10-Q 1 h07658e10vq.txt GROUP 1 AUTOMOTIVE, INC. - DATED 6/30/2003 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 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: 1-13461 GROUP 1 AUTOMOTIVE, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware 76-0506313 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 950 Echo Lane, Suite 100 Houston, Texas 77024 (Address of Principal Executive Offices) (Zip Code) (713) 647-5700 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
Title Outstanding ----- ----------- Common stock, par value $.01 22,600,673
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands)
JUNE 30, DECEMBER 31, 2003 2002 ---- ---- (unaudited) ASSETS CURRENT ASSETS: Cash ................................................. $ 21,201 $ 24,333 Contracts-in-transit and vehicle receivables, net .... 147,559 178,623 Accounts and notes receivable, net ................... 62,535 58,194 Inventories, net ..................................... 699,187 622,205 Deferred income taxes ................................ 10,467 10,793 Other assets ......................................... 9,680 8,890 ----------- ----------- Total current assets .......................... 950,629 903,038 ----------- ----------- PROPERTY AND EQUIPMENT, net ............................ 122,219 116,270 GOODWILL ............................................... 305,262 307,907 INTANGIBLE ASSETS ...................................... 61,348 60,879 INVESTMENTS RELATED TO INSURANCE POLICY SALES .......... 15,693 15,813 DEFERRED COSTS RELATED TO INSURANCE POLICY AND VEHICLE SERVICE CONTRACT SALES .. 14,383 16,824 OTHER ASSETS ........................................... 4,492 3,034 ----------- ----------- Total assets .................................. $ 1,474,026 $ 1,423,765 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Floorplan notes payable .............................. $ 662,141 $ 652,538 Current maturities of long-term debt ................. 826 997 Accounts payable ..................................... 86,805 90,809 Accrued expenses ..................................... 78,849 64,939 ----------- ----------- Total current liabilities ..................... 828,621 809,283 ----------- ----------- DEBT, net of current maturities ........................ 8,612 9,073 SENIOR SUBORDINATED NOTES .............................. 74,220 74,149 DEFERRED INCOME TAXES .................................. 12,291 7,651 OTHER LIABILITIES ...................................... 25,983 31,005 ----------- ----------- Total liabilities before deferred revenues .... 949,727 931,161 ----------- ----------- DEFERRED REVENUES FROM INSURANCE POLICY SALES .......... 22,630 24,637 DEFERRED REVENUES FROM VEHICLE SERVICE CONTRACT SALES .. 20,376 24,550 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, 1,000,000 shares authorized, none issued or outstanding .............................. -- -- Common stock, $.01 par value, 50,000,000 shares authorized 23,454,046 and 23,183,226 issued ........ 235 232 Additional paid-in capital ........................... 255,694 254,145 Retained earnings .................................... 249,820 215,024 Accumulated other comprehensive loss ................. (2,322) (3,359) Treasury stock, at cost, 933,677 and 942,419 shares... (22,134) (22,625) ----------- ----------- Total stockholders' equity .................... 481,293 443,417 ----------- ----------- Total liabilities and stockholders' equity .... $ 1,474,026 $ 1,423,765 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 2 GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------- ---------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ REVENUES: New vehicle sales ........................... $ 693,454 $ 615,532 $ 1,287,208 $ 1,168,055 Used vehicle sales .......................... 230,956 230,708 456,154 448,641 Used vehicle wholesale sales ................ 65,445 56,031 126,449 107,099 Parts and service sales ..................... 116,279 95,511 227,392 187,202 Retail finance fees ......................... 16,184 14,361 31,363 27,772 Vehicle service contract fees ............... 15,436 12,332 30,634 23,815 Other finance and insurance revenues, net ... 10,126 8,629 18,471 16,594 ------------ ------------ ------------ ------------ Total revenues ........................... 1,147,880 1,033,104 2,177,671 1,979,178 COST OF SALES: New vehicle sales ........................... 641,983 568,006 1,193,012 1,077,957 Used vehicle sales .......................... 202,782 205,046 399,840 396,517 Used vehicle wholesale sales ................ 67,660 57,458 130,459 109,821 Parts and service sales ..................... 51,239 41,831 100,696 82,611 ------------ ------------ ------------ ------------ Total cost of sales .................. 963,664 872,341 1,824,007 1,666,906 ------------ ------------ ------------ ------------ GROSS PROFIT .................................. 184,216 160,763 353,664 312,272 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ................................... 140,179 120,773 275,017 237,650 DEPRECIATION AND AMORTIZATION EXPENSE ................................... 3,691 2,785 6,941 5,621 ------------ ------------ ------------ ------------ Income from operations ........................ 40,346 37,205 71,706 69,001 OTHER INCOME AND (EXPENSE): Floorplan interest expense, excludes manufacturer interest assistance .......... (6,235) (4,342) (11,682) (8,732) Other interest expense, net ................. (2,334) (2,452) (4,703) (5,191) Other expense, net .......................... (63) (35) (89) (110) ------------ ------------ ------------ ------------ INCOME BEFORE INCOME TAXES .................... 31,714 30,376 55,232 54,968 PROVISION FOR INCOME TAXES .................... 11,734 11,239 20,436 20,338 ------------ ------------ ------------ ------------ NET INCOME .................................... $ 19,980 $ 19,137 $ 34,796 $ 34,630 ============ ============ ============ ============ EARNINGS PER SHARE: Basic ....................................... $ 0.89 $ 0.83 $ 1.55 $ 1.50 Diluted ..................................... $ 0.86 $ 0.78 $ 1.50 $ 1.42 WEIGHTED AVERAGE SHARES OUTSTANDING: Basic ....................................... 22,488,643 23,111,843 22,426,468 23,011,086 Diluted ..................................... 23,268,506 24,503,067 23,140,289 24,322,647
The accompanying notes are an integral part of these consolidated financial statements. 3 GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
SIX MONTHS ENDED JUNE 30, -------- 2003 2002 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ........................................................ $ 34,796 $ 34,630 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ................................... 6,941 5,621 Deferred income taxes ........................................... 4,975 4,033 Provision for doubtful accounts and uncollectible notes ......... 291 406 Loss on sale of assets .......................................... 158 102 Gain on sale of franchises ...................................... -- (414) Changes in operating assets and liabilities, net of effects of acquisitions and dispositions: Contracts-in-transit and vehicle receivables ................. 32,405 2,922 Accounts receivable .......................................... (1,402) (5,013) Inventories .................................................. (53,190) (52,858) Prepaid expenses and other assets ............................ 1,010 (10,783) Floorplan notes payable ...................................... (8,239) 26,812 Accounts payable, accrued expenses and deferred revenues ..... (2,489) 8,394 -------- -------- Total adjustments ......................................... (19,540) (20,778) -------- -------- Net cash provided by operating activities ......... 15,256 13,852 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Increase in notes receivable ..................................... (2,011) (6,578) Collections on notes receivable .................................. 704 678 Purchases of property and equipment .............................. (18,248) (19,488) Proceeds from sales of property and equipment .................... 4,999 570 Proceeds from sales of franchises ................................ 7,414 7,430 Cash paid in acquisitions, net of cash received .................. (12,687) (21,502) -------- -------- Net cash used by investing activities ............. (19,829) (38,890) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings on revolving credit facility ...................... -- 32,764 Principal payments of long-term debt ............................. (602) (995) Repurchase of senior subordinated notes .......................... -- (6,128) Proceeds from issuance of common stock to benefit plans, including tax benefit ..................................................... 4,541 7,870 Repurchase of common stock, amounts based on settlement date ..... (2,498) -- -------- -------- Net cash provided by financing activities ......... 1,441 33,511 -------- -------- NET INCREASE (DECREASE) IN CASH ..................................... (3,132) 8,473 CASH, beginning of period ........................................... 24,333 16,861 -------- -------- CASH, end of period ................................................. $ 21,201 $ 25,334 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for - Interest ........................................................ $ 16,768 $ 14,873 Taxes ........................................................... $ 5,292 $ 12,891
