UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2012
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to
Commission file number: 1-13461
Group 1 Automotive, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 76-0506313 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
800 Gessner, Suite 500 Houston, Texas 77024 (Address of principal executive offices, including zip code) | (713) 647-5700 (Registrant’s telephone number, including area code) | |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of exchange on which registered | |
Common stock, par value $0.01 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | þ | ¨ | Accelerated filer | |
Non-accelerated filer | ¨ | (Do not check if a smaller reporting company) | ¨ | Smaller reporting company |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ No þ
The aggregate market value of common stock held by non-affiliates of the registrant was approximately $988.4 million based on the reported last sale price of common stock on June 30, 2012, which is the last business day of the registrant’s most recently completed second quarter.
As of February 14, 2013, there were 22,730,588 shares of our common stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for its 2013 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2012, are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Item 15. | ||
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CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (“Form 10-K”) includes certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). This information includes statements regarding our plans, goals or current expectations with respect to, among other things:
• | our future operating performance; |
• | our ability to maintain or improve our margins; |
• | operating cash flows and availability of capital; |
• | the completion of future acquisitions; |
• | the future revenues of acquired dealerships; |
• | future stock repurchases and dividends; |
• | future capital expenditures; |
• | changes in sales volumes and availability of credit for customer financing in new and used vehicles and sales volumes in the parts and service markets; |
• | business trends in the retail automotive industry, including the level of manufacturer incentives, new and used vehicle retail sales volume, customer demand, interest rates and changes in industry-wide inventory levels; and |
• | availability of financing for inventory, working capital, real estate and capital expenditures. |
Although we believe that the expectations reflected in these forward-looking statements are reasonable when and as made, we cannot assure you that these expectations will prove to be correct. When used in this Form 10-K, the words “anticipate,” “believe,” “estimate,” “expect,” “may” and similar expressions, as they relate to our company and management, are intended to identify forward-looking statements. Our forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections. Known material factors that could cause our actual results to differ from those in the forward-looking statements are those described in Part I, “Item 1A. Risk Factors.”
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no responsibility to publicly release the result of any revision of our forward-looking statements after the date they are made.
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PART I
Item 1. Business
General
Group 1 Automotive, Inc., a Delaware corporation, organized in 1995, is a leading operator in the automotive retail industry. As of December 31, 2012, we owned and operated 142 franchises, representing 31 brands of automobiles, at 111 dealership locations and 28 collision service centers in the United States of America (“U.S.”) and 15 franchises at ten dealerships and three collision centers in the United Kingdom (“U.K.”). Through our dealerships, we sell new and used cars and light trucks; arrange related vehicle financing, service and insurance contracts; provide automotive maintenance and repair services; and sell vehicle parts. Our operations are primarily located in major metropolitan areas in Alabama, California, Florida, Georgia, Kansas, Louisiana, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, Oklahoma, South Carolina, and Texas in the U.S. and in the towns of Brighton, Chelmsford, Chingford, Farnborough, Hailsham, Harold Wood, Hindhead, Southend, Stanstead, and Worthing in the U.K.
As of December 31, 2012, our U.S. retail network consisted of the following two regions (with the number of dealerships they comprised): (a) the East (45 dealerships in Alabama, Florida, Georgia, Louisiana, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, and South Carolina) and (b) the West (66 dealerships in California, Kansas, Oklahoma, and Texas). Each region is managed by a regional vice president who reports directly to our Chief Executive Officer and is responsible for the overall performance of their regions, as well as for overseeing the market directors and dealership general managers that report to them. Each region is also managed by a regional chief financial officer who reports directly to our Chief Financial Officer. Our ten dealerships in the U.K. are also managed locally with direct reporting responsibilities to our corporate management team.
As discussed in more detail in Note 2 of our Consolidated Financial Statements, “Summary of Significant Accounting Policies and Estimates,” all of our operating subsidiaries operate as one reportable segment. Our financial information, including our revenues from external customers, a measure of profit or loss, and total assets is included in our Consolidated Financial Statements and related notes beginning on page F-1.
Business Strategy
Our business strategy is to leverage what we believe to be one of our key strengths — the talent of our people to: (a) sell new and used cars and light trucks; (b) arrange related vehicle financing, service and insurance contracts; (c) provide automotive maintenance and repair services; and (d) sell vehicle parts via an expanding network of franchised dealerships located primarily in growing regions of the U.S. and the U.K. We believe, as evidenced by the significant industry experience reflected in the biographical information of our executive officers below, that over the last seven years we have continued to develop a distinguished management team with substantial industry expertise. With our management structure and level of executive talent, we plan to continue empowering the operators of our dealerships to make appropriate decisions to grow their respective dealership operations and to control fixed and variable costs. We believe this approach allows us to continue to attract and retain talented employees, as well as provide the best possible service to our customers.
We continue to primarily focus on the performance of our existing dealerships to achieve growth, capture market share, and maximize the investment return to our stockholders. For 2013, we will primarily focus on five key areas as we continue to become a best-in-class automotive retailer. These areas are:
• | sustained growth of our higher margin parts and service business with an emphasis on service customer satisfaction and retention; |
• | capture of additional new and used vehicle retail market share; |
• | improve efficiencies and further leverage our cost base; |
• | further implementation of an operating model with greater commonality of key operating processes, systems and training that support the extension of best practices and the leveraging of scale as well as promote customer satisfaction; and |
• | enhancement of our current dealership portfolio by strategic acquisitions and improving or disposing of underperforming dealerships. |
Our focus in our parts and service operations will be on targeted marketing efforts, strategic selling and operational efficiencies, as well as capital investments designed to support our growth targets.
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We made significant changes in our operating model during the last five years, which were designed to reduce variable and fixed expenses, appropriately leverage our scale and generate operating efficiencies. As our business grows in 2013 and beyond, we intend to manage our costs carefully and to look for opportunities to improve our operating efficiencies.
We continue our efforts to fully leverage our scale, reduce costs, enhance internal controls, and enable further growth and, as such, we are taking steps to standardize key operating processes. We believe that our management structure supports more rapid decision making and facilitates a quicker roll-out of new processes. Over the last four years, we have consolidated portions of our dealership accounting, human resources, and other administrative functions into regional centers and we implemented standardized training programs for our vehicle and service sales processes. These actions represent key building blocks that we are using to more effectively manage the business operations, support extension of best practices, and further leverage the scale of the business.
We are constantly evaluating opportunities to improve the profitability of our dealerships. We attempt to capitalize on our size, leverage, and ability to disseminate best practices in order to expedite these efforts. We believe that our efforts will improve our financial condition and operating results in 2013 and beyond.
In 2012, we completed 16 franchise acquisitions with $715.0 million in expected annualized revenues estimated at the time of acquisition. We believe that substantial opportunities for growth through acquisitions remain in our industry. An absolute acquisition target has not been established for 2013, but we expect to acquire dealerships that meet our stringent acquisitions and return on investment criteria. We believe that we have sufficient financial resources to support additional acquisitions. We expect to grow our brand portfolio, primarily with import and luxury brands and more selectively with domestic brands. We plan to focus our growth in geographically diverse areas with positive economic outlooks over the longer-term. Further, we intend to critically evaluate our return on invested capital in our current dealership portfolio for disposition opportunities.
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Dealership Operations
Our operations are located in geographically diverse markets that extend domestically from New Hampshire to California and internationally in the U.K. By geographic area, our revenues from external customers for the years ended December 31, 2012, 2011, and 2010 were $6,954.0 million, $5,760.2 million and $5,225.5 million from our domestic operations, respectively, and $522.1 million, $319.5 million, and $283.6 million from our international operations, respectively. As of December 31, 2012, 2011, and 2010, our aggregate long-lived assets other than goodwill and intangible assets and financial instruments in our domestic operations were $642.8 million, $569.4 million, and $484.5 million, respectively, and in our international operations were $35.6 million, $28.0 million, and $29.5 million, respectively. For a discussion of the risks associated with our operations in the U.K., please see Part I, “Item 1A. Risk Factors.” The following table sets forth the regions and geographic markets in which we operate, the percentage of new vehicle retail units sold in each region in 2012 and the number of dealerships and franchises in each region:
Region | Geographic Market | Percentage of Our New Vehicle Retail Units Sold During the Year Ended December 31, 2012 | As of December 31, 2012 | ||||||||
Number of Dealerships | Number of Franchises | ||||||||||
East | Massachusetts | 9.1 | % | 7 | 7 | ||||||
New Jersey | 5.1 | 7 | 7 | ||||||||
Georgia | 3.6 | 5 | 6 | ||||||||
New York | 3.3 | 4 | 5 | ||||||||
New Hampshire | 2.8 | 3 | 3 | ||||||||
Louisiana | 2.5 | 4 | 5 | ||||||||
Mississippi | 2.0 | 3 | 3 | ||||||||
South Carolina | 1.8 | 4 | 4 | ||||||||
Florida | 1.4 | 4 | 4 | ||||||||
Alabama | 1.0 | 2 | 2 | ||||||||
Maryland | 0.7 | 2 | 2 | ||||||||
33.3 | 45 | 48 | |||||||||
West | Texas | 36.7 | 38 | 55 | |||||||
California | 14.6 | 12 | 16 | ||||||||
Oklahoma | 7.8 | 12 | 19 | ||||||||
Kansas | 1.4 | 4 | 4 | ||||||||
60.5 | 66 | 94 | |||||||||
International | United Kingdom | 6.2 | 10 | 15 | |||||||
Total | 100.0 | % | 121 | 157 | |||||||
Each of our local operations has a management structure designed to promote and reward entrepreneurial spirit and the achievement of team goals. The general manager of each dealership, with assistance from the managers of new vehicle sales, used vehicle sales, parts, service, and finance and insurance, is ultimately responsible for the operation, personnel and financial performance of the dealership. Our dealerships are operated as distinct profit centers, and our general managers have a reasonable degree of empowerment within our organization. In the U.S., each general manager reports to one of our market directors or one of two regional vice presidents. Our regional vice presidents report directly to our Chief Executive Officer and are responsible for the overall performance of their regions, as well as for overseeing the market directors and dealership general managers that report to them. Our U.K. operations are structured similarly, with a regional vice president reporting directly to our Chief Executive Officer.
New Vehicle Retail Sales
In 2012, we sold or leased 128,550 new vehicles representing 32 brands in retail transactions at our dealerships. Our retail sales of new vehicles accounted for 22.1% of our gross profit in 2012. In addition to the profit related to the transactions, a typical new vehicle retail sale or lease may create the following additional profit opportunities for our dealerships:
• | manufacturer dealer incentives; |
• | the resale of any used vehicle trade-in purchased by the dealership; |
• | the sale of third-party finance, vehicle service and insurance contracts in connection with the retail sale; |
• | the sale of accessories or after-market products; and |
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• | the service and repair of the vehicle both during and after the warranty period. |
Brand diversity is one of our strengths. Our mix of domestic, import, and luxury franchises is critical to our success. The importance of brand diversity was highlighted in 2011 when two of our largest manufacturer partners, Toyota and Honda, suffered from the natural disaster in Japan, halting production and severely limiting inventory supply for much of the year in these two brands. The following table sets forth new vehicle sales revenue by brand and the number of new vehicle retail units sold in the year ended, and the number of franchises we owned as of December 31, 2012:
New Vehicle Revenues | New Vehicle Unit Sales | % of Total Units Sold | Franchises Owned as of December 31, 2012 | ||||||||||
(In thousands) | |||||||||||||
Toyota | $ | 893,159 | 32,738 | 25.4 | % | 14 | |||||||
Nissan | 365,939 | 13,646 | 10.6 | 10 | |||||||||
Honda | 282,172 | 11,361 | 8.8 | 9 | |||||||||
Volkswagen | 120,730 | 4,698 | 3.7 | 8 | |||||||||
Hyundai | 79,209 | 3,314 | 2.6 | 6 | |||||||||
Subaru | 21,464 | 842 | 0.7 | 1 | |||||||||
Scion | 19,185 | 944 | 0.7 | N/A (1) | |||||||||
Mazda | 16,968 | 728 | 0.6 | 1 | |||||||||
Kia | 15,575 | 636 | 0.5 | 3 | |||||||||
Fiat | 4,232 | 104 | 0.1 | 1 | |||||||||
Total import | 1,818,633 | 69,011 | 53.7 | 53 | |||||||||
BMW | 554,841 | 10,824 | 8.3 | 17 | |||||||||
Mercedes-Benz | 355,770 | 6,248 | 4.8 | 6 | |||||||||
Lexus | 249,669 | 5,269 | 4.1 | 3 | |||||||||
Audi | 149,714 | 3,674 | 2.9 | 7 | |||||||||
Acura | 109,474 | 2,941 | 2.3 | 4 | |||||||||
MINI | 97,215 | 3,705 | 2.9 | 10 | |||||||||
Infiniti | 41,095 | 992 | 0.8 | 1 | |||||||||
Cadillac | 32,180 | 640 | 0.5 | 1 | |||||||||
Volvo | 28,388 | 740 | 0.6 | 1 | |||||||||
Lincoln | 13,996 | 298 | 0.2 | 2 | |||||||||
Sprinter | 6,175 | 147 | 0.1 | 2 | |||||||||
Maybach | 5,653 | 12 | — | N/A (2) | |||||||||
Porsche | 5,475 | 67 | 0.1 | 1 | |||||||||
smart | 2,950 | 206 | 0.2 | 1 | |||||||||
Total luxury | 1,652,595 | 35,763 | 27.8 | 56 | |||||||||
Ford | 406,664 | 11,659 | 9.0 | 11 | |||||||||
Chevrolet | 139,054 | 4,116 | 3.2 | 5 | |||||||||
Jeep | 75,972 | 2,332 | 1.8 | 6 | |||||||||
GMC | 68,848 | 1,759 | 1.4 | 4 | |||||||||
RAM | 48,108 | 1,308 | 1.0 | 6 | |||||||||
Dodge | 34,367 | 1,223 | 1.0 | 6 | |||||||||
Buick | 26,165 | 722 | 0.6 | 4 | |||||||||
Chrysler | 20,692 | 657 | 0.5 | 6 | |||||||||
Total domestic | 819,870 | 23,776 | 18.5 | 48 | |||||||||
Total | $ | 4,291,098 | 128,550 | 100.0 | % | 157 | |||||||
(1) | The Scion brand is not considered a separate franchise, but rather is governed by our Toyota franchise agreements. We sell the Scion brand at all of our Toyota franchised locations. |
(2) | Franchise was disposed as of December 31, 2012. |
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Our diversity by manufacturer for the years ended December 31, 2012, 2011, and 2010 is set forth below:
For the Year Ended December 31, | ||||||||||||||||||
2012 | % of Total | 2011 | % of Total | 2010 | % of Total | |||||||||||||
Toyota | 38,951 | 30.3 | % | 30,975 | 30.4 | % | 34,614 | 35.5 | % | |||||||||
Nissan | 14,638 | 11.4 | 13,957 | 13.7 | 13,734 | 14.1 | ||||||||||||
BMW | 14,529 | 11.3 | 13,357 | 13.1 | 11,571 | 11.9 | ||||||||||||
Honda | 14,302 | 11.1 | 10,870 | 10.7 | 11,733 | 12.0 | ||||||||||||
Ford | 11,957 | 9.3 | 9,075 | 8.9 | 7,631 | 7.8 | ||||||||||||
Volkswagen | 8,439 | 6.6 | 2,800 | 2.7 | 1,548 | 1.6 | ||||||||||||
General Motors | 7,237 | 5.6 | 5,723 | 5.6 | 3,932 | 4.0 | ||||||||||||
Daimler | 6,613 | 5.1 | 5,992 | 5.9 | 5,643 | 5.8 | ||||||||||||
Chrysler | 5,624 | 4.4 | 4,642 | 4.5 | 2,960 | 3.0 | ||||||||||||
Hyundai | 3,950 | 3.1 | 2,213 | 2.2 | 1,812 | 1.9 | ||||||||||||
Other | 2,310 | 1.8 | 2,418 | 2.3 | 2,333 | 2.4 | ||||||||||||
Total | 128,550 | 100.0 | % | 102,022 | 100.0 | % | 97,511 | 100.0 | % | |||||||||
Our new vehicle sales mix was affected by our acquisition mix during 2012 and 2011. And, again, our 2011 new vehicle sales mix was significantly impacted by the supply disruption resulting from the natural disaster in Japan that severely limited production from Toyota and Honda for much of the year.
Some new vehicles we sell are purchased by customers under lease or lease-type financing arrangements with third-party lenders. New vehicle leases generally have shorter terms, bringing the customer back to the vehicle market, and our dealerships specifically, sooner than if the vehicle purchase was debt financed. In addition, leasing provides our dealerships with a steady supply of late-model, off-lease vehicles to be sold as used vehicles. Generally, leased vehicles remain under factory warranty, allowing the dealerships to provide repair services for the contract term. However, the penetration of finance and insurance product sales on leases tends to be less than in other financing arrangements (such as debt financed vehicles). We typically do not guarantee residual values on lease transactions.
