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| PAG > SEC Filings for PAG > Form 10-K on 11-Mar-2009 | All Recent SEC Filings |
11-Mar-2009
Annual Report
Overview
We are the second largest automotive retailer headquartered in the U.S. as
measured by total revenues. As of December 31, 2008, we owned and operated 156
franchises in the U.S. and 148 franchises outside of the U.S., primarily in the
United Kingdom. We offer a full range of vehicle brands with 96% of our total
revenue in 2008 generated from brands of non-U.S. based manufacturers, including
sales relating to premium brands, such as Audi, BMW, Cadillac and Porsche which
represented 65% of our total revenue. As a result, we have the highest
concentration of revenues from brands of non-U.S. based manufacturers among the
U.S. publicly-traded automotive retailers. Each of our 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 higher-margin
products, such as third-party finance and insurance products, third-party
extended service contracts and replacement and aftermarket automotive products.
We are also diversified geographically, with 64% of our revenues generated from
operations in the U.S. and 36% generated from our operations outside the U.S.
(predominately in the U.K.).
We are, through smart Distributor USA, LLC, a wholly-owned subsidiary, the
exclusive distributor of the smart fortwo vehicle in the U.S. and Puerto Rico.
The smart fortwo is manufactured by Mercedes-Benz Cars and is a Daimler brand.
This technologically advanced vehicle achieves 40-plus miles per gallon on the
highway and is an ultra-low emissions vehicle as certified by the State of
California Air Resources Board. smart USA has certified a network of 75 smart
dealerships in 35 states, of which eight are owned and operated by us. The smart
fortwo offers five different versions, the pure, passion coupe, passion
cabriolet, BRABUS coupe and BRABUS cabrioletwith base prices ranging from
$11,990 to $20,990. smart USA wholesaled approximately 27,000 smart fortwo
vehicles in 2008.
In June 2008, we acquired a 9% limited partnership interest in Penske Truck
Leasing Co., L.P. ("PTL"), a leading global transportation services provider,
from subsidiaries of General Electric Capital Corporation (collectively, "GE
Capital") in exchange for $219.0 million. PTL operates and maintains more than
200,000 vehicles and serves customers in North America, South America, Europe
and Asia. Product lines include full-service leasing, contract maintenance,
commercial and consumer truck rental and logistics services, including,
transportation and distribution center management and supply chain management.
The general partner is Penske Truck Leasing Corporation, a wholly-owned
subsidiary of Penske Corporation, which together with other wholly-owned
subsidiaries of Penske Corporation, owns 40% of PTL. The remaining 51% of PTL is
owned by GE Capital. We expect to receive annual pro-rata cash distributions of
partnership profits and realize U.S. cash tax savings from this investment.
Outlook
The worldwide automotive industry experienced significant operational and
financial difficulties in 2008. The turbulence in worldwide credit markets and
resulting decrease in the availability of financing and leasing alternatives for
consumers hampered our sales efforts. In addition, there was reduced consumer
confidence and spending in the markets in which we operate, which we believe
reduced customer traffic in our dealerships, particularly since September 2008.
Rapid changes in fuel prices also resulted in rapid changes in consumer
preferences and demand, which negatively impacted vehicle retail sales. We
expect our business to remain significantly impacted by economic conditions in
2009.
Market conditions have also negatively impacted vehicle manufacturers. In
particular, the U.S. based automotive manufacturers have experienced critical
operational and financial distress, due in part to shrinking market share in the
U.S. and the recent limitation in worldwide credit capacity. In 2008 and early
2009, certain U.S. based manufacturers received support from the U.S. government
in the form of loans, due in part to their admission of limited liquidity. While
we have limited exposure to these manufacturers as a percentage of our overall
revenue, a restructuring of any one of them would likely lead to significant
disruption to the automotive supply chain and to our dealerships that represent
those manufacturers, and could possibly also impact other automotive
manufacturers and suppliers. We cannot reasonably predict the impact to the
automotive retail environment of any such disruption.