The accompanying notes are an integral part of these consolidated financial statements. 4 GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND ORGANIZATION: Group 1 Automotive, Inc., a Delaware corporation, is a leading operator in the automotive retailing industry. Group 1 Automotive, Inc. is a holding company with no independent assets or operations other than its investments in its subsidiaries, which are located in California, Colorado, Florida, Georgia, Louisiana, Massachusetts, New Mexico, Oklahoma and Texas. These subsidiaries sell new and used cars and light trucks through their dealerships and Internet sites; arrange related financing, vehicle service and insurance contracts; provide maintenance and repair services; and sell replacement parts. Group 1 Automotive, Inc. and its subsidiaries are herein collectively referred to as the "Company" or "Group 1." 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Presentation All acquisitions of dealerships completed during the periods presented have been accounted for using the purchase method of accounting and their results of operations are included from the effective dates of the closings of the acquisitions. The allocations of purchase price to the assets acquired and liabilities assumed are initially assigned and recorded based on preliminary estimates of fair value. All significant intercompany balances and transactions have been eliminated in consolidation. Interim Financial Information The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Due to seasonality and other factors, the results of operations for the interim periods are not necessarily indicative of the results that will be realized for the entire fiscal year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2002. Stock-Based Compensation Plans In October 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which, if fully adopted, requires the Company to record stock-based compensation at fair value. The Company has adopted the disclosure requirements of SFAS No. 123 and has elected to record employee compensation expense in accordance with APB No. 25, "Accounting for Stock Issued to Employees." Accordingly, compensation expense is recorded for stock options based on the excess of the fair market value of the common stock on the date the options were granted over the aggregate exercise price of the options. As the exercise price of options granted has been equal to or greater than the market price of the Company's stock on the date of grant, no compensation expense has been recorded. Additionally, no compensation expense is recorded for shares issued pursuant to the employee stock purchase plan as it is a qualified plan. 5 Had compensation expense for the stock incentive and employee stock purchase plans been determined based on the provisions of SFAS No. 123, the impact on the Company's net income would have been as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2003 2002 2003 2002 ---- ---- ---- ---- (dollars in thousands, except per share amounts) Net income as reported ..................................... $ 19,980 $ 19,137 $ 34,796 $ 34,630 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects ..... -- -- -- 120 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects ............................. (402) (1,252) (1,661) (2,294) ---------- ---------- ---------- ---------- Pro forma net income ....................................... $ 19,578 $ 17,885 $ 33,135 $ 32,456 ========== ========== ========== ========== Pro forma earnings per share: Basic - as reported .................................... $ 0.89 $ 0.83 $ 1.55 $ 1.50 Basic - pro forma ...................................... $ 0.87 $ 0.77 $ 1.48 $ 1.41 Diluted - as reported .................................. $ 0.86 $ 0.78 $ 1.50 $ 1.42 Diluted - pro forma .................................... $ 0.84 $ 0.73 $ 1.43 $ 1.33
Accounting for Guarantees In November 2002, FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" was issued. FIN No. 45 enhances the disclosures to be made by a guarantor about its obligations under certain guarantees that it has issued. It also requires, on a prospective basis, beginning after January 1, 2003, that guarantors recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. While the Company is not an obligor under the vehicle service contracts it currently sells, it was an obligor under vehicle service contracts previously sold in two states. These contracts were sold to our retail vehicle customers with terms, typically, ranging from two to seven years. The purchase price paid by the customer, net of the fee the Company receives, was remitted to an administrator. The administrator set the pricing at a level adequate to fund future claims and their profit. Additionally, the administrator purchases insurance to further secure its ability to pay the claims under the contracts. The Company can become liable if the administrator and the insurance company are unable to fund future claims. Though the Company has never had to fund any claims related to these contracts, and reviews the credit worthiness of the administrator and the insurance company, it is unable to estimate the maximum potential claim exposure, but believes there will not be any future obligation to fund claims on the contracts. The Company's revenues related to these contracts were deferred at the time of sale and recognized over the life of the contracts. The amounts deferred are presented on the face of the balance sheets as deferred revenues from vehicle service contract sales. Income Taxes The Company operates in nine different states, each of which has unique tax rates and payment calculations. As the amount of income generated in each state varies from period to period, the Company's effective tax rate will vary based on the proportion of taxable income generated in each state. 6 Recent Accounting Pronouncements In January 2003, FIN No. 46, "Consolidation of Variable Interest Entities" was issued. FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to variable interest entities, which are certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. The interpretation is intended to achieve more consistent application of consolidation policies to variable interest entities and, thus to improve comparability between enterprises engaged in similar activities even if some of those activities are conducted through variable interest entities. The interpretation is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which a company obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, for variable interest entities in which a company holds a variable interest that it acquired before February 1, 2003. The Company is currently analyzing the impact this interpretation will have on its consolidated results of operations and its financial position, with respect to entities acquired before February 1, 2003. Reclassifications Certain reclassifications have been made in the 2002 financial statements to conform to the current period presentation. 3. EARNINGS PER SHARE: SFAS No. 128, "Earnings per Share" requires the presentation of basic earnings per share and diluted earnings per share in financial statements of public enterprises. Under the provisions of this statement, basic earnings per share is computed based on weighted average shares outstanding and excludes dilutive securities. Diluted earnings per share is computed including the impacts of all potentially dilutive securities. The following table sets forth the shares outstanding for the earnings per share calculations:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2003 2002 2003 2002 ---- ---- ---- ---- Common stock issued, beginning of period ............... 23,373,326 23,120,924 23,183,226 23,029,853 Weighted average common stock issued - Employee Stock Purchase Plan ...................... 57,088 37,964 73,615 51,208 Stock options exercised ........................... 53,418 61,238 176,781 204,857 Less: Weighted average treasury shares held and weighted average shares repurchased and cancelled .. (995,189) (108,283) (1,007,154) (274,832) ---------- ---------- ---------- ---------- Shares used in computing basic earnings per share ...... 22,488,643 23,111,843 22,426,468 23,011,086 Dilutive effect of stock options, net of assumed repurchase of treasury stock ....................... 779,863 1,391,224 713,821 1,311,561 ---------- ---------- ---------- ---------- Shares used in computing diluted earnings per share .... 23,268,506 24,503,067 23,140,289 24,322,647 ========== ========== ========== ==========
