NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We are one of the largest automotive retailers in the United States. As of
March 31, 2019
we owned and operated
106
new vehicle franchises (
87
dealership locations) representing
30
brands of automobiles and
25
collision repair centers in
17
metropolitan markets within
nine
states. Our stores offer an extensive range of automotive products and services, including new and used vehicles; parts and service, which includes repair and maintenance services, replacement parts and collision repair services; and finance and insurance products. For the three months ended
March 31, 2019
, our new vehicle revenue brand mix consisted of
47%
imports,
33%
luxury, and
20%
domestic brands.
Our retail network is made up of dealerships operating primarily under the following locally-branded dealership groups:
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•
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Coggin dealerships operating primarily in Jacksonville, Fort Pierce and Orlando, Florida;
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•
|
Courtesy dealerships operating in Tampa, Florida;
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•
|
Crown dealerships operating in North Carolina, South Carolina and Virginia;
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|
•
|
Gray-Daniels dealerships operating in the Jackson, Mississippi area;
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•
|
Hare and Estes dealerships operating in the Indianapolis, Indiana area;
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•
|
McDavid dealerships operating in metropolitan Austin, Dallas and Houston, Texas;
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•
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Nalley dealerships operating in metropolitan Atlanta, Georgia; and
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•
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Plaza dealerships operating in metropolitan St. Louis, Missouri.
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Our operating results are generally subject to changes in the economic environment as well as seasonal variations. Historically, we have generated more revenue and operating income in the second, third, and fourth quarters than in the first quarter of the calendar year. Generally, the seasonal variations in our operations are caused by factors related to weather conditions, changes in manufacturer incentive programs, model changeovers, and consumer buying patterns, among other things.
Basis of Presentation
The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), and reflect the consolidated accounts of Asbury Automotive Group, Inc. and its wholly owned subsidiaries. All intercompany transactions have been eliminated in consolidation.
In the opinion of management, all adjustments, consisting only of normal, recurring adjustments, considered necessary for a fair presentation of the Condensed Consolidated Financial Statements as of
March 31, 2019
, and for the
three
months ended
March 31, 2019
and
2018
, have been included, unless otherwise indicated. The results of operations for the
three
months ended
March 31, 2019
are not necessarily indicative of the results that may be expected for any other interim period, or any full year period. Our Condensed Consolidated Financial Statements should be read together with our audited consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31,
2018
.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the periods presented. Actual results could differ materially from these estimates. Estimates and assumptions are reviewed quarterly and the effects of any revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Significant estimates made in the accompanying Condensed Consolidated Financial Statements include, but are not limited to, those relating to inventory valuation reserves, variable consideration and constraint considerations related to retro-commission arrangements, reserves for chargebacks against revenue recognized from the sale of finance and insurance products, reserves for insurance programs, certain assumptions related to intangible and long-lived assets, and reserves for certain legal or similar proceedings relating to our business operations.
Contracts-In-Transit
Contracts-in-transit represent receivables from third-party finance companies for the portion of new and used vehicle purchase price financed by customers through sources arranged by us.
Revenue Recognition
Refer to Note 2 "Revenue Recognition".
Income Taxes
We use the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are
recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and
their respective tax basis using currently enacted tax rates.
Share Repurchases
Share repurchases may be made from time-to-time in open market transactions or through privately negotiated transactions under the authorization approved by the Board of Directors. Periodically, the Company may retire repurchased shares of common stock previously held by the Company as Treasury Shares. In accordance with our accounting policy, we allocate any excess share repurchase price over par value between additional paid-in capital, which is limited to amounts initially recorded for the same issue, and retained earnings.
Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted-average common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted-average common shares and common share equivalents outstanding during the period. For all periods presented, there were no adjustments to the numerator necessary to compute diluted earnings per share.
Assets Held for Sale and Liabilities Associated with Assets Held for Sale
Certain amounts have been classified as Assets Held for Sale in the accompanying Condensed Consolidated Balance Sheets. Assets and liabilities classified as held for sale include assets and liabilities associated with a pending dealership disposal, real estate not currently used in our operations that we are actively marketing to sell, and any related mortgage notes payable, if applicable. Classification as held for sale begins on the date that we have met all of the criteria for classification as held for sale.
At the time of classifying assets as held for sale, we compare the carrying value of these assets to estimates of fair value to assess for impairment. We compare the carrying value to estimates of fair value utilizing the assistance of third-party broker opinions of value and third-party desktop appraisals to assist in our fair value estimates related to real estate properties.
