Interim Financial Statements (Policies)

9 Months Ended

Sep. 30, 2020

Interim Financial Statements.

Business Overview

Business Overview

Unless the context otherwise requires, the use of the terms “PAG,” “we,” “us,” and “our” in these Notes to the Consolidated Condensed Financial Statements refers to Penske Automotive Group, Inc. and its consolidated subsidiaries.

We are a diversified international transportation services company that operates automotive and commercial truck dealerships principally in the United States, Canada, and Western Europe and distributes commercial vehicles, diesel engines, gas engines, power systems, and related parts and services principally in Australia and New Zealand.

COVID-19 Disclosure

Overview - The outbreak of COVID-19 across the globe adversely impacted each of our markets and the global economy beginning in the first quarter of 2020, leading to disruptions to our business. Governmental authorities have taken countermeasures to slow the outbreak including shelter-in-place orders, restrictions on travel, and government-funded assistance programs to individuals and businesses. The shelter-in-place orders and resulting business closures severely and negatively impacted our results, in particular in the second quarter. While the pandemic continues in all of our markets, as these orders lapsed and businesses reopened, we experienced improved business conditions and improved financial results in the third quarter. For example, for the three months ended September 30, 2020, we experienced increased gross profit per unit, principally resulting from limited vehicle availability due to plant shutdowns related to COVID-19, as new and used retail automotive gross profit per unit increased 27.8% and 67.3%. In addition, selling, general, and administrative expenses as a percentage of gross profit decreased 10.1 percentage points in the third quarter in part due to employee reductions, temporary compensation reductions, government assistance, and other expense reductions noted below. While our third quarter retail automotive same-store new and used unit sales decreased 5.8% and 3.6% compared to the same period last year and service and parts revenue decreased 2.4%, we experienced sequential improvement of same-store new and used unit sales of 71% and 65% when compared to the second quarter of 2020 and a 51% increase in same-store service and parts revenue.

The pandemic is a highly fluid and rapidly evolving situation, and while we continue to adjust our operations to conform to regulatory changes and consumer preferences in the evolving environment, we cannot anticipate with any certainty the length, scope, or severity of the business impact from the pandemic in each of the jurisdictions that we operate. See “Part II, Item 1A. Risk Factors.”

In response to shelter-in-place orders resulting from the COVID-19 pandemic, many of our automotive and commercial vehicle showrooms experienced temporary closures during the second quarter of 2020 though all have since reopened. Virtually all of our service, parts, and collision center departments remained open during the crisis, and curbside or home delivery offerings supplemented our traditional service offerings. We modified certain business practices to conform to government restrictions and best practices encouraged by government and regulatory authorities. Even though most of our showrooms are open, we continue to offer sales activity by appointment and through our e-commerce channels. In all of our locations, we implemented enhanced cleaning procedures, enforced social distancing guidelines, and took other precautions to maintain the health and safety of our employees and customers. We continue to experience interim business closures at some of our facilities in response to a customer or employee reporting a positive test result for COVID-19. When we become aware of such result, we notify appropriate personnel and deep clean our facility, which may include closure of that facility. We also are experiencing increased costs for providing the appropriate level of safety equipment for our facilities and employees, as well as increased costs for daily and enhanced deep cleaning when appropriate.

Beginning in the first quarter of 2020, we implemented a hiring freeze and expense reductions across the company, including the postponement and elimination of an estimated $150 million in capital expenditures. We furloughed over 15,000 employees in February and March in various countries. As business conditions improved, we returned employees to work; however, approximately 650 employees remain furloughed as of October 1, 2020. We also reduced our workforce by approximately 3,700 employees or 14% compared to January 1, 2020. During 2020, many of our employees who were not furloughed worked reduced hours and experienced pay cuts, including a six-month 100% reduction in salary for our CEO and President and 25% reductions in salary for our other named executive officers. In addition, our Board of Directors waived six months of its cash compensation in 2020. The compensation levels for our officers and Board of Directors have since returned to their pre-COVID-19 levels.

Most of our manufacturer partners began suspending production beginning in late March, and production disruptions continued into the second quarter. These disruptions resulted in lower inventory levels, in particular for new vehicles and limited inventory of certain models. Our manufacturer partners began providing us with additional incentive support in March, and our manufacturer and lending partners have provided support to retail customers such as increased incentives, payment deferrals, as well as 0% financing on certain vehicles and term lengths.

