Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 001-31262

 

 

ASBURY AUTOMOTIVE GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   01-0609375
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

622 Third Avenue, 37th Floor

New York, New York

  10017
(Current address of principal executive offices)   (Zip Code)

(212) 885-2500

(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

Common Stock, par value $.01 per share

  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 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, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

Large Accelerated Filer  x    Accelerated filer  ¨    Non-Accelerated Filer  ¨

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Based on the closing price of the registrant’s common stock as of June 30, 2007, the aggregate market value of the common stock held by non-affiliates of the registrant was $808,957,642.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: The number of shares of common stock outstanding as of February 27, 2008 was 31,915,300 (net of 4,748,750 treasury shares).

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be filed within 120 days after the end of the registrant’s fiscal year are incorporated by reference into Part III, Items 10 through 14 of this Form 10-K.

 

 

 


Table of Contents

ASBURY AUTOMOTIVE GROUP, INC.

2007 FORM 10-K ANNUAL REPORT

 

          Page
PART I

Item 1.

   Business    3

Item 1A.

   Risk Factors    16

Item 1B.

   Unresolved Staff Comments    23

Item 2.

   Properties    23

Item 3.

   Legal Proceedings    24

Item 4.

   Submission of Matters to a Vote of Security Holders    24
PART II

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    25

Item 6.

   Selected Financial Data    27

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    65

Item 8.

   Financial Statements and Supplementary Data    67

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    99

Item 9A.

   Controls and Procedures    99

Item 9B.

   Other Information    99
PART III

Item 10.

   Directors and Executive Officers of the Registrant    100

Item 11.

   Executive Compensation    100

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    100

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    100

Item 14.

   Principal Accountant Fees and Services    100
PART IV

Item 15.

   Exhibits and Financial Statement Schedules    100


Table of Contents

PART I

Forward-Looking Information

Certain statements in this report constitute “forward-looking statements” as such term is defined in the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this report include statements relating to goals, plans and pending acquisitions, projections regarding our financial position, results of operations, market position, business strategy and expectations of our management with respect to, among other things:

 

   

our relationships with vehicle manufacturers;

 

   

our ability to improve our margins;

 

   

operating cash flows and availability of capital;

 

   

capital expenditures;

 

   

our ability to pay future dividends;

 

   

the completion of future acquisitions and the revenues to be generated by those acquisitions;

 

   

our ability to mitigate future negative trends in new vehicle sales with the stability of our fixed operations, our variable cost structure and our advantageous brand mix;

 

   

manufacturer’s willingness to continue to use incentive programs in the near future to drive demand for their product offerings;

 

   

general economic trends, including consumer confidence levels and interest rates;

 

   

automotive retail industry trends including (i) the recent industry-wide gain in market share of the luxury and mid-line import brands to continue in the near future (ii) our expectation that 2008 will be a challenging retail environment and the related impact of our ability to maintain our current new vehicle revenue and gross profit levels as well as our current SG&A expense as a percentage of gross profit levels, (iii) our expectation that light vehicle unit sales will outperform industry-wide U.S. light vehicle unit sales, (iv) that the luxury and mid-line import brands will continue to increase market share and (v) that heavy trucks unit sales, revenue and gross profit will continue to decrease in the first half of 2008;

 

   

our used vehicle expectations including (i) our belief that there is opportunity to improve our used vehicle profitability by offering appropriately priced used vehicle inventory, (ii) the 5% to 8% decline in our used unit sales in 2008 (iii) the improvement in our used vehicle inventory should mitigate the impact of the slower automotive retail selling season and challenging economic environment on our used vehicle performance;

 

   

our expectation that we will continue to grow our fixed operations revenue;

 

   

our expectation that we will recognize improved fixed operations gross profit in the future from heavy trucks as a result of the addition of service capacity and as the customers who purchased vehicles prior to the emission law changes begin to bring their vehicles in for maintenance and repairs;

 

   

our expectation of our 2008 interest expense; and

 

