About EDGAR Online | Login
 
Enter your Email for a Free Trial:
The following is an excerpt from a 10-Q SEC Filing, filed by GROUP 1 AUTOMOTIVE INC on 5/8/2006.
Next Section Next Section Previous Section Previous Section
GROUP 1 AUTOMOTIVE INC - 10-Q - 20060508 - NOTES_TO_FINANCIAL_STATEMENT
GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION:
     Group 1 Automotive, Inc., a Delaware corporation, through its subsidiaries, is a leading operator in the automotive retailing industry with operations in California, Colorado, Florida, Georgia, Louisiana, Massachusetts, New Hampshire, New Jersey, New Mexico, New York, Oklahoma and Texas. Through their dealerships, these subsidiaries 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. Group 1 Automotive, Inc. and its subsidiaries are herein collectively referred to as the “Company” or “Group 1.”
     Prior to January 1, 2006, our retail network was organized into 13 regional dealership groups, or “platforms”. Effective January 1, 2006, we reorganized our platforms into five regions: (i) the Northeast (comprising 21 dealerships in Massachusetts, New Hampshire, New Jersey and New York), (ii) the Southeast (comprising 16 dealerships in Florida, Georgia and Louisiana), (iii) the South Central (comprising 36 dealerships in Oklahoma and Central and Southeast Texas), (iv) the West Central (comprising 12 dealerships in Colorado, New Mexico and West Texas) and (v) the California (comprising 10 dealerships in California). Each region is managed by a regional vice president reporting directly to the Company’s chief executive officer.
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 assigned and recorded based on estimates of fair value. All 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 of a normal and recurring nature considered necessary for a fair presentation have been included. Due to seasonality and other factors, the results of operations for the interim period 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, 2005.
      Intangible Franchise Rights
     The Company’s only significant identifiable intangible assets, other than goodwill, are rights under franchise agreements with manufacturers, which are recorded at an individual dealership level. The Company expects these franchise agreements to continue for an indefinite period and, when these agreements do not have indefinite terms, the Company believes that renewal of these agreements can be obtained without substantial cost. As such, the Company believes that its franchise agreements will contribute to cash flows for an indefinite period and, therefore, the carrying amount of franchise rights are not amortized. Franchise rights acquired in acquisitions prior to July 1, 2001, were recorded and amortized as part of goodwill and remain as part of goodwill in the accompanying consolidated balance sheets at March 31, 2006 and December 31, 2005. Since July 1, 2001, intangible franchise rights acquired in business combinations have been recorded as distinctly separate intangible assets and, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company evaluates these franchise rights for impairment annually, or more frequently if events or circumstances indicate possible impairment has occurred.
     At the September 2004 meeting of the Emerging Issues Task Force (“EITF”), the SEC staff issued Staff Announcement No. D-108, “Use of the Residual Method to Value Acquired Assets Other Than Goodwill,” which states that for business combinations after September 29, 2004, the residual method should no longer be used to value intangible assets other than goodwill. Rather, a direct value method should be used to determine the fair value of all intangible assets other than goodwill required to be recognized under SFAS No. 141, “Business Combinations.” Additionally, registrants who applied a residual method to the valuation of intangible assets for purposes of impairment testing under SFAS No. 142, were required to perform an impairment test using a direct value method by no later than the beginning of their first fiscal year beginning after December 15, 2004.
     In performing this transitional impairment test as of January 1, 2005, the Company tested the carrying value of each individual franchise right that had been recorded for impairment by using a discounted cash flow model. Included in this “direct” analysis were assumptions, at a dealership level, regarding which cash flow streams were directly attributable to each dealership’s 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 future capital expenditure requirements, the Company calculated the fair value of each dealership’s franchise rights after considering estimated

