lithia_10k-123111.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C.  20549
FORM 10-K

[X]           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended: December 31, 2011
OR
   [  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-14733

LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)

Oregon
 
93-0572810
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
360 E. Jackson Street, Medford, Oregon
 
97501
(Address of principal executive offices)
 
(Zip Code)

541-776-6899
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Class A common stock, without par value
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None
 (Title of Class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes [ ] No [X]

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act:  [  ]

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 [X]    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 [X]    No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.   [X]

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 definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [  ]   Accelerated filer [X]   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 Exchange Act).  Yes [   ]  No [ X ]

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $445,604,000 computed by reference to the last sales price ($19.63) as reported by the New York Stock Exchange for the Registrant’s Class A common stock, as of the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2011).

The number of shares outstanding of the Registrant’s common stock as of February 24, 2012 was: Class A: 22,235,942 shares and Class B: 3,762,231 shares.

Documents Incorporated by Reference
The Registrant has incorporated into Part III of Form 10-K, by reference, portions of its Proxy Statement for its 2012 Annual Meeting of Shareholders.


RDGPreambleEnd
 
 

 

LITHIA MOTORS, INC.
2011 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

   
Page
 
PART I
 
     
Item 1.
Business
2
     
Item 1A.
Risk Factors
11
     
Item 1B.
Unresolved Staff Comments
24
     
Item 2.
Properties
25
     
Item 3.
Legal Proceedings
25
     
Item 4.
Reserved
26
     
 
PART II
 
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
27
     
Item 6.
Selected Financial Data
29
     
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
     
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
52
     
Item 8.
Financial Statements and Supplementary Data
54
     
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
54
     
Item 9A.
Controls and Procedures
54
     
Item 9B.
Other Information
55
     
 
PART III
 
     
Item 10.
Directors, Executive Officers and Corporate Governance
55
     
Item 11.
Executive Compensation
55
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
56
     
Item 13.
Certain Relationships and Related Transactions, and Director Independence
56
     
Item 14.
Principal Accountant Fees and Services
56
     
 
PART IV
 
     
Item 15.
Exhibits and Financial Statement Schedules
56
     
Signatures
 
61
 
 
1

 
 
PART I

Item 1.  Business

Forward Looking Statements
Certain statements under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-K involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Item 1A. of this Form 10-K.

While we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. Any forward looking statement speaks only as of the date on which it is made.  We assume no obligation to update or revise any forward looking statement.

Overview
We are a leading operator of automotive franchises and a retailer of new and used vehicles and services. As of February 24, 2012, we offered 25 brands of new vehicles and all brands of used vehicles in 86 stores in the United States and online at Lithia.com. We sell new and used cars and light trucks and replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance.

Our dealerships are primarily located throughout the Western and Midwestern regions of the United States. We target mid-sized regional markets for domestic and import franchises and metropolitan markets for luxury franchises. We believe this strategy enables brand exclusivity with minimal competition from other dealerships with the same franchise in the market.

The following table sets forth information about stores that were part of our continuing operations as of December 31, 2011:

State
 
Number of
Stores
 
Percent of
2011 Revenue
Texas
 
14
 
24%
Oregon
 
20
 
20
California
 
11
 
10
Washington
 
8
 
10
Alaska
 
7
 
9
Montana
 
7
 
8
Idaho
 
5
 
6
Iowa
 
5
 
5
Nevada
 
4
 
5
North Dakota
 
3
 
2
New Mexico
 
1
 
1
Total
 
85
 
100%

 
2

 
 
Business Strategy and Operations
Our mission statement is: “Driven by our employees and preferred by our customers, Lithia is the leading automotive retailer in each of our markets.” We offer customers personal, convenient, flexible hometown service combined with the large company advantages of selection, competitive pricing, broad access to financing, consistent service, competence and guarantees. We strive for diversification in our products, services, brands and geographic locations to insulate us from market risk and to maintain profitability. We have developed a centralized support structure to reduce store level administrative functions. This allows store personnel to focus on providing a positive customer experience. With our management information systems, our emphasis on standardized operating practices and administrative functions performed centrally in Medford, Oregon, we seek to gain economies of scale from our dealership network.

Our overall strategy is to target mid-sized and rural markets for domestic and import brands and metropolitan markets for luxury brands. We offer a variety of luxury, import and domestic new vehicle brands and models, reducing our dependence on any one manufacturer and our susceptibility to changing consumer preferences. Encompassing economy and luxury cars, sports utility vehicles (SUVs), crossovers, minivans and light trucks, we believe our brand mix is well-suited to what people want in the markets we serve. For example, in the rural, agricultural markets, as opposed to metropolitan markets, we believe more consumers prefer trucks or SUVs, and a larger percentage of customers choose domestic vehicles.

We have centralized many administrative functions to streamline store level operations. Accounts payable, accounts receivable, credit and collections, accounting and taxes, payroll and benefits, information technology, legal, human resources, personnel development, treasury, cash management, advertising and marketing are all centralized at our corporate headquarters. The reduction of administrative functions at our stores allows our local managers to focus on customer-facing opportunities to generate increased revenues and gross profit. Our operations are supported by our dedicated training and personnel development program, which shares best practices across our dealership network and seeks to develop our store management talent.

Operations are structured to promote an entrepreneurial environment at the dealership level. Each store’s general manager and department managers, with assistance from regional and corporate management, are responsible for developing retail models that perform in their communities. They are the leaders in driving dealership operations, personnel development, manufacturer relationships, store culture and financial performance.

During 2011, we focused on the following areas to achieve our mission:
 
·
increasing revenues in all business lines;
 
·
capturing a greater percentage of overall new vehicle sales in our local markets;
 
·
increasing sales of manufacturer certified pre-owned used vehicles; three to seven years old, lower-mileage vehicles; and value autos to reach additional customers;
 
·
diversifying our franchise mix through acquisitions;
 
·
increasing our return to investors through dividends and strategic share buy backs;
 
·
utilizing prudent cash management, including investing capital to produce accretive returns; and
 
·
reducing our exposure to pending debt maturities by renewing and extending debt instruments.

We believe our cost structure is aligned with current industry sales levels and is positioned to be leveraged as vehicle sales levels continue to improve. Our selling, general and administrative (“SG&A”) expense as a percentage of gross profit improved to 71.6% in 2011 compared to 78.6% in 2010. The 2011 results included a $6.3 million gain on the sale of property in California. Adjusting for this gain and other pro forma items, our adjusted SG&A expense as a percentage of gross profit in 2011 was 72.9%.
 
 
3

 
 
We also measure the leverage of our cost structure by evaluating throughput, which is calculated as the incremental percentage of gross profit retained after deducting SG&A expense. For the years ended December 31, 2011 and 2010, our incremental throughput was 58.1% and 42.9%, respectively. Adjusting for the gain on the sale of property in California and other non-core items, our adjusted throughput in 2011 was 49.3%.

We believe we are well positioned to improve our SG&A expense leverage as vehicle sales levels continue to improve. As sales volume increases and we gain leverage in our cost structure, we anticipate achieving metrics of SG&A as a percentage of gross profit in the low 70% range and incremental throughput of approximately 50%.

We continuously evaluate our portfolio of franchises, divesting stores that are not expected to meet our financial return requirements while selectively acquiring attractive stores in our target markets. In the past three years, we generated $52.5 million in cash by divesting stores that did not meet our financial return expectations. Additionally, in 2011 and 2010, we spent $84.2 million in cash on acquisitions which increase revenue and diversify our portfolio.

New Vehicles
In 2011, we sold 43,273 new vehicles, generating 24% of our gross profit for the year. New vehicle sales also have the potential to create incremental profit opportunities through manufacturer incentives, resale of trade-in vehicles, sale of third-party financing, vehicle service and insurance contracts, and future service and repair work.

In 2011, we represented 26 domestic and import brands ranging from economy to luxury cars, sport utility vehicles, crossovers, minivans and light trucks.

Manufacturer
 
Percent of
2011 Total Revenue
 
Percent of
2011 New Vehicle Revenue
 
Percent of
2011 New Vehicle Gross Profit
Chrysler, Jeep, Dodge
 
17.1%
 
32.4%
 
29.9%
Chevrolet, Cadillac, Saab
 
8.9
 
16.8
 
15.8
Toyota, Scion
 
5.6
 
10.5
 
10.4
BMW, Mini
 
5.3
 
10.1
 
9.3
Honda, Acura
 
2.9
 
5.6
 
7.1
Ford, Lincoln
 
3.3
 
6.2
 
5.0
Subaru
 
2.2
 
4.2
 
3.7
Hyundai
 
2.1
 
3.9
 
6.1
Volkswagen, Audi
 
1.1
 
2.1
 
2.6
Nissan
 
1.4
 
2.7
 
3.1
Mercedes, smart
 
2.0
 
3.7
 
4.7
Kia
 
0.4
 
0.8
 
0.9
Porsche
 
0.4
 
0.7
 
0.9
Mazda
 
0.2
 
0.3
 
0.5
Suzuki
 
*
 
*
 
*
Mitsubishi   *   *   *
Total
 
52.9%
 
100.0%
 
100.0%

* Less than 0.1%

We purchase our new car inventory directly from manufacturers, who generally allocate new vehicles to stores based on availability, monthly sales and market area. Accordingly, we rely on the manufacturers to provide us with vehicles that meet consumer demand at suitable locations, with appropriate quantities and prices. However, high demand vehicles are often in short supply. We exchange vehicles with other automotive retailers and between our own stores to accommodate customer demand and to balance inventory.
 
 
4

 

Used Vehicles
At each new vehicle store, we also sell used vehicles. In 2011, retail used vehicle sales generated 22% of our gross profit.

Our used vehicle operations give us an opportunity to:
 
·
generate sales to customers financially unable or unwilling to purchase a new vehicle;
 
·
generate sales of vehicle brands other than the store’s new vehicle franchise;
 
·
increase new and used vehicle sales by aggressively pursuing customer trade-ins; and
 
·
increase finance and insurance revenues and service and parts sales.

Our longer-term strategy is to maintain a ratio of one retail used vehicle sale to one retail new vehicle sale. As of December 31, 2011 and 2010, we had a ratio of 0.9:1 and 1.0:1, respectively. In addition, our stores currently sell an average of 40 retail used vehicle units per month and our longer-term strategy is to increase monthly sales to an average of 60 units. In 2011, we experienced stronger growth in new vehicle sales compared to 2010, resulting in performance slightly below our goal.

We strive to achieve this strategy through offering three categories of used vehicles: manufacturer certified pre-owned used vehicles; three to seven years old, lower-mileage vehicles; and value autos. We offer manufacturer certified pre-owned used vehicles at most of our franchised dealerships. These vehicles undergo additional reconditioning and receive an extended factory-provided warranty. Late model, lower-mileage vehicles are highly reconditioned and offer a Lithia certified warranty. Value autos are older, higher mileage vehicles that undergo a safety check and a lesser degree of reconditioning. Value autos are offered to customers who require a less expensive vehicle with lower monthly payments.

We acquire our used vehicles through customer trade-ins and at closed auctions. We also purchase vehicles directly from customers visiting our stores, private parties advertising through local newspapers, competing dealers and online.

In addition, as a complement to our ongoing used vehicle operation at each store, and in response to customer demand, we use personnel in our support services group to identify and communicate the optimal mix of used vehicles that are most attractive to our markets. We conduct our own internal used vehicle auctions, and often centrally manage the sale of used vehicles at public auctions at the corporate level.

Wholesale transactions result from vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to inventory age or other factors. As part of our used vehicle strategy, we have concentrated on directing more lower-priced, older vehicles to retail sale rather than wholesale disposal.

Vehicle Financing, Service Contracts and Other Products
As part of the vehicle sales process, we offer our customers financing options as well as  extended warranties, insurance contracts and vehicle and theft protection products.  The sale of these items generated 19% of our gross profit.

We believe that arranging financing is an important part of our ability to sell vehicles and related products and services. Our sales personnel and finance and insurance managers receive training in securing customer financing and possess extensive knowledge of available financing alternatives. We attempt to arrange financing for every vehicle we sell and we offer customers financing on a “same day” basis, giving us an advantage, particularly over smaller competitors who do not generate enough sales to attract our breadth of finance sources.
 
 
5

 

We earn a commission on each finance, service and insurance contract we write and subsequently sell to a third-party. We normally arrange financing for customers by selling the contracts to outside sources on a non-recourse basis to avoid the risk of default.

We were able to arrange financing on 73% of the vehicles we sold during 2011, compared to 72% in 2010. Our presence in multiple markets and changes in technology surrounding the credit application process have allowed us to utilize a larger network of lenders across a broader geographic area. Additionally, credit markets improved throughout 2010 and 2011, as the asset-backed securities market for automotive paper improved and banks increased the volume of automotive loans initiated. Sub-prime customers, who comprised approximately 13% of the financing we completed in 2011, continue to experience constraints in obtaining automotive financing. In 2011, we increased the number of vehicles sold to customers visiting our dealerships with credit scores of 620 or lower by 2.2% compared to the prior year. Over our entire customer base, the average credit score in 2011 was 723. While the market for sub-prime customers improved in 2011, we believe vehicle sales will increase as these customers are able to obtain loans at more attractive terms.