Statements of Cash Flows
Borrowings and repayments of floor plan notes payable to a lender unaffiliated with the manufacturer from which we purchase a particular new vehicle ("Non-Trade") and all floor plan notes payable relating to pre-owned vehicles (together referred to as "Floor Plan Notes Payable—Non-Trade") are classified as financing activities on the accompanying Condensed Consolidated Statements of Cash Flows, with borrowings reflected separately from repayments. The net change in floor plan notes payable to a lender affiliated with the manufacturer from which we purchase a particular new vehicle (collectively referred to as "Floor Plan Notes Payable—Trade") is classified as an operating activity on the accompanying Condensed Consolidated Statements of Cash Flows. Borrowings of floor plan notes payable associated with inventory acquired in connection with all acquisitions and repayments made in connection with all divestitures are classified as financing activities in the accompanying Condensed Consolidated Statement of Cash Flows. Cash flows related to floor plan notes payable included in operating activities differ from cash flows related to floor plan notes payable included in financing activities only to the extent that the former are payable to a lender affiliated with the manufacturer from which we purchased the related inventory, while the latter are payable to a lender not affiliated with the manufacturer from which we purchased the related inventory.
Loaner vehicles account for a significant portion of Other Current Assets. We acquire loaner vehicles either with available cash or through borrowing from either our manufacturer affiliated lenders or through our senior secured credit agreement with Bank of America, as administrative agent, and the other agents and lenders party thereto (the "2016 Senior Credit Facility"). Loaner vehicles are initially used by our service department for a short period of time (typically
six
to
twelve
months) before we seek to sell them. Therefore, we classify the acquisition of loaner vehicles in Other Current Assets and the borrowings and repayments of loaner vehicle notes payable in Accounts Payable and Accrued Liabilities in the accompanying Condensed
Consolidated Statements of Cash Flows. Loaner vehicles are depreciated over the service period to their estimated value. At the end of the loaner service period, loaner vehicles are transferred from Other Current Assets to used vehicle inventory. These transfers are reflected as non-cash transfers between Other Current Assets and Inventories in the accompanying Condensed Consolidated Statements of Cash Flows.
Recent Accounting Pronouncements
Effective January 1, 2019, the Company adopted the new lease accounting guidance in Accounting Standards Update (ASU) No. 2016-02,
Leases (Topic 842)
(“ASC 842”)
.
Refer to Note 9 for additional information.
On January 1, 2019, the Company adopted ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." ASU 2018-02 allows entities to elect to reclassify the income tax effects resulting from the Tax Cuts and Jobs Act (the "Tax Act") on items within accumulated other comprehensive income to retained earnings. During the first quarter of 2019, the Company elected to reclassify
$0.2 million
related to the change in deferred taxes associated with our cash flow hedges from accumulated other comprehensive income to retained earnings. This reclassification was recognized as a cumulative effect adjustment in the Condensed Consolidated Statements of Shareholders' Equity during the current quarter.
On January 1, 2019, the Company adopted ASU 2017-12, "Derivatives and Hedging" (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This update is intended to simplify hedge accounting by better aligning how an entity’s risk management activities and hedging relationships are presented in its financial statements and simplifies the application of
hedge accounting guidance in certain situations. This update expands and refines hedge accounting for both non-financial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. For cash flow hedges existing at the adoption date, this update requires adoption on a modified retrospective basis with a cumulative-effect adjustment to retained earnings as of the effective date and the amendments to presentation guidance and disclosure requirements are required to be adopted prospectively. The adoption of this update did not have a material impact on our condensed consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which requires an entity to assess impairment of its financial instruments based on its estimate of expected credit losses versus the current incurred loss model. The provisions of ASU 2016-13 are effective for fiscal years beginning after December 15, 2019. Entities are required to apply these changes through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We plan to adopt ASU 2016-13 in 2020 and are currently evaluating the expected impact from adopting this ASU on our consolidated financial statements.
2. REVENUE RECOGNITION
The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer. Sales and other taxes we collect concurrent with revenue-producing activities are excluded from revenue.
Disaggregation of Revenue
The following table summarizes revenue from contracts with customers for the
three months ended March 31, 2019
and
2018
:
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As of
|
|
March 31, 2019
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|
March 31, 2018
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(In millions)
|
Revenue:
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New vehicle
|
$
|
871.8
|
|
|
$
|
857.1
|
|
Used vehicle retail
|
458.2
|
|
|
435.8
|
|
Used vehicle wholesale
|
51.7
|
|
|
48.8
|
|
New and used vehicle
|
1,381.7
|
|
|
1,341.7
|
|
Sale of vehicle parts and accessories
|
36.9
|
|
|
33.8
|
|
Vehicle repair and maintenance services
|
180.7
|
|
|
165.5
|
|
Parts and services
|
217.6
|
|
|
199.3
|
|
Finance and insurance, net
|
71.5
|
|
|
68.2
|
|
Total revenue
|
$
|
1,670.8
|
|
|
$
|
1,609.2
|
|
New vehicle and used vehicle retail
Revenue from the sale of new and used vehicles (which excludes sales and other taxes) is recognized when the terms of the customer contract are satisfied which generally occurs with the signing of the sales contract and transfer of control of the vehicle to the customer. Incidental items that are immaterial in the context of the contract are accrued at the time of sale.