Used Vehicle Sales, Retail and Wholesale
We sell used vehicles at each of our franchised dealerships. In 2012, we sold or leased 85,366 used vehicles at our dealerships, and sold 43,756 used vehicles in wholesale markets. Our retail sales of used vehicles accounted for 13.1% of our gross profit in 2012, while sales of used vehicles in wholesale markets accounted for 0.2% of our gross profit. Used vehicles sold at retail typically generate higher gross margins on a percentage basis than new vehicles because of our ability to sell these vehicles at favorable prices due to their limited comparability, which is dependent on a vehicle’s age, mileage and condition, among other things. Valuations also vary based on supply and demand factors, the level of new vehicle incentives, and the availability of retail financing and general economic conditions.
Profit from the sale of used vehicles depends primarily on a dealership’s ability to obtain a high-quality supply of used vehicles at reasonable prices and to effectively manage that inventory. Our new vehicle operations provide our used vehicle operations with a large supply of generally high-quality trade-ins and off-lease vehicles, and are the best source of high-quality used vehicles. Our dealerships supplement their used vehicle inventory with purchases at auctions, including manufacturer-sponsored auctions available only to franchised dealers. We continue to extensively utilize a common used vehicle management software in all of our dealerships with the goal to enhance the management of used vehicle inventory, focusing on the more profitable retail used vehicle business and reducing our wholesale used vehicle business. This internet-based software tool enables our managers to make used vehicle inventory decisions based on real time market valuation data, and is an integral part of our used vehicle process. It also allows us to leverage our size and local market presence by expanding the pool from which used vehicles can be sold within a given market or region, effectively broadening the demand for our used vehicle inventory. In addition, this software supports increased oversight of our assets in inventory, allowing us to better control our exposure to used vehicles, the values of which typically decline over time.
In addition to active management of the quality and age of our used vehicle inventory, we have attempted to increase the total lifecycle profitability of our used vehicle operations by participating in manufacturer certification programs where available. Manufacturer certified pre-owned (“CPO”) vehicles typically cost more to recondition, but sell at a premium compared to other used vehicles and are available only from franchised new vehicle dealerships. Service loyalty also tends to be better for CPO vehicles. In some cases, CPO vehicles are eligible for manufacturer support, such as subsidized finance rates and extension of the manufacturer warranty. Our CPO vehicle sales represented 33.1% of total used retail sales in 2012.
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Parts and Service Sales
We sell replacement parts and provide maintenance and repair services at each of our franchised dealerships and provide collision repair services at the 31 collision centers that we operate. Our parts and service business accounted for 41.3% of our gross profit in 2012. We perform both warranty and non-warranty service work at our dealerships, primarily for the vehicle brand(s) sold at a particular location. Warranty work accounted for 18.9% of the revenues from our parts and service business in 2012. Our parts and service departments also perform used vehicle reconditioning and new vehicle preparation services for which they realize a profit when a vehicle is sold to a retail customer. However, the revenue for that internal work is eliminated from our parts and service revenue in the consolidation of our financial statements.
The automotive repair industry is highly fragmented, with a significant number of independent maintenance and repair facilities in addition to those of the franchised dealerships. We believe, however, that the increasing complexity of new vehicles, especially in the area of electronics, has made it difficult for many independent repair shops to retain the expertise necessary to perform major or technical repairs. We have made investments in obtaining, training, and retaining qualified technicians to work in our service and repair facilities and in state of the art diagnostic and repair equipment to be utilized by these technicians. Additionally, manufacturers only permit warranty work to be performed at franchised dealerships and a trend currently exists in the automobile industry towards longer new vehicle warranty periods. As a result, we believe an increasing percentage of all repair work will be performed at franchised dealerships that have the sophisticated equipment and skilled personnel necessary to perform repairs and warranty work on today’s complex vehicles.
Our strategy to capture an increasing share of the parts and service work performed by franchised dealerships and enhancing profitability includes the following elements:
• | Focus on Customer Relationships; Emphasize Preventative Maintenance. Our dealerships seek to retain new and used vehicle customers as customers of our parts and service departments. To accomplish this goal, we use computer systems that track customers’ maintenance records and provide advance notice to owners of vehicles purchased or serviced at our dealerships when their vehicles are due for periodic service. Our use of computer-based customer relationship management tools increases the reach and effectiveness of our marketing efforts, allowing us to target our promotional offerings to areas in which service capacity is under-utilized or profit margins are greatest. We continue to train our service personnel to establish relationships with their service customers to promote a long-term business relationship. And, we are focused on enhancing access to our service facilities by providing customers with readily-accessible means to schedule service appointments. We believe our parts and service activities are an integral part of the customer service experience, allowing us to create ongoing relationships with our dealerships’ customers thereby deepening customer loyalty to the dealership as a whole. |
• | Sell Vehicle Service Contracts in Conjunction with Vehicle Sales. Our finance and insurance sales departments attempt to connect new and used vehicle customers with vehicle service contracts, and thereby secure repeat customer business for our parts and service departments. |
• | Efficient Management of Parts Inventory. Our dealerships’ parts departments support their sales and service departments, selling factory-approved parts for the vehicle makes and models sold by a particular dealership. Parts are either used in repairs made in the service department, sold at retail to customers, or sold at wholesale to independent repair shops and other franchised dealerships. Our dealerships also frequently share parts with each other. Our dealerships employ parts managers who oversee parts inventories and sales. Software programs are used to monitor parts inventory, maximize sales, avoid obsolete and unused parts, and take advantage of manufacturer return procedures. |
Finance and Insurance Sales
Revenues from our finance and insurance operations consist primarily of fees for arranging financing, and vehicle service and insurance contracts in connection with the retail purchase of a new or used vehicle. Our finance and insurance business accounted for 23.3% of our gross profit in 2012. We offer a wide variety of third-party finance, vehicle service and insurance products in a convenient manner and at competitive prices. To increase transparency to our customers, we offer all of our products on menus that display pricing and other information, allowing customers to choose the products that suit their needs.
Financing. We arrange third-party purchase and lease financing for our customers. In return, we receive a fee from the third-party finance company upon completion of the financing. These third-party finance companies include manufacturers’ captive finance subsidiaries, selected commercial banks and a variety of other third-parties, including credit unions and regional auto finance companies. The fees we receive are subject to chargeback, or repayment, to the finance company, if a customer defaults or prepays the retail installment contract, typically during some limited time period at the beginning of the contract term. We have negotiated incentive programs with some finance companies pursuant to which we receive additional fees upon reaching a certain volume of business. Generally, we do not retain substantial credit risk after a customer has received financing, though we do retain limited credit risk in some circumstances.
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Extended Warranty, Vehicle Service and Insurance Products. We offer our customers a variety of vehicle warranty and extended protection products in connection with purchases of new and used vehicles, including:
• | extended warranties; |
• | maintenance, or vehicle service, products and programs; |
• | guaranteed asset protection insurance, which covers the shortfall between a customer’s contract balance and insurance payoff in the event of a total vehicle loss; and |
• | lease “wear and tear” insurance. |
The products our dealerships currently offer are generally underwritten and administered by independent third parties, including the vehicle manufacturers’ captive finance subsidiaries. Under our arrangements with the providers of these products, we either sell these products on a straight commission basis, or we sell the product, recognize commission and participate in future underwriting profit, if any, pursuant to a retrospective commission arrangement. These commissions may be subject to chargeback, in full or in part, if the contract is terminated prior to its scheduled maturity.
New and Used Vehicle Inventory Financing
Our dealerships finance their inventory purchases through the floorplan portion of our revolving credit facility and three separate floorplan credit facility arrangements with manufacturers that we represent, Ford, BMW, and Volkswagen. Our revolving syndicated credit arrangement matures in June 2016 and provides a total borrowing capacity of $1.35 billion of financing (“Revolving Credit Facility”). We can expand the Revolving Credit Facility to its maximum commitment of $1.6 billion, subject to participating lender approval. The Revolving Credit Facility consists of two tranches: $1.1 billion for vehicle inventory financing (“Floorplan Line”), and $250.0 million for working capital, including acquisitions (“Acquisition Line”). We utilize the $1.1 billion tranche of our Floorplan Line to finance up to 80% of the value of our used vehicle inventory, except in the U.K., and up to 100% of the value of all new vehicle inventory, other than new vehicles purchased from Ford in the U.S. and BMW and Volkswagen in the U.K. The capacity under these two tranches can be re-designated within the overall $1.35 billion commitment, subject to the original limits of a minimum of $1.1 billion for the Floorplan Line and a maximum of $250.0 million for the Acquisition Line. However, the amount of available borrowing capacity under the Acquisition Line may be limited from time to time based upon the available borrowing base calculation within the debt covenants under the Revolving Credit Facility.
Our floorplan arrangement with Ford Motor Credit Company provides $150.0 million of floorplan financing capacity (“FMCC Facility”). We use the funds available under this arrangement to exclusively finance our inventories of new Ford vehicles sold by the lender’s manufacturer affiliate. The FMCC Facility is an evergreen arrangement that may be canceled with 30 days notice by either party. Should the FMCC Facility no longer be available to us for financing of our new Ford inventory, we could utilize the available capacity under our Floorplan Line to finance our new Ford vehicle inventory.
In addition to the FMCC Facility, we finance certain rental vehicles through separate arrangements with the respective automobile manufacturers. We also utilize credit facilities with BMW Financial Services and Volkswagen Finance for the financing of new, used, and rental inventories associated with our U.K. operations. Many manufacturers offer interest assistance to offset a portion of floorplan interest charges incurred in connection with holding new vehicle inventory purchases, which we recognize as a reduction of cost of new vehicle sales.
Acquisition and Divestiture Program
We pursue an acquisition and divestiture program focused on the following objectives:
• | enhancing brand and geographic diversity with a primary focus on import and luxury brands; |
• | creating economies of scale; |
• | delivering a targeted return on investment; and |
• | eliminating underperforming dealerships. |
Since our inception, we have grown our business primarily through acquisitions. Over the five-year period from January 1, 2008 through December 31, 2012, we:
• | purchased 41 franchises with expected annual revenues, estimated at the time of acquisition, of $1.6 billion; |
• | disposed of or terminated 41 franchises with annual revenues of approximately $503.6 million; and |
• | were granted nine new franchises by vehicle manufacturers with expected annual revenues, estimated at the time of grant, of $119.7 million. |
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Acquisition Strategy. We seek to acquire large, profitable, well-established dealerships that are leaders in their markets to:
• | expand into geographic areas we currently do not serve; |
• | expand our brand, product, and service offerings in our existing markets; |
• | capitalize on economies of scale in our existing markets; and/or |
• | increase operating efficiency and cost savings in areas such as used vehicle sourcing, advertising, purchasing, data processing, personnel utilization, and the cost of floorplan financing. |
We typically pursue dealerships with superior operational management, whom we seek to retain. By retaining existing personnel who have experience and in-depth knowledge of their local market, we believe that we can mitigate the risks involved with employing and training new and untested personnel. In addition, our acquisition strategy targets the purchase of the related real estate to provide maximum operating flexibility.
We focus on the acquisition of dealerships or groups of dealerships that we believe offer opportunities for higher returns, particularly import and luxury brands, which provide growth opportunities for our parts and service operations, and will strengthen our operations in geographic regions in which we currently operate with attractive long-term economic prospects.
Recent Acquisitions. In 2012, we acquired one domestic, eight import, and seven luxury franchises with expected annualized revenues at the time of acquisition of $715.0 million. The new franchises included: (a) one Ford dealership in Georgia; (b) three Volkswagen dealerships with one in Texas and two in Florida; (c) one BMW dealership in South Carolina; (d) three Hyundai dealerships in Kansas, Texas, and Oklahoma; (e) one Honda dealership in Florida; (f) one Kia dealership in Kansas; and (g) six Audi dealerships in the U.K.
On January 24, 2013, we entered into an agreement to acquire all of the outstanding stock of UAB Motors Particpações S.A. ("UAB Motors"), an automotive retailing operator in Brazil, which is a growing global retail automotive market and currently the fourth largest new vehicle market in the world. The operations to be acquired include 18 dealerships and 21 franchises, including two Toyota, three Renault, four Nissan, four BMW, two MINI, three Peugeot, two Land Rover, and one Jaguar, as well as five collision centers, and one motorcycle dealership. Initially, we expect annualized revenues of UAB to be $650.0 million.
Divestiture Strategy. We continually review the investments in our dealership portfolio for disposition opportunities, based upon a number of criteria, including:
• | the rate of return on our capital investment over a period of time; |
• | location of the dealership in relation to existing markets and our ability to leverage our cost structure; |
• | potential future capital investment requirements; |
• | the franchise; and |
• | existing real estate obligations, coupled with our ability to exit those obligations or identify an alternate use. |
While it is our desire to only acquire profitable, well-established dealerships, at times we have been requested, in connection with the acquisition of a particular dealership group, to acquire dealerships that do not fit our acquisition strategy. We acquire such dealerships with the understanding that we may need to divest of them at some future time. The costs associated with such divestitures are included in our analysis of whether we acquire all dealerships in the same acquisition. Additionally, we may acquire a dealership whose profitability is marginal, but which we believe can be increased through various factors, such as: (a) change in management, (b) increase or improvement in facility operations, (c) relocation of facility based on demographic changes, (d) reduction in costs, or (e) sales training. If, after a period of time, a dealership’s profitability does not positively respond, management will make the decision to sell the dealership to a third party, or, in a rare case, surrender the franchise back to the manufacturer. Management constantly monitors the performance of all of our dealerships, and routinely assesses the need for divestiture. In connection with divestitures, we are sometimes required to incur additional charges associated with lease terminations or the impairment of long-lived assets. We continue to rationalize our dealership portfolio and focus on increasing the overall profitability of our operations. In conjunction with the disposition of certain of our dealerships, we may also dispose of the associated real estate.
Recent Dispositions. During 2012, we disposed of six franchises with annual revenues of approximately $127.9 million.
Competition
We operate in a highly competitive industry. In each of our markets, consumers have a number of choices in deciding where to purchase a new or used vehicle and how the purchase will be financed. Consumers also have options for the purchase of related parts and accessories, as well as the service maintenance and repair of vehicles. According to The National
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Automobile Dealers Association, there are approximately 17,500 franchised automobile dealerships as of January 1, 2012, which is down from 17,700 as of January 1, 2011 and down 1,100 over the past five years. In addition, there are approximately 37,900 independent used vehicle dealers in the retail automotive industry.
Our competitive success depends, in part, on national and regional automobile-buying trends, local and regional economic factors, and other regional competitive pressures. Conditions and competitive pressures affecting the markets in which we operate, or in any new markets we enter, could adversely affect us, although the retail automobile industry as a whole might not be affected. Some of our competitors may have greater financial, marketing and personnel resources, and lower overhead and sales costs than we do. We cannot guarantee that our operating performance and our acquisition or disposition strategies will be more effective than the strategies of our competitors.
New and Used Vehicles. We believe the principal competitive factors in the automotive retailing business are location, suitability of the facility, on-site management, the suitability of a franchise to the market in which it is located, service, price, and selection. In the new vehicle market, our dealerships compete with other franchised dealerships in their market areas, as well as auto brokers, leasing companies, and Internet companies that provide referrals to, or broker vehicle sales with, other dealerships or customers. We are subject to competition from dealers that sell the same brands of new vehicles that we sell and from dealers that sell other brands of new vehicles that we do not sell in a particular market. Our new vehicle dealer competitors also have franchise agreements with the various vehicle manufacturers and, as such, generally have access to new vehicles on the same terms as we do. We do not have any cost advantage in purchasing new vehicles from vehicle manufacturers, and our franchise agreements do not grant us the exclusive right to sell a manufacturer’s product within a given geographic area.
In the used vehicle market, our dealerships compete both in their local market and nationally, including over the Internet, with other franchised dealers, large multi-location used vehicle retailers, local independent used vehicle dealers, automobile rental agencies, and private parties for the supply and resale of used vehicles.
Parts, Service and Collision. We believe the principal competitive factors in the parts and service business are the quality of customer service, the use of factory-approved replacement parts, familiarity with a manufacturer’s brands and models, convenience, access to technology required for certain repairs and services (e.g., software patches, diagnostic equipment, etc.), location, price, the competence of technicians, and the availability of training programs to enhance such expertise. In the parts and service market, our dealerships compete with other franchised dealers to perform warranty repairs and sell factory replacement parts. Our dealerships also compete with other automobile dealers, franchised and independent service center chains, and independent repair shops for non-warranty repair and maintenance business. In addition, our dealerships sell replacement and aftermarket parts both locally and nationally over the Internet in competition with franchised and independent retail and wholesale parts outlets. A number of regional or national chains offer selected parts and services at prices that may be lower than ours. Our collision centers compete with other large, multi-location companies, as well as local, independent, collision service operations.
