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Section 1: 10-Q (10-Q)

PAG Form 10-Q June 30, 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 June 30, 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 July 23, 2018, there were 84,864,669 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 June 30, 2018 and December 31, 2017 

3

 

 

Consolidated Condensed Statements of Income for the three and six months ended June 30, 2018 and 2017 

4

 

 

Consolidated Condensed Statements of Comprehensive Income for the three and six months ended June 30, 2018 and 2017 

5

 

 

Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2018 and 2017 

6

 

 

Consolidated Condensed Statement of Equity for the six months ended June 30, 2018 

7

 

 

Notes to Consolidated Condensed Financial Statements 

8

 

 

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

34

 

 

Item 3. Quantitative & Qualitative Disclosures About Market Risk 

61

 

 

Item 4. Controls and Procedures 

62

 

 

PART II — OTHER INFORMATION 

 

 

 

Item 1. Legal Proceedings 

63

 

 

Item 1A. Risk Factors 

63

 

 

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

64

 

 

Item 6. Exhibits 

65

 

 

2


 

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

 

    

June 30,

    

December 31,

 

 

 

2018

 

2017

 

 

 

(Unaudited)

 

 

 

(In millions, except share

 

 

 

and per share amounts)

 

ASSETS

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

45.8

 

$

45.7

 

Accounts receivable, net of allowance for doubtful accounts of $5.1 and $5.5

 

 

919.6

 

 

954.9

 

Inventories

 

 

3,895.1

 

 

3,944.1

 

Other current assets

 

 

97.5

 

 

81.8

 

Total current assets

 

 

4,958.0

 

 

5,026.5

 

Property and equipment, net

 

 

2,144.9

 

 

2,108.6

 

Goodwill

 

 

1,700.7

 

 

1,660.5

 

Other indefinite-lived intangible assets

 

 

474.1

 

 

474.0

 

Equity method investments

 

 

1,279.2

 

 

1,256.6

 

Other long-term assets

 

 

13.6

 

 

14.4

 

Total assets

 

$

10,570.5

 

$

10,540.6

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

Floor plan notes payable

 

$

2,278.0

 

$

2,343.2

 

Floor plan notes payable — non-trade

 

 

1,325.7

 

 

1,418.6

 

Accounts payable

 

 

680.0

 

 

641.6

 

Accrued expenses

 

 

529.7

 

 

523.5

 

Current portion of long-term debt

 

 

92.3

 

 

72.8

 

Liabilities held for sale

 

 

0.7

 

 

0.7

 

Total current liabilities

 

 

4,906.4

 

 

5,000.4

 

Long-term debt

 

 

2,059.6

 

 

2,090.4

 

Deferred tax liabilities

 

 

530.8

 

 

481.5

 

Other long-term liabilities

 

 

547.9

 

 

540.3

 

Total liabilities

 

 

8,044.7

 

 

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; 84,865,069 shares issued and outstanding at June 30, 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

 

 

483.9

 

 

532.3

 

Retained earnings

 

 

2,199.7

 

 

2,009.4

 

Accumulated other comprehensive income (loss)

 

 

(186.4)

 

 

(146.5)

 

Total Penske Automotive Group stockholders’ equity

 

 

2,497.2

 

 

2,395.2

 

Non-controlling interest

 

 

28.6

 

 

32.8

 

Total equity

 

 

2,525.8

 

 

2,428.0

 

Total liabilities and equity

 

$

10,570.5

 

$

10,540.6

 

See Notes to Consolidated Condensed Financial Statements

3


 

Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

    

2018

    

2017

 

2018

    

2017

 

 

(Unaudited)

 

 

(In millions, except per share amounts)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

$

5,455.5

 

$

5,040.7

 

$

10,751.5

 

$

9,797.1

 

Retail commercial truck dealership

 

 

338.8

 

 

228.5

 

 

631.2

 

 

440.2

 

Commercial vehicle distribution and other

 

 

146.0

 

 

114.2

 

 

304.5

 

 

227.2

 

Total revenues

 

 

5,940.3

 

 

5,383.4

 

 

11,687.2

 

 

10,464.5

 

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

 

4,657.5

 

 

4,294.7

 

 

9,175.2

 

 

8,342.8

 

Retail commercial truck dealership

 

 

286.4

 

 

188.5

 

 

532.2

 

 

363.8

 

Commercial vehicle distribution and other

 

 

106.6

 

 

82.9

 