Used vehicle wholesale
Proceeds from the sale of these vehicles are recognized in used vehicle revenue upon transfer of control to end-users at auction.
Sale of vehicle parts and accessories
The Company recognizes revenue upon transfer of control to the customer which occurs at a point in time. When the Company performs shipping and handling activities after the transfer of control to the customer (e.g., when control transfers prior to delivery), they are considered as fulfillment activities, and accordingly, the costs are accrued for when the related revenue is recognized.
Vehicle repair and maintenance services
The Company provides vehicle repair and maintenance services to its customers pursuant to the terms and conditions included within the customer contract ("repair order"). Satisfaction of this performance obligation creates an asset with no alternative use for which an enforceable right to payment for performance to date exists within our contractual agreements. As such, the Company recognizes revenue over time as the Company satisfies its performance obligation. Additionally, the Company has determined that parts and labor are not individually distinct in the context of a repair order and therefore are treated as a single performance obligation.
Finance and Insurance, net
We receive commissions from third-party lending and insurance institutions for arranging customer financing and from the sale of vehicle service contracts, guaranteed auto protection (known as "GAP") insurance, and other insurance, to end-users. Finance and insurance commission revenue is recognized at the point of sale since our performance obligation is to arrange financing or facilitating the sale of a third party’s products or services to our customers.
The Company’s commission arrangements with third-party lenders and insurance administrators consists of fixed ("upfront") and variable consideration. Variable consideration includes commission charge backs ("chargebacks") in the event a contract is prepaid, defaulted upon, or terminated by the end-user. The Company reserves for future chargebacks based on historical chargeback experience and the termination provisions of the applicable contract and these reserves are established in the same period that the related revenue is recognized.
We also participate in future profits pursuant to retrospective commission arrangements, which meet the definition of variable consideration, for certain insurance products associated with a third-party portfolio. The Company estimates the amount of variable consideration to be included in the transaction price based on historical payment trends and further constrains the variable consideration such that it is probable that a significant reversal of previously recognized revenue will not occur. In making these assessments the Company considers the likelihood and magnitude of a potential reversal of revenue and updates its assessment when uncertainties associated with the constraint are removed.
Contract Assets
Changes in contract assets during the period are reflected in the table below. Contract assets related to vehicle repair and maintenance services are transferred to receivables when a repair order is completed and invoiced to the customer.
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Vehicle Repair and Maintenance Services
|
|
Finance and Insurance, net
|
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Total
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(In millions)
|
Contract Assets (Current), January 1, 2019
|
$
|
4.1
|
|
|
$
|
10.6
|
|
|
$
|
14.7
|
|
Transferred to receivables from contract assets recognized at the beginning of the period
|
(4.1
|
)
|
|
(3.3
|
)
|
|
(7.4
|
)
|
Increases related to revenue recognized, inclusive of adjustments to constraint, during the period
|
4.4
|
|
|
3.3
|
|
|
7.7
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|
Contract Assets (Current), March 31, 2019
|
$
|
4.4
|
|
|
$
|
10.6
|
|
|
$
|
15.0
|
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3. ACQUISITIONS
Results of acquired dealerships are included in our accompanying Condensed Consolidated Statements of Income commencing on the date of acquisition. Our acquisitions are accounted for such that the assets acquired and liabilities assumed are recognized at their acquisition date fair values, with any excess of the consideration transferred over the estimated fair values of the identifiable net assets acquired recorded as goodwill. Goodwill is an asset representing operational synergies and future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. The fair value of our manufacturer franchise rights are determined as of the acquisition date, by discounting the projected cash flows specific to each franchise. Included in this analysis are market participant assumptions, at a dealership level, regarding the cash flows directly attributable to the franchise rights, revenue growth rates, future gross margins and future selling, general, and administrative expenses. Using an estimated weighted average cost of capital, estimated residual values at the end of the forecast period and estimated future capital expenditure requirements, the Company calculates the fair value of the franchise rights.
During the
three
months ended
March 31, 2019
, we acquired the assets of
eight
franchises (
four
dealership locations) in the Indianapolis, Indiana market for a purchase price of
$121.0 million
. We funded this acquisition with
$70.8 million
of cash,
$47.7 million
of floor plan borrowings for the purchase of the related new vehicle inventory, and purchase price holdbacks of
$2.5 million
for potential indemnity claims made by us with respect to the acquired franchises.
Below is the preliminary allocation of purchase price for the acquisitions completed during the
three
months ended
March 31, 2019
. We have not finalized our valuation for manufacturer franchise rights which will be reclassified from goodwill once completed. The goodwill and manufacturer rights associated with our acquisitions will be deductible for federal and state
income tax purposes ratably over a
15
year period.