Finance and Insurance. We face competition in arranging financing for our customers’ vehicle purchases from a broad range of financial institutions. Many financial institutions now offer finance and insurance products over the Internet, which may reduce our profits from the sale of these products. We believe the principal competitive factors in the finance and insurance business are convenience, interest rates, product availability, product knowledge and flexibility in contract length. We may be charged back for unearned financing, insurance contracts or vehicle service contract fees in the event of early termination of the contracts by customers.
Acquisitions. We compete with other national dealer groups and individual investors for acquisitions. Increased competition, especially for certain luxury and import brands, may raise the cost of acquisitions. We cannot guarantee that there will be sufficient opportunities to complete desired acquisitions, nor are we able to guarantee that we will be able to complete acquisitions on terms acceptable to us.
Financing Arrangements and Indebtedness
As of December 31, 2012, our total outstanding indebtedness and lease and other obligations were $2,291.7 million, including the following:
• | $856.7 million under the Floorplan Line of our Revolving Credit Facility; |
• | $262.9 million of future commitments under various operating leases; |
• | $226.2 million of term loans, entered into independently with four of our manufacturer-affiliated finance partners, Toyota Motor Credit Corporation (“TMCC”), Mercedes-Benz Financial Services USA LLC (“MBFS”), BMW Financial Services NA, LLC (“BMWFS”), and Ford Motor Credit Company ("FMCC"), as well as other third-party financial institutions, primarily to finance real estate; |
• | $152.4 million in carrying value of 2.25% convertible senior notes due 2036 (“2.25% Notes”); |
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• | $80.7 million in carrying value of 3.00% convertible senior notes due 2020 (“3.00% Notes”); |
• | $143.0 million under our FMCC Facility; |
• | $68.9 million under floorplan notes payable to various manufacturer affiliates for foreign and rental vehicles; |
• | $56.7 million under our five-year real estate credit facility (“Mortgage Facility”); |
• | $38.2 million of capital lease obligations related to real estate, as well as $32.1 million of estimated interest; |
• | $32.2 million of various other debt obligations; |
• | $43.1 million of obligations from interest rate risk management activities, as well as $65.3 million of estimated interest associated therewith; |
• | $193.8 million of estimated interest payments on floorplan notes payable and other long-term debt obligations; |
• | $29.3 million of letters of credit, to collateralize certain obligations, issued under the Acquisition Line; and |
• | $10.2 million of other short and long-term purchase commitments. |
As of December 31, 2012, we had the following amounts available for additional borrowings under our various credit facilities:
• | $243.3 million under the Floorplan Line of our Revolving Credit Facility, including $112.3 million of immediately available funds; |
• | $220.7 million under the Acquisition Line of our Revolving Credit Facility, which is limited based upon a borrowing base calculation within certain debt covenants under the Revolving Credit Facility; and |
• | $7.0 million under our FMCC Facility. |
In addition, the indentures relating to our other debt instruments allow us to incur additional indebtedness and enter into additional operating leases, subject to certain conditions.
Stock Repurchase Program
From time to time, our Board of Directors gives authorization to repurchase shares of our common stock, subject to the restrictions of various debt agreements and our judgment. In August 2011, our Board approved a repurchase program that authorized us to purchase up to $50.0 million in common stock. The shares were to be repurchased from time to time in open market or privately negotiated transactions depending on market conditions, at our discretion, and funded by cash from operations. Pursuant to the August 2011 authorization, 241,991 shares were repurchased during 2012 at an average price of $46.75 per share, or for a total of $11.3 million. In July 2012, our Board of Directors authorized a new repurchase program of up to $50.0 million of our common stock, replacing any amount remaining from the August 2011 authorization. No repurchases have been executed under the July 2012 authorization. Future repurchases are subject to the discretion of our Board of Directors after considering our results of operations, financial condition, cash flows, capital requirements, existing debt covenants, outlook for our business, general business conditions and other factors. We are limited under the terms of the Revolving Credit Facility and Mortgage Facility in our ability to repurchase shares of our outstanding common stock ("Restricted Payment Basket").
Dividends
During 2012, our Board of Directors approved four quarterly cash dividends totaling $0.59 per share or $13.4 million. The payment of dividends in the future is subject to the discretion of our Board of Directors, after considering our results of operations, financial condition, cash flows, capital requirements, outlook for our business, general business conditions, the political and legislative environments, and other factors. Under the terms of the Restricted Payment Basket, we are also limited in our ability to make cash dividend payments to our stockholders.
As of December 31, 2012, the Restricted Payment Basket under both facilities was $115.6 million and will increase in the future periods by 50.0% of our cumulative net income, as well as the net proceeds from stock option exercises, and decrease by subsequent payments for cash dividends and share repurchases.
Relationships and Agreements with our Manufacturers
Each of our dealerships operates under a franchise agreement with a vehicle manufacturer (or authorized distributor). The franchise agreements grant the franchised automobile dealership a non-exclusive right to sell the manufacturer’s or distributor’s brand of vehicles and offer related parts and service within a specified market area. These franchise agreements grant our dealerships the right to use the manufacturer’s or distributor’s trademarks in connection with their operations, and impose numerous operational requirements and restrictions relating to, among other things:
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• | inventory levels; |
• | working capital levels; |
• | the sales process; |
• | minimum sales performance requirements; |
• | customer satisfaction standards; |
• | marketing and branding; |
• | facility standards and signage; |
• | personnel; |
• | changes in management; and |
• | monthly financial reporting. |
Our dealerships’ franchise agreements are for various terms, ranging from one year to indefinite. Each of our franchise agreements may be terminated or not renewed by the manufacturer for a variety of reasons, including unapproved changes of ownership or management and performance deficiencies in such areas as sales volume, sales effectiveness, and customer satisfaction. In most cases, manufacturers have renewed the franchises upon expiration so long as the dealership is in compliance with the terms of the agreement. From time to time, certain manufacturers may assert sales and customer satisfaction performance deficiencies under the terms of our framework and franchise agreements at a limited number of our dealerships. We work with these manufacturers to address any performance issues. In general, the states in which we operate have automotive dealership franchise laws that provide that, notwithstanding the terms of any franchise agreement, it is unlawful for a manufacturer to terminate or not renew a franchise unless “good cause” exists. It generally is difficult for a manufacturer to terminate, or not renew, a franchise under these laws, which were designed to protect dealers. Though unsuccessful to date, manufacturers’ lobbying efforts may lead to the repeal or revision of state dealer laws. If dealer laws are repealed in the states in which we operate, manufacturers may be able to terminate our franchises without providing advance notice, an opportunity to cure or showing of good cause. Without the protection of state dealer laws, it may also be more difficult for our dealers to renew their franchise agreements upon expiration. Further, federal law, including any federal bankruptcy law, may preempt state law and allow manufacturers greater freedom to terminate or not renew franchises. The economic recession, that began in 2008, caused domestic manufacturers to critically evaluate their respective dealer networks and terminate certain brands, and, as a result, the respective franchises. For example, General Motors chose to discontinue the Pontiac brand and, as a result, both of our Pontiac franchises were terminated. In addition, Ford chose to discontinue the Mercury brand and, as a result, all four of our Mercury franchises were terminated. Subject to the recent or similar future economic factors, we generally expect our franchise agreements to survive for the foreseeable future and, when the agreements do not have indefinite terms, anticipate routine renewals of the agreements without substantial cost or modification.
Our dealership service departments perform vehicle repairs and service for customers under manufacturer warranties. We are reimbursed for the repairs and service directly from the manufacturer. Some manufacturers offer rebates to new vehicle customers that we are required, under specific program rules, to adequately document, support, and typically are responsible for collecting. In addition, from time to time, some manufacturers provide us with incentives to sell certain models and levels of inventory over designated periods of time. Under the terms of our dealership franchise agreements, the respective manufacturers are able to perform warranty, incentive, and rebate audits and charge us back for unsupported or non-qualifying warranty repairs, rebates or incentives.
In addition to the individual dealership franchise agreements discussed above, we have entered into framework agreements with most major vehicle manufacturers and distributors. These agreements impose a number of restrictions on our operations, including our ability to make acquisitions and obtain financing, and our management. These agreements also impose change of control provisions related to the ownership of our common stock. For a discussion of these restrictions and the risks related to our relationships with vehicle manufacturers, please read Part I, “Item 1A. Risk Factors.”
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The following table sets forth the percentage of our new vehicle retail unit sales attributable to the manufacturers that accounted for approximately 10% or more of our new vehicle retail unit sales:
Manufacturer | Percentage of New Vehicle Retail Units Sold during the Year Ended December 31, 2012 |
Toyota | 30.3% |
Nissan | 11.4% |
BMW | 11.3% |
Honda | 11.1% |
Governmental Regulations
Automotive and Other Laws and Regulations
We operate in a highly regulated industry. A number of state and federal laws and regulations affect our business and the business of our manufacturers. In every state in which we operate, we must obtain various licenses in order to operate our businesses, including dealer, sales and finance, and insurance licenses issued by state regulatory authorities. Numerous laws and regulations govern our conduct of business, including those relating to our sales, operations, financing, insurance, advertising and employment practices. These laws and regulations include state franchise laws and regulations, consumer protection laws, and other extensive laws and regulations applicable to new and used motor vehicle dealers, as well as a variety of other laws and regulations. These laws also include federal and state wage-hour, anti-discrimination and other employment practices laws.
Our financing activities with customers are subject to federal truth-in-lending, consumer leasing, and equal credit opportunity laws and regulations, as well as state and local motor vehicle finance laws, installment finance laws, usury laws, and other installment sales laws and regulations. Some states regulate finance fees and charges that may be paid as a result of vehicle sales. Claims arising out of actual or alleged violations of law may be asserted against us, or our dealerships, by individuals or governmental entities and may expose us to significant damages or other penalties, including revocation or suspension of our licenses to conduct dealership operations and fines.
Our operations are subject to the National Traffic and Motor Vehicle Safety Act, Federal Motor Vehicle Safety Standards promulgated by the United States Department of Transportation and the rules and regulations of various state motor vehicle regulatory agencies. The imported automobiles we purchase are subject to United States customs duties, and in the ordinary course of our business we may, from time to time, be subject to claims for duties, penalties, liquidated damages or other charges.
Our operations are subject to consumer protection laws known as Lemon Laws. These laws typically require a manufacturer or dealer to replace a new vehicle or accept it for a full refund within one year after initial purchase if the vehicle does not conform to the manufacturer’s express warranties and the dealer or manufacturer, after a reasonable number of attempts, is unable to correct or repair the defect. Federal laws require various written disclosures to be provided on new vehicles, including mileage and pricing information. We are aware that several states are considering enacting consumer “bill-of-rights” statutes to provide further protection to the consumer which could affect our profitability in such states.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law on July 21, 2010, established a new consumer financial protection agency with broad regulatory powers. Although automotive dealers are generally excluded, the Dodd-Frank Act could lead to additional, indirect regulation of automotive dealers through its regulation of automotive finance companies and other financial institutions. For instance, we are required to comply with those regulations applicable to privacy notices and risk-based pricing.
Environmental and Occupational Health and Safety Laws and Regulations
Our operations involve the use, handling, storage and contracting for recycling and/or disposal of materials such as motor oil and filters, transmission fluids, antifreeze, refrigerants, paints, thinners, batteries, cleaning products, lubricants, degreasing agents, tires, and fuel. Consequently, our business is subject to a complex variety of stringent federal, state and local laws and regulations governing management and disposal of materials and wastes, protection of the environment and occupational health and safety. These laws and regulations affect many aspects of our operations, such as requiring the acquisition of permits or other governmental approvals to conduct regulated activities, restricting the manner in which we handle, recycle and dispose of our wastes, incurring capital expenditures to construct, maintain and upgrade pollution control and containment equipment and facilities, impose specific health and safety criteria addressing worker protection, and impose substantial liabilities for pollution caused by our operations or attributable to former operations. Failure to comply with these laws and regulations may result in
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the assessment of administrative, civil and criminal penalties, imposition of remedial obligations, and issuance of injunctions delaying, restricting or prohibiting some or all of our operations. We may not be able to recover some or any of these costs from insurance.
Most of our dealerships utilize above ground storage tanks and, to a lesser extent, underground storage tanks primarily for storing and dispensing petroleum-based products. Storage tanks are subject to testing, containment, upgrading and removal requirements under the Resource Conservation and Recovery Act, or RCRA, and its state law counterparts. RCRA imposes requirements relating to the handling and disposal of hazardous and non-hazardous wastes and requires us to comply with stringent and costly requirements in connection with our storage and recycling or disposal of the various used fluids, paints, batteries, tires, and fuels generated by our operations. Clean-up or other remedial action may be necessary in the event of leaks or other unauthorized discharges from storage tanks or other equipment operated by us. In addition, water quality protection programs under the federal Water Pollution Control Act (commonly known as the Clean Water Act) and comparable state and local programs govern certain wastewater and stormwater discharges from our operations, which discharges may require permitting. Similarly, certain sources of air emissions from our operations may be subject to permitting, pursuant to the federal Clean Air Act and related state and local laws. Certain health and safety standards imposed under the Federal Occupational Safety and Health Act or otherwise promulgated by the Occupational Safety and Health administration of the United States Department of Labor and related state agencies are also applicable to protection of the health and safety of our employees.
We generally conduct environmental studies on dealerships to be acquired regardless of whether we are leasing or acquiring in fee the underlying real property, and as necessary, implement environmental management practices or remedial activities to reduce the risk of noncompliance with environmental laws and regulations. Nevertheless, we currently own or lease, and in connection with our acquisition program anticipate in the future owning or leasing, properties that in some instances have been used for auto retailing and servicing for many years. Laws regarding the prevention of pollution or remediation of environmental contamination generally apply regardless of whether we lease or purchase the land and facilities. Although we or our predecessors may have utilized operating and disposal practices that were standard in the industry at the time, a risk exists that petroleum products or wastes such as new and used motor oil, transmission fluids, antifreeze, lubricants, solvents and motor fuels could have been spilled or released on or under the properties owned or leased by us or on or under other locations where such materials were taken for recycling or disposal. Further, we believe that structures found on some of these properties may contain asbestos-containing materials, although in an undisturbed condition that does not require removal or other corrective action under applicable regulations. In addition, many of these properties have been operated by third parties whose use, handling and disposal of such petroleum products or wastes were not under our control. These properties and the materials disposed or released on them may be subject to the federal Comprehensive Environmental Response, Compensation, and Liability Act (also known as the Superfund law), RCRA and analogous state laws, pursuant to which we could be required to remove or remediate previously disposed wastes or property contamination or to perform remedial activities to prevent future contamination.
The trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment. Consequently, any changes in environmental laws and regulations or re-interpretations of enforcement policies that result in more stringent and costly vehicular pollution control equipment or waste handling, storage, transport, disposal or remediation requirements could have a material adverse effect on our financial position and results of operations. For example, vehicle manufacturers are subject to federal mandated corporate average fuel economy standards, which will increase substantially from 2013 through model year 2017. Furthermore, in response to studies suggesting that emissions of carbon dioxide and certain other gases, referred to an “greenhouse gases,” may be contributing to warming of the Earth’s atmosphere and other climatic changes, climate-change legislation and regulatory changes have been made or are being considered at state and federal levels. The adoption of any laws or regulations requiring significant increases in fuel economy requirements or new federal or state restrictions on emissions of carbon dioxide on vehicles and automotive fuels in the United States could adversely affect prices of and demand for the vehicles we sell.
Insurance and Bonding
Our operations expose us to the risk of various liabilities, including:
• | claims by employees, customers or other third parties for personal injury or property damage resulting from our operations; and |
• | fines and civil and criminal penalties resulting from alleged violations of federal and state laws or regulatory requirements. |
The automotive retailing business is also subject to substantial risk of real and personal property loss as a result of the significant concentration of real and personal property values at dealership locations. Under self-insurance programs, we retain various levels of aggregate loss limits, per claim deductibles and claims handling expenses, including property and casualty, automobile physical damage, and employee medical benefits. In certain cases, we insure costs in excess of our retained risk per claim under various contracts with third-party insurance carriers. Actuarial estimates for the portion of claims not covered by
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insurance are based on historical claims experience, adjusted for current trends and changes in claims-handling procedures. Risk retention levels may change in the future as a result of changes in the insurance market or other factors affecting the economics of our insurance programs. Although we believe our insurance coverage is adequate, we cannot assure that we will not be exposed to uninsured or underinsured losses that could have a material adverse effect on our business, financial condition, and results of operations or cash flows.
