendments from this update are to be applied retrospectively. We adopted this ASU retrospectively on January 1, 2018. The adoption of this accounting standard update did not have  an impact on our consolidated cash flows for the three months ended March 31, 2018. 

 

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

 

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement — Reporting Comprehensive Income (Topic 220) — Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the enactment of the U.S. Tax Cuts and Jobs Act (“the Act”). The update also requires entities to disclose whether or not they elected to reclassify the tax effects related to the Act as well as their accounting policy for releasing income tax effects from accumulated other comprehensive income. This ASU is effective for financial statements issued for annual periods beginning after December 15, 2018, and interim periods within those annual periods, with early adoption permitted. We do not intend to adopt the optional guidance of this accounting standard update, as the potential impact on our consolidated financial statements is not material.

 

 

 

 

2. Revenues

 

Automotive and commercial truck dealerships represent the majority of our revenues. New and used vehicle revenues typically include sales to retail customers, to fleet customers, and to leasing companies providing consumer leasing. We generate finance and insurance revenues from sales of third-party extended service contracts, sales of third-party insurance policies, commissions relating to the sale of finance and lease contracts to third parties, and the sales of certain other products. Service and parts revenues include fees paid by customers for repair, maintenance and collision services,

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and the sale of replacement parts and other aftermarket accessories, as well as warranty repairs that are reimbursed directly by various OEMs. Revenues are recognized upon satisfaction of our performance obligations under contracts with our customers and are measured at the amount of consideration we expect to be entitled to in exchange for transferring goods or providing services. A discussion of revenue recognition by reportable segment is included below.

 

Retail Automotive and Retail Commercial Truck Dealership Revenue Recognition

 

Dealership Vehicle Sales. We record revenue for vehicle sales at a point in time when vehicles are delivered, which is when the transfer of title, risks and rewards of ownership and control are considered passed to the customer. The amount of consideration we receive for vehicle sales is stated within the executed contract with our customer and is reduced by any noncash consideration representing the fair value of trade-in vehicles, if applicable. Payment is typically due and collected within 30 days subsequent to transfer of control of the vehicle.

 

Dealership Parts and Service Sales. We record revenue for vehicle service and collision work over time as work is completed, and when parts are delivered to our customers. For service and parts revenues recorded over time, we utilize a method that considers total costs incurred to date and the applicable margin in relation to total expected efforts to complete our performance obligation in order to determine the appropriate amount of revenue to recognize over time. Recognition of this revenue over time reflects the amount of consideration we expect to be entitled to for the transfer of goods and services performed to date, representative of the amount for which we have a right to payment. The amount of consideration we receive for parts and service sales, including collision repair work, is based upon labor hours expended and parts utilized to perform and complete the necessary services to our customers. Payment is typically due upon delivery or within a period of time shortly thereafter. We receive payment from our customers upon transfer of control or within a period typically less than 30 days subsequent to the completion of services for the customer. We allow for customer returns of parts sales up to 30 days after the sale; however, parts returns are not material.

 

Dealership Finance and Insurance Sales. Subsequent to the sale of a vehicle to a customer, we sell installment sale contracts to various financial institutions on a non‑recourse basis (with specified exceptions) to mitigate the risk of default. We receive a commission from the lender equal to either the difference between the interest rate charged to the customer and the interest rate set by the financing institution or a flat fee. We also receive commissions for facilitating the sale of various products to customers, including guaranteed vehicle protection insurance, vehicle theft protection and extended service contracts. These commissions are recorded as revenue at a point in time when the customer enters into the contract. Payment is typically due and collected within 30 days subsequent to the execution of the contract with the customer. In the case of finance contracts, a customer may prepay or fail to pay their contract, thereby terminating the contract. Customers may also terminate extended service contracts and other insurance products, which are fully paid at purchase, and become eligible for refunds of unused premiums. In these circumstances, a portion of the commissions we received may be charged back based on the terms of the contracts. The revenue we record relating to these transactions is net of an estimate of the amount of chargebacks we will be required to pay. Our estimate is based upon our historical experience with similar contracts, including the impact of refinance and default rates on retail finance contracts and cancellation rates on extended service contracts and other insurance products. Aggregate reserves relating to chargeback activity were $25.3 million and $24.9 million as of March 31, 2018 and December 31, 2017, respectively.