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As of
|
|
March 31, 2019
|
|
(In millions)
|
Inventory
|
$
|
58.1
|
|
Real estate
|
29.8
|
|
Property and equipment
|
1.8
|
|
Goodwill
|
32.1
|
|
Liabilities assumed
|
(0.8
|
)
|
Total purchase price
|
$
|
121.0
|
|
During the
three
months ended
March 31, 2018
, we acquired the assets of
one
franchise (
one
dealership location) in the Indianapolis, Indiana market for a purchase price of $
46.5 million
. We funded this acquisition with
$36.0 million
of cash,
$9.5 million
of floor plan borrowings for the purchase of the related new vehicle inventory, and purchase price holdbacks of
$1.0 million
for potential indemnity claims made by us with respect to the acquired franchise.
4. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
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As of
|
|
March 31, 2019
|
|
December 31, 2018
|
|
(In millions)
|
Vehicle receivables
|
$
|
40.8
|
|
|
$
|
45.7
|
|
Manufacturer receivables
|
42.9
|
|
|
51.2
|
|
Other receivables
|
32.8
|
|
|
34.7
|
|
Total accounts receivable
|
116.5
|
|
|
131.6
|
|
Less—Allowance for doubtful accounts
|
(1.4
|
)
|
|
(1.3
|
)
|
Accounts receivable, net
|
$
|
115.1
|
|
|
$
|
130.3
|
|
5. INVENTORIES
Inventories consisted of the following:
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|
|
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|
|
|
As of
|
|
March 31, 2019
|
|
December 31, 2018
|
|
(In millions)
|
New vehicles
|
$
|
973.2
|
|
|
$
|
867.2
|
|
Used vehicles
|
152.5
|
|
|
158.9
|
|
Parts and accessories
|
42.1
|
|
|
41.5
|
|
Total inventories
|
$
|
1,167.8
|
|
|
$
|
1,067.6
|
|
The lower of cost and net realizable value reserves reduced total inventories by
$5.8 million
and
$6.1 million
as of
March 31, 2019
and
December 31, 2018
, respectively. In addition to the inventories shown above, we had
$14.5 million
of inventories classified as Assets Held for Sale on the accompanying Condensed Consolidated Balance Sheet as of
March 31, 2019
, associated with a pending dealership disposal. As of
March 31, 2019
and
December 31, 2018
, certain automobile manufacturer incentives reduced new vehicle inventory cost by
$11.9 million
and
$10.1 million
, respectively, and reduced new vehicle cost of sales for the
three
months ended
March 31, 2019
and
2018
by
$10.5 million
and
$9.4 million
, respectively.
6. ASSETS AND LIABILITIES HELD FOR SALE
Assets and liabilities classified as held for sale include (i) assets and liabilities associated with a pending dealership disposal, (ii) real estate not currently used in our operations that we are actively marketing to sell and (iii) the related mortgage notes payable, if applicable.
A summary of assets held for sale and liabilities associated with assets held for sale is as follows:
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As of
|
|
March 31, 2019
|
|
December 31, 2018
|
|
(In millions)
|
Assets:
|
|
|
|
Inventories
|
$
|
14.5
|
|
|
$
|
—
|
|
Property and equipment, net
|
40.7
|
|
|
26.3
|
|
Goodwill
|
0.1
|
|
|
—
|
|
Total Assets
|
55.3
|
|
|
26.3
|
|
Liabilities:
|
|
|
|
Floorplan notes payable—non trade
|
15.0
|
|
|
—
|
|
Current maturities of long-term debt
|
0.2
|
|
|
—
|
|
Long-term debt
|
2.5
|
|
|
—
|
|
Total liabilities
|
17.7
|
|
|
—
|
|
Net assets held for sale
|
$
|
37.6
|
|
|
$
|
26.3
|
|
As of
March 31, 2019
, there was
one
franchise (
one
dealership location) pending disposition, with assets and liabilities totaling
$29.0 million
and
$17.7 million
, respectively.
Assets held for sale, comprising real estate not currently used in our operations, totaled
$26.3 million
as of
March 31, 2019
and
December 31, 2018
, respectively. There were no liabilities associated with these real estate assets held for sale as of
March 31, 2019
or
December 31, 2018
.
During the
three
months ended March 31, 2018, we sold
one
vacant property with a net book value of
$2.0 million
.