We make provisions for retained losses and deductibles by reflecting charges to expense based upon periodic evaluations of the estimated ultimate liabilities on reported and unreported claims. The insurance companies that underwrite our insurance require that we secure certain of our obligations for self-insured exposures with collateral. Our collateral requirements are set by the insurance companies and, to date, have been satisfied by posting surety bonds, letters of credit and/or cash deposits. Our collateral requirements may change from time to time based on, among other things, our total insured exposure and the related self-insured retention assumed under the policies.
Employees
We believe our relationship with our employees is favorable. As of December 31, 2012, we employed 9,343 (full-time, part-time and temporary) people, of whom:
• | 1,393 were employed in managerial positions; |
• | 1,914 were employed in non-managerial vehicle sales department positions; |
• | 4,527 were employed in non-managerial parts and service department positions; and |
• | 1,509 were employed in administrative support positions. |
Eighty-two of our employees in New Jersey are represented by a labor union. Because of our dependence on vehicle manufacturers, we may be affected by labor strikes, work slowdowns and walkouts at vehicle manufacturing facilities and/or their suppliers. Additionally, labor strikes, work slowdowns and walkouts at businesses participating in the distribution of manufacturers’ products may also affect us.
For further discussion, please read Part I, “Item 1A. Risk Factors.”
Seasonality
We generally experience higher volumes of vehicle sales and service in the second and third calendar quarters of each year. This seasonality is generally attributable to consumer buying trends and the timing of manufacturer new vehicle model introductions. In addition, in some regions of the U.S., vehicle purchases decline during the winter months due to inclement weather. As a result, our revenues and operating income are typically lower in the first and fourth quarters and higher in the second and third quarters. Other factors unrelated to seasonality, such as changes in economic condition, inventory availability, and manufacturer incentive programs, may exaggerate seasonal or cause counter-seasonal fluctuations in our revenues and operating income.
For further discussion, please read Part I, “Item 1A. Risk Factors.”
Executive Officers
Our executive officers serve at the pleasure of our Board of Directors and are subject to annual appointment by our Board of Directors at its first meeting following each annual meeting of stockholders. There are no arrangements or understandings between any of our executive officers and any other person pursuant to which any person was selected as an executive officer.
The following table sets forth certain information as of the date of this Form 10-K regarding our current executive officers:
Name | Age | Position | ||
Earl J. Hesterberg | 59 | President and Chief Executive Officer, Director | ||
John C. Rickel | 51 | Senior Vice President and Chief Financial Officer | ||
Darryl M. Burman | 54 | Vice President and General Counsel | ||
Peter C. DeLongchamps | 52 | Vice President, Financial Services and Manufacturer Relations | ||
J. Brooks O’Hara | 57 | Vice President, Human Resources | ||
Earl J. Hesterberg
Mr. Hesterberg has served as our President and Chief Executive Officer and as a director since April 2005. Prior to joining us, Mr. Hesterberg had served as Group Vice President, North America Marketing, Sales and Service for Ford Motor Company, a global manufacturer and distributor of cars, trucks and automotive parts, since October 2004. From July 1999 to
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September 2004, he served as Vice President, Marketing, Sales and Service for Ford of Europe, and from 1999 until 2005, he served on the supervisory board of Ford Werke AG. Mr. Hesterberg has also served as President and Chief Executive Officer of Gulf States Toyota, an independent regional distributor of new Toyota vehicles, parts and accessories. He has also held various senior sales, marketing, general management, and parts and service positions with Nissan Motor Corporation in U.S.A. and Nissan Europe, both of which are wholly-owned by Nissan Motor Co., Ltd., a global provider of automotive products and services. Mr. Hesterberg serves on the Board of Directors of Stage Stores, Inc., a national retail clothing chain with over 800 stores located in 39 states where he is a member of the Corporate Governance and Nominating Committee and Chairman of the Compensation Committee. Mr. Hesterberg also serves on the Board of Trustees of Davidson College and on the Board of Directors of the Greater Houston Partnership, a local non-profit organization dedicated to building regional economic prosperity. Mr. Hesterberg received his BA in Psychology at Davidson College in 1975 and his MBA from Xavier University in 1978.
John C. Rickel
Mr. Rickel has served as our Senior Vice President and Chief Financial Officer since December 2005. From 1984 until joining us, Mr. Rickel held a number of executive and managerial positions of increasing responsibility with Ford Motor Company, a global manufacturer and distributor of cars, trucks and automotive parts. He most recently served as Controller, Ford Americas, where he was responsible for the financial management of Ford’s western hemisphere automotive operations. Immediately prior to that, he was Chief Financial Officer of Ford Europe, where he oversaw all accounting, financial planning, information services, tax and investor relations activities. From 2002 to 2004, Mr. Rickel was Chairman of the Board of Directors of Ford Russia and a member of the Board of Directors and the Audit Committee of Ford Otosan, a publicly traded automotive company located in Turkey and owned 41% by Ford. Mr. Rickel received his BSBA in 1982 and MBA in 1984 from The Ohio State University.
Darryl M. Burman
Mr. Burman has served as our Vice President and General Counsel since December 2006. From December 2006 through July 2010, Mr. Burman also served as our Secretary. From September 2005 to December 2006, Mr. Burman was a partner and head of the corporate and securities practice in the Houston office of the law firm of Epstein Becker Green Wickliff & Hall, P.C. From September 1995 until September 2005, Mr. Burman served as the head of the corporate and securities practice of the law firm of Fant & Burman, L.L.P. in Houston, Texas. Mr. Burman currently serves as a Director of the Texas General Counsel Forum — Houston Chapter. Mr. Burman graduated from the University of South Florida in 1980 and received his J.D. from South Texas College of Law in 1983.
Peter C. DeLongchamps
Mr. DeLongchamps has served as our Vice President, Financial Services & Manufacturer Relations since December 2011. He previously served as Vice President, Manufacturer Relations & Public Affairs from January 2006 through December 2011, and as Vice President, Manufacturer Relations from July 2004 through December 2005. Mr. DeLongchamps began his automotive retailing career in 1980, having served as District Manager for General Motors Corporation and Regional Operations Manager for BMW of North America, as well as various other management positions in the automotive industry. Immediately prior to joining us in 2004, Mr. DeLongchamps was President of Advantage BMW, a Houston-based automotive retailer. Mr. DeLongchamps also serves on the Board of Directors of Junior Achievement of Southeast Texas and the GR8 HOPE Foundation. Mr. DeLongchamps received his BBA from Baylor University in 1983.
J. Brooks O’Hara
Mr. O’Hara has served as our Vice President, Human Resources since February 2000. From 1997 until joining us, Mr. O’Hara was Corporate Manager of Organizational Development at Valero Energy Corporation, an integrated refining and marketing company. Prior to joining Valero, Mr. O’Hara served for a number of years as Vice President of Administration and Human Resources at Gulf States Toyota, an independent regional distributor of new Toyota vehicles, parts and accessories. Mr. O’Hara is certified as a Senior Professional in Human Resources (SPHR). Mr. O’Hara received his BS in Marketing from Florida State University in 1978 and his MBA in 1991 from the University of St. Thomas.
Internet Website and Availability of Public Filings
Our Internet address is www.group1auto.com. We make the following information available free of charge on our internet website:
• | Annual Report on Form 10-K; |
• | Quarterly Reports on Form 10-Q; |
• | Current Reports on Form 8-K; |
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• | Amendments to the reports filed or furnished electronically with the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act; |
• | Our Corporate Governance Guidelines; |
• | The charters for our Audit, Compensation, Finance/Risk Management and Nominating/Governance Committees; |
• | Our Code of Conduct for Directors, Officers and Employees; and |
• | Our Code of Ethics for our Chief Executive Officer, Chief Financial Officer and Controller. |
We make our filings with the Securities and Exchange Commission (“SEC”) available on our website as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the SEC. The SEC also maintains an internet website at http://sec.gov that contains reports, proxy and information statements, and other information regarding our company that we file and furnish electronically with the SEC. The above information is available in print to anyone who requests it free of charge. In addition, the public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Washington, DC 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Item 1A. Risk Factors
Demand for and pricing of our products and services is subject to economic conditions and other factors, which have had and, in the future, could have a material adverse effect on our business, revenues and profitability.
The automotive retail industry, and especially new vehicle unit sales, is influenced by general economic conditions, particularly consumer confidence, the level of personal discretionary spending, interest rates, fuel prices, unemployment rates, credit availability. During economic downturns, such as the recession experienced in 2008 and much of 2009, retail new vehicle sales typically experience periods of decline characterized by oversupply and weak demand. Periods of economic uncertainty, as well volatility in consumer preference around fuel-efficient vehicles in response to volatile fuel prices, concern about domestic manufacturer viability, may adversely impact future consumer spending and result in a difficult business environment. Any tightening of the credit markets and credit conditions may decrease the availability of automotive loans and leases and adversely impact our new and used vehicle sales and margins. In particular, if sub-prime finance companies apply higher credit standards or if there is another decline in the overall availability of credit in the sub-prime lending market, the ability of consumers to purchase used vehicles could be limited, which could have a material adverse effect on our used car business, revenues, cash flows and profitability.
Volatile fuel prices may also continue to affect consumer preferences in connection with the purchase of our vehicles. Rising fuel prices may make consumers less likely to purchase larger, more expensive vehicles, such as sports utility vehicles or luxury automobiles and more likely to purchase smaller, less expensive and more fuel efficient vehicles. Sudden changes in customer preferences make maintenance of an optimal mix of large and small vehicle inventory a challenge. Further increases or sharp declines in fuel prices could have a material adverse effect on our business, revenues, cash flows and profitability.
In addition, local economic, competitive and other conditions affect the performance of our dealerships. Our revenues, cash flows and profitability depend substantially on general economic conditions and spending habits in those regions of the U.S. where we maintain most of our operations.
We are subject to a concentration of risk in the event of financial distress, merger, sale or bankruptcy, including potential liquidation, of, or other adverse economic impacts on, certain major vehicle manufacturers.
Toyota/Scion/Lexus, Nissan/Infiniti, Honda/Acura, Ford, BMW/MINI, Daimler, Chrysler and General Motors dealerships represented approximately 88.5% of our total new vehicle retail units sold in 2012. In particular, sales of Toyota/Scion/Lexus new vehicles represented 30.3% of our new vehicle unit sales in 2012. The success of our dealerships is dependent on vehicle manufacturers in several key respects. First, we rely exclusively on the various vehicle manufacturers for our new vehicle inventory. Our ability to sell new vehicles is dependent on a vehicle manufacturer’s ability to produce and allocate to our dealerships an attractive, high quality, and desirable product mix at the right time in order to satisfy customer demand. Second, manufacturers generally support their franchisees by providing direct financial assistance in various areas, including, among others, incentives, floorplan assistance and advertising assistance. A discontinuation or change in our manufacturers’ warranty and incentive programs could adversely affect our business. Third, manufacturers provide product warranties and, in some cases, service contracts to customers. Our dealerships perform warranty and service contract work for vehicles under manufacturer product warranties and service contracts and bill the manufacturer directly as opposed to invoicing the customer. In addition, we rely on manufacturers to varying extents for original equipment manufactured replacement parts, training, product brochures and point of sale materials, and other items for our dealerships.
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Vehicle manufacturers may be adversely impacted by economic downturns or recessions, significant declines in the sales of their new vehicles, increases in interest rates, adverse fluctuations in currency exchange rates, declines in their credit ratings, reductions in access to capital or credit, labor strikes or similar disruptions (including within their major suppliers), supply shortages, or rising raw material costs, rising employee benefit costs, adverse publicity that may reduce consumer demand for their products (including due to bankruptcy), product defects, vehicle recall campaigns, litigation, poor product mix or unappealing vehicle design, governmental laws and regulations, natural disasters, or other adverse events. These and other risks could materially adversely affect any manufacturer and impact its ability to profitably design, market, produce or distribute new vehicles, which in turn could materially adversely affect our business, results of operations, financial condition, stockholders’ equity, cash flows and prospects. In 2010, Toyota was significantly impacted by adverse publicity regarding vehicle quality. In 2011, natural disasters in Asia adversely affected certain vehicle manufacturers, including Toyota and Honda, and many of the parts suppliers on which they depend by temporarily restricting the manufacturers’ ability to supply new vehicles and related parts. As a result, we experienced a decline in the supply of new vehicles and related parts associated with these manufacturers, slowing the pace of new vehicle sales in 2011.
In the event or threat of a bankruptcy by a vehicle manufacturer, among other things: (1) the manufacturer could attempt to terminate all or certain of our franchises, and we may not receive adequate compensation for them, (2) we may not be able to collect some or all of our receivables that are due from such manufacturer and we may be subject to preference claims relating to payments made by such manufacturer prior to bankruptcy, (3) we may not be able to obtain financing for our new vehicle inventory, or arrange financing for our customers for their vehicle purchases and leases, with such manufacturer’s captive finance subsidiary, which may cause us to finance our new vehicle inventory, and arrange financing for our customers, with alternate finance sources on less favorable terms, and (4) consumer demand for such manufacturer’s products could be materially adversely affected and could impact the value of our inventory. These events may result in a partial or complete write-down of our goodwill and/or intangible franchise rights with respect to any terminated franchises and cause us to incur non-cash impairment charges related to operating leases and/or receivables due from such manufacturers or to record allowances against the value of our new and used vehicle inventory.
We are dependent on our relationships with manufacturers and if we are unable to enter into new franchise agreements in connection with dealership acquisitions or maintain or renew our existing franchise agreements on favorable terms, our operations may be significantly impaired.
We are dependent on our relationships with manufacturers, which exercise a great degree of influence over our operations through the franchise agreements. For example, delays in obtaining, or failing to obtain, manufacturer approvals for dealership acquisitions could adversely affect our acquisition program. In determining whether to approve an acquisition, manufacturers may consider many factors, including the moral character and business experience of the dealership principals and the financial condition, ownership structure, CSI scores, sales efficiency, and other performance measures of our dealerships. Also, our manufacturers attempt to measure customers’ satisfaction with automobile dealerships through systems generally known as CSI, which may be modified or replaced at the manufacturer’s discretion. Manufacturers may use these performance indicators, as well as sales performance numbers, as conditions for certain payments and as factors in evaluating applications for additional acquisitions. In unusual cases where performance indicators, such as the ones described above, are not met to the satisfaction of the manufacturer, certain manufacturers may either limit our ability to acquire additional dealerships or require the disposal of existing dealerships or both. From time to time, we have not met all of the manufacturers’ requirements to make acquisitions and have received requests to dispose of certain of our dealerships. On one occasion, one of our manufacturers initiated legal proceedings to block one of our acquisitions, but before the court could address the matter, the manufacturer dismissed its proceeding when the seller elected not to sell its dealerships to us. In the event one or more of our manufacturers sought to prohibit future acquisitions, or imposed requirements to dispose of one or more of our dealerships, this could adversely affect our acquisition and growth strategy.
A manufacturer may also limit the number of its dealerships that we may own or the number that we may own in a particular geographic area. For example, we may acquire only four primary Lexus dealerships or six outlets nationally, including only two Lexus dealerships in any one of the four Lexus geographic areas. We own three primary Lexus dealerships. Also, under the manufacturer’s interpretation of existing guidelines, we own the maximum number of Toyota dealerships permitted in the Gulf States region, which is comprised of Texas, Oklahoma, Louisiana, Mississippi and Arkansas, and in the Boston region, which is comprised of Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont.
In addition, each of our franchise agreements may be terminated or not renewed by the manufacturer for a variety of reasons, including any unapproved changes of ownership or management and other material breaches of the franchise agreements. Manufacturers may also have a right of first refusal if we seek to sell dealerships. We cannot guarantee all of our franchise agreements will be renewed or that the terms of the renewals will be as favorable to us as our current agreements. Actions taken by manufacturers to exploit their bargaining position in negotiating the terms of renewals of franchise agreements could also have a material adverse effect on our revenues and profitability. Further, the terms of certain of our
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real estate related indebtedness require the repayment of all amounts outstanding in the event that the associated franchise is terminated. Our results of operations may be materially and adversely affected to the extent that our franchise rights become compromised or our operations restricted due to the terms of our franchise agreements or if we lose substantial franchises.
Finally, our franchise agreements do not give us the exclusive right to sell a manufacturer’s product within a given geographic area. Subject to state laws that are generally designed to protect dealers, a manufacturer may grant another dealer a franchise to start a new dealership near one of our locations, or an existing dealership may move its dealership to a location that would more directly compete against us. The location of new dealerships near our existing dealerships could materially adversely affect our operations and reduce the profitability of our existing dealerships.