7


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
values for tangible assets, working capital and workforce. For some of the Company’s dealerships, this transitional impairment test resulted in an estimated fair value that was less than the carrying value of their intangible franchise rights. As a result, a non-cash charge of $16.0 million, net of deferred taxes of $10.2 million, was recorded in the first quarter of 2005 as a cumulative effect of a change in accounting principle in accordance with the transitional rules of EITF D-108.
      Stock Based Compensation
     Prior to January 1, 2006, we accounted for our stock option plans and our employee stock purchase plan using the intrinsic value method of accounting provided under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. This was permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” under which no compensation expense was recognized for stock option grants and issuances of stock pursuant to the employee stock purchase plan. However, stock-based compensation expense was recognized in periods prior to January 1, 2006, (and continues to be recognized) for restricted stock award issuances. Stock-based compensation expense using the fair value method under SFAS No. 123 was included as a pro forma disclosure in the financial statement footnotes and such disclosure continues to be provided for periods prior to 2006.
     Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment,” using the modified-prospective transition method. Under this transition method, compensation cost recognized in the first quarter of 2006 includes: a) compensation cost for all stock-based payments granted through December 31, 2005, for which the requisite service period had not been completed as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, b) compensation cost for all stock-based payments granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R), and c) the fair value of the shares sold to employees subsequent to December 31, 2005, pursuant to the employee stock purchase plan. As permitted under the transition rules for SFAS 123(R), results for prior periods have not been restated. See Note 3.
      Statements of Cash Flows
      Floorplan borrowings
     With respect to all new vehicle floorplan borrowings, the manufacturers of the vehicles draft the Company’s credit facilities directly with no cash flow to or from the Company. With respect to borrowings for used vehicle financing, the Company chooses which vehicles to finance and the funds flow directly to the Company from the lender. All borrowings from, and repayments to, lenders affiliated with the vehicle manufacturers (excluding the cash flows from or to affiliated lenders participating in our syndicated lending group) are presented within cash flows from operating activities on the Consolidated Statements of Cash Flows and all borrowings from, and repayments to, the syndicated lending group under the revolving credit facility (including the cash flows from or to affiliated lenders participating in the facility) are presented within cash flows from financing activities.
      Restatement for prior period classification errors
     Subsequent to the issuance of the Company’s March 31, 2005, consolidated financial statements, the Company’s management determined that certain information in the Consolidated Statements of Cash Flows for the three months ended March 31, 2005, should be restated to comply with the guidance set forth in the rules and regulations of the Securities and Exchange Commission and SFAS No. 95, “Statement of Cash Flows,” and as set forth above under Floorplan Borrowings . A summary of the restatement is as follows:
    Cash flows relating to floorplan notes payable — Cash flows relating to floorplan notes payable to a party other than the manufacturer of a particular new vehicle, including the cash flows from or to manufacturer affiliated lenders participating in our syndicated credit facility, and all floorplan notes payable relating to used vehicles, have been reclassified from operating activities to financing activities.
 
    Cash flows relating to acquisitions and dispositions — Upon acquiring dealership operations, cash flows related to the payment of the seller’s floorplan payable obligations have been revised to be reflected as cash paid in acquisitions, net of cash received within cash flows from investing activities with a corresponding borrowing under either the Company’s revolving credit facility or other facilities within cash flows from financing activities.
 
      Likewise, when disposing of dealership operations, the Company will reflect the purchaser’s payment of the Company’s floorplan payable obligation as additional proceeds from sales of dealership franchises within cash flows from investing activities with a corresponding repayment under either its revolving credit facility or other facilities within cash flows from financing activities.
 
      Previously, the Company treated all such activity as either a non-cash acquisition or disposition of inventory and related floorplan payable.

8


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
     A summary of the effects of the restatement is as follows:
Consolidated Statements of Cash Flows
                 
    Three Months Ended
    March 31, 2005
    Reported   Restated
    (in thousands)
Cash Flows From Operating Activities
               
Floorplan notes payable
  $ 7,748     $  
Floorplan notes payable — manufacturer affiliates
          15,147  
Net cash provided by operating activities
    19,265       26,664  
 
               
Cash Flows From Investing Activities:
               
Cash paid in acquisitions, net of cash received
    (7,476 )     (17,088 )
Net cash used in investing activities
    (13,271 )     (22,883 )
 
               
Cash Flows From Financing Activities:
               