4. BUSINESS COMBINATIONS AND DISPOSITIONS: During the first six months of 2003, the Company purchased three franchises from Robert E. Howard II, a director of the Company, and sold one franchise to a company owned by Mr. Howard. The Company acquired Ford, Lincoln and Mercury franchises, with $131.2 million in annual revenues, and sold a Mercedes-Benz franchise, with $47.4 million in annual revenues. In completing the acquisitions, the aggregate consideration paid by the Company consisted of $12.7 million of cash, net of cash received and the assumption of approximately $22.9 million of inventory financing. The Company received $7.4 million in cash from the sale of the Mercedes-Benz dealership franchise and related assets, including goodwill of approximately $3.6 million. The proceeds received exceeded the Company's basis in the dealership by approximately $1.3 million. This excess sales price over cost was recorded as a reduction of the cost basis in the newly acquired Ford, Lincoln and Mercury dealerships. Additionally, the outstanding inventory 7 financing for the Mercedes-Benz dealership was assumed by a company owned by Mr. Howard. As a result of the two transactions described above, the Company's goodwill was reduced by $3.6 million and its intangible asset for franchise value increased $0.5 million. Additionally, during the first six months of 2003, the Company opened a new add-point Ford dealership in Pensacola, Florida. 5. SENIOR SUBORDINATED NOTES: The Company's 10 7/8% Senior Subordinated Notes due 2009 (the "Notes") pay interest semi-annually on March 1 and September 1, each year. The Company may redeem all or part of the Notes at redemption prices of 105.438%, 103.625%, 101.813% and 100.000% of the principal amount plus accrued interest during the twelve-month periods beginning March 1, of 2004, 2005, 2006 and 2007 and thereafter, respectively. The Notes are jointly and severally and fully and unconditionally guaranteed, on an unsecured senior subordinated basis, by all subsidiaries of the Company (the "Subsidiary Guarantors"), other than certain minor subsidiaries. All of the Subsidiary Guarantors are wholly-owned subsidiaries of the Company. 6. FLOORPLAN NOTES PAYABLE AND LONG-TERM DEBT: During June 2003, the Company completed an amendment to its existing credit facility that extends the term until June 2006. The $775.0 million credit facility consists of two tranches: 75% of the facility is for floorplan financing ("the Floorplan Tranche") and 25% is for working capital and acquisition financing ("the Acquisition Tranche"). The Acquisition Tranche bears interest at a rate of LIBOR plus a margin varying between 175 and 325 basis points, determined based on a ratio of debt to equity. The Floorplan Tranche bears interest at rates of LIBOR plus 112.5 basis points for new vehicle inventory and LIBOR plus 125 basis points for used vehicle inventory. Other than the changes in the maturity date and the total amount available to be borrowed, there were no significant changes in the terms of the agreement. Simultaneous with the amendment of the above described credit facility, the Company entered into a separate floorplan financing arrangement with Ford Motor Credit Company to provide financing for its entire Ford, Lincoln and Mercury new vehicle inventory. The arrangement provides for up to $300.0 million of financing for the inventory at an interest rate of Prime plus 100 basis points minus certain incentives. The Company expects the net cost of these borrowings, after all incentives, to approximate the floorplan cost under the $775.0 million credit facility. 7. COMPREHENSIVE INCOME:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2003 2002 2003 2002 ---- ---- ---- ---- (dollars in thousands) Net income .................................................. $ 19,980 $ 19,137 $ 34,796 $ 34,630 Other comprehensive income: Change in fair value of interest rate swaps, net of tax .. 612 (2,063) 1,037 (1,141) -------- -------- -------- -------- Comprehensive income ......................................... $ 20,592 $ 17,074 $ 35,833 $ 33,489 ======== ======== ======== ========
8. RELATED PARTY TRANSACTIONS: In addition to the transactions discussed in Note 4, effective February 18, 2003, the Company sold certain dealership buildings in Oklahoma City to Mr. Howard for $4.5 million and leased them back on a 25-year lease. The sales price represents the Company's cost basis in recently constructed buildings and no gain or loss was recognized. The Company will pay Mr. Howard a market rental rate of $44,376 per month, under standard lease terms, for land owned by Mr. Howard and the buildings sold and leased back. The Company believes that the terms of the lease are at fair market value. 8 9. COMMITMENTS AND CONTINGENCIES: From time to time, the Company's dealerships are named in claims involving the manufacturer of automobiles, contractual disputes and other matters arising in the ordinary course of business. The Texas Automobile Dealers Association ("TADA") and certain new vehicle dealerships in Texas that are members of the TADA, including a number of the Company's Texas dealership subsidiaries, have been named in two state court class action lawsuits and one federal court class action lawsuit. The three actions allege that since January 1994, Texas dealers have deceived customers with respect to a vehicle inventory tax and violated federal antitrust and other laws. In April 2002, the state court in which two of the actions are pending certified classes of consumers on whose behalf the action would proceed. On October 25, 2002, the Texas Court of Appeals affirmed the trial court's order of class certification in the state action and the Company is appealing that ruling to the Texas Supreme Court. In the other action, on March 26, 2003, the federal court also certified a class of consumers, but denied a request to certify a defendants' class consisting of all TADA members. On May 19, 2003, the Fifth Circuit Court of Appeals granted a request for permission to appeal the class certification ruling of the lower federal court. State and federal courts have ordered the parties in the three cases to participate in mediation. In May 2003, counsel for the parties agreed to withhold any objections to mediation and agreed to mediate the cases. The Company intends to vigorously defend itself and assert available defenses with respect to each of the foregoing matters and may have certain insurance coverage and rights of indemnification. While the Company does not believe this litigation will have a material adverse effect on its financial condition or results of operations, no assurance can be given as to its ultimate outcome and a settlement or an adverse resolution of this matter could result in the payment of significant costs and damages. In addition to the foregoing case, there are currently no legal proceedings pending against or involving the Company that, in management's opinion, based on current known facts and circumstances, are expected to have a material adverse effect on the Company's financial position. 10. SUBSEQUENT EVENTS: On July 31, 2003, the Company announced its intention to commence a private placement offering of $150.0 million of a new issue of senior subordinated notes. The Company intends to use the net proceeds of the offering for general corporate purposes, including the retirement on or prior to the initial redemption date of all of its outstanding 10 7/8% senior subordinated notes due 2009 and potential acquisitions. The existing notes are redeemable beginning March 1, 2004 at a redemption price of 105.438% of the principal amount, plus accrued and unpaid interest. At June 30, 2003 the principal balance of these notes was $75.4 million. Pending such uses, the Company intends to temporarily reduce outstanding floorplan borrowings. In July 2003, the Company completed a market consolidation project in conjunction with DaimlerChrysler's Alpha Initiative in Dallas, Texas. The transaction resulted in the consolidation of three dealerships consisting of four franchises into one dealership with Dodge, Chrysler and Jeep franchises. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following should be read in conjunction with the response to Part I, Item 1 of this Report and our other filings with the Securities and Exchange Commission ("SEC"). OVERVIEW We are a leading operator in the $1 trillion automotive retailing industry. Through a series of acquisitions, we operate 112 dealership franchises in California, Colorado, Florida, Georgia, Louisiana, Massachusetts, New Mexico, Oklahoma and Texas. Through our dealerships and Internet sites, we sell new and used cars and light trucks; arrange related financing, vehicle service and insurance contracts; provide maintenance and repair services; and sell replacement parts. We also operate 25 collision service centers. The following table sets forth our brand diversity, based on new vehicle retail unit sales, and the number of franchises we own:
SIX MONTH ENDED JUNE 30, 2003 ----------------------------- ACTUAL NUMBER PERCENTAGE OF NUMBER OF OF NEW TOTAL NEW FRANCHISES OWNED BRAND VEHICLES SOLD VEHICLES SOLD AS OF JULY 31, 2003 ----- ------------- ------------- ------------------- Ford................. 11,147 23.4% 14 Toyota............... 9,727 20.4 9 Honda................ 4,104 8.6 5 Nissan............... 3,935 8.3 10 Dodge................ 3,216 6.8 8 Chevrolet............ 3,015 6.3 5 Lexus................ 2,343 4.9 2 Mitsubishi........... 1,419 3.0 6 Jeep................. 1,156 2.4 7 Chrysler............. 1,038 2.2 7 GMC.................. 1,036 2.2 4 Infiniti............. 899 1.9 1 Acura................ 841 1.8 2 Mazda................ 535 1.1 2 Pontiac.............. 401 0.9 4 Lincoln.............. 378 0.8 4 Subaru............... 358 0.8 1 Audi................. 341 0.7 1 Mercury.............. 285 0.6 5 BMW.................. 274 0.6 2 Buick................ 269 0.6 4 Hyundai.............. 187 0.4 1 Volkswagen........... 174 0.4 1 Cadillac............. 158 0.3 2 Mercedes-Benz......... 155 0.3 1 Hummer................ 70 0.1 1 Kia................... 69 0.1 1 Porsche............... 63 0.1 1 Other................. 47 0.0 1 ------ ----- --- TOTAL............ 47,640 100.0% 112 ====== ===== ===
10 The following table sets forth our geographic diversity, based on new vehicle retail unit sales, and the number of dealerships and franchises we own:
PERCENTAGE OF OUR NEW VEHICLE RETAIL UNITS AS OF JULY 31, 2003 SOLD DURING THE SIX ---------------------------- MONTHS ENDED NUMBER OF NUMBER OF MARKET AREA JUNE 30, 2003 DEALERSHIPS FRANCHISES ---------------------- ------------------- ----------- ---------- Oklahoma.............. 14.1% 10 20 Houston............... 13.1 7 6 New England........... 12.4 10 13 California............ 11.6 7 7 Austin................ 7.8 6 9 Florida............... 7.8 4 4 West Texas............ 7.3 7 14 New Orleans........... 6.4 4 6 Dallas................ 6.0 4 7 Atlanta............... 5.6 6 8 Beaumont.............. 3.3 2 10 Albuquerque........... 3.3 3 7 Denver................ 1.3 1 1 ----- -- --- TOTAL.............. 100.0% 71 112 ===== == ===
We have diverse sources of revenues, including: new car sales, new truck sales, used car sales, used truck sales, manufacturer remarketed vehicle sales, parts sales, service sales, collision repair service sales, financing fees, vehicle service contract fees, insurance fees and after-market product sales. Sales revenues from new and used vehicle sales and parts and service sales include sales to retail customers, other dealerships and wholesalers. Finance and insurance revenues include fees from arranging financing, vehicle service and insurance contracts, net of a provision for anticipated chargebacks. Our total gross margin varies as our merchandise mix (the mix between new vehicle sales, used vehicle sales (retail and wholesale), parts and service sales, collision repair service sales and finance and insurance revenues) changes. Our gross margin on the sale of products and services varies significantly, with new vehicle sales generally resulting in the lowest gross margin and finance and insurance revenues generally resulting in the highest gross margin. When our new vehicle sales increase or decrease at a rate greater than our other revenue sources, our gross margin responds inversely. Factors such as seasonality, weather, cyclicality and manufacturers' advertising and incentives may impact our merchandise mix, and therefore influence our gross margin. Selling, general and administrative expenses consist primarily of incentive-based compensation for sales, administrative, finance and general management personnel, rent, marketing, insurance and utilities. We believe that approximately 65% of our selling, general and administrative expenses are variable, allowing us to adjust our cost structure based on business trends. It takes several months to adjust our cost structure when business volume changes significantly. Interest expense consists of interest charges on interest-bearing debt, including floorplan inventory financing, net of interest income earned. We receive interest assistance from several of our manufacturers. This assistance, which is reflected as a reduction of cost of sales, has ranged between 80% and 160% of our floorplan interest expense over the past three years, mitigating the impact of interest rate changes on our financial results. 11 SELECTED OPERATIONAL AND FINANCIAL DATA FOR THE THREE MONTH PERIODS ENDED JUNE 30, 2003 AND JUNE 30, 2002 NEW VEHICLE DATA
(dollars in thousands, INCREASE/ PERCENT except per unit amounts) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Retail unit sales .......................... 25,463 23,486 1,977 8.4% Retail sales revenues ...................... $693,454 $615,532 $ 77,922 12.7% Gross profit (1) ........................... $ 51,471 $ 47,526 $ 3,945 8.3% Average gross profit per retail unit sold .. $ 2,021 $ 2,024 $ (3) (0.1)% Gross margin (1) ........................... 7.4% 7.7% (0.3)%
------------------ (1) Interest assistance is recorded as a reduction of cost of sales, as the vehicles are sold to third parties. Interest assistance varies with changes in interest rates and will impact gross margin. USED VEHICLE DATA
(dollars in thousands, INCREASE/ PERCENT except per unit amounts) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Retail unit sales .................... 16,167 16,221 (54) (0.3)% Wholesale unit sales ................. 10,714 9,659 1,055 10.9% Retail sales revenues ................ $ 230,956 $ 230,708 $ 248 0.1% Wholesale sales revenues ............. 65,445 56,031 9,414 16.8% --------- --------- --------- Total revenues .................... $ 296,401 $ 286,739 $ 9,662 3.4% Total gross profit ................... $ 25,959 $ 24,235 $ 1,724 7.1% Total gross margin (1) ............... 8.8% 8.5% 0.3% Average gross profit per retail unit sold (2) ..................... $ 1,606 $ 1,494 $ 112 7.5% Retail gross margin (1) .............. 11.2% 10.5% 0.7% Wholesale gross loss ................. $ (2,215) $ (1,427) $ (788) (55.2)% Average wholesale sales gross loss per wholesale unit sold ............... $ (207) $ (148) $ (59) (39.9)% Wholesale gross margin ............... (3.4)% (2.5)% (0.9)%
------------------ (1) Total gross margin equals total gross profit divided by total revenues. Retail gross margin equals total gross profit, which includes wholesale gross loss, divided by retail sales revenues. The profit or loss on wholesale sales is included in this number, as these transactions facilitate retail vehicle sales and are not expected to generate profit. (2) Average gross profit per retail unit sold equals total gross profit, which includes wholesale gross loss, divided by retail unit sales. The profit or loss on wholesale sales is included in this number, as these transactions facilitate retail vehicle sales and are not expected to generate profit. PARTS AND SERVICE DATA
INCREASE/ PERCENT (dollars in thousands) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Sales revenues.............................. $ 116,279 $ 95,511 $ 20,768 21.7% Gross profit................................ $ 65,040 $ 53,680 $ 11,360 21.2% Gross margin................................ 55.9% 56.2% (0.3)%
12 FINANCE AND INSURANCE DATA
(dollars in thousands, INCREASE/ PERCENT except per unit amounts) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Retail new and used unit sales ........ 41,630 39,707 1,923 4.8% Retail finance fees ................... $16,184 $14,361 $ 1,823 12.7% Vehicle contract fees ................. 15,436 12,332 3,104 25.2% Other finance and insurance revenues .. 10,126 8,629 1,497 17.3% ------- ------- ------- Total finance and insurance revenues $41,746 $35,322 $ 6,424 18.2% Finance and insurance, net per retail unit sold .................... $ 1,003 $ 890 $ 113 12.7%
SAME STORE REVENUES COMPARISON (1)
INCREASE/ PERCENT (dollars in thousands) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- New vehicle retail sales ........ $ 573,056 $ 601,805 $ (28,749) (4.8)% Used vehicle retail sales ....... 196,915 224,094 (27,179) (12.1)% Used vehicle wholesale sales .... 56,918 54,636 2,282 4.2% Parts and service sales ......... 97,807 92,653 5,154 5.6% Retail finance fees ............. 13,279 14,053 (774) (5.5)% Vehicle service contract fees ... 10,914 11,601 (687) (5.9)% Other finance and insurance revenues, net ................ 6,383 7,567 (1,184) (15.6)% ---------- ---------- ---------- Total same store revenues .... $ 955,272 $1,006,409 $ (51,137) (5.1)%
------------------ (1) Includes only those dealerships owned during all of the months of both periods in the comparison. THREE MONTHS ENDED JUNE 30, 2003 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2002 REVENUES. Revenues increased $114.8 million, or 11.1%, to $1,147.9 million for the three months ended June 30, 2003, from $1,033.1 million for the three months ended June 30, 2002. The growth in total revenues came from acquisitions, which were partially offset by a same store revenues decline of $51.1 million. New vehicle revenues increased $77.9 million, as acquired operations offset a same store revenues decline of $28.7 million. The same store revenues decreased, reflecting a less robust vehicle market for the three months ended June 30, 2003, particularly with respect to our Ford dealerships. Our used vehicle retail revenues increased $0.2 million as revenues from acquired operations were offset by a $27.2 million decline in our same store sales. The same store sales decline was due to continued high levels of manufacturer incentives on new vehicle sales, which reduced the price difference to the customer between a late-model used vehicle and a new vehicle, thus switching more customers to new vehicles. Used vehicle wholesale sales increased $9.4 million as the decline in used vehicle retail sales required us to wholesale more used vehicles to keep inventory turns on target and inventory levels in line with expected retail sales volumes. The increase in parts and service revenues of $20.8 million included a same store revenues increase of $5.2 million. The same store revenues increase was driven by increased customer-pay parts and service sales and wholesale parts sales, partially offset by reduced warranty sales. Retail finance fee revenues increased $1.8 million, with a $0.8 million same store decrease partially offsetting the revenues contributed by acquisitions. The same store decline was caused primarily by a decline in retail unit sales and was partially offset by the impact of a favorable interest rate environment. Vehicle service contract fee revenues increased $3.1 million, with same store sales decreasing $0.7 million. During the three months ended June 30, 2003, revenues recognized related to contracts requiring 13 revenue deferral over the life of the contracts increased $1.6 million. The