United States – Beginning in March 2020, shelter-in-place rules in many states either required we close dealerships or limit our automotive dealership operations to essential services. Virtual/online sales of new and used vehicles remained available in all locations, while the service departments remained open to support critical transportation needs. In May, many shelter-in-place rules began to expire, and restrictions were slowly lifted in many states allowing us to reopen dealerships all of which remain open, subject in certain locations to personnel capacity limits. For the three months ended September 30, 2020, new and used retail automotive gross profit per unit increased 32.3% and 46.1%, primarily due to inventory shortages and additional manufacturer incentives, while our automotive dealerships experienced a 10.4% decrease in unit volume and a 6.1% decrease in service and parts revenues compared to the prior year on a same store basis. Our U.S. Used Vehicle SuperCenters experienced a same-store used unit sales decline of 8.9% in the third quarter, largely attributable to lower inventory.

Commercial truck dealership sales and service operations remained open throughout 2020 in most locations around the U.S. and Canada providing essential services to our customers. For the three months ended September 30, 2020, the North American Class 6-8 retail sales market declined 31.0%, and our new same-store unit sales and revenue declined 15.5% and 10.8%, respectively, during the same period.

Penske Transportation Solutions – We have a 28.9% ownership interest in Penske Transportation Solutions ("PTS"). As an integral part of the North American supply chain, PTS has been generally classified as essential by governmental authorities which allowed PTS to remain operating in much of its business, providing crucial supply chain and transportation services to its customers. While its full-service leasing and contract maintenance businesses remained consistent, commercial rental utilization slowed during the second quarter but increased with the expirations of the shelter-in-place orders. In the third quarter of 2020, PTS experienced increased levels of utilization and profitability as business conditions improved. In its logistics services business, throughout 2020, PTS experienced heavy volumes in the grocery sector which were offset by plant closings in automotive and manufacturing. In the third quarter, most of PTS’ logistics customers returned to normal operations, generating strong results. PTS has also experienced improved remarketing results as truck prices improved in response to limited inventory. In response to the pandemic, PTS initially furloughed over 5,000 employees, most of which have returned to work. PTS also reduced executive salaries by up to 30%, which reductions have been eliminated.

United Kingdom – All dealerships closed on March 24, 2020, in accordance with government orders, though we provided service and parts operations on an emergency basis. Over 90% of the employees in the U.K. were placed on furlough beginning March 24, 2020. However, we opened substantially all service and parts operations in mid-May and showrooms in early June. In October 2020, in response to increased incidence of the COVID-19 pandemic, certain parts of the U.K. have reinstated shelter-in-place orders which require our dealerships to close. For the three months ended September 30, 2020, new and used retail automotive gross profit per unit increased 25.9% and 108.6%, primarily due to inventory shortages and additional manufacturer incentives, while our automotive dealerships experienced a 2.4% increase in unit volume and a 7.3% increase in service and parts revenues compared to the prior year on a same store

basis. Our U.K. Used Vehicle SuperCenters also experienced a gross profit per unit increase of 121.1%, primarily due to improved inventory management, and a same-store used unit sales decrease of 12.7% in the third quarter.

Australia – In most jurisdictions, non-essential business operations were closed by government order in March 2020 though many governmental restrictions have since been lifted. Penske Australia has been deemed essential throughout the COVID-19 pandemic, and therefore, sales, parts, service, and defense functions continue to remain operational. Throughout 2020, Penske Australia results of operations have remained consistent in spite of the pandemic.

Government Assistance – We received government assistance in most of our jurisdictions through COVID-19 related government programs which provided tax credits or direct wage or health care assistance payments to us. These programs generally require us to claim tax credits or apply to the government for reimbursement of wages or employee health benefits based on the applicable laws and programs within each jurisdiction. In the three and nine months ended September 30, 2020, we received $6.0 million and $55.5 million of wage assistance for furloughed employees in the U.K. as well as an additional $1.9 million and $8.3 million of assistance and tax credits in our U.S. and other jurisdictions. As a result, we recorded a reduction to selling, general, and administrative expenses of approximately $8.0 million and $63.9 million for the amounts of government assistance received during those periods.