Net borrowings (payments) on revolving credit facility
    (20,292 )      
Borrowings on credit facility — Floorplan Line
          863,808  
Repayments on credit facility — Floorplan Line
          (873,887 )
Borrowings on credit facility — Acquisition Line
          20,000  
Repayments on credit facility — Acquisition Line
          (28,000 )
Net cash provided by (used in) financing activities
    (16,301 )     (14,088 )
      Effect of SFAS No. 123(R) Adoption
     Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits for deductions resulting from the exercise of options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS No. 123(R) requires the cash flows resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The $2.6 million excess tax benefit classified as a financing cash inflow for the period ended March 31, 2006, would have been classified as an operating cash inflow if the Company had not adopted SFAS No. 123(R).
      Income Taxes
     The Company operates in 12 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 estimated effective tax rate can vary based on the proportion of taxable income generated in each state.
     The effective income tax rate of 38.0% and 36.8% of pretax income for the three months ended March 31, 2006 and 2005, respectively, differed from the federal statutory rate of 35% due primarily to the adoption of SFAS No. 123(R) and the impact of a change in mix of the Company’s pre-tax income from taxable state jurisdictions.
     The Company’s option grants include options that qualify as incentive stock options for income tax purposes. The treatment of the potential tax deduction, if any, related to incentive stock options may cause variability in the Company’s effective tax rate in future periods. In the period the compensation cost related to incentive stock options is recorded in accordance with SFAS No. 123(R), a corresponding tax benefit is not recorded, as based on the design of these incentive stock options, the Company is not expected to receive a tax deduction related to such incentive stock options when exercised. However, if upon exercise such incentive stock options fail to continue to meet the qualifications for treatment as incentive stock options, the Company may be eligible for certain tax deductions in subsequent periods. In such cases, the Company would record a tax benefit for the lower of the actual income tax deduction or the amount of the corresponding cumulative stock compensation cost recorded in the financial statements for the particular options multiplied by the statutory tax rate.
      Recent Accounting Pronouncements
     In October 2005, the FASB staff issued FASB Staff Position No. FAS 13-1, “Accounting for Rental Costs Incurred During a Construction Period,” which, starting prospectively in the first reporting period beginning after December 15, 2005, requires companies to expense, versus capitalizing into the carrying costs, rental costs associated with ground or building operating leases that are incurred during a construction period. The Company adopted the provisions of FAS 13-1 effective January 1, 2006. During the three months ended March 31, 2006, the Company expensed rental cost incurred during construction of approximately $0.4 million, versus approximately $0.4 million in rental costs capitalized during the three months ended March 31, 2005. The

9


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Company is not required to restate prior year’s financial statements as a result of adopting this provision.
     In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” a replacement of APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle. The Statement eliminates the requirement in APB No. 20 to include the cumulative effect of changes in accounting principle in the income statement in the period of change, and instead requires that changes in accounting principle be retrospectively applied unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Statement applies to all voluntary changes in accounting principle, and therefore does not apply to the Company’s adoption of SFAS No. 123(R) or FAS 13-1. SFAS No. 154 is effective for changes made in fiscal years beginning after December 15, 2005. The Company did not implement any voluntary changes in its accounting principles during the three months ended March 31, 2006. The Company does not expect the adoption of SFAS No. 154 to have a material effect on its future results of operations or financial position.
      Reclassifications
     Certain reclassifications have been made to the prior period to conform to the current period presentation.
3. STOCK BASED COMPENSATION
     The Company provides compensation benefits to employees and non-employee directors pursuant to its 1996 Stock Option Plan, as amended, and 1998 Employee Stock Purchase Plan, as amended.
      1996 Stock Option Plan
     The Company’s 1996 Stock Option Plan, as amended, reserved 5.5 million shares of common stock for grants of options (including options qualified as incentive stock options under the Internal Revenue Code of 1986 and options which are non-qualified), stock appreciation rights and restricted stock awards to directors, officers and other employees of the Company and its subsidiaries at the market price at the date of grant. The terms of the awards (including vesting schedules) are established by the Compensation Committee of the Company’s Board of Directors. All outstanding awards are exercisable over a period not to exceed ten years and vest over periods ranging from three to eight years. Certain of the Company’s option awards are subject to graded vesting over a service period. In those cases, the Company recognizes compensation cost on a straight-line basis over the requisite service period for the entire award. Under SFAS 123(R), forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. Under APB 25 and SFAS 123, the Company elected to account for forfeitures when awards were actually forfeited, at which time all previous pro forma expense was reversed to reduce pro forma expense for that period. As of March 31, 2006, there were 1,230,295 shares available under the 1996 Stock Option Plan for future grants of options, stock appreciation rights and restricted stock awards.
      Stock Option Awards
     The fair value of each stock option award is estimated as of the date of grant using the Black-Scholes option-pricing model. The application of this valuation model involves assumptions that are highly sensitive in the determination of stock-based compensation expense. The weighted average assumptions for the periods indicated are noted in the following table. Expected volatility is based on historical volatility of the Company’s common stock. The Company utilizes historical data to estimate option exercise and employee termination behavior within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. No stock option awards were granted during the three-month period ended March 31, 2006.
         