In addition, the turbulence in worldwide credit markets has resulted in an
increase in the cost of capital for the captive finance subsidiaries that
provide us financing for our inventory procurement. Interest rates under our
inventory borrowing arrangements are variable and based on changes in the prime
rate, defined LIBOR or the Euro Interbank Offer Rate (the "base rate"), plus a
spread that varies by lender. While the base rate under these arrangements are
generally lower due to government actions designed to spur liquidity and bank
lending activities, certain of our lenders raised the spread charged to us, or
have established minimum lending rates. These increases became effective in late
2008 and early 2009, and varied between 50 and 250 basis points. Due to these
relative increases, we do not expect to realize the full benefit of the lower
base rates expected in 2009 compared to 2008. The increases levied by lenders to
date would result in $5.8 million of incremental floorplan interest expense
based on average outstanding balances during 2008.
In response to the challenging operating environment, we have undertaken
significant cost saving initiatives. In 2008, we eliminated approximately 1,400
positions, representing approximately 10.0% of our worldwide workforce, and
amended pay plans for certain other employees to better align our workforce for
current business levels and to reduce compensation expense generally. Other cost
curtailment initiatives include a reduction in advertising activities, a
suspension of matching contributions to our defined contribution plan in the
U.S., and the suspension of our quarterly cash dividends to stockholders. Our
Chief Executive Officer and President also announced that they will each forgo
all bonus amounts payable under their 2008 management incentive plans, and our
Board of Directors has elected to forgo approximately 25% of its annual cash fee
relating to 2008. We will continue to monitor the business climate, and take
such further actions as needed to respond to business conditions.
Operating Overview
New and used vehicle revenues include sales to retail customers and to leasing
companies providing consumer automobile leasing. We generate finance and
insurance revenues from sales of third-party extended service contracts, sales
of third-party insurance policies, fees for facilitating the sale of third-party
finance and lease contracts and the sale of certain other products. Service and
parts revenues include fees paid for repair, maintenance and collision services,
the sale of replacement parts and the sale of aftermarket accessories. During
2008, we experienced a decline on a same store basis of new and used vehicle
unit sales, coupled with a corresponding decrease in finance and insurance
revenues. Our same store service and parts business also experienced a decline
during the second half of the year, although less so than vehicle sales. We
expect a continuation of this difficult operating environment in 2009.
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. Our gross profit varies across product lines, with vehicle sales usually
resulting in lower gross profit margins and our other revenues resulting in
higher gross profit margins. Factors such as customer demand, general economic
conditions, seasonality, weather, credit availability, fuel prices and
manufacturers' advertising and incentives may impact the mix of our revenues,
and therefore influence our gross profit margin. During 2008, we experienced
margin declines relating to our new and used vehicle sales, and we expect this
margin pressure to continue in 2009. Beginning in the fourth quarter, the
economic factors described above caused deterioration in the margins realized in
our service and parts operations.
Our selling expenses consist of advertising and compensation for sales
personnel, including commissions and related bonuses. General and administrative
expenses include compensation for administration, finance, legal and general
management personnel, rent, insurance, utilities and other outside services. A
significant portion of our selling expenses are variable, and we believe 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. We
believe our selling, general and administrative expenses for compensation and
advertising will decrease in 2009, due in part to lower vehicle sales volumes,
coupled with the cost savings initiatives outlined above. However, our rent
expense is expected to grow as a result of cost of living indexes outlined in
our lease agreements. As outlined in "Outlook" above, we will continue to
monitor the business climate, and take such further actions as needed to respond
to business conditions.
Floor plan interest expense relates to financing incurred in connection with the
acquisition of new and used vehicle inventories that is secured by those
vehicles. Other interest expense consists of interest charges on all of our
interest-bearing debt, other than interest relating to floor plan financing. The
cost of our variable rate indebtedness is typically based on benchmark lending
rates, which are based in large part upon national inter-bank lending rates set
by local governments. During the latter part of 2008, such benchmark rates were
significantly reduced as a result of government actions designed to spur
liquidity and bank lending activities. As a result, we expect that our cost of
capital on variable rate indebtedness will decline at least during a portion of
2009. However, the significance of this decrease is expected to be limited
somewhat by the increases in rate spreads being charged by our vehicle finance
partners outlined in "Outlook" above.