We also market third-party extended warranty contracts, insurance contracts and vehicle and theft protection products to our customers. These products and services yield higher profit margins than vehicle sales and contribute significantly to our profitability. Extended warranty contracts for new vehicles provide additional coverage beyond the duration or scope of the manufacturer’s warranty. We also sell service contracts, which provide coverage for certain major repairs. We believe the sale of extended warranties and service contracts increases our service and parts business as well, linking future repair work to our locations.

When customers finance an automobile purchase, we offer them guaranteed auto protection (“gap”) coverage that provides protection from loss incurred by the difference in the amount owed and the amount received under a comprehensive insurance claim. We receive a commission on each gap policy sold.

We offer a lifetime lube, oil and filter (“LOF”) service, which, in 2011, was purchased by 36% of our total new and used vehicle buyers. This service helps us retain customers by building customer loyalty and it provides opportunities for selling additional routine maintenance items and generating repeat service and parts business. In 2011, we sold approximately $48 of additional maintenance on each lifetime LOF service we performed.

Service, Body and Parts
In 2011, our service, body and parts operations generated 34% of our gross profit. Our service, body and parts operations are an integral part of establishing customer loyalty and contribute significantly to our overall revenue and profits. We provide parts and service primarily for the new vehicle brands sold by our stores, but we also service most other makes and models.

The service and parts business provides important repeat revenues to our stores. We market our parts and service products by notifying owners when their vehicles are due for periodic service. This encourages preventive maintenance rather than post-breakdown repairs. The number of customers who purchase our lifetime LOF service helps to improve customer loyalty and provides opportunities for repeat parts and service business.

Revenues from the service and parts departments are particularly important during economic downturns, as owners tend to repair their existing vehicles rather than buy new vehicles during such periods. This partially mitigates the effects of a drop in new vehicle sales that may occur in a recessionary economic environment.
 
 
6

 

Our service, body and parts operations provide us an opportunity to build the Lithia Automotive brand independent of new vehicle franchises. We have branded our service processes as “Assured Service.” Assured Service provides customer benefits such as same day service, upfront price guarantees and a three-year/50,000 mile warranty on repairs. We have also launched “Assured Automotive Products” on various commodity items such as tires, filters and batteries. These branded parts provide improved margins as we procure in bulk directly from the manufacturer.

The number of vehicles in operation has been declining over the past several years as the extended challenging economic environment has curtailed vehicle purchases. We believe that this presents a challenge to our service, body and parts business in the foreseeable future as there are near-term impacts to warranty work, as well as an overall decrease in the number of vehicles requiring service.

To counteract the impact of fewer units in operation, we have increased marketing efforts and lowered prices on routine maintenance items. We have also focused on offering more commodity products, such as wiper blades and tires, with the goal of being a full service provider for all of our customers’ vehicle needs. We believe offering ‘one-stop shopping’ will be an important point of differentiation, particularly to take advantage of additional sales opportunities with customers purchasing a lifetime LOF service. These return customers provide an opportunity to offer more diversified services, and will help to offset the impact from the decline in the number of vehicles in operation.

We believe body shops provide an attractive opportunity to grow our business, and we continue to evaluate potential locations to expand. We currently operate 14 collision repair centers: four in Texas; three in Oregon; two in Idaho; and one each in Alaska, Washington, Montana, Iowa and Nevada.

Marketing
We market ourselves as Lithia Auto Stores-Serving our Communities since 1946. In most markets, except where prohibited by franchise requirements, our stores are identified as Lithia Auto Stores.

We emphasize customer satisfaction and we realize that customer retention is critical to our success. We want our customers’ experiences to be satisfying so that they refer us to their families and friends. We utilize an owner marketing strategy, consisting of email, traditional mail and phone contact, to maintain regular communication and solicit feedback.

To increase awareness and traffic at our stores, we employ a combination of traditional, digital and social media to reach potential customers. Total advertising expense, net of manufacturer credits, was $25.1 million in 2011, $26.2 million in 2010 and $17.8 million in 2009. In 2011, approximately 48% of those funds were spent in traditional media and 52% were spent in digital and owner communications. In all of our communications, we seek to differentiate ourselves from competitors by conveying price, selection and finance benefits unique to Lithia.

Certain advertising and marketing expenditures are offset by manufacturer co-op programs. Advertising credits not tied to specific vehicles are earned as requests for reimbursement are submitted to manufacturers for qualifying advertising expenditures. These reimbursements are recognized as a reduction of advertising expense upon manufacturer confirmation of submitted expenditures. Manufacturer cooperative advertising credits were $7.9 million in 2011, $2.6 million in 2010 and $3.7 million in 2009.

Many people now shop online before visiting our stores. We maintain websites for all of our stores and a corporate site (Lithia.com) dedicated to generating customer leads for our stores. Today, our websites enable our customers to:
 
·
locate our stores and identify the new vehicle brands sold at each store;
 
·
search new and pre-owned vehicle inventory;
 
 
7

 
 
 
·
view current pricing and specials;
 
·
obtain a value for their vehicle to trade or sell to us;
 
·
submit credit applications;
 
·
shop for and order manufacturers’ vehicle parts;
 
·
schedule service appointments; and
 
·
provide feedback about their Lithia experience.

We also maintain mobile versions of our websites in anticipation of greater adoption of mobile technology.

We post our inventory on major new and used vehicle listing services (cars.com, autotrader.com, kbb.com, ebay, craigslist, etc.) to reach online shoppers. We also employ search engine optimization, search engine marketing and online display advertising to reach more online prospects. 

Social influence marketing represents a very cost-effective method to enhance our corporate reputation and increase vehicle sales and service. We are deploying tools and training to our employees in ways that will help us listen to our customers and create more ambassadors for Lithia.

Franchise Agreements
Each of our stores operates under a separate agreement (“Franchise Agreement”) with the manufacturer of the new vehicle brand it sells.

Typical automobile Franchise Agreements specify the locations within a designated market area at which the store may sell vehicles and related products and perform certain approved services. The designation of such areas and the allocation of new vehicles among stores are at the discretion of the manufacturer. Franchise Agreements do not, however, guarantee exclusivity within a specified territory.

A Franchise Agreement may impose requirements on the store with respect to:
 
·
facilities and equipment;
 
·
inventories of vehicles and parts;
 
·
minimum working capital;
 
·
training of personnel; and
 
·
performance standards for market share and customer satisfaction.

Each manufacturer closely monitors compliance with these requirements and requires each store to submit monthly financial statements. Franchise Agreements also grant a store the right to use and display manufacturers’ trademarks, service marks and designs in the manner approved by each manufacturer.

We have determined the useful life of a Franchise Agreement is indefinite, even though certain Franchise Agreements are renewed after one to five years. In our experience, agreements are routinely renewed without substantial cost and there are legal remedies to help prevent termination. Certain Franchise Agreements, including those with Ford and Chrysler, have no termination date. In addition, state franchise laws protect franchised automotive retailers. Under certain laws, a manufacturer may not terminate or fail to renew a franchise without good cause or prevent any reasonable changes in the capital structure or financing of a store.

The typical Franchise Agreement provides for early termination or non-renewal by the manufacturer upon:
 
·
a change of management or ownership without manufacturer consent;
 
·
insolvency or bankruptcy of the dealer;
 
·
death or incapacity of the dealer/manager;
 
·
conviction of a dealer/manager or owner of certain crimes;
 
·
misrepresentation of certain sales or inventory information by the store, dealer/manager or owner to the manufacturer;
 
 
8

 
 
 
·
failure to adequately operate the store;
 
·
failure to maintain any license, permit or authorization required for the conduct of business;
 
·
poor market share; or
 
·
low customer satisfaction index scores.

Franchise Agreements generally provide for prior written notice before a franchise may be terminated under most circumstances. We also sign master framework agreements with most manufacturers that impose additional requirements on our stores.  See Item 1A. “Risk Factors.”

Competition
The retail automotive business is highly competitive. Currently, there are approximately 17,700 dealers in the United States, many of whom are independent operators managed by individuals, families or small retail groups. We compete primarily with other automotive retailers, both publicly and privately-held.

Vehicle manufacturers have designated specific marketing and sales areas within which only one dealer of a vehicle brand may operate. In addition, our Franchise Agreements typically limit our ability to acquire multiple dealerships of a given brand within a particular market area. Certain state franchise laws also restrict us from relocating our dealerships, or establishing new dealerships of a particular brand, within any area that is served by another dealer with the same brand. Accordingly, to the extent that a market has multiple dealers of a particular brand, as certain markets we operate in do, we are subject to significant intra-brand competition.

We are larger and have more financial resources than most private automotive retailers with which we currently compete in the majority of our regional markets. We compete directly with retailers with similar or greater resources in our metropolitan markets in Seattle, Washington and Portland, Oregon. If we enter other metropolitan markets, we may face competitors that are larger or have access to greater financial resources. We do not have any cost advantage in purchasing new vehicles from manufacturers. We rely on advertising and merchandising, pricing, our customer guarantees and sales model, our sales expertise, service reputation and the location of our stores to sell new vehicles.

Regulation

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. 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, privacy laws, escheatment laws, anti-money laundering 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 numerous federal, state and local laws and regulations. Claims arising out of actual or alleged violations of law may be asserted against us or our stores by individuals, a class of individuals, or governmental entities. These claims may expose us to significant damages or other penalties, including revocation or suspension of our licenses to conduct store 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.

 
9

 

Environmental, 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 federal, state and local requirements that regulate the environment and public health and safety.

Most of our stores utilize aboveground storage tanks, and, to a lesser extent, underground storage tanks, primarily for petroleum-based products. Storage tanks are subject to periodic testing, containment, upgrading and removal under the Resource Conservation and Recovery Act and its state law counterparts. Clean-up or other remedial action may be necessary in the event of leaks or other discharges from storage tanks or other sources. In addition, water quality protection programs under the federal Water Pollution Control Act (commonly known as the Clean Water Act), the Safe Drinking Water Act and comparable state and local programs govern certain discharges from our operations. Similarly, certain air emissions from operations, such as auto body painting, may be subject to the federal Clean Air Act and related state and local laws. Health and safety standards promulgated by the Occupational Safety and Health Administration of the United States Department of Labor and related state agencies also apply.

Certain stores may be party to proceedings under the Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, typically in connection with materials that were sent to former recycling, treatment and/or disposal facilities owned and operated by independent businesses. The remediation or clean-up of facilities where the release of a regulated hazardous substance occurred is required under CERCLA and other laws.

We incur certain costs to comply with applicable environmental, health and safety laws and regulations in the ordinary course of our business. We do not anticipate, however, that the costs of such compliance will have a material adverse effect on our business, results of operations, cash flows or financial condition, although such outcome is possible given the nature of our operations and the extensive environmental, public health and safety regulatory framework. We are aware of minor contamination at certain of our facilities, and we are in the process of conducting investigations and/or remediation at certain properties. In certain cases, the current or prior property owner is conducting the investigation and/or remediation or we have been indemnified by either the current or prior property owner for such contamination. The current level of contamination is such that we do not expect to incur significant costs for the remediation.   However, no assurances can be given that material environmental commitments or contingencies will not arise in the future, or that they do not already exist but are unknown to us.

Employees
As of December 31, 2011, we employed approximately 4,397 persons on a full-time equivalent basis.

Available Information and NYSE Compliance
We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). You may inspect and copy our reports, proxy statements, and other information filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet Web site at http://www.sec.gov where you may access copies of our SEC filings. We also make available, on our website at www.lithia.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after they are filed electronically with the SEC. The information found on our website is not part of this Form 10-K. You may also obtain copies of these reports by contacting Investor Relations at 877-331-3084.
 
 
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As required by the NYSE Corporate Governance Standards, we filed the appropriate certifications with the NYSE in 2011 confirming that our CEO is not aware of any violations of the NYSE Corporate Governance Standards and we also filed with the SEC, in 2011, the Chief Executive Officer and Chief Financial Officer certifications required under Section 302 of the Sarbanes-Oxley Act.

Item 1A.  Risk Factors

You should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.

Risks related to our business

Our business will be harmed if overall consumer demand continues to suffer from a severe or sustained downturn.

Our business is heavily dependent on consumer demand and preferences. The downturn in overall levels of consumer spending has materially and adversely affected our revenues. Retail vehicle sales are cyclical and historically have experienced periodic downturns characterized by oversupply and weak demand. These cycles are often dependent on general economic conditions and consumer confidence, as well as the level of discretionary personal income and credit availability. Economic conditions may remain anemic for an extended period of time, or deteriorate in the future.  This continuation would have a material adverse effect on our retail business, particularly sales of new and used automobiles.