same store decline is due to the decline in retail unit sales, partially offset by increased revenues per unit sold. The increased revenues per unit sold was driven by increased sales training and our customers' increased ability and willingness to finance vehicle service contract purchases due to the low interest rates available. Other finance and insurance revenues increased $1.5 million, with same store sales declining $1.2 million. The same store decreases were caused primarily by the decline in retail unit sales and a decline in the sales of insurance contracts, as we emphasized the sales of products with a higher value to the customer. GROSS PROFIT. Gross profit increased $23.4 million, or 14.6%, to $184.2 million for the three months ended June 30, 2003, from $160.8 million for the three months ended June 30, 2002. The increase was attributable to an increase in gross margin to 16.0% for the three months ended June 30, 2003, from 15.6% for the three months ended June 30, 2002, and increased revenues derived from acquisitions. The gross margin increased as higher margin parts and service, and finance and insurance revenues increased as a percentage of total revenues, and increased finance and insurance revenues, per retail unit sold, offset the decline in the new vehicle gross margin. Although our new vehicle gross profit per retail unit sold remained consistent with the prior year, the gross margin on new retail vehicle sales declined to 7.4% from 7.7%, primarily due to an increase in the average selling price of vehicles sold. Our used vehicle gross profit per retail unit sold increased to $1,606 for the three months ended June 30, 2003, from $1,494 for the three months ended June 30, 2002. The increase per retail unit sold and the increase in our used vehicle retail gross margin improved primarily due to increased gross margins in the Florida and Oklahoma markets. Our wholesale losses increased as we wholesaled more vehicles in light of the decline in the used vehicle retail sales volume. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased $19.4 million, or 16.1%, to $140.2 million for the three months ended June 30, 2003, from $120.8 million for the three months ended June 30, 2002. The increase was primarily attributable to the additional operations acquired. Selling, general and administrative expenses increased as a percentage of gross profit to 76.1% from 75.1% due primarily to below expected operating performance in our Atlanta and Dallas operations, partially offset by a $1.0 million benefit from positive claims experience in our property and casualty insurance program. Excluding the gross profit and selling, general and administrative expenses of our Atlanta and Dallas operations, our selling, general and administrative expenses as a percentage of gross profit would have been approximately 50 basis points higher when comparing the three months ended June 30, 2003, to the three months ended June 30, 2002. INTEREST EXPENSE. Floorplan and other interest expense, net, increased $1.8 million, or 26.5%, to $8.6 million for the three months ended June 30, 2003, from $6.8 million for the three months ended June 30, 2002. The increase was due to an increase in the average balance of debt outstanding, partially offset by lower interest rates. During October 2001, we completed a $98.5 million stock offering and initially used the proceeds to pay down borrowings under our credit facility, which resulted in a lower average balance of debt outstanding during the three months ended June 30, 2002. By the end of 2002, we had reborrowed the amounts used to pay down the floorplan portion of our credit facility. Additionally, we have increased floorplan borrowings outstanding due to acquisitions completed during the past twelve months and higher overall inventory levels. At June 30, 2003, we had an 83 days supply of new vehicle inventory, which is higher than our targeted 60 days supply. During the three months ended June 30, 2003, there was an approximately 50 basis point reduction in our average floorplan financing rate as compared to the three months ended June 30, 2002. 14 SELECTED OPERATIONAL AND FINANCIAL DATA FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2003 AND JUNE 30, 2002 NEW VEHICLE DATA
(dollars in thousands, INCREASE/ PERCENT except per unit amounts) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Retail unit sales .......................... 47,640 44,255 3,385 7.6% Retail sales revenues ...................... $1,287,208 $1,168,055 $ 119,153 10.2% Gross profit (1) ........................... $ 94,196 $ 90,098 $ 4,098 4.5% Average gross profit per retail unit sold .. $ 1,977 $ 2,036 $ (59) (2.9)% Gross margin (1) ........................... 7.3% 7.7% (0.4)%
------------------- (1) Interest assistance is recorded as a reduction of cost of sales, as the vehicles are sold to third parties. Interest assistance varies with changes in interest rates and will impact gross margin. USED VEHICLE DATA
(dollars in thousands, INCREASE/ PERCENT except per unit amounts) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------- Retail unit sales ............. 32,479 32,380 99 0.3% Wholesale unit sales .......... 20,811 18,908 1,903 10.1% Retail sales revenues ......... $ 456,154 $ 448,641 $ 7,513 1.7% Wholesale sales revenues ...... 126,449 107,099 19,350 18.1% --------- --------- --------- Total revenues ............. $ 582,603 $ 555,740 $ 26,863 4.8% Total gross profit ............ $ 52,304 $ 49,402 $ 2,902 5.9% Total gross margin (1) ........ 9.0% 8.9% 0.1% Average gross profit per retail unit sold (2) ............... $ 1,610 $ 1,526 $ 84 5.5% Retail gross margin (1) ....... 11.5% 11.0% 0.5% Wholesale gross loss .......... $ (4,010) $ (2,722) $ (1,288) (47.3)% Average wholesale gross loss per wholesale unit sold ..... $ (193) $ (144) $ (49) (34.0)% Wholesale gross margin ........ (3.2)% (2.5)% (0.7)%
------------------ (1) Total gross margin equals total gross profit divided by total revenues. Retail gross margin equals total gross profit, which includes wholesale gross loss, divided by retail sales revenues. The profit or loss on wholesale sales is included in this number, as these transactions facilitate retail vehicle sales and are not expected to generate profit. (2) Average gross profit per retail unit sold equals total gross profit, which includes wholesale gross loss, divided by retail unit sales. The profit or loss on wholesale sales is included in this number, as these transactions facilitate retail vehicle sales and are not expected to generate profit. PARTS AND SERVICE DATA
INCREASE/ PERCENT (dollars in thousands) 2003 2002 (DECREASE) CHANGE ---- ---- ---------- ------ Sales revenues.............................. $ 227,392 $ 187,202 $ 40,190 21.5% Gross profit................................ $ 126,696 $ 104,591 $ 22,105 21.1% Gross margin................................ 55.7% 55.9% (0.2)%
15 FINANCE AND INSURANCE, NET
(dollars in thousands, PERCENT except per unit amounts) 2003 2002 INCREASE CHANGE ---- ---- -------- ------ Retail new and used unit sales.............. 80,119 76,635 3,484 4.5% Retail finance fees......................... $31,363 $27,772 $ 3,591 12.9% Vehicle service contract fees............... 30,634 23,815 6,819 28.6% Other finance and insurance revenues........ 18,471 16,594 1,877 11.3% ------- ------- --------- Total finance and insurance revenues..... $80,468 $68,181 $ 12,287 18.0% Finance and insurance, net per retail unit sold.......................... $ 1,004 $ 890 $ 114 12.8%
SAME STORE REVENUES COMPARISON (1)
INCREASE/ PERCENT (dollars in thousands) 2003 2002 (DECREASE) CHANGE ---- ---- -------- ------ New vehicle retail sales.................... $1,051,296 $1,136,481 $ (85,185) (7.5)% Used vehicle retail sales................... 389,503 435,480 (45,977) (10.6)% Used vehicle wholesale sales................ 106,601 102,612 3,989 3.9% Parts and service sales..................... 188,516 180,500 8,016 4.4% Retail finance fees......................... 25,424 27,192 (1,768) (6.5)% Vehicle service contract fees............... 21,641 22,523 (882) (3.9)% Other finance and insurance revenues, net............................ 12,285 14,067 (1,782) (12.7)% ---------- ---------- --------- Total same store revenues............ $1,795,266 $1,918,855 $(123,589) (6.4)%