   

our expectation of our 2008 effective income tax rate

To the extent that statements in this report are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, are based on our current expectations and assumptions and involve significant risks and uncertainties. As a result, there can be no guarantees that our plans for future operations will be successfully implemented or that they will prove to be commercially successful. The following are some but not all of the factors that could cause actual results or events to differ materially from those anticipated, including:

 

   

our ability to generate sufficient cash flows;

 

   

market factors and the future economic environment, including consumer confidence, interest rates, the price of oil and gasoline, the level of manufacturer incentives, and the availability of consumer credit;

 

   

the reputation and financial condition of vehicle manufacturers whose brands we sell, and their ability to design, manufacture, deliver and market their vehicles successfully;

 

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the ability of our principal vehicle manufacturers to continue to produce vehicles that are in high demand by our customers;

 

   

our ability to enter into and/or renew our framework and dealership agreements on favorable terms;

 

   

the inability of our dealership operations to perform at expected levels or achieve expected targets;

 

   

our ability to successfully integrate recent and future acquisitions;

 

   

our relationships with the automotive manufacturers which may affect our ability to complete additional acquisitions;

 

   

changes in, or failure or inability to comply with, laws and regulations governing the operation of automobile franchises, accounting standards, the environment and taxation requirements;

 

   

high levels of competition in the automotive retailing industry which may create pricing pressures on the products and services we offer;

 

   

our inability to minimize operating expenses or adjust our cost structure;

 

   

the loss of key personnel; and

 

   

the outcome of any pending or threatened litigation.

These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this report. We expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, whether as a result of new information, future events or otherwise, except as required under federal securities law. Please see the section under “Item 1A. Risk Factors” for a further discussion of the factors that may cause our actual results of operations to differ from our projections.

Moreover, the factors set forth under “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below and other cautionary statements made in this report should be read and understood as being applicable to all related forward-looking statements wherever they appear in this report. We urge you to carefully consider those factors.

Additional Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act are made available free of charge on our Internet site at http://www.asburyauto.com on the same day that the information is filed with the Securities and Exchange Commission (the “Commission”). In addition, the proxy statement that will be delivered to our stockholders in connection with our 2008 annual meeting, when filed, will also be available on our web site, at the URL stated in such proxy statement. We also make available on our web site copies of our charter, bylaws and materials that outline our corporate governance policies and practices, including:

 

   

the respective charters of our audit committee, governance and nominating committee, and compensation committee;

 

   

our criteria for independence of the members of our board of directors, audit committee and compensation committee;

 

   

our Corporate Governance Guidelines; and

 

   

our Code of Business Conduct and Ethics for Directors, Officers and Employees.

We intend to provide any information required by Item 5.05 of Form 8-K (relating to amendments or waivers of our Code of Business Conduct and Ethics) by the alternative of disclosure on our website.

You may also obtain a printed copy of the foregoing materials by sending a written request to: Investor Relations Department, Asbury Automotive Group, Inc., 622 Third Avenue, 37th Floor, New York, New York 10017. In addition, the Commission makes available on its web site, free of charge, reports, proxy and information statements and other information regarding issuers, such as us, that file electronically with the Commission. The Commission’s web site is http://www.sec.gov. Unless otherwise specified, information contained on our web site, available by hyperlink from our web site or on the Commission’s web site, is not incorporated into this report or other documents we file with, or furnish to, the Commission.

As required by Section 303A.12 of the Listed Company Manual of the New York Stock Exchange (the “NYSE”), our Chief Executive Officer submitted to the NYSE his annual certification on May 21, 2007, stating that he was not aware of any violation by our company of the corporate governance listing standards of the NYSE. In addition, we have filed, as exhibits to our annual report on Form 10-K/A for the year ended December 31, 2006, the certifications of our Chief Executive Officer and Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act of 2002 to be filed with the Commission.

 

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Except as the context otherwise requires, “we,” “our,” “us,” “Asbury” and the “Company” refer to Asbury Automotive Group, Inc. and its subsidiaries.