Our business may be adversely affected by unfavorable conditions in our local markets, even if those conditions are not prominent nationally.

Our performance is subject to local economic, competitive and other conditions prevailing in our various geographic areas. Our dealerships are currently located in limited markets in 11 states, with sales in the top three states accounting for approximately 54% of our annualized revenue in 2011. Our results of operations, therefore, depend substantially on general economic conditions and consumer spending levels in those markets and could be materially adversely affected to the extent these markets experience sustained economic downturns regardless of improvements in the U.S. economy overall.

Increasing competition among automotive retailers reduces our profit margins on vehicle sales and related businesses. Further, the use of the Internet in the car purchasing process could materially adversely affect us.

Automobile retailing is a highly competitive business. Our competitors include publicly and privately-owned dealerships, of which certain competitors are larger and have greater financial and marketing resources than we have. Many of our competitors sell the same or similar makes of new and used vehicles that we offer in our markets at competitive prices. We do not have any cost advantage in purchasing new vehicles from manufacturers due to economies of scale or otherwise.

Our finance and insurance business and other related businesses, which have higher margins than sales of new and used vehicles, are subject to strong competition from various financial institutions and other third parties.
 
 
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The Internet has become a significant part of the sales process in our industry. Customers are using the Internet to compare pricing for vehicles and related finance and insurance services, which may further reduce margins for new and used vehicles and profits for related finance and insurance services. If Internet new vehicle sales are allowed to be conducted without the involvement of franchised dealers, our business could be materially adversely affected. In addition, other franchise groups have aligned themselves with services offered on the Internet or are investing heavily in the development of their own Internet capabilities, which could materially adversely affect our business, results of operations, financial condition and cash flows.

Our Franchise Agreements do not grant us the exclusive right to sell a manufacturer’s product within a given geographic area. Our revenues or profitability could be materially adversely affected if any of our manufacturers award franchises to others in the same markets where we operate or if existing franchised dealers increase their market share in our markets.

In addition, we may face increasingly significant competition as we strive to gain market share through acquisitions or otherwise. Our operating margins may decline over time as we expand into markets where we do not have a leading position.

Increasing fuel prices change consumer demand. Significant increases in fuel prices can be expected to reduce vehicle sales.

Historically, in times of rapid increase in crude oil and fuel prices, sales of vehicles have dropped, particularly in the short term, as the economy slows, consumer confidence wanes and fuel costs become more prominent to the consumer’s buying decision. Limited supply of, and an increasing demand for, crude oil over time are expected to result in significant price increases in the future. In sustained periods of higher fuel costs, consumers who do purchase vehicles tend to prefer smaller, more fuel efficient vehicles (which typically have lower margins) or hybrid vehicles (which can be in limited supply during these periods).
 
Additionally, a significant portion of our new vehicle revenue and gross profit is derived from domestic manufacturers. These manufacturers have historically sold a higher percentage of trucks and SUVs than import or luxury brands. As such, they may experience a more significant decline in sales in the event that fuel prices increase.

A decline of available financing in the lending market has adversely affected, and may continue to adversely affect, our vehicle sales volume.

A significant portion of vehicle buyers finance their purchases of automobiles. Sub-prime lenders have historically provided financing for consumers who, for a variety of reasons, including poor credit histories and lack of down payment, do not have access to more traditional finance sources. Lenders have generally tightened their credit standards. In the event lenders maintain or further tighten their credit standards or there is a further decline in the availability of credit in the lending market, the ability of these consumers to purchase vehicles could be limited, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Adverse conditions affecting one or more key manufacturers may negatively impact our business, results of operations, financial condition and cash flows.

In March 2011, an earthquake, tsunami and subsequent nuclear crisis in Japan impacted automotive manufacturers and automotive suppliers. These events damaged facilities, reduced production of vehicles and parts and destroyed inventory in Japan. Many Japanese manufacturers and suppliers were forced to halt production as they reconfigured production logistics. Many plants in Japan were inoperable or ran at limited capacity for a period of time. These events caused a global disruption to the supply of vehicles and automotive parts. As a result, new vehicle sales volumes for these manufacturers were negatively impacted in 2011. Vehicle production levels for these automotive manufacturers began improving during the last half of 2011. We have seen inventory levels return to normal in early 2012. We depend on our manufacturers to provide a supply of vehicles which supports expected sales levels. In the event that manufacturers are unable to supply the needed level of vehicles, our financial performance may be adversely impacted. As of December 31, 2011 and 2010, we had $372.8 million and $305.7 million, respectively, in new vehicle inventory. We had $27.0 million and $22.2 million in parts and accessories inventory as of December 31, 2011 and 2010, respectively.
 
 
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A lack of new vehicle supply may increase demand for late-model used vehicles. In 2008, 2009 and 2010, vehicle production and sales in North America were reduced by the recessionary environment. As a result, used vehicle supply, especially late-model vehicles, may be constrained, resulting in increased supply pressures and limited availability. Our used vehicle sales volume could be adversely impacted if we are unable to maintain an adequate supply of vehicles or if we are unable to obtain the makes and models desired by our customers. As of December 31, 2011, and 2010, we had $106.6 million and $87.3 million, respectively, in used and program vehicle inventory. We are subject to a concentration of risk in the event of financial distress, including potential reorganization or bankruptcy, of a major vehicle manufacturer. We purchase substantially all of our new vehicles from various manufacturers or distributors at the prevailing prices available to all franchised dealers. Our sales volume could be materially adversely impacted by the manufacturers’ or distributors’, inability to supply the stores with an adequate supply of vehicles. Our Chrysler, General Motors (“GM”) and Ford (collectively, the “Domestic Manufacturers”) stores represented approximately 32%, 17% and 6% of our new vehicle sales for 2011, respectively, and approximately 30%, 17% and 6% for 2010, respectively.

In the event a manufacturer or distributor bankruptcy, we could be held liable for damages related to product liability claims, intellectual property suits or other legal actions. These legal actions are typically directed towards the vehicle manufacturer and it is customary to indemnify us from exposure related to any judgments associated with the claims. In the event that damages could not be collected from the manufacturer or distributor, we could be named in lawsuits and judgments could be levied against us.

There can be no assurance that we will be able to successfully address the risks described above or those of the current economic circumstances and sales environment.

Our success depends in large part upon the overall demand for the particular lines of vehicles that each of our stores sell and the ability of the manufacturers to continue to deliver high quality, defect-free vehicles.

Demand for our primary manufacturers’ vehicles, as well as the financial condition, management, marketing, production and distribution capabilities of these manufacturers, can significantly affect our business. Events that adversely affect a manufacturer’s ability to timely deliver new vehicles may adversely affect us by reducing our supply of popular new vehicles and leading to lower sales in our stores during those periods than would otherwise occur. In addition, the discontinuance of a particular brand could negatively impact our revenues and profitability.

In 2010, Toyota announced vehicle recalls for possible accelerator pedal sticking issues and also halted the sale of eight models of vehicles until potentially defective parts were replaced, both of which reduced sales at our Toyota stores and adversely affected the manufacturer’s reputation for quality. We depend on our manufacturers to deliver high-quality, defect-free vehicles. In the event that manufacturers, including Toyota, experience future quality issues, our financial performance may be adversely impacted.
 
 
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Many new competitors are entering the automotive industry. New companies have recently raised capital to produce fully electric vehicles or to license battery technology to existing manufacturers. Foreign manufacturers from China and India are producing significant volumes of new vehicles and are entering the U.S. and selecting partners to distribute their products. As the automotive market in the U.S. is mature and the overall level of new vehicle sales may not increase in the coming years, the success of new competitors will likely be at the expense of other, established brands. This could have a material adverse impact on our success in the future.

Vehicle manufacturers would be adversely impacted by economic downturns or recessions, adverse fluctuations in currency exchange rates, significant declines in the sales of their new vehicles, increases in interest rates, declines in their credit ratings, 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, product defects, vehicle recall campaigns, litigation, poor product mix or unappealing vehicle design, or other adverse events. These and other risks could materially adversely affect any manufacturer and limit 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 and cash flows.

Additionally, federal and certain state laws mandate minimum levels of vehicle fuel economy and establish emission standards.  These levels and standards could be increased in the future, including the required use of renewable energy sources. Such laws often increase the costs of new vehicles, which would be expected to reduce demand. Further, changes in these laws could result in fewer vehicles available for sale by manufacturers unwilling or unable to comply with the higher standards.

If manufacturers or distributors discontinue or change sales incentives, warranties and other promotional programs, our business, results of operations, financial condition and cash flows may be materially adversely affected.

We depend upon the manufacturers and distributors for sales incentives, warranties and other programs that are intended to promote new vehicle sales or support dealership profitability. Manufacturers and distributors routinely make changes to their incentive programs. Key incentive programs include:
 
·
customer rebates;
 
·
dealer incentives on new vehicles;
 
·
special rates on certified, pre-owned cars;
 
·
below-market financing on new vehicles and special leasing terms; and
 
·
sponsorship of used vehicle sales by authorized new vehicle dealers.
 
Our financial condition could be materially adversely impacted by a discontinuation or change in our manufacturers’ or distributors’ incentive programs. In addition, certain manufacturers, including BMW and Mercedes, use a dealership’s manufacturer-determined customer satisfaction index, or CSI, score as a factor governing participation in incentive programs. To the extent we cannot meet minimum score requirements, we may be precluded from receiving certain incentives, which could materially adversely affect our business, results of operations, financial condition and cash flows.

The ability of our stores to make new vehicle sales depends in large part upon the manufacturers and, therefore, any disruption or change in our relationships with manufacturers may materially and adversely affect our business, results of operations, financial condition and cash flows.

We depend on the manufacturers to provide us with a desirable mix of new vehicles. The most popular vehicles usually produce the highest profit margins and are frequently in short supply. If we cannot obtain sufficient quantities of the most popular models, our profitability may be adversely affected. Sales of less desirable models may reduce our profit margins.
 
 
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Each of our stores operates pursuant to a Franchise Agreement with each of the respective manufacturers for which it serves as franchisee. These agreements are typically renewed after one to five years, but may also be granted into perpetuity. In our experience, agreements are routinely renewed without substantial cost and there are legal remedies to help prevent termination.

However, manufacturers exert significant control over our stores through the terms and conditions of their franchise agreements. Such agreements contain provisions for termination or non-renewal for a variety of causes, including CSI scores and sales and financial performance. From time to time, certain of our stores have failed to comply with certain provisions of their franchise agreements, and we cannot assure you that our stores will be able to comply with these provisions in the future. In addition, actions taken by a manufacturer to exploit its bargaining position in negotiating the terms of renewals of franchise agreements or otherwise could also have a material adverse effect on our revenues and profitability. If a manufacturer terminates or fails to renew one or more of our significant franchise agreements or a large number of our franchise agreements, such action could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Our Franchise Agreements also specify that, except in certain situations, we cannot operate a franchise by another manufacturer in the same building as the manufacturer’s franchised store. This may require us to build new facilities at a significant cost. Moreover, our manufacturers generally require that the store meet defined image standards. These commitments could require us to make significant capital expenditures.

Manufacturer stock ownership restrictions may impair our ability to maintain or renew franchise agreements or issue additional equity.

Certain of our Franchise Agreements prohibit transfers of ownership interests of a store or, in selected cases, its parent. The most prohibitive restriction which could be imposed by various manufacturers, including Honda/Acura, Hyundai, Mazda and Nissan, provides that, under certain circumstances, we may lose a franchise if a person or entity acquires an ownership interest in us above a specified level (ranging from 20% to 50% depending on the particular manufacturer’s restrictions and falling as low as 5% if another vehicle manufacturer is the entity acquiring the ownership interest) without the approval of the applicable manufacturer. Other restrictions in certain Franchise Agreements with manufacturers, including Ford, GM, Honda/Acura and Toyota, provide that a change in control in the Company without prior consent is a violation of our franchise or dealer framework agreement. Transactions in our stock by our shareholders or prospective shareholders are generally outside of our control and may result in the termination or non-renewal of one or more of our franchises or impair our ability to negotiate new franchise agreements for dealerships we desire to acquire in the future, which may have a material adverse effect on our business, results of operations, financial condition and cash flows. These restrictions may also prevent or deter a prospective acquirer from acquiring control of us or otherwise adversely affect the market price of our Class A common stock or limit our ability to restructure our debt obligations.

If state dealer laws are repealed or weakened, our dealerships will be more susceptible to termination, non-renewal or renegotiation of their franchise agreements. Additionally, federal bankruptcy law can override protections afforded under state dealer laws.

State dealer laws generally provide that a manufacturer may not terminate or refuse to renew a franchise agreement unless it has first provided the dealer with written notice setting forth good cause and stating the grounds for termination or non-renewal. Certain state dealer laws allow dealers to file protests or petitions or attempt to comply with the manufacturer’s criteria within the notice period to avoid the termination or non-renewal. 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 a 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.
 