Our ability to acquire new dealerships and successfully integrate those dealerships into our business could adversely affect the growth of our revenues and earnings.
Growth in our revenues and earnings partially depends on our ability to acquire new dealerships and successfully integrate those dealerships into our existing operations. We cannot guarantee that we will be able to identify and acquire dealerships in the future. In addition, we cannot guarantee that any acquisitions will be successful or on terms and conditions consistent with past acquisitions. Restrictions by our manufacturers, as well as covenants contained in our debt instruments, may directly or indirectly limit our ability to acquire additional dealerships. In addition, increased competition for acquisitions may develop, which could result in fewer acquisition opportunities available to us and/or higher acquisition prices. And, some of our competitors may have greater financial resources than us.
We will continue to need substantial capital in order to acquire additional automobile dealerships. We currently intend to finance future acquisitions by using cash generated from operations, borrowings under our acquisition lines, proceeds from debt and/or equity offerings and/or issuing shares of our common stock as partial consideration for acquired dealerships. If potential acquisition candidates are unwilling to accept our common stock, we will rely solely on available cash or proceeds from debt or equity financings, which could adversely affect our acquisition program. While it has improved recently, access to funding through the debt or equity capital markets could become challenging again in the future. Also, in the recent past, the cost of obtaining money from the credit markets increased as many lenders and institutional investors increased interest rates, enacted tighter lending standards, refused to refinance existing debt as maturity at all or on terms similar to current debt, and reduced and, in some cases, ceased to provide funding to borrowers. Accordingly, our ability to make acquisitions could be adversely affected if the price of our common stock is depressed or if our access to capital is limited.
In addition, managing and integrating additional dealerships into our existing mix of dealerships may result in substantial costs, diversion of our management’s attention, delays, or other operational or financial problems. Acquisitions involve a number of special risks, including, among other things:
• | incurring significantly higher capital expenditures and operating expenses; |
• | failing to integrate the operations and personnel of the acquired dealerships; |
• | entering new markets with which we are not familiar; |
• | incurring undiscovered liabilities at acquired dealerships, in the case of stock acquisitions; |
• | disrupting our ongoing business; |
• | failing to retain key personnel of the acquired dealerships; |
• | impairing relationships with employees, manufacturers and customers; and |
• | incorrectly valuing acquired entities. |
All of these risks could have a material adverse effect on our business, financial condition, cash flows and results of operations. Although we conduct what we believe to be a prudent level of investigation regarding the operating condition of the businesses we purchase, in light of the circumstances of each transaction, an unavoidable level of risk remains regarding the actual operating condition of these businesses.
We are subject to substantial regulations, which may adversely affect our profitability.
The “Energy Policy Conservation Act”, enacted into law by Congress in 1975, added Title V, “Improving Automotive Efficiency”, to the Motor Vehicle Information and Cost Savings Act and established Corporate Average Fuel Economy (“CAFE”) standards for passenger cars and light trucks. CAFE is the sales weighted average fuel economy, expressed in miles per gallon of a manufacturer’s fleet of passenger cars or light trucks with a gross vehicle weight rating of 8,500 pounds or less, manufactured for sale in the U.S., for any given model year. The Secretary of Transportation has delegated authority to establish CAFE standards to the Administrator of the National Highway Traffic Safety Administration (“NHTSA”). NHTSA is responsible for establishing and amending the CAFE standards; promulgating regulations concerning CAFE procedures, definitions and reports; considering petitions for exemptions from standards for low volume manufacturers and
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establishing unique standards for them; enforcing fuel economy standards and regulations; responding to petitions concerning domestic production by foreign manufacturers and all other aspects of CAFE.
The primary goal of CAFE was to substantially increase passenger car fuel efficiency. Congress has continuously increased the standards since 1974, and, since mid-year 1990, the passenger car standard was increased to 27.5 miles per gallon, and had remained at this level through 2010 until it increased to 30.2 miles per gallon in 2011. In 2011 and then revised in 2012 the CAFE standards began to be expressed as a mathematical function depending on the vehicle "footprint".
A number of state and federal laws and regulations affect our business. We are also subject to laws and regulations relating to business corporations generally. Any failure to comply with these laws and regulations may result in the assessment of administrative, civil, or criminal penalties, the imposition of remedial obligations or the issuance of injunctions limiting or prohibiting our operations. In every state in which we operate, we must obtain various licenses in order to operate our businesses, including dealer, sales, finance and insurance-related licenses issued by state authorities. These laws also regulate our conduct of business, including our advertising, operating, financing, employment and sales practices. Other laws and regulations include state franchise laws and regulations and other extensive laws and regulations applicable to new and used motor vehicle dealers, as well as federal and state wage-hour, anti-discrimination and other employment practices laws. Furthermore, some states have initiated consumer “bill of rights” statutes which involve increases in our costs associated with the sale of vehicles, or decreases in some of our profit centers.
Our financing activities with customers are subject to federal truth-in-lending, consumer leasing and equal credit opportunity laws and regulations, as well as state and local motor vehicle finance laws, installment finance laws, insurance laws, usury laws and other installment sales laws and regulations. Some states regulate finance fees and charges that may be paid as a result of vehicle sales. Claims arising out of actual or alleged violations of law may be asserted against us or our dealerships by individuals or governmental entities and may expose us to significant damages or other penalties, including revocation or suspension of our licenses to conduct dealership operations and fines.
Our operations are also subject to the National Traffic and Motor Vehicle Safety Act, the Magnusson-Moss Warranty Act, Federal Motor Vehicle Safety Standards promulgated by the United States Department of Transportation and various state motor vehicle regulatory agencies. The imported automobiles we purchase are subject to U.S. customs duties and, in the ordinary course of our business, we may, from time to time, be subject to claims for duties, penalties, liquidated damages, or other charges.
Our operations are subject to consumer protection laws known as Lemon Laws. These laws typically require a manufacturer or dealer to replace a new vehicle or accept it for a full refund within one year after initial purchase if the vehicle does not conform to the manufacturer’s express warranties and the dealer or manufacturer, after a reasonable number of attempts, is unable to correct or repair the defect. Federal laws require various written disclosures to be provided on new vehicles, including mileage and pricing information.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law on July 21, 2010, established a new consumer financial protection agency with broad regulatory powers. Although automotive dealers are generally excluded, the Dodd-Frank Act could lead to additional, indirect regulation of automotive dealers through its regulation of automotive finance companies and other financial institutions. For instance, we are required to comply with those regulations applicable to privacy notices and risk-based pricing.
Possible penalties for violation of any of these laws or regulations include revocation or suspension of our licenses and civil or criminal fines and penalties. In addition, many laws may give customers a private cause of action. Violation of these laws, the cost of compliance with these laws, or changes in these laws could result in adverse financial consequences to us.
Our operations are subject to environmental laws and regulations that may expose us to significant costs and liabilities.
In the course of our operations, we generate, handle, store and recycle or dispose of various used products and wastes. These business activities are subject to stringent federal, regional, state and local laws and regulations governing the release of materials into the environment or otherwise relating to environmental protection. These laws and regulations may impose numerous obligations upon our operations including the acquisition of permits to conduct regulated activities, the imposition of restrictions on where or how to manage or dispose of used products and wastes, the incurrence of capital expenditures to limit or prevent releases of such material, and the imposition of substantial liabilities for pollution resulting from our operations. Failure to comply with these laws, regulations, and permits may result in the assessment of administrative, civil, and criminal penalties, the imposition of remedial and corrective action obligations, and the issuance of injections limiting or preventing some or all of our operations.
There is a risk of incurring significant environmental costs and liabilities in the operations or our automotive dealerships due to our handling of regulated used products and wastes, because of releases arising in the course of our operations, especially from storage tanks, and due to contamination arising from historical operations and waste disposal practices. Under certain environmental laws, we could be subject to joint and several, strict liability for the removal or
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remediation of previously released materials or property contamination or for correction of previously unknown equipment or facility deficiencies regardless of whether we were responsible for the release, contamination or deficiency or if the operations were in compliance with all applicable laws at the time those actions were taken.
The trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment, and thus any changes in environmental laws and regulations that result in more stringent and costly pollution control equipment or waste containment, management or disposal requirements could have a material adverse effect on our financial position and results of operation. For instance, vehicle manufacturers are currently subject to federally mandated corporate average fuel economy standards, which require most manufacturers to modify their engines to achieve a fleet-wide average fuel efficiency equivalent of 35.5 miles per gallon by model year 2017 and to achieve a fuel efficiency equivalent of 54.5 miles per gallon by 2025. These increased fuel efficiency requirements are expected to increase the cost of new vehicles over time, which could potentially result in a reduction in new vehicle sales. Also, in response to studies suggesting that emissions of carbon dioxide and certain other gases, referred to as “greenhouse gases,” may be contributing to warming of the Earth’s atmosphere and other climatic changes, the Congress and numerous states have from time to time considered and — in the case of some states, adopted — legislation to restrict greenhouse gases. Moreover, the EPA has adopted rules under existing provisions of the federal Clean Air Act that require a reduction in emissions of greenhouse gases from motor vehicles, require certain construction and operating permit reviews for greenhouse gas emissions from certain large stationary sources, and require monitoring and reporting of greenhouse gas emissions from specified sources on an annual basis. The adoption of any laws or regulations requiring significant increases in fuel economy requirements or new federal or state restrictions on emissions of greenhouse gases from our operations or on vehicles and automotive fuels in the United States could adversely affect prices of and demand for the vehicles we sell. Please see “Item 1. Business — Governmental Regulations — Environmental and Occupational Health and Safety Laws and Regulations” for more information.
If we lose key personnel or are unable to attract additional qualified personnel, our business could be adversely affected because we rely on the industry knowledge and relationships of our key personnel.
We believe our success depends to a significant extent upon the efforts and abilities of our executive officers, senior management and key employees, including our regional vice presidents. The unexpected or unanticipated loss of the services of one or more members of our senior management team could have an adverse effect on us and impair the efficiency and productivity of our operations. We do not have key man insurance for any of our executive officers or key personnel. In addition, the market for qualified employees in the industry and in the regions in which we operate, particularly for general managers and sales and service personnel, is highly competitive and may subject us to increased labor costs during periods of low unemployment. We do not have employment agreements with most of our dealership general managers and other key dealership personnel. Accordingly, the loss of any of our key employees or the failure to attract qualified managers could have an adverse effect on our business and may impact the ability of our dealerships to conduct their operations in accordance with our national standards.
Substantial competition in automotive sales and services may adversely affect our profitability due to our need to lower prices to sustain sales.
The automotive retail industry is highly competitive. Depending on the geographic market, we compete with:
• | franchised automotive dealerships in our markets that sell the same or similar makes of new and used vehicles that we offer, occasionally at lower prices than we do; |
• | other national or regional affiliated groups of franchised dealerships and/or of used vehicle dealerships; |
• | private market buyers and sellers of used vehicles; |
• | Internet-based vehicle brokers that sell vehicles obtained from franchised dealers directly to consumers; |
• | service center chain stores; and |
• | independent service and repair shops. |
We do not have any cost advantage in purchasing new vehicles from vehicle manufacturers and typically rely on advertising, merchandising, sales expertise, service reputation and dealership location in order to sell new vehicles. Our franchise agreements do not grant us the exclusive right to sell a manufacturer’s product within a given geographic area. Our revenues and profitability may be materially and adversely affected if competing dealerships expand their market share or are awarded additional franchises by manufacturers that supply our dealerships.
In addition to competition for vehicle sales, our dealerships compete with franchised dealerships to perform warranty repairs and with other automotive dealers, franchised and independent service center chains and independent garages for non-warranty repair and routine maintenance business. Our parts operations compete with other automotive dealers, service stores and auto parts retailers. We believe the principal competitive factors in the parts and service business are the quality of
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customer service, the use of factory-approved replacement parts, familiarity with a manufacturer’s brands and models, convenience, access to technology required for certain repairs and services, location, price, the competence of technicians and the availability of training programs to enhance such expertise. A number of regional or national chains offer selected parts and services at prices that may be lower than our dealerships’ prices. We also compete with a broad range of financial institutions in arranging financing for our customers’ vehicle purchases.
The Internet has also become a significant part of the advertising and sales process in our industry. Customers are using the Internet as part of the sales process to compare pricing for cars and related finance and insurance services, which may reduce gross profit margins for new and used cars and profits for related finance and insurance services. Some websites offer vehicles for sale over the Internet without the benefit of having a dealership franchise, although they must currently source their vehicles from a franchised dealer. If Internet new vehicle sales are allowed to be conducted without the involvement of franchised dealers, or if dealerships are able to effectively use the Internet to sell outside of their markets, our business could be materially adversely affected. We would also be materially adversely affected to the extent that Internet companies acquire dealerships or align themselves with our competitors’ dealerships.
Please see “Item 1. Business — Competition” for more discussion of competition in our industry.
The impairment of our goodwill, our indefinite-lived intangibles and our other long-lived assets has had, and may have in the future, a material adverse effect on our reported results of operations.
We assess goodwill and other indefinite-lived intangibles for impairment on an annual basis, or more frequently when events or circumstances indicate that an impairment may have occurred. We assess the carrying value of our long-lived assets when events or circumstances indicate that an impairment may have occurred.
Based on the organization and management of our business, we determined that each region qualified as reporting units for the purpose of assessing goodwill for impairment. To determine the fair value of our reporting units in assessing the carrying value of our goodwill for impairment, we use a combination of the discounted cash flow and market approaches. In addition, we are required to evaluate the carrying value of our indefinite-lived, intangible franchise rights at a dealership level. To test the carrying value of each individual intangible franchise right for impairment, we also use a discounted cash flow based approach. Both these analyses are based upon a series of assumptions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Policies and Accounting Estimates — Goodwill” and “Intangible Franchise Rights” for additional information on our assumptions. If any one of these assumptions changes, or fails to materialize, the resulting decline in our estimated fair value could result in a material non-cash impairment charge.
We are required to evaluate the carrying value of our long-lived assets at the lowest level of identifiable cash flows. To test the carrying value of assets to be sold, we generally use independent, third-party appraisals or pending transactions as an estimate of fair value. In the event of an adverse change in the real estate market, the resulting decline in our estimated fair value could result in a material non-cash impairment charge to the associated long-lived assets.
Changes in interest rates could adversely impact our profitability.
Borrowings under our Revolving Credit Facility, FMCC Facility, Mortgage Facility, and various other notes payable bear interest based on a floating rate. Therefore, our interest expense would increase with any rise in interest rates. We have entered into derivative transactions to convert a portion of our variable-rate debt to fixed rates to partially mitigate this risk. A rise in interest rates may also have the effect of depressing demand in the interest rate sensitive aspects of our business, particularly new and used vehicle sales, because many of our customers finance their vehicle purchases. As a result, a rise in interest rates may have the effect of simultaneously increasing our costs and reducing our revenues. In addition, we receive credit assistance from certain automobile manufacturers, which is reflected as a reduction in cost of sales on our statements of operations. Please see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” for a discussion regarding our interest rate sensitivity.
Natural disasters and adverse weather events can disrupt our business.
Our dealerships are concentrated in states and regions in the U.S. in which actual or threatened natural disasters and severe weather events (such as hurricanes, earthquakes and hail storms) have in the past, and may in the future disrupt our dealership operations. A disruption in our operations may adversely impact our business, results of operations, financial condition and cash flows. In addition to business interruption, the automotive retailing business is subject to substantial risk of property loss due to the significant concentration of property at dealership locations. Although we have, subject to certain limitations and exclusions, substantial insurance, including business interruption insurance, we may be exposed to uninsured or underinsured losses that could have a material adverse effect on our business, financial condition, and results of operations or cash flows.
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Our indebtedness and the associated covenants could materially adversely affect our financial health, limit our ability to finance future acquisitions and capital expenditures, prevent us from fulfilling our financial obligations and restrict our use of capital.
Our indebtedness could impact us, in the following ways:
• | our ability to obtain additional financing for acquisitions, capital expenditures, working capital or general corporate purposes may be impaired in the future; |
• | a portion of our current cash flow from operations must be dedicated to the payment of principal on our indebtedness, thereby reducing the funds available to us for our operations and other purposes; |
• | some of our borrowings are and will continue to be at variable rates of interest, which exposes us to the risk of increasing interest rates; and |
• | we may be more leveraged than some of our competitors, which may place us at a relative competitive disadvantage and make us more vulnerable to changing market conditions and regulations. |
Our debt instruments contain numerous covenants that limit our discretion with respect to business matters, including mergers or acquisitions, paying dividends, repurchasing our common stock, international investments, incurring additional debt or disposing of assets. A breach of any of these covenants could result in a default under the applicable agreement or indenture. In addition, a default under one agreement or indenture could result in a default and acceleration of our repayment obligations under the other agreements or indentures under the cross default provisions in those agreements or indentures. If a default or cross default were to occur, we may be required to renegotiate the terms of our indebtedness, which would likely be on less favorable terms than our current terms and cause us to incur additional fees to process. Alternatively, we may not be able to pay our debts or borrow sufficient funds to refinance them. As a result of this risk, we could be forced to take actions that we otherwise would not take, or not take actions that we otherwise might take, in order to comply with the covenants in these agreements and indentures.