 

225.6

 

 

166.3

 

Total cost of sales

 

 

5,050.5

 

 

4,566.1

 

 

9,933.0

 

 

8,872.9

 

Gross profit

 

 

889.8

 

 

817.3

 

 

1,754.2

 

 

1,591.6

 

Selling, general and administrative expenses

 

 

675.4

 

 

622.0

 

 

1,338.5

 

 

1,223.7

 

Depreciation

 

 

25.7

 

 

23.3

 

 

51.3

 

 

45.7

 

Operating income

 

 

188.7

 

 

172.0

 

 

364.4

 

 

322.2

 

Floor plan interest expense

 

 

(19.9)

 

 

(15.5)

 

 

(38.8)

 

 

(29.2)

 

Other interest expense

 

 

(28.6)

 

 

(26.4)

 

 

(58.4)

 

 

(51.4)

 

Equity in earnings of affiliates

 

 

36.0

 

 

26.8

 

 

53.3

 

 

40.0

 

Income from continuing operations before income taxes

 

 

176.2

 

 

156.9

 

 

320.5

 

 

281.6

 

Income taxes

 

 

(41.0)

 

 

(50.2)

 

 

(77.6)

 

 

(91.3)

 

Income from continuing operations

 

 

135.2

 

 

106.7

 

 

242.9

 

 

190.3

 

Income (loss) from discontinued operations, net of tax

 

 

 —

 

 

0.2

 

 

0.1

 

 

(0.4)

 

Net income

 

 

135.2

 

 

106.9

 

 

243.0

 

 

189.9

 

Less: Income attributable to non-controlling interests

 

 

0.6

 

 

0.7

 

 

0.3

 

 

1.1

 

Net income attributable to Penske Automotive Group common stockholders

 

$

134.6

 

$

106.2

 

$

242.7

 

$

188.8

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

1.59

 

$

1.23

 

$

2.84

 

$

2.20

 

Discontinued operations

 

 

 —

 

 

0.00

 

 

0.00

 

 

(0.00)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

1.59

 

$

1.23

 

$

2.84

 

$

2.20

 

Shares used in determining basic earnings per share

 

 

84.9

 

 

86.1

 

 

85.4

 

 

85.9

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

1.58

 

$

1.23

 

$

2.84

 

$

2.20

 

Discontinued operations

 

 

 —

 

 

0.00

 

 

0.00

 

 

(0.00)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

1.58

 

$

1.23

 

$

2.84

 

$

2.20

 

Shares used in determining diluted earnings per share

 

 

85.0

 

 

86.1

 

 

85.5

 

 

85.9

 

Amounts attributable to Penske Automotive Group common stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

135.2

 

$

106.7

 

$

242.9

 

$

190.3

 

Less: Income attributable to non-controlling interests

 

 

0.6

 

 

0.7

 

 

0.3

 

 

1.1

 

Income from continuing operations, net of tax

 

 

134.6

 

 

106.0

 

 

242.6

 

 

189.2

 

Income (loss) from discontinued operations, net of tax

 

 

 —

 

 

0.2

 

 

0.1

 

 

(0.4)

 

Net income attributable to Penske Automotive Group common stockholders

 

$

134.6

 

$

106.2

 

$

242.7

 

$

188.8

 

Cash dividends per share

 

$

0.35

 

$

0.31

 

$

0.69

 

$

0.61

 

 

See Notes to Consolidated Condensed Financial Statements

 

 

4


 

Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

    

2018

    

2017

 

2018

    

2017

 

 

(Unaudited)

 

 

(In millions)

 

Net income

 

$

135.2

 

$

106.9

 

$

243.0

 

$

189.9

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(68.3)

 

 

37.7

 

 

(37.6)

 

 

62.4

 

Other adjustments to comprehensive income, net

 

 

(4.5)

 

 

2.8

 

 

(3.4)

 

 

4.2

 

Other comprehensive (loss) income, net of tax

 

 

(72.8)

 

 

40.5

 

 

(41.0)

 

 

66.6

 

Comprehensive income

 

 

62.4

 

 

147.4

 

 

202.0

 

 

256.5

 

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

 

 

(0.5)

 

 

2.4

 

 

(0.8)

 

 

3.2

 

Comprehensive income attributable to Penske Automotive Group common stockholders

 

$

62.9

 

$

145.0

 

$

202.8

 

$

253.3

 

 

See Notes to Consolidated Condensed Financial Statements

5


 