 
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In addition, these laws restrict the ability of automobile manufacturers to directly enter the retail market in the future. If manufacturers obtain the ability to directly retail vehicles and do so in our markets, such competition could have a material adverse effect on our business, results of operations, financial condition and cash flows.

As evidenced by the bankruptcy proceedings of both Chrysler and GM in 2009, state dealer laws do not afford continued protection from manufacturer terminations or non-renewal of franchise agreements. While we do not believe additional bankruptcy filings are probable, no assurances can be given that a manufacturer will not seek protection under bankruptcy laws, or that, in this event, they will not seek to terminate franchise rights held by us.
 
Import product restrictions and foreign trade risks may impair our ability to sell foreign vehicles profitably.

A significant portion of the vehicles we sell, as well as certain major components of such vehicles, are manufactured outside the United States. Accordingly, we are affected by import and export restrictions of various jurisdictions and are dependent, to a certain extent, on general socio-economic conditions in, and political relations with, a number of foreign countries. Additionally, fluctuations in currency exchange rates may increase the price and adversely affect our sales of vehicles produced by foreign manufacturers. Imports into the United States may also be adversely affected by increased transportation costs and tariffs, quotas or duties, any of which could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Environmental, health or safety regulations could have a material adverse effect on our business, results of operations, financial condition and cash flows or cause us to incur significant expenditures.

We are subject to various federal, state and local environmental, health and safety regulations which govern items such as the generation, storage, handling, use, treatment, recycling, transportation, disposal and remediation of hazardous material and the emission and discharge of hazardous material into the environment. Under certain environmental regulations or pursuant to signed private contracts, we could be held responsible for all of the costs relating to any contamination at our present, or our previously owned, facilities, and at third party waste disposal sites. We are aware of minor contamination at certain of our facilities, and we are in the process of conducting investigations and/or remediation at certain properties. The current level of contamination is such that we do not expect to incur significant costs for the remediation. In certain cases, the current or prior property owner is conducting the investigation and/or remediation or we have been indemnified by either the current or prior property owner for such contamination. There can be no assurance that these owners will remediate, or continue to remediate, these properties or pay, or continue to pay, pursuant to these indemnities. We are also required to obtain permits from governmental authorities for certain operations. If we violate or fail to fully comply with these regulations or permits, we could be fined or otherwise sanctioned by regulators.

Environmental, health and safety regulations are becoming increasingly stringent. There can be no assurance that the cost of compliance with these regulations will not result in a material adverse effect on our results of operations or financial condition. Further, no assurances can be given that additional environmental, health or safety matters will not arise or new conditions or facts will not develop in the future at our currently or formerly owned or operated facilities, or at sites that we may acquire in the future, which will require us to incur significant expenditures.
 
 
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With the breadth of our operations and volume of consumer and financing transactions, compliance with the many applicable federal and state laws and regulations cannot be assured. New regulations are enacted on an ongoing basis. These regulations may impact our profitability and require continuous training and vigilance. Fines, judgments and administrative sanctions can be severe.

We are subject to federal, state and local laws and regulations in each of the 11 states in which we have stores. New laws and regulations are enacted on an ongoing basis. With the number of stores we operate, the number of personnel we employ and the large volume of transactions we handle, it is likely that technical mistakes will be made. It is also likely that these regulations may impact our profitability and require ongoing training. Current practices in stores may become prohibited. We are responsible for ensuring that continued compliance with laws is maintained. If there are unauthorized activities of serious magnitude, the state and federal authorities have the power to impose civil penalties and sanctions, suspend or withdraw dealer licenses or take other actions. These actions could materially impair our activities or our ability to acquire new stores in those states where violations occurred. Further, private causes of action on behalf of individuals or a class of individuals could result in significant damages or injunctive relief.

Compliance with the variety of federal, state and local advertising related regulations cannot be assured. These regulations, which impact various forms of advertising including print, media, text and Internet, could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Advertising in our business is subject to numerous federal, state and local laws and regulations. These laws and regulations address unfair, deceptive and/or fraudulent trade practices. Claims arising out of actual or alleged violations of law may be asserted against us or any of our dealers by individuals, either individually or through class actions, or by governmental entities in civil or criminal investigations and proceedings. Such actions may expose us to substantial monetary damages and legal defense costs, injunctive relief and criminal and civil fines and penalties.

The seasonality of our business magnifies the importance of second and third quarter operating results.

Our business is subject to seasonal variations in revenues. In our experience, demand for automobiles is generally lower during the first and fourth quarters of each year and this variance is even more pronounced in stores located in cold-weather states. We, therefore, generally receive a disproportionate amount of revenues in the second and third quarters and expect our revenues and operating results to be generally lower in the first and fourth quarters. Consequently, if conditions surface during the second and third quarters that impair vehicle sales, such as higher fuel costs, depressed economic conditions or similar adverse conditions, our revenues for the full year could be materially adversely affected.

Our ability to increase revenues through acquisitions depends on our ability to acquire and successfully integrate additional stores.

General
The U.S. automobile industry is considered a mature industry in which minimal growth is expected in unit sales of new vehicles. Accordingly, a principal component of our growth in sales is to make acquisitions in our existing markets and in new geographic markets. To complete the acquisition of additional stores, we need to successfully address each of the following challenges.
 
 
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Limitations on our capital resources
The acquisition of additional stores will require substantial capital investment. Limitations on our capital resources would restrict our ability to complete new acquisitions.

We have financed our past acquisitions from a combination of the cash flow from our operations, borrowings under our credit arrangements, issuances of our common stock and proceeds from private debt offerings. The use of any of these financing sources could have the effect of reducing our earnings per share. We may not be able to obtain financing in the future due to the market price of our Class A common stock and overall market conditions. Furthermore, using cash to complete acquisitions could substantially limit our operating or financial flexibility.
 
Substantially all of the assets of our dealerships are pledged to secure the indebtedness under our Credit Facility and our floor plan financing indebtedness. These pledges may limit our ability to borrow from other sources in order to fund our acquisitions.

Manufacturers
We are required to obtain consent from the applicable manufacturer prior to the acquisition of a franchised store. In determining whether to approve an acquisition, a manufacturer considers many factors, including our financial condition, ownership structure, the number of stores currently owned and our performance with those stores. Obtaining manufacturer approval of acquisitions also takes a significant amount of time, typically 60 to 90 days. We cannot assure you that manufacturers will approve future acquisitions timely, if at all, which could significantly impair the execution of our acquisition strategy.

Most major manufacturers have now established limitations or guidelines on the:
 
·
number of such manufacturers’ stores that may be acquired by a single owner;
 
·
number of stores that may be acquired in any market or region;
 
·
percentage of market share that may be controlled by one automotive retailer group;
 
·
ownership of stores in contiguous markets;
 
·
performance requirements for existing stores; and
 
·
frequency of acquisitions.

In addition, such manufacturers generally require that no other manufacturers’ brands be sold from the same store location, and many manufacturers have site control agreements in place that limit our ability to change the use of the facility without their approval.

A manufacturer also considers our past performance as measured by the Minimum Sales Responsibility (“MSR”) scores, Customer Satisfaction Index (“CSI”) scores and Sales Satisfaction Index (“SSI”) scores at our existing stores. At any point in time, certain stores may have scores below the manufacturers’ sales zone averages or have achieved sales below the targets manufacturers have set. Our failure to maintain satisfactory scores and to achieve market share performance goals could restrict our ability to complete future acquisitions. We currently have, and at any point in the future may have, manufacturers that restrict our ability to complete future acquisitions.

Acquisition risks
We will face risks commonly encountered with growth through acquisitions. These risks include, without limitation:
 
·
failing to assimilate the operations and personnel of acquired dealerships;
 
·
failing to achieve predicted sales levels;
 
·
incurring significantly higher capital expenditures and operating expenses;
 
·
entering new markets with which we are unfamiliar;
 
·
encountering undiscovered liabilities and operational difficulties at acquired dealerships;
 
·
disrupting our ongoing business;
 
 
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·
diverting our management resources;
 
·
failing to maintain uniform standards, controls and policies;
 
·
impairing relationships with employees, manufacturers and customers as a result of changes in management;
 
·
incurring increased expenses for accounting and computer systems, as well as integration difficulties;
 
·
failing to obtain a manufacturer’s consent to the acquisition of one or more of its dealership franchises or renew the franchise agreement on terms acceptable to us; and
 
·
incorrectly valuing entities to be acquired.

In addition, we may not adequately anticipate all of the demands that growth will impose on our systems, procedures and structures.

Consummation and competition
We may not be able to consummate any future acquisitions at acceptable prices and terms or identify suitable candidates. In addition, increased competition in the future for acquisition candidates could result in fewer acquisition opportunities for us and higher acquisition prices. The magnitude, timing, pricing and nature of future acquisitions will depend upon various factors, including:
 
·
the availability of suitable acquisition candidates;
 
·
competition with other dealer groups for suitable acquisitions;
 
·
the negotiation of acceptable terms with the seller and with the manufacturer;
 
·
our financial capabilities and ability to obtain financing on acceptable terms;
 
·
our stock price;
 
·
our ability to maintain required financial covenant levels after the acquisition; and
 
·
the availability of skilled employees to manage the acquired businesses.

Financial condition
The operating and financial condition of acquired businesses cannot be determined accurately until we assume control. Although we conduct what we believe to be a prudent level of investigation regarding the operating and financial 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. Similarly, many of the dealerships we acquire do not have financial statements audited or prepared in accordance with U.S. generally accepted accounting principles. We may not have an accurate understanding of the historical financial condition and performance of our acquired businesses. Until we actually assume control of the business assets and their operations, we may not be able to ascertain the actual value or understand the potential liabilities of the acquired businesses and their earnings potential.

Indefinite-lived intangible assets, which consist of goodwill and franchise value, comprise a meaningful portion of our total assets ($78.1 million at December 31, 2011). We must test our indefinite-lived intangible assets for impairment at least annually, which may result in a non-cash write-down of franchise rights or goodwill and could have a material adverse impact on our business, results of operations, financial condition and cash flows and impair our ability to comply with loan covenants.

Indefinite-lived intangible assets are subject to impairment assessments at least annually (or more frequently when events or circumstances indicate that an impairment may have occurred) by applying a fair-value based test. Our principal intangible assets are goodwill and our rights under our Franchise Agreements with vehicle manufacturers. The risk of impairment charges associated with goodwill increases if there are declines in our market capitalization, profitability or cash flows. The risk of impairment charges associated with franchise value increases if operating losses are suffered at those stores, if a manufacturer files for bankruptcy or if the stores are closed. Impairment charges result in non-cash write-downs of the affected franchise values or goodwill. Furthermore, impairment charges could have an adverse impact on our ability to satisfy the financial ratios or other covenants under our debt agreements and could have a material adverse impact on our business, results of operations, financial condition and cash flows.
 
 
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A net deferred tax asset position comprises a meaningful portion of our total assets (approximately $34.0 million at December 31, 2011). We are required to assess the recoverability of this asset on an ongoing basis. Future negative operating performance or other unfavorable developments may result in a valuation allowance being recorded against part or all of this amount. This could have a material adverse impact on our business, results of operations, financial condition and cash flows and impair our ability to comply with loan covenants.

Deferred tax assets are evaluated periodically to determine if they are expected to be recoverable in the future. This evaluation considers positive and negative evidence in order to assess whether it is more likely than not that a portion of the asset will not be realized. The risk of a valuation allowance increases if continuing operating losses are incurred. A valuation allowance on our deferred tax asset could have an adverse impact on our ability to satisfy financial ratios or other covenants under our debt agreements and could have a material adverse impact on our business, results of operations, financial condition and cash flows.

Our indebtedness and lease obligations could materially adversely affect our financial health, limit our ability to finance future acquisitions and capital expenditures and prevent us from fulfilling our financial obligations. Much of our debt has a variable interest rate component that may significantly increase our interest costs in a rising rate environment.

As of December 31, 2011, our total outstanding indebtedness was approximately $630.8 million, including $343.9 million in floor plan financing, $87.0 million in borrowings under our Credit Facility, $194.4 million in mortgage debt and $5.5 million in other long-term debt. Mortgage indebtedness consists primarily of real estate loans on individual properties from thirteen different banks and finance companies at fixed and variable rates.

Our floor plan financing is provided by five banks and finance companies which are, or previously were, associated with automobile manufacturers. We also have floor plan financing provided by lenders not associated with automobile manufacturers.  For new vehicles and vehicles purchased at dealer auctions, advances are made at the time such vehicles are purchased and are typically required to be repaid no later than upon sale or lease of the vehicle.
 
Most of our floor plan financing may be terminated at any time by the lender and is due on demand.