 

Item 1. Business

We are one of the largest automotive retailers in the United States, operating 124 franchises at 93 dealership locations as of December 31, 2007. We offer our customers an extensive range of automotive products and services, including:

 

   

new and used vehicles;

 

   

vehicle maintenance and repair services;

 

   

replacement parts;

 

   

arranging new and used vehicle financing; and

 

   

arranging the sale of warranty, insurance and extended service contracts.

For the year ended December 31, 2007, our revenues were $5.7 billion and our net income was $51.0 million. Our income from continuing operations and net income during 2007 was impacted by several items (the “Adjusting items”) as detailed in the “Reconciliation of Non-GAAP Financial Information” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. Excluding these adjusting items, adjusted income from continuing operations and adjusted net income for the year ended December 31, 2007 and 2006 was $69.5 million and $66.2 million, respectively.

Asbury Automotive Group, Inc. was incorporated in the State of Delaware on February 15, 2002. On March 13, 2002, we effected an initial public offering of our common stock, and on March 14, 2002, our stock was listed on the NYSE under the ticker symbol “ABG”.

General Description of Our Operations

As of December 31, 2007, we operated dealerships in 22 metropolitan markets throughout the United States. We developed our dealership portfolio through the acquisition of large, locally branded dealership groups operating throughout the United States. We complemented these large dealership groups with the purchase of numerous single point dealerships and small dealership groups in our existing market areas (referred to as “tuck in acquisitions.”) Our retail network is currently organized into principally four regions and includes nine locally branded dealership groups. The following is a detailed breakdown of our markets and dealerships as of December 31, 2007:

 

Brand Names by Region

  

Date of Initial
Acquisition

  

Markets

  

Franchises

South

        

Nalley Automotive Group

  

September 1996

  

Atlanta, GA

   Acura, Audi, BMW, Chrysler, Hino(a), Honda, IC Bus, Infiniti(a), International(a), Isuzu Truck, Jaguar, Jeep, Lexus(a), Nissan, Peterbilt, Volvo, Workhorse

Florida

        

Courtesy Autogroup

  

September 1998

  

Tampa, FL

   Chrysler, Dodge, Honda, Hyundai, Infiniti, Jeep, Kia, Mercedes-Benz, Nissan, Toyota, Volkswagen(c)

Coggin Automotive Group

  

October 1998

  

Jacksonville, FL

   Buick, Chevrolet, GMC(a), Honda(a), Kia (a)(b), Nissan(a), Pontiac(a), Toyota
     

Orlando, FL

   Buick, Chevrolet, Ford, GMC, Honda(a), Lincoln, Mercury, Pontiac
     

Fort Pierce, FL

   Acura, BMW, Honda, Mercedes-Benz

West

        

David McDavid Auto Group

  

April 1998

  

Dallas/Fort Worth, TX

   Acura, Honda(a), Lincoln, Mercury
     

Houston, TX

   Honda, Nissan
     

Austin, TX

   Acura

 

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California Dealerships    April 2003    Fresno, CA    Mercedes-Benz, Nissan
      Sacramento, CA    Mercedes-Benz
      Los Angeles, CA    Honda
North Point Auto Group    February 1999    Little Rock, AR    BMW, Ford, Lincoln, Mazda, Mercury, Nissan(a), Toyota, Volkswagen, Volvo
Mid-Atlantic         
Crown Automotive Company    December 1998   

Princeton, NJ

Greensboro, NC

  

BMW, MINI

Acura, BMW, Cadillac, Chevrolet, Chrysler, Dodge, Honda, Nissan, Volvo

      Chapel Hill, NC    Honda, Volvo
      Fayetteville, NC    Dodge, Ford
      Charlotte, NC    Honda
      Richmond, VA    Acura, BMW(a), MINI
      Charlottesville, VA    BMW
      Greenville, SC    Chrysler(b), Jeep(b), Nissan
Gray-Daniels Auto Family    April 2000    Jackson, MS    Buick, Cadillac, Chevrolet(a), Ford, GMC, Lincoln, Mercury, Nissan(a), Pontiac, Toyota
Plaza Motor Company    December 1997    St. Louis, MO    Audi, BMW, Cadillac, Infiniti, Land Rover, Lexus, Mercedes-Benz, Porsche

 

(a) This market has two of these franchises.
(b) Represents pending divestitures as of December 31, 2007, which were sold in the first quarter of 2008.
(c) Represents pending divestitures as of December 31, 2007.

