AutoNation 2005 Annual Report Download - page 41

Table of Contents
violation of any of these laws or regulations, or if new laws or regulations are enacted that adversely affect our operations, our
business, operating results and prospects could suffer.
• Our ability to grow our business may be limited by our ability to acquire automotive stores on favorable terms or at all.
• We are subject to interest rate risk in connection with our vehicle floorplan payable, revolving credit facility and mortgage facility that
could have a material adverse effect on our profitability.
• Our revolving credit facility and the indenture relating to our senior unsecured notes contain certain restrictions on our ability to conduct
our business.
• We must test our intangible assets for impairment at least annually, which may result in a material, non-cash write-down of goodwill or
franchise rights and could have a material adverse impact on our results of operations and shareholders’ equity.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is increasing interest rates. Our policy is to manage interest rates through the use of a combination of
fixed and floating rate debt. At December 31, 2005 and 2004, fixed rate debt, primarily consisting of amounts outstanding under senior
unsecured notes, totaled $371.3 million and $494.5 million, respectively, and had a fair value of $398.5 million and $561.5 million,
respectively. Interest rate derivatives may be used to hedge a portion of our variable rate debt when appropriate based upon market conditions.
Interest Rate Risk
At December 31, 2005 and 2004, we had variable rate vehicle floorplan payable — trade and vehicle floorplan payable — non-trade
totaling $2.5 billion for both years. Based on these amounts at December 31, 2005 and 2004, a 100 basis point change in interest rates
would result in an approximate $25.4 million and $24.6 million, respectively, change to our annual floorplan interest expense. Our exposure
to changes in interest rates with respect to total vehicle floorplan payable is partially mitigated by manufacturers’ floorplan assistance.
At December 31, 2005 and 2004, we had other variable rate debt outstanding totaling $153.7 million and $318.1 million, respectively.
Based on the amounts outstanding at December 31, 2005 and 2004, a 100 basis point change in interest rates would result in an
approximate $1.5 million and $3.2 million change to interest expense, respectively.
Hedging Risk
We reflect the current fair value of all derivatives on our balance sheet. The related gains or losses on these transactions are deferred in
stockholders’ equity as a component of accumulated other comprehensive income (loss). These deferred gains and losses are recognized in
income in the period in which the related items being hedged are recognized in expense. However, to the extent that the change in value of a
derivative contract does not perfectly offset the change in the value of the items being hedged, that ineffective portion is immediately
recognized in income. All of our interest rate hedges are designated as cash flow hedges. We have a series of interest rate hedge transactions
with a notional value of $800 million, consisting of a combination of swaps, and cap and floor options (collars). The hedge instruments are
designed to convert certain floating rate vehicle floorplan payable and portions of our mortgage facilities to fixed rate debt. We have
$200 million in swaps, which started in 2004 and effectively lock in a LIBOR-based rate of approximately 3.0%, and $600 million in collars
that cap floating rates to a maximum LIBOR-based rate no greater than 2.4%. All of our hedge instruments mature between February 2006
and July 2006. At December 31, 2005 and 2004, net unrealized gains (losses), net of income taxes, related to hedges included in
Accumulated Other Comprehensive Income (Loss) were $2.1 million and $(1.5) million, respectively. For the years ended December 31,
2005, 2004 and 2003, the income statement impact from interest rate hedges was an additional income (expense) of $.2 million,
$(2.9) million and $(.6) million, respectively. At December 31, 2005 and 2004, all of our derivative contracts were determined to be highly
effective, and no ineffective portion was recognized in income.
39