Liquidity – As of September 30, 2020, we had $93 million of cash and access to an additional $1.0 billion of availability through our revolving credit facilities. This amount includes $100 million of additional borrowing capacity under our U.S. credit agreement which we amended effective August 1, 2020.

During the third quarter of 2020, we repaid in full at scheduled maturity our $300 million senior subordinated notes due August 15, 2020, using availability under our U.S. revolving credit facility. We also issued $550 million in aggregate principal amount of 3.50% senior subordinated notes due 2025 in August 2020, the proceeds of which were used to redeem our $550 million in aggregate principal amount of 5.75% senior subordinated notes due 2022 on October 1. In the meantime, we utilized the proceeds from the 3.50% senior subordinated notes to temporarily pay down floorplan, U.S. revolver and mortgage revolver balances. Refer to Note 10 “Long-Term Debt” for further discussion.

Risks and Uncertainties – The full impact that COVID-19 will have on our business cannot be predicted at this time due to numerous uncertainties, including the duration of the outbreak, travel restrictions, business closures, the effectiveness of actions taken to contain the disease, the development of a reliable vaccine, the effect of government assistance programs, production levels from our manufacturing partners, and other unintended consequences. This impact could include changes in customer demand; our relationship with, and the financial and operational capacities of, vehicle manufacturers, captive finance companies and other suppliers; workforce availability; risks associated with our indebtedness (including available borrowing capacity, compliance with financial covenants and ability to refinance or repay indebtedness on favorable terms); the adequacy of our cash flow and earnings and other conditions which may affect our liquidity; our ability to pay our quarterly dividend at prior levels; and disruptions to our technology network and other critical systems, including our dealer management systems and software or other facilities or equipment.

We believe that business disruption relating to the COVID-19 pandemic will continue to negatively impact the global economy and may materially affect our businesses as outlined above, or in other manners, all of which would adversely impact our business and results of operations.

Business Overview

Retail Automotive Dealership. We believe we are the second largest automotive retailer headquartered in the U.S. as measured by the $20.6 billion in total retail automotive dealership revenue we generated in 2019. As of September 30, 2020, we operated 311 retail automotive franchises, of which 145 franchises are located in the U.S. and 166 franchises are located outside of the U.S. The franchises outside the U.S. are located primarily in the U.K. In the nine months ended September 30, 2020, we retailed and wholesaled more than 371,000 vehicles. We are diversified geographically, with 57% of our total retail automotive dealership revenues in the nine months ended September 30, 2020, generated in the U.S. and Puerto Rico and 43% generated outside the U.S. We offer over 35 vehicle brands, with 70% of our retail automotive dealership revenue in the nine months ended September 30, 2020, generated from premium brands, such as Audi, BMW, Land Rover, Mercedes-Benz and Porsche. Each of our franchised dealerships offers a wide selection of

new and used vehicles for sale. In addition to selling new and used vehicles, we generate higher-margin revenue at each of our dealerships through maintenance and repair services and the sale and placement of third-party finance and insurance products, third-party extended service and maintenance contracts and replacement and aftermarket automotive products. We operate our franchised dealerships under franchise agreements with a number of automotive manufacturers and distributors that are subject to certain rights and restrictions typical of the industry.

We also operate sixteen Used Vehicle SuperCenters in the U.S. and the U.K. which retail and wholesale used vehicles under a one price, “no-haggle” methodology. Our CarSense operations in the U.S. consist of six retail locations operating in the Philadelphia and Pittsburgh, Pennsylvania market areas. Our CarShop operations in the U.K. consist of ten retail locations and a vehicle preparation center.

During the nine months ended September 30, 2020, we disposed of ten retail automotive franchises in the U.K. and made no acquisitions.

Retail Commercial Truck Dealership. We operate a heavy and medium-duty truck dealership group known as Premier Truck Group (“PTG”) offering primarily Freightliner and Western Star trucks (both Daimler brands), with locations in Texas, Oklahoma, Tennessee, Georgia, Utah, Idaho, and Canada. As of September 30, 2020, PTG operated twenty-five locations. PTG also offers a full range of used trucks available for sale as well as service and parts departments, providing a full range of maintenance and repair services.