------------------ (1) Includes only those dealerships owned during all of the months of both periods in the comparison. SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2002 REVENUES. Revenues increased $198.5 million, or 10.0%, to $2,177.7 million for the six months ended June 30, 2003, from $1,979.2 million for the six months ended June 30, 2002. The growth in total revenues came from acquisitions, which were partially offset by a same store revenues decline of $123.6 million. New vehicle revenues increased $119.2 million, as acquired operations offset a same store revenues decline of $85.2 million. The same store revenues decreased, reflecting a less robust vehicle market for the six months ended June 30, 2003, particularly with respect to our Ford and Toyota dealerships. Our used vehicle retail revenues increased $7.5 million as revenues from acquired operations were partially offset by a $46.0 million decline in our same store sales. The same store sales decline was due to high levels of manufacturer incentives on new vehicle sales, which reduced the price difference to the customer between a late-model used vehicle and a new vehicle, thus switching more customers to new vehicles. Used vehicle wholesale sales increased $19.4 million as the decline in used vehicle retail sales required us to wholesale more used vehicles to keep inventory turns on target and inventory levels in line with expected retail sales volumes. The increase in parts and service revenues of $40.2 million included a same store revenues increase of $8.0 million. The same store revenues increase was driven by increased customer-pay parts and service sales and wholesale parts sales, partially offset by reduced warranty sales. Retail finance fee revenues increased $3.6 million, with a $1.8 million same store decrease partially offsetting the revenues contributed by acquisitions. The same store decline was caused primarily by the decline in retail unit sales which was partially offset by the impact of a favorable interest rate environment. Vehicle service contract fee revenues increased $6.8 million, with same store sales decreasing $0.9 million. During the six months ended June 30, 2003, revenues recognized related to contracts requiring 16 revenue deferral over the life of the contracts increased approximately $3.0 million. The same store decline is due to the decline in retail unit sales, partially offset by increased revenues per unit sold. The increased revenues per unit sold was driven by the receipt of increased annual incentives on vehicle service contract sales, increased sales training and our customers' increased ability and willingness to finance vehicle service contract purchases due to the low interest rates available. Other finance and insurance revenues increased $1.9 million, with same store sales decreasing $1.8 million. The same store decline was caused primarily by the decline in retail unit sales. GROSS PROFIT. Gross profit increased $41.4 million, or 13.3%, to $353.7 million for the six months ended June 30, 2003, from $312.3 million for the six months ended June 30, 2002. The increase was attributable to an increase in gross margin to 16.2% for the six months ended June 30, 2003, from 15.8% for the six months ended June 30, 2002, and increased revenues derived from acquisitions. The gross margin increased as higher margin parts and service, and finance and insurance revenues increased as a percentage of total revenues, and increased finance and insurance revenues, per retail unit sold, offset the decline in the new gross margin. Our new vehicle gross profit per retail unit sold declined to $1,977 for the six months ended June 30, 2003, from $2,036 for the six months ended June 30, 2002, primarily due to a decline in the floorplan assistance per retail unit sold recognized and declines in gross profit per retail unit sold in our Houston operations. The gross margin on new retail vehicle sales declined to 7.3% from 7.7%, primarily due to an increase in the average selling price of vehicles sold and declines in the new vehicle gross profit per retail unit sold. Our used vehicle gross profit per retail unit sold increased to $1,610 for the six months ended June 30, 2003, from $1,526 for the six months ended June 30, 2002. The increase per retail unit sold and the increase in our used vehicle retail gross margin improved primarily due to increased gross margins in the Florida and Oklahoma markets. Our wholesale losses increased as we wholesaled more vehicles in light of the decline in the used vehicle retail sales volume. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased $37.3 million, or 15.7%, to $275.0 million for the six months ended June 30, 2003, from $237.7 million for the six months ended June 30, 2002. The increase was primarily attributable to the additional operations acquired. Selling, general and administrative expenses increased as a percentage of gross profit to 77.8% from 76.1% due primarily to below expected operating performance in our Atlanta and Dallas operations, and adjustments to variable selling expenses lagging the decline in sales volume. Partially offsetting the increases in selling, general and administrative expenses was a $1.0 million benefit from positive claims experience in our property and casualty insurance program. INTEREST EXPENSE. Floorplan and other interest expense, net, increased $2.5 million, or 18.0%, to $16.4 million for the six months ended June 30, 2003, from $13.9 million for the six months ended June 30, 2002. The increase was due to an increase in the average balance of debt outstanding, partially offset by lower interest rates. During October 2001, we completed a $98.5 million stock offering and initially used the proceeds to pay down borrowings under our credit facility, which resulted in a lower average balance of debt outstanding during the six months ended June 30, 2002. By the end of 2002, we had reborrowed the amounts used to pay down the floorplan portion of our credit facility. Additionally, we have increased floorplan borrowings outstanding due to acquisitions completed during the past twelve months and higher overall inventory levels. During the six months ended June 30, 2003, there was an approximately 50 basis point reduction in our average floorplan financing rate as compared to the six months ended June 30, 2002. 17 LIQUIDITY AND CAPITAL RESOURCES Our principal sources of liquidity are cash on hand, cash from operations, our credit facility, which includes the floorplan tranche and the acquisition tranche, and equity and debt offerings. CASH FLOWS Total cash at June 30, 2003, was $21.2 million. OPERATING ACTIVITIES. During the first six months of 2003, we generated $15.3 million of cash flow from operations, primarily driven by net income plus depreciation and amortization, partially offset by excess cash balances used to fund inventory purchases. Amounts received from reduction of contracts in transit and vehicle receivables outstanding were used to pay down the floorplan balance. INVESTING ACTIVITIES. During the first six months of 2003, we used approximately $19.8 million in investing activities. We paid $18.2 million for purchases of property and equipment, of which $12.8 million was used for the purchase of land and construction of facilities for new or expanded operations. We received $5.0 million in proceeds from the sales of property and equipment. We have used $12.7 million in the acquisitions of three franchises and received $7.4 million from the sale of one franchise, for which no gain was recognized. FINANCING ACTIVITIES. During the first six months of 2003, we obtained approximately $1.4 million from financing activities, primarily from issuances of stock to our benefit plans, net of repurchases of our common stock. WORKING CAPITAL. At June 30, 2003, we had working capital of $122.0 million, which is approximately $30 million higher than we believe we need to operate our business. While we cannot guarantee it, based on current facts and circumstances, we believe we have adequate cash flows, coupled with borrowing capacity under our credit facility, to fund our current operations, capital expenditures and acquisitions budgeted for 2003. If our capital expenditure or acquisition plans, as outlined below, change, we may need to access the private or public capital markets to obtain additional funding. RECENT DEVELOPMENTS On July 31, 2003, we announced our intention to commence a private placement offering of $150.0 million of a new issue of senior subordinated notes. We intend to use the net proceeds of the offering for general corporate purposes, including the retirement on or prior to the initial redemption date of all of our outstanding 10 7/8% senior subordinated notes due 2009 and potential acquisitions. The existing notes are redeemable beginning March 1, 2004 at a redemption price of 105.438% of the principal amount, plus accrued and unpaid interest. At June 30, 2003 the principal balance of these notes was $75.4 million. Pending such uses, we intend to temporarily reduce outstanding floorplan borrowings. CREDIT FACILITIES During June 2003, we completed an amendment to our existing credit facility that extends the term until June 2006. The $775.0 million credit facility consists of two tranches: 75% of the facility is for floorplan financing ("the Floorplan Tranche") and 25% is for working capital and acquisition financing ("the Acquisition Tranche"). The Acquisition Tranche, which bears interest at a rate of LIBOR plus a margin varying between 175 and 325 basis points, determined based on a ratio of debt to equity, totals $193.8 million and, as of July 31, 2003, $189.7 million was available, after deducting $4.1 million for outstanding letters of credit, to be drawn for working capital, acquisition or floorplan financing. At June 30, 2003, there was $425.6 million outstanding under the Floorplan Tranche, which bears interest at rates of LIBOR plus 112.5 basis points for new vehicle inventory and LIBOR plus 125 basis points for used vehicle inventory. Other than the changes in the maturity date and the total amount available to be borrowed, there were no significant changes in the terms of the agreement. Simultaneous with the amendment of the above described credit facility, we entered into a separate floorplan financing arrangement with Ford Motor Credit Company to provide financing for our entire Ford, 18 Lincoln and Mercury new vehicle inventory. The arrangement provides for up to $300.0 million of financing for the inventory at an interest rate of Prime plus 100 basis points minus certain incentives. We expect the net cost of these