Equity in earnings of affiliates represents our share of the earnings relating
to investments in joint ventures and other non-consolidated investments, notably
PTL. It is our expectation that the external factors outlined above will
similarly impact these businesses in 2009.
Under an arrangement which terminated at the end of 2008, we and Sirius
Satellite Radio Inc. ("Sirius") agreed to jointly promote Sirius Satellite Radio
service. As compensation for our efforts, we received warrants to purchase ten
million shares of Sirius common stock at $2.392 per share in 2004 that were
earned ratably on an annual basis through January 2009. We measured the fair
value of the warrants earned ratably on the date they were earned as there were
no significant disincentives for non-performance. We also had the right to earn
additional warrants to purchase Sirius common stock at $2.392 per share based
upon the sale of certain units of specified brands through December 31, 2007. We
earned warrants for 189,300 and 1,269,700 during the years ended December 31,
2007 and 2006, respectively. Since we could not reasonably estimate the number
of warrants that were earned subject to the sale of units, the fair value of
these warrants was recognized when they were earned. Based on the value of
Sirius stock on December 31, 2008, we do not expect to receive any further value
for the unexercised warrants we achieved under this arrangement, which expire on
July 5, 2009.
The future success of our business will likely be dependent on, among other
things, general economic and industry conditions, our ability to consummate and
integrate acquisitions, our ability to increase sales of higher margin products,
especially service and parts services, our ability to realize returns on our
significant capital investment in new and upgraded dealerships, the success of
our distribution of the smart fortwo, and the return realized from our
investments in various joint ventures and other non-consolidated investments,
notably PTL. See "Item 1A-Risk Factors."
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires the application of
accounting policies that often involve making estimates and employing judgments.
Such judgments influence the assets, liabilities, revenues and expenses
recognized in our financial statements. Management, on an ongoing basis, reviews
these estimates and assumptions. Management may determine that modifications in
assumptions and estimates are required, which may result in a material change in
our results of operations or financial position.
The following are the accounting policies applied in the preparation of our
financial statements that management believes are most dependent upon the use of
estimates and assumptions.
Revenue Recognition
Vehicle, Parts and Service Sales
We record revenue when vehicles are delivered and title has passed to the
customer, when vehicle service or repair work is performed and when parts are
delivered to our customers. Sales promotions that we offer to customers are
accounted for as a reduction of revenues at the time of sale. Rebates and other
incentives offered directly to us by manufacturers are recognized as a reduction
of cost of sales. Reimbursement of qualified advertising expenses are treated as
a reduction of selling, general and administrative expenses. The amounts
received under various manufacturer rebate and incentive programs are based on
the attainment of program objectives, and such earnings are recognized either
upon the sale of the vehicle for which the award was received, or upon
attainment of the particular program goals if not associated with individual
vehicles. During the years ended December 31, 2008, 2007 and 2006, we earned
$323.6 million, $342.5 million and $266.2 million, respectively, of rebates,
incentives and reimbursements from manufacturers, of which $316.1 million,
$335.9 million and $259.7 million was recorded as a reduction of cost of sales.
Finance and Insurance Sales
Subsequent to the sale of a vehicle to a customer, we sell our 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
third-party insurance products to customers, including credit and life insurance
policies and extended service contracts. These commissions are recorded as
revenue at the time the customer enters into the contract.
Intangible Assets
Our principal intangible assets relate to our franchise agreements with vehicle
manufacturers, which represent the estimated value of franchises acquired in
business combinations, and goodwill, which represents the excess of cost over
the fair value of tangible and identified intangible assets acquired in business
combinations. We believe the franchise value of our dealerships has an
indefinite useful life based on the following facts:
• Automotive retailing is a mature industry and is based on franchise
agreements with the vehicle manufacturers;
• There are no known changes or events that would alter the automotive retailing franchise environment;
• Certain franchise agreement terms are indefinite;
• Franchise agreements that have limited terms have historically been renewed by us without substantial cost; and
• Our history shows that manufacturers have not terminated our franchise agreements.