Penske Australia. We are the exclusive importer and distributor of Western Star heavy-duty trucks, MAN heavy and medium-duty trucks and buses (a VW Group brand), and Dennis Eagle refuse collection vehicles, together with associated parts, across Australia, New Zealand and portions of the Pacific. In most of these same markets, we are also a leading distributor of diesel and gas engines and power systems, principally representing MTU, Detroit Diesel, Allison Transmission, MTU Onsite Energy, and Rolls Royce Power Systems. This business, known as Penske Australia, offers products across the on- and off-highway markets, including in the construction, mining, marine, and defense sectors, and supports full parts and aftersales service through a network of branches, field locations and dealers across the region.

Penske Transportation Solutions. We hold a 28.9% ownership interest in Penske Truck Leasing Co., L.P (“PTL”). PTL is owned 41.1% by Penske Corporation, 28.9% by us, and 30.0% by Mitsui & Co., Ltd. (“Mitsui”). We account for our investment in PTL under the equity method, and we therefore record our share of PTL’s earnings on our statements of income under the caption “Equity in earnings of affiliates,” which also includes the results of our other equity method investments. Penske Transportation Solutions (“PTS”) is the universal brand name for PTL’s various business lines through which it is capable of meeting customers’ needs across the supply chain with a broad product offering that includes full-service truck leasing, truck rental and contract maintenance, along with logistic services such as dedicated contract carriage, distribution center management, transportation management, lead logistics provider services and dry van truckload carrier services.

Basis of Presentation

Basis of Presentation

The accompanying unaudited consolidated condensed financial statements of PAG have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in our annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC rules and regulations. The information presented as of September 30, 2020, and December 31, 2019, and for the three and nine months ended September 30, 2020, and 2019 is unaudited but includes all adjustments which our management believes to be necessary for the fair presentation of results for the periods presented. Results for interim periods are not necessarily indicative of results to be expected for the year. These consolidated condensed financial statements should be read in conjunction with our audited financial statements for the year ended December 31, 2019, which are included as part of our Annual Report on Form 10-K.

Estimates

Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounts requiring the use of significant estimates include accounts receivable, inventories, income taxes, intangible assets and certain reserves.

Fair Value of Financial Instruments

Fair Value of Financial Instruments

Accounting standards define fair value as the price that would be received from selling an asset, or paid to transfer a liability in the principal, or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. Accounting standards establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and also establishes the following three levels of inputs that may be used to measure fair value:

Level 1	Quoted prices in active markets for identical assets or liabilities
Level 2	Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted market prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Our financial instruments consist of cash and cash equivalents, debt, floor plan notes payable, forward exchange contracts and interest rate swaps used to hedge future cash flows. Other than our fixed rate debt, the carrying amount of all significant financial instruments approximates fair value due either to length of maturity, the existence of variable interest rates that approximate prevailing market rates, or as a result of mark to market accounting.

Our fixed rate debt consists of amounts outstanding under our senior subordinated notes and mortgage facilities. We estimate the fair value of our senior unsecured notes using quoted prices for the identical liability (Level 2), and we estimate the fair value of our mortgage facilities using a present value technique based on current market interest rates for similar types of financial instruments (Level 2). A summary of the carrying values and fair values of our senior subordinated notes and our fixed rate mortgage facilities are as follows:

	September 30, 2020				December 31, 2019
	Carrying Value		Fair Value		Carrying Value		Fair Value
5.75% senior subordinated notes due 2022		550.0		550.3		547.6		556.7
5.375% senior subordinated notes due 2024		298.4		304.5		298.0		306.7
3.50% senior subordinated notes due 2025		542.9		541.9		—		—
5.50% senior subordinated notes due 2026		496.2		511.9		495.7		521.7
Mortgage facilities		333.8		354.8		423.2		430.9

During the third quarter of 2020, we repaid in full at scheduled maturity our $300 million senior subordinated notes due August 15, 2020 using availability under our U.S. revolving credit facility. We also issued $550 million in aggregate principal amount of 3.50% senior subordinated notes due 2025 in August 2020, the proceeds of which were used to

redeem our $550 million in aggregate principal amount of 5.75% senior subordinated notes due 2022 on October 1. Refer to Note 10 “Long-Term Debt” for further discussion.