Our indebtedness and lease obligations could have important consequences to us, including the following:
 
·
limitations on our ability to make acquisitions;
 
·
impaired ability to obtain additional financing for acquisitions, capital expenditures, working capital or general corporate purposes;
 
·
reduced funds available for our operations and other purposes, as a portion of our current cash flow from operations would be dedicated to the payment of principal and interest on our indebtedness; and
 
·
exposure to the risk of increasing interest rates as certain borrowings are, and will continue to be, at variable rates of interest.
 
 
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In addition, our loan agreements contain covenants that limit our discretion with respect to business matters, including incurring additional debt or disposing of assets. Other covenants are financial in nature, including tangible net worth, vehicle equity, fixed charge coverage and liabilities to tangible net worth. A breach of any of these covenants could result in a default under the applicable agreement. In addition, a default under one agreement could result in a default and acceleration of our repayment obligations under the other agreements under the cross-default provisions in such other agreements.

Certain debt agreements contain subjective acceleration clauses based on a lender deeming itself insecure or if a “material adverse change” in our business has occurred. If these clauses are implicated, and the lender declares that an event of default has occurred, the outstanding indebtedness would likely be immediately due and owing.

If these events were to occur, we may not be able to pay our debts or borrow sufficient funds to refinance them. Even if new financing were available, it may not be on terms acceptable to us. 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 these agreements.

The global credit and capital markets are undergoing a period of substantial volatility and disruption. There can be no assurance that this credit environment will not worsen or further impact the availability and cost of debt financing, including the refinancing of our indebtedness. If we are unable to refinance or renegotiate our debt, we cannot guarantee that we will be able to generate enough cash flow from operations or that we will be able to obtain enough capital to service our debt, make acquisitions or fund our planned capital expenditures. In such an event, we could face substantial liquidity issues and might be required to issue equity securities or sell assets to meet our debt payments and other obligations. There can be no assurance that we will be able to effect refinancing of our indebtedness on terms acceptable to us, if at all.

Additionally, our real estate debt generally has a five-year term, after which the debt needs to be renewed or replaced. Over the last three years, the appraised value of commercial real estate, generally, and much of our real estate, specifically, has declined. Further, many lenders are reducing the loan-to-value lending ratios for new or renewed real estate loans. The effect of these developments could result in our inability to renew maturing real estate loans at the debt level existing at maturity, or on terms acceptable to us, requiring us to find replacement lenders or to refinance at lower loan amounts.

We have significant levels of mortgage debt maturing after 2012. Approximately $27.9 million, $31.9 million and $52.6 million matures in 2013, 2014 and 2015, respectively. There can be no assurance that, if requested by us, our current lenders will be willing or able to extend these maturities, or that we will be able to find other counterparties to provide financing in the future.

As of December 31, 2011, including the effect of interest rate swaps, approximately 74% of our total debt was variable rate. The majority of our variable rate debt is indexed to the 30 day LIBOR rate. The current interest rate environment is at historically low levels, and interest rates will likely increase in the future. In the event interest rates increase, our borrowing costs may increase substantially. Additionally, fixed rate debt that matures may be renewed at interest rates significantly higher than current levels. As a result, this could have a material adverse impact on our business, results of operations, financial condition and cash flows.

We are dependent on manufacturer, manufacturer-affiliated or other financing companies to provide floor plan sources for our new vehicle inventories. If floor plan sources are eliminated or reduced, no assurance can be given that we will be able to secure additional borrowing facilities. Additionally, our floor plan debt with manufacturers, their affiliated finance companies and Ally Bank are due upon demand, and may be called at any time.

We secure real estate financing from certain lenders with a commitment that we continue to maintain associated floor plan lines at the location so long as any mortgage debt remains outstanding. Such a commitment subjects us to the prevailing floor plan line rate and terms offered by the lender, unless we are able to refinance our real estate debt placed with them.
 
 
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We currently have relationships with a number of manufacturers, their affiliated finance companies or other finance companies, including Mercedes-Benz Financial Services USA, LLC, Toyota Financial Services, Ford Motor Credit Company, American Honda Finance Corporation and BMW Financial Services NA, LLC. These companies provide new vehicle floor plan financing for their respective brands. Our credit facility with U.S. Bank National Association and JPMorgan Chase Bank, N.A. as well as floor plan financing with Ally Bank serve as the primary source of financing for all other brands. Certain of these companies, including Ally Bank, have incurred significant losses and are operating under financial constraints. Other companies may incur losses in the future or undergo funding limitations. As a result, credit that has typically been extended to us by the companies may be modified with terms unacceptable to us or revoked entirely. If these events were to occur, we may not be able to pay our floor plan debts or borrow sufficient funds to refinance the vehicles. Even if new financing were available, it may not be on terms acceptable to us.

We have a significant relationship with a third-party warranty insurer and administrator. If the insurer should be unable to meet claims under our customers’ policies, such events could negatively impact our business, results of operations, financial condition and cash flows.

We sell service warranty policies to our customers issued by a third-party obligor. We receive additional fee income if actual claims are less than the amounts reserved for anticipated claims and the costs of administration and administrator profit.  As such, the service contracts must expire before the ultimate claims experience on the service contracts are known and the profit component can be calculated.

A decline in the financial health of the third-party insurer could jeopardize the claims reserves held by the administrator, and prevent us from collecting the experience payments anticipated to be earned in future years. While the amount we receive varies annually, the loss of this income could negatively impact our business, results of operations, financial condition and cash flows. Further, the inability of the insurer to honor service warranty claims would likely result in reputational risk to us and might result in claims to cover any default by the insurer.

The loss of key personnel or the failure to attract additional qualified management personnel could adversely affect our operations and growth.

Our success depends to a significant degree on the efforts and abilities of our senior management, particularly Sidney B. DeBoer, our Chairman and Chief Executive Officer, and Bryan B. DeBoer, our President and Chief Operating Officer. Further, we have identified Sidney B. DeBoer and/or Bryan B. DeBoer in most of our store franchise agreements as the individuals who control the franchises and upon whose financial resources and management expertise the manufacturers may rely when awarding or approving the transfer of any franchise.

In addition, as we expand, we may need to hire additional managers. 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. The loss of the services of key employees or the inability to attract additional qualified managers could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, the lack of qualified management or employees employed by potential acquisition candidates may limit our ability to consummate future acquisitions.
 
 
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The sole voting control of our company is currently held by Sidney B. DeBoer, who may have interests different from our other shareholders. Further, 3.8 million shares of our Class B common stock held by Lithia Holding Company, LLC (“Lithia Holding”) are pledged, with other assets, to secure personal indebtedness of Mr. DeBoer. The failure to repay the indebtedness could result in the sale of such shares and the loss of such control, which may violate agreements with certain manufacturers.

Lithia Holding, of which Sidney B. DeBoer, our Chairman and Chief Executive Officer, is the sole managing member, holds all of the outstanding shares of our Class B common stock. A holder of Class B common stock is entitled to ten votes for each share held, while a holder of Class A common stock is entitled to one vote per share held. On most matters, the Class A and Class B common stock vote together as a single class. As of February 24, 2012, Lithia Holding controlled approximately 63% of the aggregate number of votes eligible to be cast by shareholders for the election of directors and most other shareholder actions. In addition, because Mr. DeBoer is the managing member of Lithia Holding, he currently controls, and will continue to control, all of the outstanding Class B common stock, thereby allowing him to control the company.

Lithia Holding has pledged 3.8 million shares of our Class B common stock, together with other personal assets of Mr. DeBoer, to secure a personal loan to Mr. DeBoer from U.S. Bank National Association. Should he be unable to repay the loan, the bank could foreclose against the Class B common stock, which would result in the automatic conversion of such shares to Class A common stock. In such event, Mr. DeBoer would no longer be in control of the company and this loss of (change in) control, if not consented to by the manufacturers, would be a technical violation under most of the dealer sales and service agreements held by us. While applicable state franchise laws prohibit manufacturers from unreasonably withholding consent to a change in control or the appointment of a new individual responsible for the operations of a store should a loss of control result in the removal of both Sidney DeBoer and Bryan DeBoer, there can be no assurance that such laws will not change. In addition, the market price of our Class A common stock could decline materially if the bank foreclosed on such pledged stock and subsequently sold such stock in the open market.
 
Risks related to investing in our Class A common stock

Future sales of our Class A common stock in the public market could adversely impact the market price of our Class A common stock.

As of February 24, 2012, we had 2,863,254 shares of Class A common stock reserved for issuance under our equity plans (including our employee stock purchase plan). As of February 24, 2012, a total of 1,396,351 shares were outstanding related to outstanding restricted stock, restricted stock units and options (with the options having a weighted average exercise price of $12.70 per share and options to purchase 403,008 shares being exercisable). In addition, we had 3,762,231 shares of Class B common stock outstanding convertible into 3,762,231 shares of Class A common stock.

In the future, we may issue additional shares of our Class A common stock to raise capital or effect acquisitions. We cannot predict the size of future sales or issuance or the effect, if any, they may have on the market price of our Class A common stock. The sale of substantial amounts of Class A common stock, or the perception that such sales may occur, could adversely affect the market price of our Class A common stock and impair our ability to raise capital through the sale of additional equity securities, or to sell equity at a price acceptable to us.
 
 
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Volatility in the market price and trading volume of our Class A common stock could adversely impact the value of the shares of our Class A common stock.

The stock market in recent years has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies like ours. These broad market factors may materially reduce the market price of our Class A common stock, regardless of our operating performance. The market price of our Class A common stock, which has experienced large price and volume fluctuations over the last five years, could continue to fluctuate significantly for many reasons, including in response to the risks described herein or for reasons unrelated to our operations, such as:
 
·
reports by industry analysts;
 
·
changes in financial estimates by securities analysts or us, or our inability to meet or exceed securities analysts’,  investors’ or our own estimates or expectations;
 
·
actual or anticipated sales of common stock by existing shareholders;
 
·
capital commitments;
 
·
additions or departures of key personnel;
 
·
developments in our business or in our industry;
 
·
a prolonged downturn in our industry;
 
·
general market conditions, such as interest or foreign exchange rates, commodity and equity prices, availability of credit, asset valuations and volatility;
 
·
changes in global financial and economic markets;
 
·
armed conflict, war or terrorism;
 
·
regulatory changes affecting our industry generally or our business and operations in particular;
 
·
changes in market valuations of other companies in our industry;
 
·
the operating and securities price performance of companies that investors consider to be comparable to us; and
 
·
announcements of strategic developments, acquisitions and other material events by us, our competitors or our suppliers.

Oregon law and our Restated Articles of Incorporation may impede or discourage a takeover, which could impair the market price of our Class A common stock.

We are an Oregon corporation, and certain provisions of Oregon law and our Restated Articles of Incorporation may have anti-takeover effects. These provisions could delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider to be in his or her best interest. These provisions may also affect attempts that might result in a premium over the market price for the shares held by shareholders, and may make removal of the incumbent management and directors more difficult, which, under certain circumstances, could reduce the market price of our Class A common stock.

Our issuance of preferred stock could adversely affect holders of Class A common stock.

Our Board of Directors is authorized to issue a series of preferred stock without any action on the part of our holders of Class A common stock. Our Board of Directors also has the power, without shareholder approval, to set the terms of any such series of preferred stock that may be issued, including voting powers, preferences over our Class A common stock with respect to dividends or if we voluntarily or involuntarily dissolve or distribute our assets, and other terms. If we issue preferred stock in the future that has preference over our Class A common stock with respect to the payment of dividends or upon our liquidation, dissolution or winding up, or if we issue preferred stock with voting rights that dilute the voting power of our Class A common stock, the rights of holders of our Class A common stock or the price of our Class A common stock could be adversely affected.

Item 1B.  Unresolved Staff Comments

None.
 
 
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Item 2.  Properties

Our stores and other facilities consist primarily of automobile showrooms, display lots, service facilities, collision repair and paint shops, supply facilities, automobile storage lots, parking lots and offices. We believe our facilities are currently adequate for our needs and are in good repair. Some of our facilities do not currently meet manufacturer image or size requirements and we are actively working to find a mutually acceptable outcome in terms of timing and overall cost. We own certain properties, but also lease certain properties, providing future flexibility to relocate our retail stores as demographics, economics, traffic patterns or sales methods change. Most leases provide us the option to renew the lease for one or more lease extension periods. We also hold certain vacant dealerships and undeveloped land for future expansion.

Item 3.  Legal Proceedings

We are party to numerous legal proceedings arising in the normal course of our business. While we cannot predict with certainty the outcomes of these matters, we do not anticipate that the resolution of legal proceedings arising in the normal course of business or the proceedings described below will have a material adverse effect on our business, results of operations, financial condition, or cash flows.

Text Messaging Claims
In April 2011, a third party vendor assisted us in promoting a targeted “0% financing on used vehicles” advertising campaign during a limited sale period. The marketing included sending a “Short Message Service” communication to cell phones (a “text message”) of our previous customers. The message was sent to over 50,000 cell phones in 14 states. The message indicated that the recipients could “Opt-Out” of receiving any further messages by replying “STOP,” but, due to a technical error, some recipients who responded requesting to be unsubscribed nonetheless may have received a follow-on message.