 

Commercial Vehicle Distribution and Other Revenue Recognition

 

Penske Commercial Vehicles Australia. We record revenue from the distribution of vehicles and other products at a point in time when delivered, which is when the transfer of title, risks and rewards of ownership and control are considered passed to the customer. We record revenue for service or repair work over time as work is completed, and when parts are delivered to our customers. For service and parts revenues recorded over time, we utilize a method that considers total costs incurred to date and the applicable margin in relation to total expected efforts to complete our performance obligation in order to determine the appropriate amount of revenue to recognize over time. Recognition of this revenue over time reflects the amount of consideration we expect to be entitled to for the transfer of goods and services performed to date, representative of the amount for which we have a right to payment.

 

The amount of consideration we receive for vehicle and product sales is stated within the executed contract with our customer. The amount of consideration we receive for parts and service sales is based upon labor hours expended and

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parts utilized to perform and complete the necessary services to our customers. Payment is typically due upon delivery, upon invoice, or within a period of time shortly thereafter. We receive payment from our customers upon transfer of control or within a period typically less than 30 days subsequent to transfer of control or invoice.  

 

Penske Power Systems. We record revenue from the distribution of engines and other products at a point in time when delivered, which is when the transfer of title, risks and rewards of ownership and control are considered passed to the customer. We record revenue for service or repair work over time as work is completed, and when parts are delivered to our customers. For service and parts revenues recorded over time, we utilize a method that considers total costs incurred to date and the applicable margin in relation to total expected efforts to complete our performance obligation in order to determine the appropriate amount of revenue to recognize over time. Recognition of revenue over time reflects the amount of consideration we expect to be entitled to for the transfer of goods and services performed to date, representative of the amount for which we have a right to payment.

 

For our long-term power generation contracts, we record revenue over time as services are provided in accordance with contract milestones, which is considered an output method that requires judgment to determine our progress towards contract completion and the corresponding amount of revenue to recognize. Any revisions to estimates related to revenues or costs to complete contracts are recorded in the period in which the revisions to estimates are identified and the amounts can be reasonably estimated.

 

The amount of consideration we receive for engine, product, and power generation sales is stated within the executed contract with our customer. The amount of consideration we receive for service sales is based upon labor hours expended and parts utilized to perform and complete the necessary services to our customers. Payment is typically due upon delivery, upon invoice, or within a period of time shortly thereafter. We receive payment from our customers upon transfer of control or within a period typically less than 30 days subsequent to transfer of control or invoice.

 

Other. Other revenue primarily consists of our non-automotive motorcycle dealership operations. Revenue recognition practices for these operations do not differ materially from those described under “Retail Automotive and Retail Commercial Truck Dealership Revenue Recognition” above.

 

Retail Automotive Dealership

 

The following tables disaggregate our retail automotive reportable segment revenue by product type and geographic location for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

Retail Automotive Dealership Revenue

    

2018

    

2017

  

New vehicle

 

$

2,446.8

 

$

2,307.4

 

Used vehicle

 

 

1,866.8

 

 

1,541.0

 

Finance and insurance, net

 

 

160.8

 

 

137.4

 

Service and parts

 

 

543.5

 

 

498.9

 

Fleet and wholesale

 

 

278.1

 

 

271.7

 

Total retail automotive dealership revenue

 

$

5,296.0

 

$

4,756.4

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

Retail Automotive Dealership Revenue

    

2018

    

2017

 

U.S.

 

$

2,750.9

 

$

2,656.2

 

U.K.

 

 

2,192.8

 

 

1,826.4

 

Germany and Italy

 

 

352.3

 

 

273.8

 

Total retail automotive dealership revenue

 

$

5,296.0

 

$

4,756.4

 

 

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Retail Commercial Truck Dealership

 

The following table disaggregates our retail commercial truck reportable segment revenue by product type for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

Retail Commercial Truck Dealership Revenue

    

2018

    

2017

  

New truck

 

$

170.4

 

$

110.7

 

Used truck

 

 

26.5

 

 

19.0

 

Finance and insurance, net

 

 

3.2

 

 

2.1

 

Service and parts

 

 

90.4

 

 

78.0

 

Wholesale

 

 

1.9

 

 

1.9

 

Total retail commercial truck dealership revenue

 

$

292.4

 

$