Our U.K. operations are subject to risks associated with foreign currency and exchange rate fluctuations.
We are exposed to additional risks related to our foreign operations in the U.K., including:
• | exposure to currency and exchange rate fluctuations; |
• | unexpected changes in laws, regulations, and policies of foreign governments or other regulatory bodies; |
• | lack of franchise protection, which creates greater competition; and |
• | additional tariffs, trade restrictions, restrictions on repatriation of foreign earnings, and international tax laws and treaties. |
Our Consolidated Financial Statements reflect that our results of operations and financial position are reported in local currency and are converted into U.S. Dollars at the applicable currency rate. Fluctuations in such currency rates may have a material effect on our results of operations or financial position as reported in U.S. Dollars. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk — Foreign Currency Exchange Rates” for additional information on foreign currency exchange rate sensitivity.
Certain restrictions relating to our management and ownership of our common stock could deter prospective acquirers from acquiring control of us and adversely affect our ability to engage in equity offerings.
As a condition to granting their consent to our previous acquisitions and our initial public offering, some of our manufacturers have imposed other restrictions on us. These restrictions prohibit, among other things:
• | any one person, who in the opinion of the manufacturer is unqualified to own its franchised dealership or has interests incompatible with the manufacturer, from acquiring more than a specified percentage of our common stock (ranging from 20% to 50% depending on the particular manufacturer’s restrictions) and this trigger level can fall to as low as 5% if another vehicle manufacturer is the entity acquiring the ownership interest or voting rights; |
• | certain material changes in our business or extraordinary corporate transactions such as a merger or sale of a material amount of our assets; |
• | the removal of a dealership general manager without the consent of the manufacturer; and |
• | a change in control of our Board of Directors or a change in management. |
Our manufacturers may also impose additional similar restrictions on us in the future. Actions by our stockholders or prospective stockholders, which would violate any of the above restrictions, are generally outside our control. If we are
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unable to comply with or renegotiate these restrictions, we may be forced to terminate or sell one or more franchises, which could have a material adverse effect on us. These restrictions may prevent or deter prospective acquirers from acquiring control of us and, therefore, may adversely impact the value of our common stock. These restrictions also may impede our ability to acquire dealership groups, to raise required capital or to issue our stock as consideration for future acquisitions.
Our certificate of incorporation, bylaws and franchise agreements contain provisions that make a takeover of us difficult.
Our certificate of incorporation and bylaws could make it more difficult for a third party to acquire control of us, even if such change of control would be beneficial to our stockholders. These include provisions:
• | providing for a Board of Directors with staggered, three-year terms, permitting the removal of a non-employee director from office only for cause; |
• | allowing only the Board of Directors to set the number of non-employee directors; |
• | requiring super-majority or class voting to affect certain amendments to our certificate of incorporation and bylaws; |
• | limiting the persons who may call special stockholders’ meetings; |
• | limiting stockholder action by written consent; and |
• | establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted upon at stockholders’ meetings. |
In addition, our certificate of incorporation authorizes us to issue “blank check” preferred stock, the designation, number, voting powers, preferences, and rights of which may be fixed or altered from time to time by our Board of Directors. Accordingly, the Board of Directors has the authority, without stockholder approval, to issue preferred stock with rights that could materially adversely affect the voting power or other rights of the common stock holders or the market value of the common stock and prevent a change of our control.
Finally, certain of our franchise agreements prohibit the acquisition of more than a specified percentage of our common stock without the consent of the relevant manufacturer. These terms of our franchise agreements could also make it more difficult for a third party to acquire control of us.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
We presently lease our corporate headquarters, which is located at 800 Gessner, Suite 500, Houston, Texas. In addition, as of December 31, 2012, we had 157 franchises situated in 121 dealership locations throughout 15 states in the U.S. and in the U.K. As of December 31, 2012, we leased 72 of these locations and owned the remainder. We have one location in Massachusetts, one location in Alabama and one location in California where we lease the land, but own the building facilities. These locations are included in the leased column of the table below.
Dealerships | ||||||||
Region | Geographic Location | Owned | Leased | |||||
East | Massachusetts | 4 | 3 | |||||
Georgia | 4 | 1 | ||||||
New Jersey | 4 | 3 | ||||||
Maryland | 2 | — | ||||||
Mississippi | 3 | — | ||||||
South Carolina | 3 | 1 | ||||||
Alabama | 1 | 1 | ||||||
New York | 1 | 3 | ||||||
Florida | 3 | 1 | ||||||
New Hampshire | 1 | 2 | ||||||
Louisiana | — | 4 | ||||||
26 | 19 | |||||||
West | Texas | 10 | 28 | |||||
California | 2 | 10 | ||||||
Kansas | 4 | — | ||||||
Oklahoma | 2 | 10 | ||||||
18 | 48 | |||||||
International | United Kingdom | 5 | 5 | |||||
Total | 49 | 72 | ||||||
We use a number of facilities to conduct our dealership operations. Each of our dealerships may include facilities for (1) new and used vehicle sales, (2) vehicle service operations, (3) retail and wholesale parts operations, (4) collision service operations, (5) storage and (6) general office use. Prior to 2005, we tried to structure our operations so as to avoid the ownership of real property. In connection with our dealership acquisitions, we generally sought to lease, rather than acquire, the facilities on which the acquired dealerships were located. We generally entered into lease agreements with respect to such facilities that have 30-year total terms, consisting of 15-year initial terms and three five-year option periods, at our option. As a result, we lease the majority of our facilities under long-term operating leases. See Note 18 to our Consolidated Financial Statements, “Operating Leases.”
Since 2005, Group 1 Realty, Inc., one of our wholly-owned subsidiaries, has typically acquired the property in connection with our dealership acquisitions and relocations and acts as the landlord for those dealership operations. For the year ended December 31, 2012, we acquired $69.7 million of real estate, of which $44.4 million was purchased in conjunction with our dealership acquisitions. With these acquisitions, the capitalized value of the real estate used in operations that we owned was $518.0 million as of December 31, 2012. Of this total, $441.3 million is mortgaged through our Mortgage Facility or another real estate related borrowing arrangement. We do not believe that any single facility is material to our operations and, if necessary, we would obtain a replacement facility.
Item 3. Legal Proceedings
From time to time, our dealerships are named in various types of litigation involving customer claims, employment matters, class action claims, purported class action claims, as well as claims involving the manufacturer of automobiles, contractual disputes and other matters arising in the ordinary course of business. Due to the nature of the automotive retailing business, we may be involved in legal proceedings or suffer losses that could have a material adverse effect on our business. In the normal course of business, we are required to respond to customer, employee and other third-party complaints. Amounts that have been accrued or paid related to the settlement of litigation are included in Selling, General and Administrative expenses ("SG&A") in our Consolidated Statements of Operations. In addition, the manufacturers of the vehicles that we sell and service have audit rights allowing them to review the validity of amounts claimed for incentive, rebate or warranty-related
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items and charge us back for amounts determined to be invalid payments under the manufacturers’ programs, subject to our right to appeal any such decision. Amounts that have been accrued or paid related to the settlement of manufacturer chargebacks of recognized incentives and rebates are included in cost of sales in our Consolidated Statements of Operations, while such amounts for manufacturer chargebacks of recognized warranty-related items are included as a reduction of revenues in our Consolidated Statements of Operations.
In December 2011, an adverse jury verdict was rendered against us in the San Diego County Superior Court, awarding $7.5 million to the plaintiff who sought reimbursement for medical expenses, lost wages and pain and suffering arising from an accident involving one of our customer shuttle vans and the plaintiff’s motorcycle. We have appealed the verdict and will continue to pursue the appeal at all levels available under the law. We maintain insurance coverage for any loss in excess of our $1.0 million self-insured retention. We have fully accrued the amount of the award and the related insurance charge as a current account receivable and a current accrued expense, respectively, in the accompanying Consolidated Balance Sheets as of December 31, 2012 and 2011. Our insurance deductible was recognized as SG&A expense during the year ended December 31, 2011.
Notwithstanding the foregoing, we are not party to any legal proceedings, including class action lawsuits that, individually or in the aggregate, are reasonably expected to have a material adverse effect on our results of operations, financial condition or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our results of operations, financial condition or cash flows.
Item 4. Mine Safety Disclosures
Not Applicable.
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PART II
Item 5. Market for Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the New York Stock Exchange under the symbol “GPI.” There were 54 holders of record of our common stock as of February 14, 2013. A substantially greater number of holders of our common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.
The following table presents the quarterly high and low sales prices for our common stock, as reported on the New York Stock Exchange Composite Tape under the symbol “GPI” and dividends paid per common share for 2011 and 2012:
High | Low | Dividends Declared | ||||||||||
2011: | ||||||||||||
First Quarter | $ | 43.15 | $ | 37.32 | $ | 0.11 | ||||||
Second Quarter | 44.98 | 35.43 | 0.11 | |||||||||
Third Quarter | 49.82 | 33.67 | 0.13 | |||||||||
Fourth Quarter | 52.16 | 33.31 | 0.13 | |||||||||
2012: | ||||||||||||
First Quarter | $ | 57.71 | $ | 47.95 | $ | 0.14 | ||||||
Second Quarter | 59.97 | 43.63 | 0.15 | |||||||||
Third Quarter | 61.06 | 44.98 | 0.15 | |||||||||
Fourth Quarter | 65.99 | 57.31 | 0.15 | |||||||||
We expect comparable cash dividends to be paid in the future. However, payment of dividends in the future is subject to the discretion of our Board of Directors after considering our results of operations, financial condition, cash flows, capital requirements, outlook for our business, general business conditions, the political and legislative environments and other factors.
Further, we are limited under the terms of the Revolving Credit Facility and Mortgage Facility in our ability to make cash dividend payments to our stockholders and to repurchase shares of our outstanding common stock, based primarily on our quarterly net income or loss. As of December 31, 2012, the Restricted Payment Basket under both facilities was $115.6 million. The Restricted Payment Basket will increase in the future periods by 50.0% of our cumulative net income, as well as the net proceeds from stock option exercises, and decrease by subsequent payments for cash dividends and share repurchases.
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Performance Graph
The following Performance Graph and related information shall not be deemed “soliciting material” or “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
The graph compares the performance of our common stock to the S&P 500 Index and to an industry peer group for our last five fiscal years. The members of the peer group are Asbury Automotive Group, Inc., AutoNation, Inc., Lithia Motors, Inc., Penske Automotive Group, Inc. and Sonic Automotive, Inc. The source for the information contained in this table is Zacks Investment Research, Inc.
The returns of each member of the peer group are weighted according to each member’s stock market capitalization as of the beginning of each period measured. The graph assumes that the value of the investment in our common stock, the S&P 500 Index and the peer group was $100 on the last trading day of December 2007, and that all dividends were reinvested. Performance data for Group 1 Automotive, Inc., the S&P 500 Index and for the peer group is provided as of the last trading day of each of our last five fiscal years.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS
AMONG GROUP 1 AUTOMOTIVE, INC., S&P 500 INDEX AND A PEER GROUP
TOTAL RETURN BASED ON $100 INITIAL INVESTMENT & REINVESTMENT OF DIVIDENDS
Measurement Date | Group 1 Automotive, Inc. | S&P 500 | Peer Group | |||
December 2007 | $100.00 | $100.00 | $100.00 | |||
December 2008 | 46.39 | 62.99 | 47.61 | |||
December 2009 | 122.10 | 79.65 | 96.65 | |||
December 2010 | 180.31 | 91.64 | 134.95 | |||
December 2011 | 226.18 | 93.57 | 168.77 | |||
December 2012 | 273.58 | 108.53 | 216.06 | |||
Purchases of Equity Securities by the Issuer
No shares of our common stock were repurchased during the three months ended December 31, 2012. See “Item 1. Business — Stock Repurchase Program” for more information.
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Item 6. Selected Financial Data
The following selected historical financial data as of December 31, 2012, 2011, 2010, 2009, and 2008, and for the five years in the period ended December 31, 2012, have been derived from our audited Consolidated Financial Statements, subject to certain reclassifications to make prior years conform to the current year presentation, except for the earnings per share data in 2008, which has been restated to conform with our adoption of the two-class method for computing earnings per share. This selected financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related notes included elsewhere in this Form 10-K.
We have accounted for all of our dealership acquisitions using the purchase method of accounting. As a result, we do not include in our financial statements the results of operations of these dealerships prior to the date we acquired them, which may impact the comparability of the financial information presented. Also, as a result of the effects of our acquisitions, dispositions, and other potential factors in the future, the historical financial information described in the selected financial data is not necessarily indicative of our results of operations and financial position in the future or the results of operations and financial position that would have resulted had such transactions occurred at the beginning of the periods presented in the selected financial data.
Year Ended December 31, | ||||||||||||||||||||
2012 | 2011 | 2010 | 2009 | 2008 (3) | ||||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||||
Income Statement Data: | ||||||||||||||||||||
Revenues | $ | 7,476,100 | $ | 6,079,765 | $ | 5,509,169 | $ | 4,525,707 | $ | 5,654,087 | ||||||||||
Cost of sales | 6,358,848 | 5,119,165 | 4,632,136 | 3,749,870 | 4,738,426 | |||||||||||||||
Gross profit | 1,117,252 | 960,600 | 877,033 | 775,837 | 915,661 | |||||||||||||||
Selling, general and administrative expenses | 848,446 | 735,229 | 693,635 | 621,048 | 739,430 | |||||||||||||||
Depreciation and amortization expense | 31,534 | 27,063 | 26,455 | 25,828 | 25,652 | |||||||||||||||
Asset impairments | 7,276 | 4,805 | 10,840 | 20,887 | 163,023 | |||||||||||||||
Income (loss) from operations | 229,996 | 193,503 | 146,103 | 108,074 | (12,444 | ) | ||||||||||||||
Other income and (expense): | ||||||||||||||||||||
Floorplan interest expense | (31,796 | ) | (27,687 | ) | (34,110 | ) | (32,345 | ) | (46,377 | ) | ||||||||||
Other interest expense, net | (37,465 | ) | (33,722 | ) | (27,217 | ) | (29,075 | ) | (36,783 | ) | ||||||||||
Gain (loss) on redemption of long-term debt | — | — | (3,872 | ) | 8,211 | 18,126 | ||||||||||||||
Other income (expense), net | — | — | — | (14 | ) | 302 | ||||||||||||||
Income (loss) from continuing operations before income taxes | 160,735 | 132,094 | 80,904 | 54,851 | (77,176 | ) | ||||||||||||||
Benefit (provision) for income taxes | (60,526 | ) | (49,700 | ) | (30,600 | ) | (20,006 | ) | 31,166 | |||||||||||
Income (loss) from continuing operations | 100,209 | 82,394 | 50,304 | 34,845 | (46,010 | ) | ||||||||||||||
Loss related to discontinued operations, net of tax | — | — | — | — | (2,003 | ) | ||||||||||||||
Net income (loss) | $ | 100,209 | $ | 82,394 | $ | 50,304 | $ | 34,845 | $ | (48,013 | ) | |||||||||
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Year Ended December 31, | ||||||||||||||||||||
2012 | 2011 | 2010 | 2009 | 2008 (3) | ||||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||||
Earnings (loss) per common share: | ||||||||||||||||||||
Basic: | ||||||||||||||||||||
Income (loss) from continuing operations | $ | 4.39 | $ | 3.50 | $ | 2.09 | $ | 1.43 | $ | (1.57 | ) | |||||||||
Loss related to discontinued operations, net of tax | — | — | — | — | (0.09 | ) | ||||||||||||||
Net income (loss) | $ | 4.39 | $ | 3.50 | $ | 2.09 | $ | 1.43 | $ | (1.66 | ) | |||||||||
Diluted: | ||||||||||||||||||||
Income (loss) from continuing operations | $ | 4.19 | $ | 3.47 | $ | 2.09 | $ | 1.43 | $ | (1.57 | ) | |||||||||
Loss related to discontinued operations, net of tax | — | — | — | — | (0.09 | ) | ||||||||||||||
Net income (loss) | $ | 4.19 | $ | 3.47 | $ | 2.09 | $ | 1.43 | $ | (1.66 | ) | |||||||||
Dividends per share | $ | 0.59 | $ | 0.48 | $ | 0.10 | $ | — | $ | 0.47 | ||||||||||
Weighted average common shares outstanding: | ||||||||||||||||||||
Basic | 21,620 | 22,157 | 22,767 | 22,888 | 22,513 | |||||||||||||||
Diluted | 22,688 | 22,409 | 22,788 | 22,906 | 22,532 | |||||||||||||||
December 31, | ||||||||||||||||||||
2012 | 2011 | 2010 | 2009 | 2008 | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
Working capital | $ | 170,603 | $ | 130,637 | $ | 124,300 | $ | 103,225 | $ | 92,128 | ||||||||||
Inventories | 1,194,288 | 867,470 | 777,771 | 596,743 | 845,944 | |||||||||||||||
Total assets | 3,023,015 | 2,476,343 | 2,201,964 | 1,969,414 | 2,288,114 | |||||||||||||||
Floorplan notes payable — credit facility (1) | 856,698 | 609,738 | 560,840 | 420,319 | 693,692 | |||||||||||||||
Floorplan notes payable — manufacturer affiliates | 211,965 | 155,980 | 103,345 | 115,180 | 128,580 | |||||||||||||||
Acquisition line | — | — | — | — | 50,000 | |||||||||||||||
Mortgage facility, including current portion | 56,677 | 41,003 | 42,600 | 192,727 | 177,998 | |||||||||||||||
Long-term debt, including current portion | 521,010 | 456,261 | 423,539 | 265,769 | 322,319 | |||||||||||||||
Temporary Equity (4) | 32,505 | — | — | — | — | |||||||||||||||
Stockholders’ equity | $ | 860,284 | $ | 807,100 | $ | 784,368 | $ | 720,156 | $ | 662,117 | ||||||||||
Long-term debt to capitalization (2) | 39 | % | 38 | % | 37 | % | 39 | % | 45 | % | ||||||||||
(1) Includes immediately available funds of $112.3 million, $109.2 million, $129.2 million, $71.6 million, and $44.9 million, respectively, that we temporarily invest as an offset to the gross outstanding borrowings.