7. FLOOR PLAN NOTES PAYABLE
Floor plan notes payable consisted of the following:
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|
|
|
|
|
As of
|
|
March 31, 2019
|
|
December 31, 2018
|
|
(In millions)
|
Floor plan notes payable—trade
|
$
|
146.4
|
|
|
$
|
125.3
|
|
Floor plan notes payable offset account
|
(14.1
|
)
|
|
(11.3
|
)
|
Floor plan notes payable—trade, net
|
$
|
132.3
|
|
|
$
|
114.0
|
|
|
|
|
|
Floor plan notes payable—new non-trade (a)
|
$
|
933.9
|
|
|
$
|
843.0
|
|
Floor plan notes payable—used non-trade
|
—
|
|
|
30.0
|
|
Floor plan notes payable offset account
|
(30.9
|
)
|
|
(20.9
|
)
|
Floor plan notes payable—non-trade, net
|
$
|
903.0
|
|
|
$
|
852.1
|
|
____________________________
|
|
(a)
|
Amounts reflected for floor plan notes payable—new non-trade as of
March 31, 2019
, excluded
$15.0 million
classified as Liabilities Associated with Assets Held for Sale.
|
We have established a floor plan notes payable offset account with Ford Motor Credit Company that allows us to transfer cash to the account as an offset of our outstanding Floor Plan Notes Payable—Trade. Additionally, we have a similar floor plan offset account with Bank of America that allows us to offset our outstanding Floor Plan Notes Payable—Non-Trade. These accounts allow us to transfer cash to reduce the amount of outstanding floor plan notes payable that would otherwise accrue
interest, while retaining the ability to transfer amounts from the floor plan offset accounts into our operating cash accounts within one to two days. As of
March 31, 2019
and December 31, 2018, we had
$45.0 million
and
$32.2 million
, respectively, in these floor plan offset accounts.
8. LONG-TERM DEBT
Long-term debt consisted of the following:
|
|
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|
|
|
|
|
|
|
As of
|
March 31, 2019
|
|
December 31, 2018
|
(In millions)
|
6.0% Senior Subordinated Notes due 2024
|
$
|
600.0
|
|
|
$
|
600.0
|
|
Mortgage notes payable bearing interest at fixed rates
|
130.6
|
|
|
132.2
|
|
2018 Bank of America Facility
|
25.4
|
|
|
25.7
|
|
2018 Wells Fargo Master Loan Facility
|
25.0
|
|
|
25.0
|
|
Prior real estate credit agreement (a)
|
37.4
|
|
|
40.8
|
|
Restated master loan agreement
|
82.0
|
|
|
83.3
|
|
Finance lease liability
|
17.6
|
|
|
3.1
|
|
Total debt outstanding
|
918.0
|
|
|
910.1
|
|
Add—unamortized premium on 6.0% Senior Subordinated Notes due 2024
|
5.8
|
|
|
6.0
|
|
Less—debt issuance costs
|
(10.4
|
)
|
|
(10.8
|
)
|
Long-term debt, including current portion
|
913.4
|
|
|
905.3
|
|
Less—current portion, net of current portion of debt issuance costs
|
(38.7
|
)
|
|
(38.8
|
)
|
Long-term debt
|
$
|
874.7
|
|
|
$
|
866.5
|
|
_____________________________
|
|
(a)
|
Amounts reflected for prior real estate credit agreement as of
March 31, 2019
, excluded a
$2.7 million
mortgage note payable classified as Liabilities Associated with Assets Held for Sale.
|
We are a holding company with no independent assets or operations. For all relevant periods presented, our
6.0%
Senior Subordinated Notes due 2024 (our "6.0% Notes") have been fully and unconditionally guaranteed, on a joint and several basis, by substantially all of our subsidiaries. Any subsidiaries that have not guaranteed such notes are "minor" (as defined in Rule 3-10(h) of Regulation S-X). As of
March 31, 2019
, there were no significant restrictions on the ability of our subsidiaries to distribute cash to us or our guarantor subsidiaries.
9. LEASES
Effective January 1, 2019, the Company adopted the new lease accounting guidance in Accounting Standards Update No. 2016-02,
Leases (Topic 842)
. The new standard establishes a right-of-use ("ROU") model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification impacting the pattern of expense recognition in the income statement.
The Company elected the package of practical expedients permitted in ASC 842. Accordingly, the Company accounted for its existing operating leases as an operating lease under the new guidance, without reassessing (a) whether the contract contains a lease under ASC 842, (b) whether classification of the operating lease would be different in accordance with ASC 842, or (c) whether the unamortized initial direct costs before transition adjustments (as of December 31, 2018) would have met the definition of initial direct costs in ASC 842 at lease commencement. In addition, the Company opted for the transition relief method specified in Accounting Standards Update No. 2018-11, which allowed for the effective date of the new leases standard as the date of initial application on transition. As a result of this election the Company (a) did not adjust comparative period financial information for the effects of ASC 842; (b) made the new required lease disclosures for periods after the effective date; and (c) carried forward our ASC 840 disclosures for comparative periods. As a result of the adoption of ASC 842, the Company recorded a right-of-use asset of
$86.9 million
, which represents the lease liability reduced for deferred rent amounts of
$4.4 million
and a lease liability of
$91.3 million
which represents the present value of remaining lease payments, discounted using the Company’s incremental borrowing rates based on the remaining lease terms.