    Three Months
    Ended
    March 31, 2005
Risk-free interest rate
    5.9 %
Expected life of options
  6.0 yrs  
Expected volatility
    42.0 %
Expected dividend yield
     
Fair Value
  $ 13.84  

10


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
     The following summary presents information regarding outstanding options as of March 31, 2006, and the changes during the three months then ended:
                                 
                    Weighted Average        
            Weighted Average     Remaining     Aggregate  
    Shares Under     Exercise Price     Contractual     Intrinsic  
    Option     Per Share     Term     Value  
                          (in thousands)  
Outstanding December 31, 2005
    1,314,560     $ 23.43                  
Granted
                           
Exercised
    (700,322 )     18.92                  
Canceled
    (15,144 )     27.60                  
 
                           
Outstanding March 31, 2006
    599,094     $ 28.60     6.4 years   $ 11,356  
 
                       
Vested or expected to vest at March 31, 2006
    535,438     $ 28.44             $ 10,232  
 
                         
Exercisable at March 31, 2006
    244,523     $ 25.93     5.1 years   $ 5,287  
 
                       
     The total intrinsic value of options exercised during the three months ended March 31, 2006 and 2005 was $15.4 million and $3.2 million, respectively.
      Restricted Stock Awards
     Beginning in March 2005, the Company began granting directors and certain employees, at no cost to the recipient, restricted stock awards or, at their election, phantom stock awards, pursuant to the Company’s 1996 Stock Incentive Plan, as amended. Restricted stock awards are considered outstanding at the date of grant, but are restricted from disposition for periods ranging from six months to five years. The phantom stock awards will settle in shares of common stock upon the termination of the grantees’ employment or directorship and have vesting periods also ranging from six months to five years. In the event the employee or director terminates his or her employment or directorship with the Company prior to the lapse of the restrictions, the shares, in most cases, will be forfeited to the Company.
     A summary of these awards as of March 31, 2006, is as follows:
                 
            Weighted Average  
            Grant Date  
    Awards     Fair Value  
Nonvested at December 31, 2005
    234,900     $ 27.83  
Granted
    49,270       36.98  
Vested
    (29,000 )     27.83  
Forfeited
    (17,600 )     28.41  
 
           
Nonvested at March 31, 2006
    237,570       29.69  
 
           
     The total fair value of shares vested during the three months ended March 31, 2006, was $1.2 million. No shares vested during the three months ended March 31, 2005.
      Employee Stock Purchase Plan
     In September 1997, the Company adopted the Group 1 Automotive, Inc. 1998 Employee Stock Purchase Plan, as amended (the “Purchase Plan”). The Purchase Plan authorizes the issuance of up to 2.0 million shares of common stock and provides that no options to purchase shares may be granted under the Purchase Plan after June 30, 2007. As of March 31, 2006, there were 215,410 shares remaining in reserve for future issuance under the Purchase Plan. The Purchase Plan is available to all employees of the Company and its participating subsidiaries and is a qualified plan as defined by Section 423 of the Internal Revenue Code. At the end of each fiscal quarter (the “Option Period”) during the term of the Purchase Plan, the employee contributions are used by the employee to acquire shares of common stock from the Company at 85% of the fair market value of the common stock on the first or the last day of the Option Period, whichever is lower. During the three months ended March 31, 2006 and 2005, the Company issued 42,557 and 46,995 shares, respectively, of common stock to employees participating in the Purchase Plan.
     The weighted average fair value of employee stock purchase rights issued pursuant to the Purchase Plan was $6.45 and $7.73 during the three months ended March 31, 2006 and 2005, respectively. The fair value of the stock purchase rights was calculated as the sum of (a) the difference between the stock price and the employee purchase price, (b) the value of the embedded call