(2) Includes the Acquisition Line, Mortgage Facility and other long-term debt and excludes short-term financing.
(3) Earnings per share data has been restated to conform with our adoption of the two-class method of computing earnings per share.
(4) For the long-term debt to capitalization, temporary equity is included as a component of the capitalization.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with Part I, including the matters set forth in “Item 1A. Risk Factors,” and our Consolidated Financial Statements and notes thereto included elsewhere in this Form 10-K.
Overview
We are a leading operator in the automotive retail industry. As of December 31, 2012, we owned and operated 142 franchises, representing 31 brands of automobiles, at 111 dealership locations and 28 collision service centers in the U.S. and 15 franchises at ten dealerships and three collision centers in the U.K. Through our dealerships, we sell new and used cars and light trucks; arrange related vehicle financing; service and insurance contracts; provide automotive maintenance and repair services; and sell vehicle parts. Our operations are primarily located in major metropolitan areas in Alabama, California, Florida, Georgia, Kansas, Louisiana, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, Oklahoma, South Carolina, and Texas in the U.S. and in the towns of Brighton, Chelmsford, Chingford, Farnborough, Hailsham, Harold Wood, Hindhead, Southend, Stanstead, and Worthing in the U.K.
As of December 31, 2012, our U.S. retail network consisted of the following two regions (with the number of dealerships they comprised): (a) the East (45 dealerships in Alabama, Florida, Georgia, Louisiana, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, and South Carolina) and (b) the West (66 dealerships in California, Kansas, Oklahoma, and Texas). Each region is managed by a regional vice president who reports directly to our Chief Executive Officer and is responsible for the overall performance of their regions, as well as for overseeing the market directors and dealership general managers that report to them. Each region is also managed by a regional chief financial officer who reports directly to our Chief Financial Officer. Our dealerships in the U.K. are also managed locally with direct reporting responsibilities to our corporate management team.
We typically seek to acquire large, profitable, well-established and well-managed dealerships that are leaders in their respective market areas. From January 1, 2008, through December 31, 2012, we have purchased 41 franchises with expected annual revenues at the time of acquisition of $1.6 billion and been granted nine new franchises by our manufacturers, with expected annual revenues at the time of acquisition of $119.7 million. In 2012 alone, we acquired one domestic, eight import, and seven luxury franchises with expected annual revenues at the time of acquisition of $715.0 million. We make disposition decisions based principally on the rate of return on our capital investment, the location of the dealership, our ability to leverage our cost structure, the brand, and existing real estate obligations. From January 1, 2008 through December 31, 2012, we disposed of or terminated 41 franchises with annual revenues of approximately $503.6 million. Specifically, during 2012, we disposed of three luxury and three import franchises with annual revenues of approximately $127.9 million. In the following discussion and analysis, we report certain performance measures of our newly acquired and disposed dealerships separately from those of our existing dealerships.
Our operating results reflect the combined performance of each of our interrelated business activities, which include the sale of new vehicles, used vehicles, finance and insurance products, and parts, as well as service and collision repair services. Historically, each of these activities has been directly or indirectly impacted by a variety of supply/demand factors, including vehicle inventories, consumer confidence, consumer discretionary spending, availability and affordability of consumer credit, manufacturer incentives, weather patterns, fuel prices, and interest rates. For example, during periods of sustained economic downturn or significant supply/demand imbalances, new vehicle sales may be negatively impacted as consumers tend to shift their purchases to used vehicles. Some consumers may even delay their purchasing decisions altogether, electing instead to repair their existing vehicles. In such cases, however, we believe the new vehicle sales impact on our overall business is mitigated by our ability to offer other products and services, such as used vehicles and parts, service and collision repair services, as well as our ability to reduce our costs in response to lower sales.
We generally experience higher volumes of vehicle sales and service in the second and third calendar quarters of each year. This seasonality is generally attributable to consumer buying trends and the timing of manufacturer new vehicle model introductions. In addition, in some regions of the U.S., vehicle purchases decline during the winter months due to inclement weather. As a result, our revenues and operating income are typically lower in the first and fourth quarters and higher in the second and third quarters. Other factors unrelated to seasonality, such as changes in economic condition and manufacturer incentive programs, may exaggerate seasonal or cause counter-seasonal fluctuations in our revenues and operating income.
According to industry experts, the annual new unit sales for 2012 increased 1.7 million units, or 13.3%, to 14.5 million units, compared to 12.8 million units in 2011. For the year ended December 31, 2012, our total revenues increased 23.0% from 2011 to $7.5 billion and gross profit improved 16.3% to $1.1 billion. For the years ended December 31, 2011 and 2010, total revenues were $6.1 billion and $5.5 billion, respectively. For the years ended December 31, 2011 and 2010, gross profits were $960.6 million and 877.0 million, respectively. For the year ended December 31, 2012, we realized net income of $100.2 million, or $4.19 per diluted common share, and for the years ended December 31, 2011 and 2010, we realized net income of $82.4 million, or $3.47 per diluted share, and $50.3 million, or $2.09 per diluted share, respectively. In addition to the matters described above, the following factors impacted our financial condition and results of operations in 2012, 2011, and 2010:
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Year Ended December 31, 2012:
• | Asset Impairments: We determined that the fair value of indefinite-lived intangible franchise rights related to three of our franchises did not exceed their carrying value and an impairment charge was required. Accordingly, we recorded a $7.0 million pretax non-cash impairment charge during the fourth quarter of 2012. We also recognized a total of $0.3 million in pretax non-cash asset impairment charges related to impairment of various long-lived assets. |
• | Non-Cash Interest Expense: Our 2012 results were negatively impacted by $9.9 million of non-cash interest expense relative to the amortization of the discount associated with our 2.25% Notes and 3.00% Notes representing the impact of the accounting for convertible debt as required by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 470, Debt (“ASC 470”). |
Year Ended December 31, 2011:
• | Asset Impairments: We recognized a total of $4.8 million in pretax non-cash asset impairment charges, primarily related to the impairment of held-for-sale assets of $3.2 million and other various long-lived assets of $1.6 million. |
• | Non-Cash Interest Expense: Our 2011 results were negatively impacted by $9.1 million of non-cash interest expense relative to the amortization of the discount associated with our 2.25% Notes and 3.00% Notes representing the impact of the accounting for convertible debt as required by ASC 470. |
Year Ended December 31, 2010:
• | Asset Impairments: We recognized a total of $10.8 million in pretax non-cash asset impairment charges, primarily related to the impairment of assets held-for-sale and leasehold improvements, as well as other long-term assets. |
• | Convertible Debt Offering and Debt Redemption: We issued $115.0 million aggregate principal amount of 3.00% Notes at par in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act which will mature on March 15, 2020, unless earlier repurchased or converted in accordance with their terms prior to such date. In conjunction with using the proceeds of our 3.00% Notes offering, we completed the redemption of our then outstanding $74.6 million face value 8.25% Senior Subordinated Notes (“8.25% Notes”) at a redemption price of 102.75% of the principal amount of the notes. We incurred a $3.9 million pretax charge in completing the redemption, consisting primarily of a $2.1 million redemption premium, a $1.5 million write-off of unamortized bond discount and deferred costs and $0.3 million of other debt extinguishment costs. |
• | Non-Cash Interest Expense: Our 2010 results were negatively impacted by $7.7 million of non-cash interest expense relative to the amortization of the discount associated with our 2.25% Notes and 3.00% Notes representing the impact of the accounting for convertible debt as required by ASC 470. |
These items, and other variances between the periods presented, are covered in the following discussion.
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Key Performance Indicators
The following table highlights certain of the key performance indicators we use to manage our business:
Consolidated Statistical Data
For the Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Unit Sales | ||||||||||||
Retail Sales | ||||||||||||
New Vehicle | 128,550 | 102,022 | 97,511 | |||||||||
Used Vehicle | 85,366 | 70,475 | 66,001 | |||||||||
Total Retail Sales | 213,916 | 172,497 | 163,512 | |||||||||
Wholesale Sales | 43,756 | 35,997 | 33,524 | |||||||||
Total Vehicle Sales | 257,672 | 208,494 | 197,036 | |||||||||
Gross Margin | ||||||||||||
New Vehicle Retail Sales | 5.8 | % | 6.2 | % | 5.8 | % | ||||||
Total Used Vehicle Sales | 7.3 | % | 7.7 | % | 7.9 | % | ||||||
Parts and Service Sales | 52.4 | % | 52.3 | % | 53.8 | % | ||||||
Total Gross Margin | 14.9 | % | 15.8 | % | 15.9 | % | ||||||
SG&A as a % of Gross Profit | 75.9 | % | 76.5 | % | 79.1 | % | ||||||
Operating Margin | 3.1 | % | 3.2 | % | 2.7 | % | ||||||
Pretax Margin | 2.1 | % | 2.2 | % | 1.5 | % | ||||||
Finance and Insurance Revenues per Retail Unit Sold | $ | 1,215 | $ | 1,135 | $ | 1,032 | ||||||
The following discussion briefly highlights certain of the results and trends occurring within our business. Throughout the following discussion, references are made to Same Store results and variances that are discussed in more detail in the “Results of Operations” section that follows.
Over the course of 2012, our industry experienced an increase in new vehicle unit sales. While total industry sales are still low relative to years before 2008, unit sales have risen from 12.8 million for the twelve months ended December 31, 2011 to 14.5 million in 2012. Our new vehicle retail sales revenues increased 26.1% for the twelve months ended December 31, 2012 as compared to 2011. This growth primarily reflects an increase in new vehicle unit sales of 26.0% for the year ended December 31, 2012, reflecting stronger consumer confidence, improved inventory levels in our import brands that had experienced shortages as a result of the March 2011 natural disaster in Japan, and strong execution by our operating team. New vehicle retail gross margin declined during the year ended December 31, 2012 primarily as industry-wide new vehicle inventory levels returned to more normalized levels following the shortage in most of 2011.
Our used vehicle results are directly affected by economic conditions, the level of manufacturer incentives on new vehicles and new vehicle financing, the number and quality of trade-ins and lease turn-ins, the availability of consumer credit, and our ability to effectively manage the level and quality of our overall used vehicle inventory. Our used vehicle retail sales revenues increased 24.0% for the twelve months ended December 31, 2012 as compared to 2011. This growth primarily reflects an increase in the used vehicle unit sales of 21.1% for the year ended December 31, 2012 as compared to 2011. The improving economic environment that has benefited new vehicle sales also supported improved used vehicle demand. Used vehicle gross margins declined for the twelve months ended December 31, 2012, due to a decrease in gross profit per unit sold coupled with an increase in the sales price per unit.
Our parts and service sales increased by 8.1%, for the year ended December 31, 2012, as compared to the same period in 2011, primarily driven by increases in our customer-pay parts and service business and in our collision business, as well as in our wholesale parts business. Our parts and service margins for 2012 increased to 52.4%, up 10 basis points from 2011, primarily as a result of an increase in internal work generated by increased new and used retail vehicle sales volumes.
Our consolidated finance and insurance income per retail unit sold increased to $1,215 for the twelve months of 2012, as compared to $1,135 in 2011, primarily driven by increases in income per contract from our finance, insurance, and other product offerings, as well as an increase in penetration rates for finance and vehicle service contracts.
Our total gross margin decreased 90 basis points to 14.9% for the twelve months ended December 31, 2012, primarily due to the shift in business mix towards the lower margin new and used vehicle businesses.
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Our consolidated SG&A expenses increased in absolute dollars for the twelve months ended December 31, 2012, as compared to 2011, primarily as a result of the correlation to vehicle sales volumes, as well as dealership acquisitions. However, SG&A as a percentage of gross profit declined 60 basis points to 75.9%, for the year ended December 31, 2012 from the same period in 2011, reflecting ongoing cost control and the leverage on our cost structure that higher revenues and gross profits provide.
For the twelve months ended December 31, 2012, floorplan interest expense increased 14.8%, as compared to 2011, primarily due to higher weighted average borrowings as our import brand inventories returned to more normalized levels following the March 2011 natural disasters in Japan and recent acquisitions. Other interest expense increased 11.1% for the year ended December 31, 2012, largely due to an increase in real estate related borrowings.
The combination of all of these factors, including $7.3 million of asset impairments, resulted in an operating margin of 3.1% for the twelve months ended December 31, 2012, which reflects a 10 basis-point decrease from 2011.
We address these items further, and other variances between the periods presented, in the “Results of Operations” section below.
Recent Accounting Pronouncements
Refer to Note 2 of our Consolidated Financial Statements, “Summary of Significant Accounting Polices and Estimates,” for a discussion of those most recent pronouncements that impact us.
Critical Accounting Policies and Accounting Estimates
The preparation of our financial statements in conformity with generally accepted accounting (“GAAP”) principles requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the balance sheet date and the amounts of revenues and expenses recognized during the reporting period. We analyze our estimates based on our historical experience and various other assumptions that we believe to be reasonable under the circumstances. However, actual results could differ from such estimates. The following is a discussion of our critical accounting estimates and policies.
We have identified below what we believe to be the most pervasive accounting policies and estimates that are of particular importance to the portrayal of our financial position, results of operations and cash flows. See Note 2 to our Consolidated Financial Statements, “Summary or Significant Accounting Policies and Estimates,” for further discussion of all our significant accounting policies and estimates.
Inventories. We carry new, used and demonstrator vehicle inventories, as well as parts and accessories inventories, at the lower of cost (determined on a first-in, first-out basis for parts and accessories) or market in the Consolidated Balance Sheets. Vehicle inventory cost consists of the amount paid to acquire the inventory, plus the cost of reconditioning, cost of equipment added and transportation cost. Additionally, we receive interest assistance from some of our automobile manufacturers. This assistance is accounted for as a vehicle purchase price discount and is reflected as a reduction to the inventory cost on our Consolidated Balance Sheets and as a reduction to cost of sales in our Statements of Operations as the vehicles are sold. At December 31, 2012 and 2011, inventory cost had been reduced by $7.8 million and $5.5 million, respectively, for interest assistance received from manufacturers. New vehicle cost of sales was reduced by $33.9 million, $26.1 million, and $24.0 million for interest assistance received related to vehicles sold for the years ended December 31, 2012, 2011, and 2010, respectively. Manufacturers' interest assistance ranged, over the past three years, from approximately 69.2% of our quarterly floorplan interest expense in the first quarter of 2010 to 115.9% for the third quarter of 2012, and was 103.2% for the fourth quarter of 2012.
As the market value of inventory typically declines over time, we establish new and used vehicle reserves based on our historical loss experience and considerations of current market trends. These reserves are charged to cost of sales and reduce the carrying value of inventory on hand. Used vehicles are complex to value as there is no standardized source for determining exact values and each vehicle and each market in which we operate is unique. As a result, the value of each used vehicle taken at trade-in, or purchased at auction, is determined based on industry data, primarily accessed via our used vehicle management software and the industry expertise of the responsible used vehicle manager. Valuation risk is partially mitigated, by the speed at which we turn this inventory. At December 31, 2012, our used vehicle days’ supply was 38 days.