Impairment Testing
Franchise value impairment is assessed as of October 1 every year and upon the
occurrence of an indicator of impairment through a comparison of its carrying
amounts and estimated fair values. An indicator of impairment exists if the
carrying value of a franchise exceeds its estimated fair value and an impairment
loss may be recognized up to that excess. We also evaluate our franchises in
connection with the annual impairment testing to determine whether events and
circumstances continue to support its assessment that the franchise has an
indefinite life. As discussed in Note 7, we determined that the carrying value
relating to certain of our franchise rights as of December 31, 2008 was impaired
and recorded a pre-tax non-cash impairment charge of $37.1 million.
Goodwill impairment is assessed at the reporting unit level as of October 1
every year and upon the occurrence of an indicator of impairment. We have
determined that the dealerships in each of our operating segments within the
Retail reportable segment, which are organized by geography, are components that
are aggregated into five reporting units as they (A) have similar economic
characteristics (all are automotive dealerships having similar margins),
(B) offer similar products and services (all sell new and used vehicles,
service, parts and third-party finance and insurance products), (C) have similar
target markets and customers (generally individuals) and (D) have similar
distribution and marketing practices (all distribute products and services
through dealership facilities that market to customers in similar fashions).
Accordingly, our operating segments are also considered our reporting units for
the purpose of goodwill impairment testing relating to our Retail segment. There
is no goodwill recorded in our Distribution or PAG Investments reportable
segments. An indicator of goodwill impairment exists if the carrying amount of
the reporting unit, including goodwill, is determined to exceed the estimated
fair value. If an indication of goodwill impairment exists, an analysis
reflecting the allocation of the fair value of the reporting unit to all assets
and liabilities, including previously unrecognized intangible assets, is
performed. The impairment is measured by comparing the implied fair value of the
reporting unit goodwill with its carrying amount and an impairment loss may be
recognized up to that excess. As discussed in Note 7, we determined that the
carrying value of goodwill as of December 31, 2008 relating to certain reporting
units was impaired and recorded a pre-tax non-cash impairment charge of
$606.3 million.
The fair values of franchise rights and goodwill are determined using a
discounted cash flow approach, which includes assumptions that include revenue
and profitability growth, franchise profit margins, residual values and our cost
of capital.
Investments
Investments include marketable securities and investments in businesses
accounted for under the equity method. A majority of our investments are in
joint venture relationships that are more fully described in "Joint Venture
Relationships" below. Such joint venture relationships are accounted for under
the equity method, pursuant to which we record our proportionate share of the
joint venture's income each period. In June 2008, we acquired a 9% limited
partnership interest in PTL for $219.0 million from GE Capital.
Investments in marketable securities held by us are typically classified as
available for sale and stated at fair value, determined by the use of Level 1
inputs as described under SFAS No. 157, on our balance sheet with unrealized
gains and losses included in other comprehensive income (loss), a separate
component of stockholders' equity.
The net book value of our investments was $297.8 million and $64.4 million as of
December 31, 2008 and 2007, respectively. Investments for which there is not a
liquid, actively traded market are reviewed periodically by management for
indicators of impairment. If an indicator of impairment were to be identified,
management would estimate the fair value of the investment using a discounted
cash flow approach, which would include assumptions relating to revenue and
profitability growth, profit margins, residual values and our cost of capital.
Declines in investment values that are deemed to be other than temporary may
result in an impairment charge reducing the investments' carrying value to fair
value. During 2007, we recorded an adjustment to the carrying value of our
investment in Internet Brands to recognize an other than temporary impairment of
$3.4 million which became apparent upon their initial public offering. As a
result of continued deterioration in the value of the stock, the Company
recorded an additional other than temporary impairment charge of $0.5 million
during the fourth quarter of 2008.