We lease real estate and equipment primarily under operating lease agreements. For leases with terms in excess of 12 months, we record a right-of-use asset and lease liability based on the present value of lease payments over the lease term. Escalation clauses, lease payments dependent on existing rates/indexes, renewal options, and purchase options are included within the
determination of lease payments when appropriate. We have elected the practical expedient not to separate lease and non-lease components for all leases that qualify, except for information technology ("IT") assets that are embedded within service agreements (such as software license arrangements).
When available, the rate implicit is utilized to discount lease payments to present value; however, substantially all of our leases do not provide a readily determinable implicit rate. Therefore, we estimate our incremental borrowing rate to discount the lease payments based on information available at lease commencement.
Balance Sheet Presentation
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As of
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Leases
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Classification
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March 31, 2019
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(In millions)
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Assets:
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Operating
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Operating lease right-of-use assets
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$
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73.4
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Finance
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Property and equipment, net
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14.6
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Total right-of-use assets
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$
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88.0
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Liabilities:
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Current
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Operating
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Current maturities of operating leases
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$
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18.3
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Finance
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Current maturities of long-term debt
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0.6
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Non-Current
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Operating
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Operating lease liabilities
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59.4
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Finance
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Long-term debt
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17.0
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Total lease liabilities
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$
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95.3
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Lease Term and Discount Rate
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As of
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March 31, 2019
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Weighted Average Lease Term - Operating Leases
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6.1 years
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Weighted Average Lease Term - Finance Lease
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1.9 years
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Weighted Average Discount Rate - Operating Leases
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4.9
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%
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Weighted Average Discount Rate - Finance Lease
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4.1
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%
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Lease Costs
The following table provides certain information related to the lease costs for finance and operating leases during the three months ended March 31,
2019
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March 31, 2019
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(In millions)
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Finance lease cost
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Amortization of right-of-use assets
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$
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—
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Interest
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0.1
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Operating lease cost
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5.5
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Short-term lease cost
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1.0
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Variable lease cost
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0.2
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Total lease cost
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$
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6.8
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Supplemental Cash Flow Information
The following table presents supplemental cash flow information for leases during the three months ended March 31,
2019
. During the three months ended March 31,
2019
, we reassessed and remeasured an existing real estate lease, which was previously accounted for as an operating lease and finance lease for the land and building elements, respectively, due to the presence of a purchase price option which we concluded we are now reasonably certain to exercise. As reflected within the table below, we reduced a portion of the new finance lease right-of-use asset based on the existing finance lease liability at the time of remeasurement.
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March 31, 2019
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(In millions)
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Supplemental Cash Flow:
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Cash paid for amounts included in the measurements of lease liabilities
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Operating cash flows from finance lease
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$
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0.1
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Operating cash flows from operating leases
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5.6
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Financing cash flows from finance lease
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0.1
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Right-of-use assets obtained in exchange for new finance lease liabilities
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17.7
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Right-of-use assets obtained in exchange for new operating lease liabilities
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0.2
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Changes to finance lease right-of-use asset resulting from lease reassessment event
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(3.1
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)
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Undiscounted Cash Flow
The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the finance lease liabilities and operating lease liabilities as of March 31, 2019.
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Finance
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Operating
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(In millions)
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2019 (remaining nine months)
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$
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1.0
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$
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16.2
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2020
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1.3
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21.3
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2021
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16.7
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18.2
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2022
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—
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12.8
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2023
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—
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4.8
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Thereafter
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—
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19.2
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Total minimum lease payments
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19.0
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92.5
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Less: amount of lease payments representing interest
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(1.4
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)
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(14.8
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)
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Present value of future minimum lease payments
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17.6
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77.7
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Less: current obligations under leases
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(0.6
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(18.3
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)
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Long-term lease obligation
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$
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17.0
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$
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59.4
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Future minimum payments under non-cancelable leases with initial terms in excess of one year at December 31, 2018, are as follows:
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Capital
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Operating
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(In millions)
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2019
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$
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0.4
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$
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22.5
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2020
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0.4
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22.2
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2021
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0.4
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19.2
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2022
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0.4
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14.0
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2023
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0.4
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6.0
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Thereafter
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2.8
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25.5
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Total minimum lease payments
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4.8
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109.4
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Less: Amounts representing interest
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(1.7
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)
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N/A
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$
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3.1
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$
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109.4
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Certain of our lease agreements include financial covenants and incorporate by reference the financial covenants set forth in the 2016 Senior Credit Facility. A breach of any of these covenants could immediately give rise to certain landlord remedies under our various lease agreements, the most severe of which include the following: (i) termination of the applicable lease and/or other leases with the same or an affiliated landlord under a cross-default provision, (ii) eviction from the premises; and (iii) the landlord having a claim for various damages.