On or about April 21, 2011, a Complaint for Damages, Injunctive and Declaratory Relief was filed against us (Kevin McClintic vs. Lithia Motors, 11-2-14632-4 SEA, Superior Court of the State of Washington for King County) alleging the text messaging activity violated State of Washington anti-texting and consumer protection laws and the federal Telephone Consumer Protection Act, and seeking statutory damages of $500 for each violation, trebled, plus injunctive relief and attorney fees. The suit seeks class action designation for all similarly situated entities and individuals. The suit has been removed to the United States District Court for the Western District of Washington at Seattle.
 
On or about July 5, 2011, a complaint was filed alleging nearly identical claims, also seeking class action designation (Dan McLaren vs. Lithia Motors, Civil # 11-810, United States District Court of Oregon, Portland Division). This case was stayed pending the outcome of the McClintic matter by order of the court on or about October 11, 2011. The class representative in the McLaren case also attempted to intervene in the McClintic case. This intervention motion was denied on October 19, 2011.
 
We participated in a mediation of the McClintic case and have entered into a settlement agreement with the plaintiffs, which is subject to court approval. Under this settlement agreement, we agreed to pay a total of $2.5 million, all of which such amounts will be reimbursed by the vendor pursuant to contractual indemnification. No assurances can be given that the court will approve the settlement.
 
 
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Alaska Consumer Protection Act Claims
In December 2006, a suit was filed against us (Jackie Neese, et al vs. Lithia Chrysler Jeep of Anchorage, Inc, et al, Case No. 3AN-06-13341 CI, and in April, 2007, a second case (Jackie Neese, et al vs. Lithia Chrysler Jeep of Anchorage, Inc, et al, Case No. 3AN-06-4815 CI) (now consolidated)), in the Superior Court for the State of Alaska, Third Judicial District at Anchorage. In the suits, plaintiffs alleged that we, through our Alaska dealerships, engaged in three practices that purportedly violate Alaska consumer protection laws: (i) charging customers dealer fees and costs (including document preparation fees) not disclosed in the advertised price, (ii) failing to disclose the acquisition, mechanical and accident history of used vehicles or whether the vehicles were originally manufactured for sale in a foreign country, and (iii) engaging in deception, misrepresentation and fraud by providing to customers financing from third parties without disclosing that we receive a fee or discount for placing that loan (a “dealer reserve”). The suit seeks statutory damages of $500 for each violation (or three times plaintiff’s actual damages, whichever is greater), and attorney fees and costs and the plaintiffs sought class action certification.  Before and during the pendency of these suits, we engaged in settlement discussions with the State of Alaska through its Office of Attorney General with respect to the first two practices enumerated above. As a result of those discussions, we entered into a Consent Judgment subject to court approval and permitted potential class members to “opt-out” of the proposed settlement. Counsel for the plaintiffs attempted to intervene and, after various motions, hearings and an appeal to the state Court of Appeals, the Consent Judgment became final.
 
Plaintiffs then filed a motion in November 2010 seeking certification of a class for (i) the 339 customers who “opted-out” of the state settlement, (ii) for those customers who did not qualify for recovery under the Consent Judgment but were allegedly eligible for recovery under the Plaintiffs’ broader interpretation of the applicable statutes and (iii) arguing that since the State’s suit against our dealerships did not address the loan fee/discount (dealer reserve) claim, for those customers who arranged their vehicle financing through us. On June 14, 2011, the District Court granted Plaintiffs’ motion to certify a class without addressing either the merits of the claims or the size of the class or classes. We intend to defend the claims vigorously and do not believe the novel “dealer reserve” claim has merit.

The ultimate resolution of these matters cannot be predicted with certainty, and an unfavorable resolution of any of the matters could have a material adverse effect on our results of operations, financial condition or cash flows.

Item 4.  Reserved

 
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PART II

Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Stock Prices and Dividends
Our Class A common stock trades on the New York Stock Exchange under the symbol LAD. The following table presents the high and low sale prices for our Class A common stock, as reported on the New York Stock Exchange Composite Tape for each of the quarters in 2010 and 2011:

2010
 
High
   
Low
 
First quarter
  $ 9.55     $ 5.18  
Second quarter
    9.36       6.09  
Third quarter
    9.94       5.87  
Fourth quarter
    14.45       9.45  
                 
2011
               
First quarter
  $ 16.07     $ 13.28  
Second quarter
    20.31       14.12  
Third quarter
    23.84       13.80  
Fourth quarter
    24.85       13.57  
 
The number of shareholders of record and approximate number of beneficial holders of Class A common stock as of February 24, 2012 was 968 and 10,165, respectively. All shares of Lithia’s Class B common stock are held by Lithia Holding Company, LLC.

Dividends declared on our Class A and Class B common stock during 2010 and 2011 were as follows:

Quarter declared:
 
Dividend amount per share
   
Total amount of dividend (in thousands)
 
2010
           
First quarter
  $ -     $ -  
Second quarter
    0.05       1,300  
Third quarter
    0.05       1,307  
Fourth quarter
    0.05       1,312  
2011
               
First quarter
  $ 0.05     $ 1,316  
Second quarter
    0.07       1,851  
Third quarter
    0.07       1,838  
Fourth quarter
    0.07       1,817  
 
We did not declare or pay any dividends on our Class A and Class B common stock in 2009.

Repurchases of Class A Common Stock
We repurchased the following shares of our Class A common stock during the fourth quarter of 2011:

   
Total number of shares purchased
   
Average price paid per share
   
Total number of shares purchased as part of publicly announced plan
   
Maximum number of shares that may yet be purchased under the plans
 
October 1 to October 31
    43,137     $ 16.43       29,822       1,736,145  
November 1 to November 30
    68,650       20.73       33,200       1,702,945  
December 1 to December 31
    -       -       -       1,702,945  
Total
    111,787 (1)   $ 19.07       63,022       1,702,945  
 
(1)
Includes 48,765 shares repurchased in association with tax withholdings on the exercises of stock options.

The plan to repurchase up to a total of 1.0 million shares of our Class A common stock, which was approved by our Board of Directors in June 2000 and renewed in August 2005, was fully utilized during the third quarter of 2011. In August 2011, our Board of Directors approved a plan to repurchase up to a total of 2.0 million shares of our Class A common stock. This plan does not have an expiration date.
 
 
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Equity Compensation Plan Information
Information regarding securities authorized for issuance under equity compensation plans is included in Item 12.

Stock Performance Graph
The following line-graph shows the annual percentage change in the cumulative total returns for the past five years on an assumed $100 initial investment and reinvestment of dividends, on (a) Lithia Motors, Inc.’s Class A common stock; (b) the Russell 2000; and (c) a peer group index composed of Penske Automotive Group, AutoNation, Sonic Automotive, Group 1 Automotive and Asbury Automotive Group, the only other comparable publicly traded automobile dealerships in the United States as of December 31, 2011. The peer group index utilizes the same methods of presentation and assumptions for the total return calculation as does Lithia Motors and the Russell 2000. All companies in the peer group index are weighted in accordance with their market capitalizations.
 
 
   
Base
                               
   
Period
   
Indexed Returns for the Year Ended
 
Company/Index
 
12/31/2006
   
12/31/2007
   
12/31/2008
   
12/31/2009
   
12/31/2010
   
12/31/2011
 
Lithia Motors, Inc.
  $ 100.00     $ 48.94     $ 12.42     $ 31.31     $ 55.34     $ 85.86  
Auto Peer Group
    100.00       69.23       33.52       69.37       96.60       119.51  
Russell 2000
    100.00       98.45       65.18       82.90       105.16       100.75  
 
 
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Item 6.  Selected Financial Data

You should read the Selected Financial Data in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our Consolidated Financial Statements and Notes thereto and other financial information contained elsewhere in this Annual Report on Form 10-K. The results of operations for stores classified as discontinued operations have been presented on a comparable basis for all periods presented.

(In thousands, except per share amounts)
 
Year Ended December 31,
 
Consolidated Statements of Operations Data:
 
2011
   
2010
   
2009
   
2008
   
2007
 
Revenues:
                             
New vehicle
  $ 1,426,888     $ 1,038,321     $ 857,096     $ 1,128,279     $ 1,497,984  
Used vehicle retail
    695,796       566,803       465,001       451,257       538,486  
Used vehicle wholesale
    130,720       105,714       70,699       92,317       129,541  
Finance and insurance
    85,852       65,274       54,953       75,447       97,480  
Service, body and parts
    325,658       284,170       278,336       289,395       288,450  
Fleet and other
    34,446       11,706       2,544       4,846       4,626  
Total revenues
  $ 2,699,360     $ 2,071,988     $ 1,728,629     $ 2,041,541     $ 2,556,567  
                                         
Gross Profit:
                                       
New vehicle
  $ 110,475     $ 85,135     $ 72,295     $ 88,910     $ 117,163  
Used vehicle retail
    100,618       80,064       65,515       51,929       75,863  
Used vehicle wholesale
    553       644       471       (2,978 )     2,898  
Finance and insurance
    85,852       65,274       54,953       75,447       97,480  
Service, body and parts
    157,120       137,051       132,500       138,226       137,225  
Fleet and other
    2,920       1,691       1,319       1,551       1,343  
Total gross profit
  $ 457,538     $ 369,859     $ 327,053     $ 353,085     $ 431,972  
                                         
Operating income (loss)(1)
  $ 111,991     $ 46,571     $ 34,907     $ (295,760 )   $ 77,986  
                                         
Income (loss) from continuing operations before income taxes(1)
  $ 89,175     $ 22,120     $ 11,764     $ (327,030 )   $ 38,496  
                                         
Income (loss) from continuing operations(1)
  $ 55,767     $ 13,531     $ 6,722     $ (221,425 )   $ 22,876  
                                         
Basic income (loss) per share from continuing operations
  $ 2.13     $ 0.52     $ 0.31     $ (10.96 )   $ 1.16  
Basic income (loss) per share from discontinued operations
    0.11       0.01       0.11       (1.55 )     (0.06 )
Basic net income (loss) per share
  $ 2.24     $ 0.53     $ 0.42     $ (12.51 )   $ 1.10  
Shares used in basic per share
    26,230       26,062       22,037       20,195       19,675  
                                         
Diluted income (loss) per share from continuing operations
  $ 2.09     $ 0.51     $ 0.30     $ (10.96 )   $ 1.11  
Diluted income (loss) per share from discontinued operations
    0.12       0.01       0.11       (1.55 )     (0.05 )
Diluted net income (loss) per share
  $ 2.21     $ 0.52     $ 0.41     $ (12.51 )   $ 1.06  
Shares used in diluted per share
    26,664       26,279       22,176       20,195       22,204  
                                         
Cash dividends declared per common share
  $ 0.26     $ 0.15     $ -     $ 0.47     $ 0.56  

 
(In thousands)
 
As of December 31,
 
Consolidated Balance Sheets Data:
 
2011
   
2010
   
2009
   
2008
   
2007
 
Working capital
  $ 191,607     $ 162,675     $ 96,886     $ 99,524     $ 193,447  
Inventories
    506,484       415,228       333,628       428,032       606,056  
Total assets
    1,146,133       971,676       895,100       1,133,459       1,626,735  
Floor plan notes payable
    343,940       251,257       216,082       343,290       456,237  
Long-term debt, including current maturities
    286,874       280,774       265,773       338,229       464,175  
Total stockholders’ equity
    367,121       320,217       307,038       248,343       508,212  
 
(1)
Includes $1.4 million, $15.3 million, $8.0 million, $333.8 million and $0.2 million of non-cash charges related to asset impairments and terminated construction projects for the years ended 2011, 2010, 2009, 2008 and 2007, respectively. See Notes 1, 4 and 5 of Notes to Consolidated Financial Statements for additional information.
 
 
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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 Item 1. “Business,” Item 1A. “Risk Factors” and our Consolidated Financial Statements and Notes thereto.

Overview
As discussed in Overview in Item 1, “Business” above, we are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of February 24, 2012, we offered 25 brands of new vehicles and all brands of used vehicles in 86 stores in the United States and online at Lithia.com. We sell new and used cars and light trucks and replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance.

We continue to believe that the fragmented nature of the automotive dealership sector provides us with the opportunity to achieve growth through consolidation. We seek exclusive franchises for acquisition, where we are the only representative of the brand within a market. We have completed over 100 acquisitions since our initial public offering in 1996. Our acquisition strategy has been to acquire underperforming dealerships and, through the application of our centralized operating structure, leverage costs and improve store profitability. We believe the current economic environment provides us with attractive acquisition opportunities.