Table of Contents

PENSKE AUTOMOTIVE GROUP, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

    

2018

    

2017

 

 

 

(Unaudited)

 

 

 

(In millions)

 

Operating Activities:

 

 

 

 

 

 

 

Net income

 

$

243.0

 

$

189.9

 

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

 

 

 

 

 

 

 

Depreciation

 

 

51.3

 

 

45.7

 

Earnings of equity method investments

 

 

(45.3)

 

 

(34.1)

 

(Income) loss from discontinued operations, net of tax

 

 

(0.1)

 

 

0.4

 

Deferred income taxes

 

 

48.5

 

 

89.2

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

39.8

 

 

58.2

 

Inventories

 

 

93.3

 

 

(177.8)

 

Floor plan notes payable

 

 

(56.7)

 

 

66.7

 

Accounts payable and accrued expenses

 

 

28.7

 

 

86.1

 

Other

 

 

14.5

 

 

(3.8)

 

Net cash provided by continuing operating activities

 

 

417.0

 

 

320.5

 

Investing Activities:

 

 

 

 

 

 

 

Purchase of equipment and improvements

 

 

(118.8)

 

 

(113.4)

 

Proceeds from sale of dealerships

 

 

58.4

 

 

9.0

 

Proceeds from sale-leaseback transactions

 

 

5.8

 

 

 —

 

Acquisitions net, including repayment of sellers’ floor plan notes payable of $25.8 and $99.0, respectively

 

 

(168.6)

 

 

(431.9)

 

Other

 

 

(3.0)

 

 

6.0

 

Net cash used in continuing investing activities

 

 

(226.2)

 

 

(530.3)

 

Financing Activities:

 

 

 

 

 

 

 

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

 

 

797.0

 

 

1,012.0

 

Repayments under U.S. credit agreement revolving credit line

 

 

(870.0)

 

 

(929.0)

 

Net borrowings of other long-term debt

 

 

96.1

 

 

54.9

 

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

 

 

(92.9)

 

 

131.3

 

Repurchases of common stock

 

 

(55.8)

 

 

(8.5)

 

Dividends

 

 

(59.0)

 

 

(52.4)

 

Other

 

 

(6.1)

 

 

(5.8)

 

Net cash (used in) provided by continuing financing activities

 

 

(190.7)

 

 

202.5

 

Discontinued operations:

 

 

 

 

 

 

 

Net cash provided by discontinued operating activities

 

 

0.2

 

 

0.4

 

Net cash provided by discontinued investing activities

 

 

 —

 

 

2.3

 

Net cash used in discontinued financing activities

 

 

 —

 

 

(0.2)

 

Net cash provided by discontinued operations

 

 

0.2

 

 

2.5

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(0.2)

 

 

1.5

 

Net change in cash and cash equivalents

 

 

0.1

 

 

(3.3)

 

Cash and cash equivalents, beginning of period

 

 

45.7

 

 

24.0

 

Cash and cash equivalents, end of period

 

$

45.8

 

$

20.7

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid (received) for:

 

 

 

 

 

 

 

Interest

 

$

95.9

 

$

78.9

 

Income taxes

 

 

24.1

 

 

8.3

 

Seller financed/assumed debt

 

 

 —

 

 

3.8

 

Non cash activities:

 

 

 

 

 

 

 

Deferred consideration

 

$

6.8

 

$

 —

 

Consideration transferred through common stock issuance

 

 

 —

 

 

32.4

 

Contingent consideration

 

 

 —

 

 

20.0

 

 

See Notes to Consolidated Condensed Financial Statements

 

6


 

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

 

330,186

 

 

 —

 

 

9.0

 

 

 

 

 

 —

 

 

9.0

 

 

 —

 

 

9.0

 

Repurchases of common stock

 

(1,252,624)

 

 

 —

 

 

(55.8)

 

 

 —

 

 

 —

 

 

(55.8)

 

 

 —

 

 

(55.8)

 

Dividends

 

 —

 

 

 —

 

 

 —

 

 

(59.0)

 

 

 —

 

 

(59.0)

 

 

 —

 

 

(59.0)

 

Purchase of subsidiary shares from non-controlling interest

 

 —

 

 

 —

 

 

(1.4)

 

 

 —

 

 

 —

 

 

(1.4)

 

 

(3.1)

 

 

(4.5)

 

Distributions to non-controlling interest

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(0.7)

 

 