10. FINANCIAL INSTRUMENTS AND FAIR VALUE
In determining fair value, we use various valuation approaches, including market and income approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the assumptions market participants would use in pricing the asset or liability, developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1-Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2-Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Assets and liabilities utilizing Level 2 inputs include interest rate swap instruments, exchange-traded debt securities that are not actively traded or do not have a high trading volume, mortgage notes payable, and certain real estate properties on a non-recurring basis.
Level 3-Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Asset and liability measurements utilizing Level 3 inputs include those used in estimating the fair value of certain non-financial assets and non-financial liabilities in purchase acquisitions and those used in the assessment of impairment for goodwill and manufacturer franchise rights.
The availability of observable inputs can vary and is affected by a wide variety of factors. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment required to determine fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input that is significant to the fair value measurement.
Fair value is a market-based exit price measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, our assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use inputs that are current as of the measurement date, including during periods of significant market fluctuations.
Financial instruments consist primarily of cash and cash equivalents, contracts-in-transit, accounts receivable, cash surrender value of corporate-owned life insurance policies, accounts payable, floor plan notes payable, subordinated long-term debt, mortgage notes payable, and interest rate swap instruments. The carrying values of our financial instruments, with the exception of subordinated long-term debt and mortgage notes payable, approximate fair value due to (i) their short-term nature,
(ii) recently completed market transactions, or (iii) existence of variable interest rates, which approximate market rates. The fair value of our subordinated long-term debt is based on reported market prices in an inactive market that reflects Level 2 inputs. We estimate the fair value of our mortgage notes payable using a present value technique based on current market interest rates for similar types of financial instruments that reflect Level 2 inputs.
A summary of the carrying values and fair values of our
6.0%
Notes and our mortgage notes payable is as follows:
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As of
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March 31, 2019
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December 31, 2018
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(In millions)
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Carrying Value:
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6.0% Senior Subordinated Notes due 2024
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$
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605.8
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$
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606.0
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Mortgage notes payable (a)
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300.4
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307.0
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Total carrying value
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$
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906.2
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$
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913.0
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Fair Value:
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6.0% Senior Subordinated Notes due 2024
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$
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617.3
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$
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570.0
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Mortgage notes payable (a)
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305.1
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306.7
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Total fair value
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$
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922.4
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$
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876.7
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_____________________________
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(a)
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Amounts reflected for mortgage notes payable as of
March 31, 2019
excluded a mortgage with an aggregate carrying value of
$2.7 million
classified as Liabilities Associated with Assets Held for Sale.
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Interest Rate Swap Agreements
In June 2015, we entered into an interest rate swap agreement with a notional principal amount of
$100.0 million
. This swap was designed to provide a hedge against changes in variable rate cash flows regarding fluctuations in the one month London Interbank Offered Rate ("LIBOR"), through maturity in February 2025. The notional value of this swap was
$83.8 million
as of
March 31, 2019
and is reducing over its remaining term to
$53.1 million
at maturity.
In November 2013, we entered into an interest rate swap agreement with a notional principal amount of
$75.0 million
. This swap was designed to provide a hedge against changes in variable rate cash flows regarding fluctuations in the one month LIBOR rate, through maturity in September 2023. The notional value of this swap was
$55.5 million
as of
March 31, 2019
and is reducing over its remaining term to
$38.7 million
at maturity.
The fair value of cash flow swaps is calculated as the present value of expected future cash flows, determined on the basis of forward interest rates and present value factors. Fair value estimates reflect a credit adjustment to the discount rate applied to all expected cash flows under the swaps. Other than this input, all other inputs used in the valuation of these swaps are designated to be Level 2 fair values. The fair value of our swaps was a
$1.2 million
liability as of
March 31, 2019
and a
$0.6 million
asset as of
December 31, 2018
.
The following table provides information regarding the fair value of our interest rate swap agreements and the impact on the Condensed Consolidated Balance Sheets:
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As of
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March 31, 2019
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December 31, 2018
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(In millions)
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Other current assets
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$
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—
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$
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(0.2
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)
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Other long-term liabilities/(assets)
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1.2
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(0.4
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)
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Total fair value
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$
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1.2
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$
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(0.6
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)
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Both of our interest rate swaps qualify for cash flow hedge accounting treatment. These interest rate swaps are marked to market at each reporting date and
any unrealized gains or losses are included in AOCI and reclassified to interest expense in the same period or periods during which the hedged transactions affect earnings. Information about the effect of our interest rate swap agreements on the accompanying Condensed Consolidated Statements of Income and Condensed Consolidated Statements of Comprehensive Income, is as follows (in millions):
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For the Three Months Ended March 31,
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Results Recognized in Accumulated Other Comprehensive Income/(Loss)
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Location of Results Reclassified from Accumulated Other Comprehensive Income/(Loss)
to Earnings
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Amount Reclassified from Accumulated Other Comprehensive Income/(Loss)
to Earnings
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2019
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$
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(1.8
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)
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Floor plan interest expense and Other interest expense, net
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$
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—
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2018
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$
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2.6
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Swap interest expense
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$
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(0.2
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)
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On the basis of yield curve conditions as of
March 31, 2019
and including assumptions about future changes in fair value, we expect the amount to be reclassified out of Accumulated Other Comprehensive Income/(Loss) into earnings within the next 12 months will be income of less than
$0.1 million
.