11


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
     option and (c) the value of the embedded put option.
      All Stock-Based Payment Arrangements
     Total stock-based compensation cost was $1.3 million and $0.2 million for the three months ended March 31, 2006 and 2005, respectively. Total income tax benefit recognized for stock-based compensation arrangements was $0.2 million and $60.0 thousand for the three months ended March 31, 2006 and 2005, respectively.
     As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company recognized $0.6 million of additional stock-based compensation expense related to stock options and $0.3 million related to the employee stock purchase plan. The Company’s income before income taxes and net income for the period ended March 31, 2006, were therefore $0.9 million and $0.8 million lower, respectively, than if the Company had continued to account for stock-based compensation under APB No. 25. Basic and diluted earnings per share for the period ended March 31, 2006, would have been $0.96 and $0.95, respectively, if the Company had not adopted SFAS No. 123(R), compared to reported basic and diluted earnings per share of $0.93 and $0.91, respectively.
     As of March 31, 2006, there was $9.0 million of total unrecognized compensation cost related to stock-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.7 years.
     Cash received from option exercises and Purchase Plan purchases was $14.4 million and $4.3 million for the three months ended March 31, 2006 and 2005, respectively. The actual tax benefit realized for the tax deductions from option exercises and Purchase Plan purchases totaled $5.4 million and $1.1 million for the three months ended March 31, 2006 and 2005, respectively.
     The Company generally issues new shares when options are exercised, restricted stock vests or ESPP shares are issued or, at times, will use treasury shares if available. There were no modifications to the Company’s stock-based compensation plans during the three-month period ended March 31, 2006.
      Pro Forma Net Loss
     The following table provides pro forma net loss and net loss per share had the Company applied the fair value method of SFAS No. 123 for the three month period ended March 31, 2005. The pro forma effects for the period presented are not necessarily indicative of the pro forma effects in future years (amounts in thousands except per share amounts):
         
Net loss, as reported
  $ (1,638 )
Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects
    95  
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
    (643 )
 
     
Pro forma net loss
  $ (2,186 )
 
     
 
       
Loss per share:
       
Basic — as reported
  $ (0.07 )
Basic — pro forma
  $ (0.09 )
 
       
Diluted — as reported
  $ (0.07 )
Diluted — pro forma
  $ (0.09 )

12


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
4. EARNINGS (LOSS) PER SHARE:
     Basic earnings per share is computed based on weighted average shares outstanding and excludes dilutive securities. Diluted earnings per share is computed including the impact of all potentially dilutive securities. The following table sets forth the calculation of earnings per share:
                 
    Three Months Ended March 31,  
    2006     2005  
    (in thousands, except per share amounts)  
Income before cumulative effect of a change in accounting principle
  $ 22,311     $ 14,400  
Cumulative effect of a change in accounting principle, net of tax benefit
          (16,038 )
 
           
Net income (loss)
  $ 22,311     $ (1,638 )
 
           
 
               
Weighted average basic shares outstanding
    24,040       23,453  
Dilutive effect of stock-based awards, net of assumed repurchase of treasury stock
    413       433  
 
           
Weighted average diluted shares outstanding
    24,453       23,886  
 
           
 
               
Earnings (loss) per share:
               
Basic:
               
Income before cumulative effect of a change in accounting principle
  $ 0.93     $ 0.61  
Cumulative effect of a change in accounting principle
          (0.68 )
 
           
Net income (loss)
  $ 0.93     $ (0.07 )
 
           
 
               
Diluted:
               
Income before cumulative effect of a change in accounting principle
  $ 0.91     $ 0.60  
Cumulative effect of a change in accounting principle
          (0.67 )
Net income (loss)
  $ 0.91     $ (0.07 )
 
           
     The adoption of SFAS 123(R) results in lower diluted shares outstanding than would have been calculated had compensation cost not been recorded for stock options and stock issuances under the employee stock purchase plan. This is due to a modification required by SFAS 123(R) of the treasury stock method calculation utilized to compute the dilutive effect of stock options. The weighted average number of stock-based awards not included in the calculation of the dilutive effect of stock based awards was 0.3 million for 2006 and 0.1 million for 2005.
5. COMMITMENTS AND CONTINGENCIES:
      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 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. In October 2002, the Texas Court of Appeals affirmed the trial court’s order of class certification in the state court actions. The defendants requested that the Texas Supreme Court review that decision, and the Court declined that request on March 26, 2004. The defendants petitioned the Texas Supreme Court to reconsider its denial, and that petition was denied on September 10, 2004. In the federal antitrust action, in March 2003, the federal district court also certified a class of consumers. Defendants appealed the district court’s certification to the Fifth Circuit Court of Appeals, which on October 5, 2004, reversed the class certification order and remanded the case back to the federal district court for further proceedings. In February 2005, the plaintiffs in the federal action sought a writ of certiorari to the United States Supreme Court in order to obtain review of the Fifth Circuit’s order, which request the Court denied. In June 2005, the Company’s Texas dealerships and certain other defendants in the lawsuits entered settlements with the plaintiffs in each of the cases. The settlements are contingent upon and subject to court approval. The settlement of the state court actions was preliminarily approved by the state court in December 2005. As a result of that settlement, the state court certified a settlement class of certain Texas automobile purchasers. Dealers participating in the

