AutoNation 2005 Annual Report Download - page 54

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Table of Contents
AUTONATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Derivative Financial Instruments
The Company’s primary market risk exposure is increasing interest rates. Interest rate derivatives are used to hedge a portion of the
Company’s variable rate debt when appropriate based on market conditions.
The Company recognizes all derivative instruments on the balance sheet at fair value. 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 or expense 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. The Company recognizes gains or losses when the underlying transaction settles. All of the
Company’s interest rate hedges are designated as cash flow hedges. The Company has a series of interest rate hedge transactions, with a
notional value of $800.0 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 the Company’s mortgage facility to fixed rate debt. The
Company has $200 million in swaps, which started in 2004 and effectively lock in a rate of 3.0%, and $600 million in collars that cap floating
rates to a maximum LIBOR-based rate no greater than 2.4%. All of its hedge instruments mature between February 2006 and July 2006. At
December 31, 2005 and 2004, net unrealized 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 the Company’s derivative contracts were determined to be highly effective, and no ineffective portion
was recognized in income.
Revenue Recognition
Revenue consists of sales of new and used vehicles and related finance and insurance (“F&I”) products, sales of parts and services and
sales of other products. As further described below, the Company recognizes revenue in the period in which products are sold or services are
provided. The Company recognizes vehicle and finance and insurance revenue when a sales contract has been executed, the vehicle has
been delivered and payment has been received or financing has been arranged. Revenue on finance and insurance products represents
commissions earned by the Company for: (i) loans and leases placed with financial institutions in connection with customer vehicle
purchases financed and (ii) vehicle protection products sold. Rebates, holdbacks, floorplan assistance and certain other dealer credits received
directly from manufacturers are recorded as a reduction of the cost of the vehicle and recognized into income upon the sale of the vehicle or
when earned under a specific manufacturer program, whichever is later.
The Company sells and receives a commission, which is recognized upon sale, on the following types of insurance products: extended
warranties, guaranteed auto protection (“GAP,” which covers the shortfall between loan balance and insurance payoff), credit insurance,
lease “wear and tear” insurance and theft protection products. The Company may also participate in future profit, pursuant to retrospective
commission arrangements, that would be recognized over the life of the policies. Certain commissions earned from the sales of insurance
products are subject to chargebacks should the contracts be terminated prior to their expirations. An estimated liability for chargebacks against
revenue recognized from sales of F&I products is recorded in the period in which the related revenue is recognized. Chargeback liabilities
were $67.7 million and $65.8 million at December 31, 2005 and 2004, respectively.
Through 2002, the Company reinsured through its captive insurance subsidiaries a portion of the underwriting risk related to extended
warranty and credit insurance products sold and administered by certain independent third parties. Revenue and related direct costs from
these reinsurance transactions were deferred
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