We also believe that we can continue to improve operations at our existing stores. By promoting entrepreneurial leadership within our general managers and department managers, we strive for continual improvement to drive sales and capture market share in our local markets. Our goal is to retail approximately one used vehicle for every new vehicle sold and we believe we can make additional improvements in our used vehicle sales performance by offering lower-priced value vehicles and selling brands other than the new vehicle franchise at each location. Our service, body and parts operations provide important repeat business for our stores. We have increased our marketing efforts, lowered prices on routine maintenance items and focused on offering more commodity products to offset the impact of fewer units in operations. In 2011, we focused on organic growth through increasing market share and maintaining a lean cost structure.

We believe our cost structure is aligned with current industry sales levels and positioned to be leveraged as vehicle sales levels continue to improve. As we focus on maintaining discipline in controlling costs, we target retaining, on a same store pre-tax basis, 50% of each incremental gross profit dollar after deducting selling, general and administrative (“SG&A”) expense.

Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and reported amounts of revenues and expenses at the date of the financial statements. Certain accounting policies require us to make difficult and subjective judgments on matters that are inherently uncertain. The following accounting policies involve critical accounting estimates because they are particularly dependent on assumptions made by management. While we have made our best estimates based on facts and circumstances available to us at the time, different estimates could have been used in the current period. Changes in the accounting estimates we used are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations.
 
 
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Our most critical accounting estimates include those related to goodwill and franchise value, long-lived assets, deferred tax assets, service contracts and other insurance contracts, and lifetime oil change and self insurance programs. We also have other key accounting policies for valuation of accounts receivable, expense accruals and revenue recognition. However, these policies either do not meet the definition of critical accounting estimates described above or are not currently material items in our financial statements. We review our estimates, judgments and assumptions periodically and reflect the effects of revisions in the period that they are deemed to be necessary. We believe that these estimates are reasonable. However, actual results could differ materially from these estimates.

Goodwill and Franchise Value
We are required to test our goodwill and franchise value for impairment at least annually, or more frequently if conditions indicate that an impairment may have occurred.

We have determined that we operate as one reporting unit for evaluating goodwill. For the goodwill impairment testing, we apply a fair value based test using the Adjusted Present Value method (“APV”) to indicate the fair value of our reporting unit. Under the APV method, future cash flows are based on recently prepared budget forecasts and business plans to estimate the future economic benefits that the reporting unit will generate. An estimate of the appropriate discount rate is utilized to convert the future economic benefits to their present value equivalent.

The goodwill impairment test is a two step process. The first step identifies potential impairments by comparing the calculated fair value of a reporting unit with its book value. If the fair value of the reporting unit exceeds the carrying amount, goodwill is not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step includes determining the implied fair value through further market research. The implied fair value of goodwill is then compared with the carrying amount to determine if an impairment loss should be recorded.

As of December 31, 2011, we had $19.0 million of goodwill on our balance sheet. The first step of our annual goodwill impairment analysis, which we perform as of October 1 of each year, did not result in an indication of impairment in 2011 or in 2010. We did not have any goodwill as of December 31, 2009.  The fair value of the reporting unit as of December 31, 2011, using the APV method, was 42% greater than the carrying value at December 31, 2011.

We have determined the appropriate unit of accounting for testing franchise rights for impairment is on an individual store basis. For the franchise value impairment testing, we estimate the fair value of our franchise rights primarily using the Multi-Period Excess Earnings (“MPEE”) model. The forecasted cash flows used in the MPEE model contain inherent uncertainties, including significant estimates and assumptions related to growth rates, margins, general operating expenses, and cost of capital. We use primarily internally-developed forecasts and business plans to estimate the future cash flows that each franchise will generate. We have determined that only certain cash flows of the store are directly attributable to the franchise rights. We estimate the appropriate interest rate to discount future cash flows to their present value equivalent taking into consideration factors such as a risk-free rate, a beta, an equity risk premium, a small stock risk premium, and a subject-company risk premium.

We also use third-party brokers’ estimates to assist us in determining the fair value of our franchise rights, which are developed using marketplace data related to current transactions involving franchise rights.

As of December 31, 2011, we had $59.1 million of franchise value on our balance sheet. Our impairment testing of franchise value did not indicate any impairment in 2011 or 2010. Our impairment testing of franchise value in 2009 resulted in impairment charges of $0.3 million, primarily due to the adverse change in the business climate and our reduced earnings.

We are subject to financial statement risk to the extent that our goodwill or franchise rights become impaired due to decreases in the fair value. A future decline in performance, decreases in projected growth rates or margin assumptions or changes in discount rates could result in a potential impairment, which could have a material adverse impact on our financial position and results of operations. Furthermore, in the event that a manufacturer is unable to remain solvent, we may be required to record a partial or total impairment on the remaining franchise value related to that manufacturer.
 
 
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See Notes 1 and 5 of Notes to Consolidated Financial Statements for additional information.

Long-Lived Assets
We estimate the depreciable lives of our property and equipment, including leasehold improvements, and review them for impairment when events or circumstances indicate that their carrying amounts may not be recoverable.

We determine a triggering event has occurred by reviewing store forecasted and historical financial performance. A store is evaluated for recoverability if it has an operating loss in the current year and two of the prior three years. Additionally, we may judgmentally evaluate a store if its financial performance indicates it may not support the carrying amount of the long-lived assets. If a store meets these criteria, we estimate the projected undiscounted cash flows for each asset group based on internally developed forecasts. If the undiscounted cash flows are lower than the carrying value of the asset group, we determine the fair value of the asset group based on additional market data, including recent experience in selling similar assets.

We hold certain property for future development or investment purposes. If a triggering event is deemed to have occurred, we evaluate the property for impairment by comparing its estimated fair value based on listing price less costs to sell and other market data, including similar property that is for sale or has been recently sold, to the current carrying value. If the carrying value is more than the estimated fair value, an impairment is recorded.

Although we believe our property and equipment and assets held and used are appropriately valued, the assumptions and estimates used may change and we may be required to record impairment charges to reduce the value of these assets. A future decline in store performance, decrease in projected growth rates or changes in other operating assumptions could result in an impairment of long-lived asset groups, which could have a material adverse impact on our financial position and results of operations. A decline in the commercial real estate market could result in a potential impairment of certain investment properties not currently used in operations. Currently, $14.0 million of our long-lived assets are considered held for future development or investment purposes.

Due to the adverse change in the business climate and the commercial real estate market, we performed impairment testing on long-lived assets, mainly related to certain property held for future development or investment purposes in 2011, 2010 and 2009. As a result, we recorded impairments related to long-lived assets of $1.4 million, $15.3 million and $9.7 million in 2011, 2010 and 2009, respectively.

See Notes 1 and 4 of Notes to Consolidated Financial Statements for additional information.

Deferred Tax Assets
As of December 31, 2011, we had deferred tax assets of approximately $69.2 million and deferred tax liabilities of $22.3 million. The principal components of our deferred tax assets are related to goodwill, allowances and accruals, deferred revenue and cancellation reserves. The principal components of our deferred tax liabilities are related to depreciation on property and equipment and inventories.

We consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment.
 
 
32

 

Based upon the scheduled reversal of deferred tax liabilities, and our projections of future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences.

At December 31, 2011, we recorded a $12.8 million valuation allowance against our deferred tax assets. In 2011, we recorded an allowance associated with losses from the sale of corporate entities.  As these amounts are characterized as capital losses, we evaluated the availability of projected capital gains and determined that it would be unlikely these amounts would be fully utilized.  If we are unable to meet the projected taxable income levels utilized in our analysis, and depending on the availability of feasible tax planning strategies, we might record a valuation allowance on a portion or all of our deferred tax assets in the future. In the event that a manufacturer is unable to remain solvent, our operations may be impacted and we might record a valuation allowance on a portion or all of the deferred tax assets, which could have a material adverse impact on our financial position and results of operations.

Service Contracts and Other Insurance Contracts
We receive commissions from the sale of vehicle service contracts and certain other insurance contracts. The contracts are sold through unrelated third parties, but we may be charged back for a portion of the commissions in the event of early termination of the contracts by customers. We sell these contracts on a straight commission basis; in addition, we may also participate in future underwriting profit pursuant to retrospective commission arrangements, which are recognized as income upon receipt.

We record commissions at the time of sale of the vehicles, net of an estimated liability for future charge-backs. We have established a reserve for estimated future charge-backs based on an analysis of historical charge-backs in conjunction with estimated lives of the applicable contracts. If future cancellations are different than expected, we could have additional expense related to the cancellations in future periods, which could have a material adverse impact on our financial position and results of operations.

At December 31, 2011 and 2010, the reserve for future cancellations totaled $10.4 million and $9.4 million, respectively, and is included in accrued liabilities and other long-term liabilities on our Consolidated Balance Sheets. A 10% increase in expected cancellations would result in an additional reserve of approximately $1.0 million.

Lifetime Oil Change Self-Insurance
In March 2009, we assumed from a third party the obligation to provide future lifetime oil service for a pool of existing contracts and began to self-insure the majority of the lifetime oil contracts we sell.

Payments we receive upon sale of the lifetime oil contracts are deferred and recognized in revenue over the expected life of the service agreement to best match the expected timing of the costs to be incurred to perform the service. We estimate the timing and amount of future costs for claims and cancellations related to our lifetime oil contracts using historical experience rates and estimated future costs.

If our estimates of future costs to perform under the contracts exceed the existing deferred revenue, we record a charge in the statement of operations. We perform our loss contingency analysis separately for the pool of assumed contracts and the pool of self-insured contracts sold starting in March 2009. We recorded a charge of $1.0 million, $1.0 million and $1.4 million in 2011, 2010 and 2009, respectively, for expected costs in excess of revenue deferred related to the pool of assumed contracts. The analysis on our self-insured sold contracts did not indicate a loss reserve was needed in 2011, 2010 and 2009.

We believe the new vehicle purchase cycle has been delayed for many buyers. If the ownership cycle does not accelerate towards pre-recession levels, our estimate of the number of oil changes to be performed over a vehicle’s life may increase, which would adversely affect our financial position and results of operations. In addition, other changes in assumptions about future costs expected to be incurred to service contracts could result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.
 
 
33

 

A 10% change in expected claims costs per contract for the assumed pool of contracts would result in an additional reserve of approximately $0.9 million. A 10% change in expected claims per contract for the self-insured sold contracts would not require any reserve. At December 31, 2011 and 2010, the remaining deferred revenue related to the assumed obligation and the self-insured sold contracts was $5.5 million and $7.5 million, respectively.

Self Insurance Programs
We self-insure a portion of our property and casualty insurance, medical insurance and workers’ compensation insurance. A third-party is engaged to estimate the loss exposure related to the self-retained portion of the risk associated with these insurances. Additionally, we analyze our historical loss and claims experience to estimate the loss exposure associated with these programs. Any changes in assumptions or claim experience could result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.

At December 31, 2011 and 2010, the total reserve associated with these programs was $10.4 million and $7.3 million, respectively, and is included in accrued liabilities and other long-term liabilities on our Consolidated Balance Sheets. A 10% increase in claims experience would result in an additional reserve of approximately $3.9 million.

Results of Continuing Operations
For the year ended December 31, 2011, we reported income from continuing operations, net of tax, of $55.8 million, or $2.09 per diluted share. For the years ended December 31, 2010 and 2009, we reported income from continuing operations, net of tax, of $13.5 million, or $0.51 per diluted share, and $6.7 million, or $0.30 per diluted share, respectively.

Discontinued Operations
Results for sold or closed stores, qualifying for reclassification under the applicable accounting guidance, have their results presented as discontinued operations in our Consolidated Statements of Operations. As a result, our results from continuing operations are presented on a comparable basis for all periods. Within discontinued operations, we realized a gain, net of tax, of $3.1 million, $0.2 million and $2.4 million for the years ended December 31, 2011, 2010 and 2009, respectively. See Notes 1 and 17 of Notes to Consolidated Financial Statements for additional information.
 