11. SUPPLEMENTAL CASH FLOW INFORMATION
During the
three
months ended
March 31, 2019
and
2018
, we made interest payments, including amounts capitalized, totaling
$14.1 million
and
$10.1 million
, respectively. Included in these interest payments are
$9.8 million
and
$6.3 million
, of floor plan interest payments during the
three
months ended
March 31, 2019
and
2018
, respectively.
During the
three
months ended
March 31, 2019
,
no
income tax payments were made. During the three months ended March 31,
2018
, we made income tax payments, net of refunds received, totaling
$0.2 million
.
During the
three
months ended
March 31, 2019
and
2018
, we transferred
$37.0 million
and
$44.7 million
, respectively, of loaner vehicles from Other Current Assets to Inventories on our Condensed Consolidated Balance Sheets.
12. COMMITMENTS AND CONTINGENCIES
Our dealerships are party to dealer and framework agreements with applicable vehicle manufacturers. In accordance with these agreements, each dealership has certain rights and is subject to restrictions typical in the industry. The ability of these manufacturers to influence the operations of the dealerships or the loss of any of these agreements could have a materially negative impact on our operating results.
In some instances, manufacturers may have the right, and may direct us, to implement costly capital improvements to dealerships as a condition to entering into, renewing, or extending franchise agreements with them. Manufacturers also typically require that their franchises meet specific standards of appearance. These factors, either alone or in combination, could cause us to use our financial resources on capital projects that we might not have planned for or otherwise determined to undertake.
From time to time, we and our dealerships are or may become involved in various claims relating to, and arising out of, our business and our operations. These claims may involve, but not be limited to, financial and other audits by vehicle manufacturers or lenders and certain federal, state, and local government authorities, which have historically related primarily to (i) incentive and warranty payments received from vehicle manufacturers, or allegations of violations of manufacturer agreements or policies, (ii) compliance with lender rules and covenants, and (iii) payments made to government authorities relating to federal, state, and local taxes, as well as compliance with other government regulations. Claims may also arise through litigation, government proceedings, and other dispute resolution processes. Such claims, including class actions, could relate to, but may not be limited to, the practice of charging administrative fees and other fees and commissions, employment-related matters, truth-in-lending and other dealer assisted financing obligations, contractual disputes, actions brought by governmental authorities, and other matters. We evaluate pending and threatened claims and establish loss contingency reserves based upon outcomes we currently believe to be probable and reasonably estimable.
We believe we have adequately accrued for the potential impact of loss contingencies that are probable and reasonably estimable. Based on our review of the various types of claims currently known to us, there is no indication of material reasonably possible losses in excess of amounts accrued in the aggregate. We currently do not anticipate that any known claim will materially adversely affect our financial condition, liquidity, or results of operations. However, the outcome of any matter cannot be predicted with certainty, and an unfavorable resolution of one or more matters presently known or arising in the future could have a material adverse effect on our financial condition, liquidity, or results of operations.
A significant portion of our business involves the sale of vehicles, parts, or vehicles composed of parts that are manufactured outside the United States. As a result, our operations are subject to customary risks of importing merchandise, including fluctuations in the relative values of currencies, import duties, exchange controls, trade restrictions, work stoppages, and general political and socio-economic conditions in foreign countries. The United States or the countries from
which our products are imported may, from time to time, impose new quotas, duties, tariffs, or other restrictions, or adjust presently prevailing quotas, duties, or tariffs, which may affect our operations, and our ability to purchase imported vehicles and/or parts at reasonable prices.
Substantially all of our facilities are subject to federal, state and local provisions regarding the discharge of materials into the environment. Compliance with these provisions has not had, nor do we expect such compliance to have, any material effect upon our capital expenditures, net earnings, financial condition, liquidity or competitive position. We believe that our current practices and procedures for the control and disposition of such materials comply with applicable federal, state, and local requirements. No assurances can be provided, however, that future laws or regulations, or changes in existing laws or regulations, would not require us to expend significant resources in order to comply therewith.
We had
$13.0 million
of letters of credit outstanding as of
March 31, 2019
, which are required by certain of our insurance providers. In addition, as of
March 31, 2019
, we maintained a
$5.0 million
surety bond line in the ordinary course of our business. Our letters of credit and surety bond line are considered to be off balance sheet arrangements.
Our other material commitments include (i) floor plan notes payable, (ii) operating leases, (iii) long-term debt and (iv) interest on long-term debt, as described elsewhere herein.
13. SUBSEQUENT EVENTS
On April 29, 2019, the Company closed on the sale of the dealership referred to in Note 6.