Assets Held For Sale and Discontinued Operations

Assets Held for Sale and Discontinued Operations

We had no entities newly classified as held for sale during the nine months ended September 30, 2020, or 2019 that met the criteria to be classified as discontinued operations. The financial information for entities that were classified as discontinued operations prior to adoption of Accounting Standards Update No. 2014-08 are included in “Income from discontinued operations” in the accompanying consolidated condensed statements of income and “Liabilities held for sale” in the accompanying consolidated condensed balance sheets for all periods presented.

Disposals

Disposals

During the nine months ended September 30, 2020, we disposed of ten retail automotive franchises. The results of operations for these businesses are included within continuing operations for the three and nine months ended September 30, 2020, and 2019 as these franchises did not meet the criteria to be classified as held for sale and treated as discontinued operations.

Income Taxes

Income Taxes

Tax regulations may require items to be included in our tax returns at different times than the items are reflected in our financial statements. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as the timing of depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that will be used as a tax deduction or credit in our tax returns in future years which we have already recorded in our financial statements. Deferred tax liabilities generally represent deductions taken on our tax returns that have not yet been recognized as expense in our financial statements. We establish valuation allowances for our deferred tax assets if the amount of expected future taxable income is not likely to allow for the use of the deduction or credit.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, includes various income and payroll tax provisions, modifications to federal net operating loss rules, business interest deduction limitations, and bonus depreciation eligibility for qualified improvement property. As a result of net operating loss carryback provision of the CARES Act and various other U.S. and foreign tax legislation changes, we recorded an income tax benefit of $15.4 million in the third quarter of 2020. Additionally, we received payroll tax deferrals and benefits from the employee retention tax credit.

Recent Accounting Pronouncements

Recent Accounting Pronouncements

Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU replaces the current incurred loss impairment methodology of recognizing credit losses when a loss is probable, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to assess credit loss estimates. This ASU is effective for financial statements issued for annual periods beginning after December 15, 2019, with early adoption permitted. We adopted this ASU on the effective date of January 1, 2020. The adoption of this accounting standard update has not had a material impact on our consolidated financial position, results of operations, and cash flows.

Fair Value Measurement Disclosure

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, modifies, and adds certain disclosure requirements on fair value measurements. For public companies, this ASU is effective for

financial statements issued for annual periods beginning after December 15, 2019, and interim periods within those annual periods, with early adoption permitted. Entities were permitted to early adopt any eliminated or amended disclosures and delay adoption of the additional disclosure requirements until the effective date. We adopted this ASU on the effective date of January 1, 2020. The adoption of this accounting standard update has not had a material impact on our on our consolidated financial statements and disclosures.

Accounting for Cloud Computing Arrangements

In August 2018, the FASB issued ASU No. 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” Under this new guidance, certain implementation costs incurred in a hosted cloud computing service arrangement will be capitalized in accordance with ASC 350-40. For public companies, this ASU is effective for financial statements issued for annual periods beginning after December 15, 2019, and interim periods within those annual periods, with early adoption permitted. The amendments from this update are to be applied retrospectively or prospectively to all implementation costs incurred after adoption. We adopted this ASU on the effective date of January 1, 2020. The adoption of this accounting standard update has not had a material impact on our consolidated financial position, results of operations, and cash flows.

Facilitation of the Effects of Reference Rate Reform on Financial Reporting

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” This ASU provides optional guidance for a limited time to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. Additionally, entities can elect to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain conditions are met. The new standard was effective upon issuance and generally can be applied to applicable contract modifications through December 31, 2022. We are currently evaluating the impact of the transition from LIBOR to alternative reference interest rates, but do not expect a significant impact on our consolidated financial position, results of operations, and cash flows.

Financial Disclosures about Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities

In March 2020, the Securities and Exchange Commission (“SEC”) adopted final rules that amend the financial disclosure requirements for subsidiary issuers and guarantors of registered debt securities in Rule 3-10 of Regulation S-X. The amended rules narrow the circumstances that require separate financial statements of subsidiary issuers and guarantors and streamline the alternative disclosures required in lieu of those statements. The amended rules allow the registrants, among other things, to disclose summarized financial information of the issuer and guarantors on a combined basis and to present only the most recently completed fiscal year and subsequent year-to-date interim period. The rule is effective January 4, 2021, but earlier compliance is permitted. The Company early adopted the rule in the first quarter of 2020.