13


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
settlement, including a number of the Company’s Texas dealership subsidiaries, are expected to issue certificates for discounts off future vehicle purchases, refund cash in some circumstances, pay attorneys’ fees, and make certain disclosures regarding inventory tax charges when itemizing such charges on customer invoices. In addition, participating dealers have funded and will fund certain costs of the settlement, including costs associated with notice of the settlement to the class members. The federal action settlement does not involve the certification of any additional classes. The estimated expense of the proposed settlements of $1.3 million has been included in accrued expenses in the accompanying consolidated financial statements. If the settlements are not approved, the Company will continue to vigorously assert available defenses in connection with these lawsuits. While the Company does not believe this litigation will have a material adverse effect on its financial position, results of operations or cash flows, no assurance can be given as to its ultimate outcome. A settlement on different terms or an adverse resolution of this matter in litigation could result in the payment of significant costs and damages.
     On August 29, 2005, the Company’s Dodge dealership in Metairie, Louisiana, suffered severe damage due to Hurricane Katrina and subsequent flooding. The dealership facility was leased. Pursuant to its terms, the Company terminated the lease based on damages suffered at the facility. The lessor has disputed the termination as wrongful and has instituted arbitration proceedings against the Company. The lessor has demanded damages for alleged wrongful termination and other items related to alleged breaches of the lease agreement. The Company has answered the arbitration demand and has denied liability. The Company intends to vigorously assert available defenses in connection with the arbitration. The Company is unable to estimate the total potential exposure at this time; however, an adverse resolution of this matter in arbitration, or any potential settlement of this matter, could result in the payment of significant costs and/or damages.
     Other than the foregoing cases, 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 or results of operations.
      Vehicle Service Contract Obligations
     While the Company is not an obligor under the vehicle service contracts it currently sells, it is an obligor under vehicle service contracts previously sold in two states. The contracts were sold to 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 received, was remitted to an administrator. The administrator set the pricing at a level adequate to fund expected future claims and their profit. Additionally, the administrator purchased 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 are being recognized over the life of the contracts. The amounts deferred are presented on the face of the balance sheets as deferred revenues.
      Other Matters
     The Company, acting through its subsidiaries, is the lessee under many real estate leases that provide for the use by the Company’s subsidiaries of their respective dealership premises. Pursuant to these leases, the Company’s subsidiaries generally agree to indemnify the lessor and other parties from certain liabilities arising as a result of the use of the leased premises, including environmental liabilities, or a breach of the lease by the lessee. Additionally, from time to time, the Company enters into agreements in connection with the sale of assets or businesses in which it agrees to indemnify the purchaser, or other parties, from certain liabilities or costs arising in connection with the assets or business. Also, in the ordinary course of business in connection with purchases or sales of goods and services, the Company enters into agreements that may contain indemnification provisions. In the event that an indemnification claim is asserted, liability would be limited by the terms of the applicable agreement.
     From time to time, primarily in connection with dealership dispositions, the Company’s subsidiaries assign or sublet to the dealership purchaser the subsidiaries’ interests in any real property leases associated with such stores. In general, the Company’s subsidiaries retain responsibility for the performance of certain obligations under such leases to the extent that the assignee or sublessee does not perform, whether such performance is required prior to or following the assignment or subletting of the lease. Additionally, the Company and its subsidiaries generally remain subject to the terms of any guarantees made by the Company and its subsidiaries in connection with such leases. Although the Company generally has indemnification rights against the assignee or sublessee in the event of non-performance under these leases, as well as certain defenses, and the Company presently has no reason to believe that it or its subsidiaries will be called on to perform under any such assigned leases or subleases, the Company estimates that lessee rental payment obligations during the remaining terms of these leases are approximately $26.8 million at March 31, 2006. The Company and its subsidiaries also may be called on to perform other obligations under these leases, such as

14


 

GROUP 1 AUTOMOTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
environmental remediation of the leased premises or repair of the leased premises upon termination of the lease, although the Company presently has no reason to believe that it or its subsidiaries will be called on to so perform and such obligations cannot be quantified at this time. The Company’s exposure under these leases is difficult to estimate and there can be no assurance that any performance of the Company or its subsidiaries required under these leases would not have a material adverse effect on the Company’s business, financial condition and cash flows.

15


BROKERAGE PARTNERS