 
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Key Performance Metrics
Certain key performance metrics for revenue and gross profit were as follows for 2011, 2010 and 2009 (dollars in thousands):

2011
 
Revenues
   
Percent of
Total Revenues
   
Gross Profit
   
Gross Profit
Margin
   
Percent of Total
Gross Profit
 
New vehicle
  $ 1,426,888       52.9 %   $ 110,475       7.7 %     24.1 %
Used vehicle, retail
    695,796       25.8       100,618       14.5       22.0  
Used vehicle, wholesale
    130,720       4.8       553       0.4       0.1  
Finance and insurance(1)
    85,852       3.2       85,852       100.0       18.8  
Service, body and parts
    325,658       12.0       157,120       48.2       34.3  
Fleet and other
    34,446       1.3       2,920       8.5       0.7  
    $ 2,699,360       100.0 %   $ 457,538       16.9 %     100.0 %
 
2010
 
Revenues
   
Percent of
Total Revenues
   
Gross Profit
   
Gross Profit
Margin
   
Percent of Total
Gross Profit
 
New vehicle
  $ 1,038,321       50.1 %   $ 85,135       8.2 %     23.0 %
Used vehicle, retail
    566,803       27.4       80,064       14.1       21.6  
Used vehicle, wholesale
    105,714       5.1       644       0.6       0.2  
Finance and insurance(1)
    65,274       3.1       65,274       100.0       17.6  
Service, body and parts
    284,170       13.7       137,051       48.2       37.1  
Fleet and other
    11,706       0.6       1,691       14.4       0.5  
    $ 2,071,988       100.0 %   $ 369,859       17.9 %     100.0 %
 
2009
 
Revenues
   
Percent of
Total Revenues
   
Gross Profit
   
Gross Profit
Margin
   
Percent of Total
Gross Profit
 
New vehicle
  $ 857,096       49.6 %   $ 72,295       8.4 %     22.1 %
Used vehicle, retail
    465,001       26.9       65,515       14.1       20.0  
Used vehicle, wholesale
    70,699       4.1       471       0.7       0.2  
Finance and insurance(1)
    54,953       3.2       54,953       100.0       16.8  
Service, body and parts
    278,336       16.1       132,500       47.6       40.5  
Fleet and other
    2,544       0.1       1,319       51.8       0.4  
    $ 1,728,629       100.0 %   $ 327,053       18.9 %     100.0 %
 
 
(1)
Commissions reported net of anticipated cancellations.

Same Store Operating Data
We believe that same store sales are a key indicator of our financial performance. Same store metrics demonstrate our ability to grow our revenue and profitability in our existing locations. As a result, same store sales have been integrated into the discussion below.

A same store basis represents stores that were operating during 2011, and only includes the months when operations occur in both comparable periods. For example, a store acquired in August 2010 would be included in same store operating data beginning in September 2011, after its first full complete comparable month of operation. Thus, operating results for same store comparisons would include only the period of September through December of both comparable years.   
 
 
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New Vehicle Revenues
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2011
   
2010
   
Increase
   
Increase
 
Reported
                       
Revenue
  $ 1,426,888     $ 1,038,321     $ 388,567       37.4 %
Retail units sold
    43,273       32,664       10,609       32.5  
Average selling price per retail unit
  $ 32,974     $ 31,788     $ 1,186       3.7  
                                 
Same store
                               
Revenue
  $ 1,341,171     $ 1,039,886     $ 301,285       29.0 %
Retail units sold
    41,144       32,703       8,441       25.8  
Average selling price per retail unit
  $ 32,597     $ 31,798     $ 799       2.5  
 
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2010
   
2009
   
Increase
   
Increase
 
Reported
                       
Revenue
  $ 1,038,321     $ 857,096     $ 181,225       21.1 %
Retail units sold
    32,664       28,439       4,225       14.9  
Average selling price per retail unit
  $ 31,788     $ 30,138     $ 1,650       5.5  
                                 
Same Store
                               
Revenue
  $ 1,024,085     $ 857,877     $ 166,208       19.4 %
Retail units sold
    32,136       28,457       3,679       12.9  
Average selling price per retail unit
  $ 31,867     $ 30,146     $ 1,721       5.7  
 
New vehicle sales in 2011 improved compared to 2010 as both volumes and average selling prices increased. We remain focused on increasing our share of overall new vehicle sales within our markets, and had targeted increased market share as an operational objective in 2011. As a result of this initiative, as well as improved consumer demand, domestic brand new vehicle same store sales increased 41% in 2011 compared to 2010. Import and luxury brands had a same store sales improvement of 15% in 2011 compared to 2010. The sales growth for import and luxury brands was not as robust as domestic brands as inventory constraints resulting from the events in Japan and the subsequent disruption to new vehicle supply negatively affected sales.

New vehicle sales improved throughout 2010 compared to 2009 due to a recovery in the U.S. economy and our efforts to increase our share of the new vehicles sold within each local market. Credit availability improved throughout 2010, although, within the sub-prime market, lending remained constrained. Additionally, domestic brands experienced a recovery of market share due to improved product and increased consumer confidence as Chrysler and GM emerged from their restructuring, and as Toyota lost market share due to perceived quality issues and recall campaigns.
 
 
36

 

Used Vehicle Retail Revenues
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2011
   
2010
   
Increase
   
Increase
 
Reported
                       
Retail revenue
  $ 695,796     $ 566,803     $ 128,993       22.8 %
Retail units sold
    40,457       33,869       6,588       19.5  
Average selling price per retail unit
  $ 17,198     $ 16,735     $ 463       2.8  
                                 
Same store
                               
Retail revenue
  $ 658,586     $ 563,587     $ 94,999       16.9 %
Retail units sold
    38,762       33,646       5,116       15.2  
Average selling price per retail unit
  $ 16,991     $ 16,750     $ 241       1.4  
 
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2010
   
2009
   
Increase
   
Increase
 
Reported
                       
Retail revenue
  $ 566,803     $ 465,001     $ 101,802       21.9 %
Retail units sold
    33,869       28,577       5,292       18.5  
Average selling price per retail unit
  $ 16,735     $ 16,272     $ 463       2.8  
                                 
Same store
                               
Retail revenue
  $ 554,150     $ 464,365     $ 89,785       19.3 %
Retail units sold
    33,073       28,532       4,541       15.9  
Average selling price per retail unit
  $ 16,755     $ 16,275     $ 480       2.9  

We continue to emphasize used vehicle retail sales and respond to potential supply constraints in late-model used vehicles as a result of the lower new vehicle sales in 2008, 2009 and 2010. Our strategy is to offer three categories of used vehicles: manufacturer certified pre-owned used vehicles; late model, lower-mileage vehicles; and value autos. This approach allows us to expand our target customer and increase the conversion of vehicles acquired via trade-in to retail used vehicle sales. In 2011, we continued to focus on increasing the number of lower-price, higher-margin, older used vehicles we sell and the sale of brands other than the store’s new vehicle franchise. Our retail used to new vehicle sales ratio fell slightly to 0.9:1 for the year ended December 31, 2011 compared to 1.0:1 in 2010 and 1.0:1 in 2009, primarily related to stronger growth in new vehicle sales in 2011. On average, each of our stores currently sells 40 retail used vehicle units per month and we target increasing sales to 60 units per month. Our goal continues to be a retail used to new ratio of 1.0:1.

Used vehicle retail unit sales increased in 2010 compared to 2009 as consumers elected to purchase used vehicles instead of new vehicles, and as we increased the number of lower-price, higher-margin, older used vehicles we sell. We focused our store personnel on maximizing retail used vehicle sales and reducing the number of used vehicles we wholesale after acquiring them via trade-in.
 
 
37

 
 
Used Vehicle Wholesale Revenues
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2011
   
2010
   
Increase
   
Increase
 
Reported
                       
Wholesale revenue
  $ 130,720     $ 105,714     $ 25,006       23.7 %
Wholesale units sold
    16,439       13,906       2,533       18.2  
Average selling price per wholesale unit
  $ 7,952     $ 7,602     $ 350       4.6  
                                 
Same store
                               
Wholesale revenue
  $ 125,324     $ 104,292     $ 21,032       20.2 %
Wholesale units sold
    15,942       13,769       2,173       15.8  
Average selling price per wholesale unit
  $ 7,861     $ 7,574     $ 287       3.8  
 
   
Year Ended
December 31,
         
%
 
(Dollars in thousands)
 
2010
   
2009
   
Increase
   
Increase
 
Reported
                       
Wholesale revenue
  $ 105,714     $ 70,699     $ 35,015       49.5 %
Wholesale units sold
    13,906       13,211       695       5.3  
Average selling price per wholesale unit
  $ 7,602     $ 5,352     $ 2,250       42.0  
                                 
Same store
                               
Wholesale revenue
  $ 103,302     $ 69,970     $ 33,332       47.6 %
Wholesale units sold
    13,584       13,159       425       3.2  
Average selling price per wholesale unit
  $ 7,605     $ 5,317     $ 2,288       43.0  
 
Wholesale transactions are vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to inventory age or other factors. Since 2010, we have concentrated on directing more lower-priced, older vehicles to retail sale rather than wholesale disposal, which resulted in an increase in the average selling price per wholesale unit in 2011 compared to 2010 and in 2010 compared to 2009.

Wholesale vehicle sales are typically done at or near inventory cost and do not comprise a meaningful component of our gross profit. We generated wholesale profit of $0.6 million, $0.6 million and $0.5 million in 2011, 2010 and 2009, respectively.
 
 
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Finance and Insurance
   
Year Ended
December 31,
   
Increase
   
%
Increase
 
(Dollars in thousands)
 
2011
   
2010
   
(Decrease)
   
(Decrease)
 
Reported
                       
Revenue
  $ 85,852     $ 65,274     $ 20,578       31.5 %
                                 
Revenue per retail unit
                               
Finance reserves
  $ 387     $ 338     $ 49       14.5 %
Maintenance contracts
    528       535       (7 )     (1.3 )
Insurance and other
    110       108       2       1.9  
Revenue per retail unit
  $ 1,025     $ 981     $ 44       4.5 %
                                 
Same store
                               
Revenue
  $ 81,335     $ 62,433     $ 18,902       30.3 %
                                 
Revenue per retail unit
                               
Finance reserves
  $ 382     $ 333     $ 49       14.7 %
Maintenance contracts
    532       508       24       4.7  
Insurance and other
    104       100       4       4.0  
Revenue per retail unit
  $ 1,018     $ 941     $ 77       8.2 %
 
   
Year Ended
December 31,
   
Increase
   
%
Increase
 
(Dollars in thousands)
 
2010
   
2009
   
(Decrease)
   
(Decrease)
 
Reported
                       
Revenue
  $ 65,274     $ 54,953     $ 10,321       18.8 %
                                 
Revenue per retail unit
                               
Finance reserves
  $ 338     $ 291     $ 47       16.2 %
Maintenance contracts
    535       560       (25 )     (4.5 )
Insurance and other
    108       113       (5 )     (4.4 )
Revenue per retail unit
  $ 981     $ 964     $ 17       1.8 %
                                 
Same store
                               
Revenue
  $ 61,263     $ 52,445     $ 8,818       16.8 %
                                 
Revenue per retail unit
                               
Finance reserves
  $ 334     $ 286     $ 48       16.8 %
Maintenance contracts
    505       530       (25 )     (4.7 )
Insurance and other
    100       104       (4 )     (3.8 )
Revenue per retail unit
  $ 939     $ 920     $ 19       2.1 %

The increases in finance and insurance sales in 2011 compared to 2010, and 2010 compared to 2009 were primarily due to more vehicles sold. The availability of consumer credit has expanded and lenders have increased the loan-to-value amount available to most customers. Additionally, competition has continued to increase among lenders and we have seen an increase in finance reserves.  As a result, we have experienced continued improvement in the average amount of revenue per unit. These shifts afford us the opportunity to sell additional or more comprehensive products, while remaining within a loan-to-value framework acceptable to our retail customer lenders.

In 2010, banks returned to the auto finance market and provided alternate financing options to customers that we had primarily shifted to credit unions in 2009. Banks typically pay a higher commission for arranging retail automotive financing and our revenue per retail unit increased as a result.

Penetration rates for certain products were as follows:

   
2011
   
2010
   
2009
 
Finance and insurance
    73%       72%       69%  
Service contracts
    40       41       41  
Lifetime oil change and filter
    36       34       35  
 
 
39

 
 
Service, Body and Parts Revenue
   
Year Ended
December 31,
   
Increase
   
%
Increase
 
(Dollars in thousands)
 
2011
   
2010
   
(Decrease)
   
(Decrease)
 
Reported
                       
Customer pay
  $ 184,335     $ 160,395     $ 23,940       14.9 %
Warranty
    53,377       49,360       4,017       8.1  
Wholesale parts
    57,734       48,342       9,392       19.4  
Body shop
    30,212       26,073       4,139       15.9  
Total service, body and parts
  $ 325,658     $ 284,170     $ 41,488       14.6 %
                                 
Same store
                               
Customer pay
  $ 166,418     $ 160,148     $ 6,270       3.9 %
Warranty
    47,470       49,311       (1,841 )     (3.7 )
Wholesale parts
    53,078       48,137       4,941       10.3  
Body shop
    29,689       26,040       3,649       14.0  
Total service, body and parts
  $ 296,655     $ 283,636     $ 13,019       4.6 %
 
   
Year Ended
December 31,
   
Increase
   
%
Increase
 
(Dollars in thousands)
 
2010
   
2009
   
(Decrease)
   
(Decrease)
 
Reported
                       
Customer pay
  $ 160,395     $ 151,035     $ 9,360       6.2 %
Warranty
    49,360       53,062       (3,702 )     (7.0 )
Wholesale parts
    48,342       48,075       267       0.6  
Body shop
    26,073       26,164       (91 )     (0.3 )
Total service, body and parts
  $ 284,170     $ 278,336     $ 5,834