Self-Insurance
We retain risk relating to certain of our general liability insurance, workers'
compensation insurance, auto physical damage insurance, property insurance,
employment practices liability insurance, director's and officers insurance, and
employee medical benefits in the U.S. As a result, we are likely to be
responsible for a majority of the claims and losses incurred under these
programs. The amount of risk we retain varies by program, and, for certain
exposures, we have pre-determined maximum loss limits for certain individual
claims and/or insurance periods. Losses, if any, above the pre-determined loss
limits are paid by third-party insurance carriers. Our estimate of future losses
is prepared by management using our historical loss experience and
industry-based development factors. Aggregate reserves relating to retained risk
were $19.2 million and $12.8 million as of December 31, 2008 and 2007,
respectively. Changes in the reserve estimate during 2008 relate primarily to
the inclusion of additional participants in our employee medical benefit plans,
reserves for current year activity and changes in loss experience in our
historical employee medical, general liability and workers compensation
programs.
Income Taxes
Tax regulations may require items to be included in our tax return 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 return in future years which we have already
recorded in our financial statements. Deferred tax liabilities generally
represent deductions taken on our tax return 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. A valuation allowance of
$3.4 million has been recorded relating to net operating losses and credit
carryforwards in the U.S. based on our determination that it is more likely than
not that they will not be utilized.
Classification of Franchises in Continuing and Discontinued Operations
We classify the results of our operations in our consolidated financial
statements based on the provisions of Statement of Financial Accounting
Standards (SFAS) No. 144, which requires judgment in determining whether a
franchise will be reported within continuing or discontinued operations. Such
judgments include whether a franchise will be divested, the period required to
complete the divestiture, and the likelihood of changes to the divestiture
plans. If we determine that a franchise should be either reclassified from
continuing operations to discontinued operations or from discontinued operations
to continuing operations, our consolidated financial statements for prior
periods are revised to reflect such reclassification.
New Accounting Pronouncements
SFAS No. 157, "Fair Value Measurements" defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosure requirements relating to fair value measurements. The
FASB provided a one year deferral of the provisions of this pronouncement for
non-financial assets and liabilities, however, the relevant provisions of SFAS
No. 157 required by SFAS No. 159 were adopted as of January 1, 2008. SFAS No.
157 thus became effective for our non-financial assets and liabilities on
January 1, 2009. We continue to evaluate the impact of this pronouncement on our
non-financial assets and liabilities, including but not limited to, the
valuation of our reporting units for the purpose of assessing goodwill
impairment, the valuation of our franchise rights in connection with assessing
franchise value impairments, the valuation of property and equipment in
connection with assessing long-lived asset impairment, the valuation of
liabilities in connection with exit or disposal activities, and the valuation of
assets acquired and liabilities assumed in business combinations.
SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities Including an Amendment of FASB Statement No. 115" permits entities
to choose to measure many financial instruments and certain other items at fair
value and consequently report unrealized gains and losses on such items in
earnings. We did not elect the fair value option with respect to any of our
current financial assets or financial liabilities when the provisions of this
pronouncement became effective on January 1, 2008. As a result, there was no
impact upon the adoption.
SFAS No. 141(R) "Business Combinations" requires almost all assets acquired and
liabilities assumed in connection with a business combination to be recorded at
fair value as of the acquisition date, liabilities related to contingent
consideration to be remeasured at fair value in each subsequent reporting
period, and all acquisition related costs to be expensed as incurred. The
pronouncement also clarifies the accounting under various scenarios such as step
purchases or in situations in which the fair value of assets and liabilities
acquired exceeds the total consideration. SFAS No. 141(R) became effective for
us on January 1, 2009.
SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements an
Amendment of ARB No. 51" clarifies that a noncontrolling interest in a
subsidiary must be measured at fair value and classified as a separate component
of equity. This pronouncement also outlines the accounting for changes in a
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