borrowings, after all incentives, to approximate our floorplan cost under the $775.0 million credit facility. At June 30, 2003, there was $236.5 million outstanding under this floorplan financing arrangement. This floorplan financing arrangement matures in June 2006. On July 25, 2003, one of our interest rate swaps, with a notional amount of $100.0 million, reached its termination date. As such, at this time, we have one interest rate swap outstanding, with a notional amount of $100.0 million that converts the interest rate on a portion of our floorplan borrowings from the 30-day LIBOR-based rate to a fixed rate of 3.75% plus the applicable spread. CAPITAL EXPENDITURES Our capital expenditures include expenditures to extend the useful life of current facilities and expenditures to start or expand operations. Historically, our annual capital expenditures, exclusive of new or expanded operations, have approximately equaled our annual depreciation charge. Expenditures relating to the construction or expansion of dealership facilities, generally, are driven by new franchises being awarded to us by a manufacturer, significant growth in sales at an existing facility or manufacturer imaging programs. ACQUISITIONS AND ACQUISITION FINANCING Our acquisition target for 2003 is to complete platform and tuck-in acquisitions that have approximately $800 million in annual revenues. We expect the cash needed to complete our acquisitions will come from excess working capital, operating cash flows of our dealerships, borrowings under our credit facility and debt or equity offerings. Depending on the market value of our common stock, we may issue common stock to fund a portion of the purchase price of acquisitions. In July 2003, we completed a market consolidation project in conjunction with DaimlerChrysler's Alpha Initiative in Dallas, Texas. The transaction resulted in the consolidation of three dealerships consisting of four franchises into one dealership with Dodge, Chrysler and Jeep franchises. STOCK REPURCHASE In February 2003, the board of directors authorized us to repurchase up to $25.0 million of our stock, subject to management's judgment and the restrictions of our various debt agreements. Our agreements, subject to other covenants, allow us to use approximately 33% of our cumulative net income to repurchase stock and pay dividends. During the first six months of 2003 we repurchased approximately 117,000 shares for approximately $2.5 million. As of June 30, 2003, we had the capacity to repurchase an additional $22.5 million of stock under the board of directors' authorization. DISCUSSION OF CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions in determining the reported amounts of assets and liabilities and 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. The significant estimates made by us in the accompanying consolidated financial statements relate to reserves for inventory valuations and future chargebacks on finance and vehicle service contract fees, and valuation of intangible assets. Actual results could differ from those estimates. Critical accounting policies are those that are both most important to the portrayal of a company's financial position and results of operations, and require management's most difficult, subjective or complex judgments. Below is a discussion of what we believe are our critical accounting policies. See Note 2 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2002. 19 INVENTORIES New, used and demonstrator vehicles are stated at the lower of cost or market. Vehicle inventory cost consists of the amount paid to acquire the inventory, plus reconditioning cost, cost of equipment added and transportation cost. Additionally, we receive interest assistance from most of our manufacturers. The assistance is accounted for as a purchase discount and is reflected as a reduction to the inventory cost on the balance sheet and as a reduction to cost of sales in the income statement as the vehicles are sold. Parts and accessories are stated at the lower of cost (determined on a first-in, first-out basis) or market. As the market value of our inventories typically declines with the passage of time, valuation reserves are provided against the inventory balances based on the agings of the inventories and market trends. In particular, used vehicles present added complexity to the inventory valuation process. There is no standardized source for determining exact values, as each vehicle and each market in which we operate, is unique. As such, these factors are also considered in determining the appropriate level of valuation reserves. RETAIL FINANCE AND VEHICLE SERVICE CONTRACT REVENUES RECOGNITION We arrange financing for customers through various institutions and receive financing fees based on the difference between the loan rates charged to customers over predetermined financing rates set by the financing institution. In addition, we receive fees from the sale of vehicle service contracts to customers. We may be charged back ("chargebacks") for unearned financing fees or vehicle service contract fees in the event of early termination of the contracts by customers. The revenues from financing fees and vehicle service contract fees in administrator-obligor states are recorded at the time of the sale of the vehicles and a reserve for future chargebacks is established based on historical operating results and the termination provisions of the applicable contracts. In dealer-obligor states, revenues from vehicle service contract fees and related direct costs are deferred and recognized over the life of the contracts. Currently, none of the states in which we operate are dealer-obligor states. INTANGIBLE ASSETS In June 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was issued. The statement requires, at least annually, an assessment for impairment of goodwill and other indefinite life intangible assets (franchise value) by applying a fair-value based test. We complete the required assessment at the end of each calendar year, and at such other times as required by events and circumstances at a reporting unit indicating a potential reduction of fair value below book value. In performing the assessment, we estimate fair value using a calculation based on historical and expected cash flows of the dealerships, market trends and conditions, review of completed transactions and current market valuations. Our fair value estimate requires numerous subjective assumptions and estimates to determine fair value. Depending on future levels of cash flows and other facts and circumstances, and changes in our estimates and assumptions, we could be required to recognize impairment charges in the future. 20 CAUTIONARY STATEMENT ABOUT FORWARD LOOKING STATEMENTS This quarterly report includes certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include statements regarding our plans, goals, beliefs or current expectations, including those plans, goals, beliefs and expectations of our officers and directors with respect to, among other things: - the completion of future acquisitions - operating cash flows and availability of capital - future stock repurchases - capital expenditures - changes in sales volumes in the new and used vehicle and parts and service markets - business trends, including incentives, product cycles and interest rates - availability of financing for inventory and working capital - inventory levels - the completion of announced notes offering - the early retirement of outstanding senior subordinated notes Any such forward-looking statements are not assurances of future performance and involve risks and uncertainties. Actual results may differ materially from anticipated results in the forward-looking statements for a number of reasons, including: - the future economic environment, including consumer confidence, interest rates, the price of gasoline, the level of manufacturer incentives and the availability of consumer credit may affect the demand for new and used vehicles and parts and service sales - the effect of adverse international developments such as war, terrorism, political conflicts or other hostilities - regulatory environment, adverse legislation, or unexpected litigation - our principal automobile manufacturers, especially Ford, Toyota, GM and DaimlerChrysler, may not continue to produce or make available to us vehicles that are in high demand by our customers - requirements imposed on us by our manufacturers may limit our acquisitions and affect capital expenditures related to our dealership facilities - our dealership operations may not perform at expected levels or achieve expected improvements - we may not achieve expected future cost savings and our future costs could be higher than we expected - available capital resources and various debt agreements may limit our ability to complete acquisitions, complete construction of new or expanded facilities and repurchase shares - our cost of financing could increase significantly - new accounting standards could materially impact our reported earnings per share - we may not complete additional acquisitions or the pace of acquisitions may change - we may not be able to adjust our cost structure - we may lose key personnel - competition in our industry may impact our operations or our ability to complete acquisitions - insurance costs could increase significantly - we may not achieve expected sales volumes from the new franchises granted to us - we may not obtain inventory of new and used vehicles and parts, including imported inventory, at the cost, or in the volume, we expect This information and additional factors that could affect our operating results and performance are described in our filings with the SEC. We urge you to carefully consider those factors. All forward-looking statements attributable to us are qualified in their entirety by this cautionary statement. 