Goodwill. As of December 31, 2012, we defined our reporting units as each of our two regions in the U.S. and the U.K. Goodwill represents the excess, at the date of acquisition, of the purchase price of the business acquired over the fair value of the net tangible and intangible assets acquired. Annually in the fourth quarter, based on the carrying values of our regions as of October 31st, we perform a fair value and potential impairment assessment of goodwill. An impairment analysis is done more frequently if certain events or circumstances arise that would indicate a change in the fair value of the non-financial asset has occurred (i.e., an impairment indicator).
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In evaluating goodwill for impairment, we compare the carrying value of the net assets of each reporting unit to its respective fair value. This represents the first step of the impairment test. If the fair value of a reporting unit is less than the carrying value of its net assets, we are then required to proceed to step two of the impairment test. Step two involves allocating the calculated fair value to all of the tangible and identifiable intangible assets of the reporting unit as if the calculated fair value was the purchase price in a business combination. To the extent the carrying value of the goodwill exceeds its implied fair value under step two of the impairment test, a non-cash impairment charge equal to the difference is recorded.
We use a combination of the discounted cash flow, or income approach (80% weighted), and the market approach (20% weighted) to determine the fair value of our reporting units. Included in the discounted cash flow are assumptions regarding revenue growth rates, future gross margins, future SG&A expenses and an estimated WACC. We also must estimate residual values at the end of the forecast period and future capital expenditure requirements. Specifically, with regards to the valuation assumptions utilized in the income approach as of December 31, 2012, we based our analysis on a slow recovery back to a seasonally adjusted annual rate ("SAAR") of 16.5 million units by 2017. For the market approach, we utilize recent market multiples of guideline companies for both revenue (20% weighted) and pretax net income (80% weighted). Each of these assumptions requires us to use our knowledge of (1) the industry, (2) recent transactions and (3) reasonable performance expectations for our operations. If any one of the above assumptions change, in some cases insignificantly, or fails to materialize, the resulting decline in the estimated fair value could result in a material non-cash impairment charge to the goodwill associated with our reporting unit(s).
Intangible Franchise Rights. Our only significant identifiable intangible assets, other than goodwill, are rights under franchise agreements with manufacturers, which are recorded at an individual dealership level. We expect these franchise agreements to continue for an indefinite period and, when these agreements do not have indefinite terms, we believe that renewal of these agreements can be obtained without substantial cost. As such, we believe that our franchise agreements will contribute to cash flows for an indefinite period and, therefore, the carrying amounts of the franchise rights are not amortized. Franchise rights acquired in business acquisitions prior to July 1, 2001, were recorded and amortized as part of goodwill and remain as part of goodwill at December 31, 2012 and 2011 in the accompanying Consolidated Balance Sheets. Since July 1, 2001, intangible franchise rights acquired in business combinations have been recorded as distinctly separate intangible assets and, in accordance with guidance primarily codified within ASC 350, Intangibles — Goodwill and Other (“ASC 350”), we evaluate these franchise rights for impairment annually in the fourth quarter, based on the carrying values of our individual dealerships as of October 31st, or more frequently if events or circumstances indicate possible impairment has occurred.
In performing our impairment assessments, we test the carrying value of each individual franchise right that was recorded using a direct value method discounted cash flow model, or income approach, specifically the excess earnings method. Included in this analysis are assumptions, at a dealership level, regarding the cash flows directly attributable to the franchise right, revenue growth rates, future gross margins and future SG&A expenses. Using an estimated WACC, estimated residual values at the end of the forecast period and future capital expenditure requirements, we calculate the fair value of each dealership’s franchise rights after considering estimated values for tangible assets, working capital and workforce.
If any one of the above assumptions change or fails to materialize, the resulting decline in the intangible franchise rights’ estimated fair value could result in a non-cash impairment charge to the intangible franchise right associated with the applicable dealership. See Note 15 to our Consolidated Financial Statements, “Asset Impairments,” and Note 16 to our Consolidated Financial Statements, “Intangible Franchise Rights and Goodwill,” for additional details regarding our intangible franchise rights.
Revenue Recognition. Revenues from vehicle sales, parts sales, and vehicle service are recognized upon completion of the sale or service and delivery to the customer. Conditions to completing a sale include having an agreement with the customer, including pricing, and the sales price must be reasonably expected to be collected. We include revenues from our collision center operations in parts and services sales.
We record the profit we receive for arranging vehicle fleet transactions net in other finance and insurance revenues. Since all sales of new vehicles must occur through franchised new vehicle dealerships, the dealerships effectively act as agents for the automobile manufacturers in completing sales of vehicles to fleet customers. As these customers typically order the vehicles, we have no significant inventory risk. Additionally, fleet customers generally receive special purchase incentives from the automobile manufacturers and we receive only a nominal fee for facilitating the transactions. Taxes collected from customers and remitted to governmental agencies are not included in total revenues.
We arrange financing for customers through various institutions and receive financing fees based on the difference between the loan rates charged to customers and wholesale financing rates set by the financing institution. In addition, we receive fees from the sale of insurance and vehicle service contracts to customers. Further, through agreements with certain vehicle service contract administrators, we earn volume incentive rebates and interest income on reserves, as well as participate in the underwriting profits of the products. We may be charged back for unearned financing, insurance contract or vehicle service contract fees in the event of early termination of the contracts by customers. Revenues from these fees are recorded at
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the time of the sale of the vehicles and a reserve for future amounts which might be charged back is established based on our historical chargeback results and the termination provisions of the applicable contracts. While chargeback results vary depending on the type of contract sold, a 10% change in the historical chargeback results used in determining estimates of future amounts which might be charged back would have changed the reserve at December 31, 2012, by $2.2 million.
Self-Insured Property and Casualty Reserves. We purchase insurance policies for worker’s compensation, liability, auto physical damage, property, pollution, employee medical benefits and other risks consisting of large deductibles and/or self-insured retentions.
Annually we engage a third-party actuary to conduct a study of the exposures under the self-insured portion of our worker’s compensation and general liability insurance programs for all open policy years. In the interim, we review the estimates within the study and monitor actual experience for unusual variances. The appropriate adjustments are made to the accrual, based upon these procedures. Actuarial estimates for the portion of claims not covered by insurance are based on historical claims experience adjusted for loss trending and loss development factors. Changes in the frequency or severity of claims from historical levels could influence our reserve for claims and our financial position, results of operations and cash flows. A 10% change in the actuarially determined estimate of aggregate future losses would have changed the reserve for these losses at December 31, 2012, by $2.7 million. Our auto physical damage insurance coverage contains an annual aggregate retention (stop loss) limit. For policy years ended prior to October 31, 2005, our workers’ compensation and general liability insurance coverage included aggregate retention (stop loss) limits in addition to a per claim deductible limit (“Stop Loss Plans”). Due to historical experience in both claims frequency and severity, the likelihood of breaching the aggregate retention limits described above was deemed remote, and as such, we elected not to purchase this stop loss coverage for the policy year beginning November 1, 2005 and for each subsequent year (“No Stop Loss Plans”). Our exposure per claim under the No Stop Loss Plans is limited to $1.0 million per occurrence, with unlimited exposure on the number of claims up to $1.0 million that we may incur.
Our maximum potential exposure under all of the Stop Loss Plans totaled $40.4 million at December 31, 2012, before consideration of amounts previously paid or accruals recorded related to our loss projections. After consideration of the amounts paid or accrued, the remaining potential loss exposure under the Stop Loss Plans totaled $16.7 million at December 31, 2012.
Fair Value of Assets Acquired and Liabilities Assumed. The values of assets acquired and liabilities assumed in business combinations are estimated using various assumptions. The most significant assumptions, and those requiring the most judgment, involve the estimated fair values of property and equipment and intangible franchise rights, with the remaining attributable to goodwill, if any. We utilize third-party experts to determine the fair values of property and equipment purchased and our fair value model to determine the fair value of our franchise rights.
Derivative Financial Instruments. One of our primary market risk exposures is increasing interest rates. Interest rate derivatives are used to adjust interest rate exposures when appropriate based on market conditions.
We follow the requirements of guidance primarily codified within ASC 815, Derivatives and Hedging (“ASC 815”) pertaining to the accounting for derivatives and hedging activities. ASC 815 requires us to recognize all derivative instruments on our Consolidated 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 loss. These deferred gains and losses are recognized in income in the period in which the related items being hedged are recognized in interest 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 interest expense. All of our interest rate hedges were designated as cash flow hedges and were deemed to be effective at December 31, 2012, 2011, and 2010.
We measure interest rate derivative instruments utilizing an income approach valuation technique, converting future amounts of cash flows to a single present value in order to obtain a transfer exit price within the bid and ask spread that is most representative of the fair value of our derivative instruments. In measuring fair value, the option-pricing Black-Scholes present value technique is utilized for all of our derivative instruments. This option-pricing technique utilizes a one-month London Interbank Offered Rate (“LIBOR”) forward yield curve, obtained from an independent external service provider, matched to the identical maturity term of the instrument being measured. Observable inputs utilized in the income approach valuation technique incorporate identical contractual notional amounts, fixed coupon rates, periodic terms for interest payments and contract maturity. Also included in our fair value estimate is a consideration of credit risk. Because the interest rate derivative instruments were in a liability position, an estimate of our own credit risk was included in the fair value calculation, based upon the spread between the one-month LIBOR yield curve and the average 10 and 20-year retail rate for BB S&P rated companies, or 6.5%, as of December 31, 2012. We have determined the valuation measurement inputs of these derivative instruments to maximize the use of observable inputs that market participants would use in pricing similar or identical instruments and market data obtained from independent sources, which is readily observable or can be corroborated by observable market data for substantially the full term of the derivative instrument. Further, the valuation measurement inputs minimize the use of
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unobservable inputs. Accordingly, we have classified the derivatives within Level 2 of the ASC 820 hierarchy framework in Note 13 to our Consolidated Financial Statements, “Fair Value Measurements.” We validate the outputs of our valuation technique by comparison to valuations from the respective counterparties.
Income Taxes. Currently, we operate in 15 different states in the U.S. and in the U.K., each of which has unique tax rates and payment calculations. As the amount of income generated in each jurisdiction varies from period to period, our estimated effective tax rate can vary based on the proportion of taxable income generated in each jurisdiction. Deferred income taxes are recorded based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the underlying assets are realized or liabilities are settled. A valuation allowance reduces deferred tax assets when it is more likely than not that some or all of the deferred tax assets will not be realized. Each tax position must satisfy a threshold of more-likely-than-not and a measurement attribute for some or all of the benefits of that position to be recognized in a company's financial statements. See Note 7 to our Consolidated Financial Statements, “Income Taxes,” for additional information.
We have recognized deferred tax assets, net of valuation allowances, that we believe will be realized, based primarily on the assumption of future taxable income. To the extent that we have determined that net income attributable to certain state jurisdictions will not be sufficient to realize certain net operating losses, a corresponding valuation allowance has been established.
Results of Operations
The “Same Store” amounts presented below include the results of dealerships for the identical months in each period presented in the comparison, commencing with the first full month in which the dealership was owned by us and, in the case of dispositions, ending with the last full month it was owned by us. For example, for a dealership acquired in June 2011, the results from this dealership will appear in our Same Store comparison beginning in 2012 for the period July 2012 through December 2012, when comparing to July 2011 through December 2011 results. Depending on the periods being compared, the dealerships included in Same Store will vary. For this reason, the 2011 Same Store results that are compared to 2012 differ from those used in the comparison to 2010. Same Store results also include the activities of our corporate headquarters.
The following table summarizes our combined Same Store results for the year ended December 31, 2012 as compared to 2011 and for the year ended December 31, 2011 compared to 2010.
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Total Same Store Data
(dollars in thousands, except per unit amounts)
For The Year Ended December 31, | |||||||||||||||||||||
2012 | % Change | 2011 | 2011 | % Change | 2010 | ||||||||||||||||
Revenues | |||||||||||||||||||||
New vehicle retail | $ | 3,932,266 | 16.3% | $ | 3,381,216 | $ | 3,252,960 | 6.4% | $ | 3,056,307 | |||||||||||
Used vehicle retail | 1,618,272 | 14.8% | 1,409,253 | 1,361,006 | 7.9% | 1,261,856 | |||||||||||||||
Used vehicle wholesale | 254,052 | 1.7% | 249,693 | 240,467 | 13.1% | 212,631 | |||||||||||||||
Parts and service | 826,119 | 2.0% | 809,632 | 776,005 | 2.5% | 757,132 | |||||||||||||||
Finance, insurance and other | 242,706 | 24.6% | 194,775 | 188,105 | 12.4% | 167,339 | |||||||||||||||
Total revenues | $ | 6,873,415 | 13.7% | $ | 6,044,569 | $ | 5,818,543 | 6.7% | $ | 5,455,265 | |||||||||||
Cost of Sales | |||||||||||||||||||||
New vehicle retail | $ | 3,708,763 | 16.9% | $ | 3,172,080 | $ | 3,050,345 | 5.9% | $ | 2,880,105 | |||||||||||
Used vehicle retail | 1,483,616 | 15.4% | 1,285,545 | 1,241,438 | 8.2% | 1,147,551 | |||||||||||||||
Used vehicle wholesale | 251,381 | 2.3% | 245,615 | 236,166 | 12.6% | 209,649 | |||||||||||||||
Parts and service | 393,704 | 2.1% | 385,779 | 364,724 | 4.5% | 349,139 | |||||||||||||||
Total cost of sales | $ | 5,837,464 | 14.7% | $ | 5,089,019 | $ | 4,892,673 | 6.7% | $ | 4,586,444 | |||||||||||
Gross profit | $ | 1,035,951 | 8.4% | $ | 955,550 | $ | 925,870 | 6.6% | $ | 868,821 | |||||||||||
Selling, general and administrative expenses | $ | 783,702 | 7.2% | $ | 731,036 | $ | 706,558 | 4.1% | $ | 678,405 | |||||||||||
Depreciation and amortization expenses | $ | 29,834 | 10.6% | $ | 26,966 | $ | 26,187 | 2.0% | $ | 25,673 | |||||||||||
Floorplan interest expense | $ | 29,383 | 6.9% | $ | 27,486 | $ | 26,493 | (21.5)% | $ | 33,756 | |||||||||||
Gross margin | |||||||||||||||||||||
New vehicle retail | 5.7 | % | 6.2 | % | 6.2 | % | 5.8 | % | |||||||||||||
Used vehicle | 7.3 | % | 7.7 | % | 7.7 | % | 8.0 | % | |||||||||||||
Parts and service | 52.3 | % | 52.4 | % | 53.0 | % | 53.9 | % | |||||||||||||
Total gross margin | 15.1 | % | 15.8 | % | 15.9 | % | 15.9 | % | |||||||||||||
SG&A as a % of gross profit | 75.7 | % | 76.5 | % | 76.3 | % | 78.1 | % | |||||||||||||
Operating margin | 3.1 | % | 3.2 | % | 3.2 | % | 2.9 | % | |||||||||||||
Finance and insurance revenues per retail unit sold | $ | 1,232 | 8.4% | $ | 1,137 | $ | 1,139 | 10.3% | $ | 1,033 | |||||||||||
The discussion that follows provides explanation for the variances noted above. In addition, each table presents by primary income statement line item comparative financial and non-financial data of our Same Store locations, those locations acquired or disposed of (“Transactions”) during the periods and the consolidated company for the years ended December 31, 2012, 2011, and 2010.
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New Vehicle Retail Data
(dollars in thousands, except per unit amounts)
For The Year Ended December 31, | |||||||||||||||||||||
2012 | % Change | 2011 | 2011 | % Change | 2010 | ||||||||||||||||
Retail Unit Sales | |||||||||||||||||||||
Same Stores | 117,916 | 16.4% | 101,265 | 97,495 | 0.9% | 96,629 | |||||||||||||||
Transactions | 10,634 | 757 | 4,527 | 882 | |||||||||||||||||
Total | 128,550 | 26.0% | 102,022 | 102,022 | 4.6% | 97,511 | |||||||||||||||
Retail Sales Revenues | |||||||||||||||||||||
Same Stores | $ | 3,932,266 | 16.3% | $ | 3,381,216 | $ | 3,252,960 | 6.4% | $ | 3,056,307 | |||||||||||
Transactions | 358,832 | 21,431 | 149,687 | 30,500 | |||||||||||||||||
Total | $ | 4,291,098 | 26.1% | $ | 3,402,647 | $ | 3,402,647 | 10.2% | $ | 3,086,807 | |||||||||||
Gross Profit | |||||||||||||||||||||
Same Stores | $ | 223,503 | 6.9% | $ | 209,136 | $ | 202,615 | ||||||||||||||