(0.7)

 

Foreign currency translation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(36.5)

 

 

(36.5)

 

 

(1.1)

 

 

(37.6)

 

Other

 

 —

 

 

 —

 

 

(0.2)

 

 

 —

 

 

(3.4)

 

 

(3.6)

 

 

0.4

 

 

(3.2)

 

Net income

 

 —

 

 

 —

 

 

 —

 

 

242.7

 

 

 —

 

 

242.7

 

 

0.3

 

 

243.0

 

Balance, June 30, 2018

 

84,865,069

 

$

 —

 

$

483.9

 

$

2,199.7

 

$

(186.4)

 

$

2,497.2

 

$

28.6

 

$

2,525.8

 

 

See Notes to Consolidated Condensed Financial Statements

 

7


 

Table of Contents

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 June 30, 2018, we operated 341 retail automotive franchises, of which 151 franchises are located in the U.S. and 190 franchises are located outside of the U.S. The franchises outside the U.S. are located primarily in the U.K. In the six months ended June 30, 2018, we retailed and wholesaled more than 330,000 vehicles. We are diversified geographically, with 53% of our total retail automotive dealership revenues in the six months ended June 30, 2018 generated in the U.S. and Puerto Rico and 47% generated outside the U.S. We offer over 40 vehicle brands, with 70% of our retail automotive dealership revenue in the six months ended June 30, 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 complement CarShop’s Southern England locations.

 

During the six months ended June 30, 2018, we acquired four retail automotive franchises and disposed of six 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 June 30, 2018, PTG operated twenty-one locations, including fifteen full-service dealerships and six collision centers, offering primarily Freightliner and Western Star branded trucks. One of these locations was acquired in April 2018 in Canada. 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

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business, known as Penske Commercial Vehicles Australia (“PCV Australia”), distributes commercial vehicles and parts 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 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”). 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 June 30, 2018 and December 31, 2017 and for the three and six month periods ended June 30, 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 our fixed rate debt is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

December 31, 2017

 

 

  

Carrying Value

  

Fair Value

  

Carrying Value

  

Fair Value

 

3.75% senior subordinated notes due 2020

 

$

297.2

 

$

294.0

 

$

296.5

 

$

301.7

 

5.75% senior subordinated notes due 2022

 

 

546.4

 

 

559.6

 

 

545.9

 

 

562.3

 

5.375% senior subordinated notes due 2024

 

 

297.4

 

 

292.8

 

 

297.2

 

 

300.2

 

5.50% senior subordinated notes due 2026

 

 

494.7

 

 

484.9

 

 

494.4

 

 

505.0

 

Mortgage facilities

 

 

245.8

 

 

243.2

 

 

235.5

 

 

233.4

 

 

Assets Held for Sale and Discontinued Operations

 

We had no entities newly classified as held for sale during the six months ended June 30, 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 six months ended June 30, 2018, we disposed of six retail automotive franchises. The results of operations for these businesses are included within continuing operations for the three and six months ended June 30, 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.

 

The U.S. Tax Cuts and Jobs Act (the “Act”) was signed into law on December 22, 2017. The Act modified 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 changed international tax laws for tax

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years beginning after December 31, 2017 and required 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 is underway 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 six months 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 is 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 six months 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 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.

 

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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 and six months ended and as of June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30, 2018

 

Statement of Income

 

As

 

Without Adoption

 

Impact of Adoption

 

 

  

Reported

    

of ASC 606

    

of ASC 606

 

Revenue:

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

$

5,455.5

 

$

5,453.3

 

$

2.2

 

Retail commercial truck dealership

 

 

338.8

 

 

339.6

 

 

(0.8)

 

Commercial vehicle distribution and other

 

 

146.0

 

 

143.7

 

 

2.3

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

 

Retail automotive dealership

 

 

4,657.5

 

 

4,656.3

 

 

1.2

 

Retail commercial truck dealership

 

 

286.4

 

 

286.8

 

 

(0.4)

 

Commercial vehicle distribution and other

 

 

106.6

 

 

106.1

 

 

0.5

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

889.8

 

 

887.4

 

 

2.4

 

Income taxes

 

 

(41.0)

 

 

(40.3)

 

 

0.7

 

Net income

 

 

135.2

 

 

133.5

 

 

1.7

 

 

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For the Six Months Ended June 30, 2018

 

Statement of Income

 

As

 

Without Adoption

 

Impact of Adoption