21 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following information about our market sensitive financial instruments updates the information provided as of December 31, 2002, in our Annual Report on Form 10-K and constitutes a "forward-looking statement." Our major market risk exposure is changing interest rates. Our policy is to manage interest rate exposure through the use of a combination of fixed and floating rate debt. Additionally, interest rate swaps may be used to adjust our exposure to interest rate movements. These swaps are entered into with financial institutions with investment grade credit ratings, thereby minimizing the risk of credit loss. All interest rate swaps are non-trading and qualify for hedge accounting. Since December 31, 2002, our variable rate floorplan notes payable have increased due to increases in inventory levels. A 100 basis point increase in interest rates would have increased floorplan interest expense approximately $3.2 million for the six month period ended June 30, 2003, before the impact of our interest rate swaps. We have had no other significant balances outstanding under variable rate borrowing agreements. At times, we have used interest rate swaps to reduce our exposure to interest rate fluctuations. Currently, we have two interest rate swaps outstanding, each with notional amounts of $100.0 million and converting 30-day LIBOR to a fixed rate. As these swaps are hedging our floorplan interest rate exposure, the impact on interest expense is included in floorplan interest expense in our statements of operations. A 100 basis point increase in interest rates would reduce the cost of the swaps and, thus, reduce our floorplan interest expense by $1.0 million for the six month period ended June 30, 2003. One of the swaps, with a notional amount of $100.0 million, expires at the end of July 2003. As such, depending on interest rate levels during the last five months of 2003, our floorplan interest expense could be impacted. The net result on floorplan interest expense of a 100 basis point increase in interest rates is an increase of $2.2 million, after combining the increase in expense on our borrowings and the decrease in expense from our swaps. Additionally, we receive floorplan interest assistance from the majority of our manufacturers. This assistance, which has ranged from approximately 80% to 160% of our floorplan interest expense over the past three years, totaled $12.8 million during the first six months of 2003 and $12.6 million during the first six months of 2002. We treat this interest assistance as a purchase discount, and reflect it as a reduction of new vehicle cost of sales as new vehicles are sold. Approximately half of the assistance we receive varies with changes in interest rates. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Within 90 days before the filing of this Report, the Company's principal executive officer and principal financial officer evaluated the effectiveness of the Company's disclosure controls and procedures. Based on the evaluation, the Company's principal executive officer and principal financial officer believe that: - the Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms; and - the Company's disclosure controls and procedures were effective to ensure such information was accumulated and communicated to the Company's management, including the Company's principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. 22 CHANGES IN INTERNAL CONTROLS There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls subsequent to their evaluation, nor have there been any corrective actions with regard to significant deficiencies or material weaknesses. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, our dealerships are named in claims involving the manufacture of automobiles, contractual disputes and other matters arising in the ordinary course of business. The Texas Automobile Dealers Association ("TADA") and certain new vehicle dealerships in Texas that are members of the TADA, including a number of our Texas dealership subsidiaries, have been named in two state court class action lawsuits and one federal court class action lawsuit. The three actions allege that since January 1994, Texas dealers have deceived customers with respect to a vehicle inventory tax and violated federal antitrust and other laws. In April 2002, the state court in which two of the actions are pending certified classes of consumers on whose behalf the action would proceed. On October 25, 2002, the Texas Court of Appeals affirmed the trial court's order of class certification in the state action and we are appealing that ruling to the Texas Supreme Court. In the other action, on March 26, 2003, the federal court also certified a class of consumers, but denied a request to certify a defendants' class consisting of all TADA members. On May 19, 2003, the Fifth Circuit Court of Appeals granted a request for permission to appeal the class certification ruling of the lower federal court. State and federal courts have ordered the parties in the three cases to participate in mediation. In May 2003, counsel for the parties agreed to withhold any objections to mediation and agreed to mediate the cases. We intend to vigorously defend ourselves and assert available defenses with respect to each of the foregoing matters and may have certain insurance coverage and rights of indemnification. While we do not believe this litigation will have a material adverse effect on our financial condition or results of operations, no assurance can be given as to its ultimate outcome and a settlement or an adverse resolution of this matter could result in the payment of significant costs and damages. In addition to the foregoing case, there are currently no legal proceedings pending against or involving us that, in our opinion, based on current known facts and circumstances, are expected to have a material adverse effect on our financial position. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 23 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the May 21, 2003, Annual Meeting of Stockholders, our stockholders voted on three matters. 1) Election of two directors: The stockholders elected two nominees as directors for a three-year term based on the following voting results:
VOTES CAST: ------------------------------------ AGAINST OR NOMINEES ELECTED FOR WITHHELD ----------------------- ------------------ ---------------- B.B. Hollingsworth, Jr. 18,763,918 779,264 Robert E. Howard II 18,911,410 631,772
Our other continuing directors are: John L. Adams Louis E. Lataif Stephen D. Quinn Max P. Watson, Jr. Kevin H. Whalen 2) Approval of amendment to 1998 Employee Stock Purchase Plan: The stockholders approved the amendment to the 1998 Employee Stock Purchase Plan. The results of the voting were as follows: For 20,608,506 Against 1,809 Abstain 26,277
3) Appointment of Independent Public Auditors: The stockholders ratified the appointment of Ernst & Young LLP as independent auditors for the year ended December 31, 2003. The results of the voting were as follows: For 19,431,551 Against 103,572 Abstain 8,059
ITEM 5. OTHER INFORMATION The certifications by our chief executive officer and chief financial officer required by Section 1350 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, have been filed as exhibits 32.1 and 32.2, respectively, to this Quarterly Report on Form 10-Q. 24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K A. EXHIBITS: 10.1 Fifth Amended and Restated Revolving Credit Agreement dated June 2, 2003. 10.2 Form of Ford Motor Credit Company Automotive Wholesale Plan Application for Wholesale Financing and Security Agreement. 11.1 Statement re: computation of earnings per share is included under Note 3 to the financial statements. 31.1 Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002. B. REPORTS ON FORM 8-K: On July 31, 2003, the Company filed a Current Report on Form 8-K reporting under Item 12. On July 31, 2003, the Company filed a Current Report on Form 8-K reporting under Item 5. On July 10, 2003, the Company filed a Current Report on Form 8-K reporting under Item 9. On June 3, 2003, the Company filed a Current Report on Form 8-K reporting under Item 9. On June 2, 2003, the Company filed a Current Report on Form 8-K reporting under Item 9. On May 21, 2003, the Company filed a Current Report on Form 8-K reporting under Item 9. 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Group 1 Automotive, Inc. July 31, 2003 By:/s/ Scott L. Thompson ------------- -------------------------------------------- Date Scott L. Thompson, Executive Vice President, Chief Financial Officer and Treasurer 26 INDEX TO EXHIBITS Exhibit No. Description 10.1 Fifth Amended and Restated Revolving Credit Agreement dated June 2, 2003. 10.2 Form of Ford Motor Credit Company Automotive Wholesale Plan Application for Wholesale Financing and Security Agreement. 11.1 Statement re: computation of earnings per share is included under Note 3 to the financial statements. 31.1 Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.