New Vehicle Sales

Our franchises include a diverse portfolio of 35 American, European and Asian brands. Our new vehicle sales include the sale of new vehicles to individual retail customers (“new retail”) and the sale of new vehicles to commercial customers (“fleet”) (the terms “new retail” and “fleet” being collectively referred to as “new”). In 2007, we retailed 101,871 new vehicles through our dealerships. New vehicle retail sales were 56.4% of our total revenues and 26.6% of our total gross profit for the year ended December 31, 2007. Fleet sales, which provide significantly less gross margins than retail sales, were approximately 2.8% of total revenues for the year ended December 31, 2007. We evaluate the results of our new and used vehicle sales based on unit volumes and gross profit per vehicle retailed (“PVR”). We believe we are well-positioned to capitalize on changes in consumer preferences as a result of our strong brand mix, which is heavily weighted towards mid-line import and luxury brands. Please see “Business Strategy—Focus on Premier Brand Mix, Strategic Markets and Diversification” below for a discussion on our diverse offering of brands and products.

Our new vehicle retail sales include new vehicle sales, new vehicle retail lease transactions provided by third parties and other similar agreements arranged by our individual dealerships. As a result of finite lease terms, customers who lease new vehicles generally return to the market more frequently than customers who purchase new vehicles. In addition, because third party lessors frequently give our dealerships the first option to purchase vehicles returned by customers at lease-end, leases provide us with an additional source of late-model vehicles for our used vehicle inventory. Generally, leased vehicles remain under factory warranty for the term of the lease, allowing dealerships to provide repair service to the lessee throughout the lease term.

Used Vehicle Sales

We sell used vehicles at all of our dealership locations. Used vehicle sales include the sale of used vehicles to individual retail customers (“used retail”) and the sale of used vehicles to other dealers at auction (“wholesale”) (the terms “used retail” and “wholesale” being collectively referred to as “used”). In 2007, we retailed 60,764 used vehicles through our dealerships. Retail sales of used vehicles, which generally have higher gross margins than new vehicles, made up approximately 19.5% of our total revenues and 14.2% of our total gross profit for the year ended December 31, 2007. Used vehicle revenue from wholesale sales was 6.1% of total revenue for the year ended December 31, 2007. Profits from the sales of used vehicles depend primarily on the

 

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ability of our dealerships to obtain a high quality supply of used vehicles and the use of the best available technology to manage our inventory. Our new vehicle operations provide our used vehicle operations with a large supply of high quality trade-ins and off-lease vehicles, which we believe are good sources of attractive used vehicle inventory. We purchase a significant portion of our used vehicle inventory at auctions restricted to new vehicle dealers (offering off-lease, rental and fleet vehicles) and “open” auctions that offer vehicles sold by other dealers and repossessed vehicles. Used vehicle inventory is typically wholesaled after approximately 60 days, except for used vehicles that do not fit within our inventory mix, which are wholesaled almost immediately. The reconditioning of used vehicles also creates profitable service work for our fixed operations departments.

In addition to our high quality supply of used vehicles, we manage our used car sales on a local basis and employ the best available technology to manage our inventory and used car sales on a local basis. We transfer used vehicles among our dealerships to provide a balanced mix of used vehicle inventory at each of our dealerships. We believe that acquisitions of additional dealerships will expand the internal market for the transfer of used vehicles among our dealerships and, therefore, increase the ability of each dealership to offer a balanced mix of used vehicles.

We have taken several steps towards building customer confidence in our used vehicle inventory, including participation in manufacturer certification programs as well as the development of our own used vehicle certification program. The manufacturer programs make certain used vehicles eligible for vehicle benefits such as special finance rates and extended manufacturer warranties. Our used vehicle certification program includes a thorough inspection of used vehicle inventory within the program and allows our customers to return used vehicles for any reason within five days or five hundred miles. We guarantee the operation of the vehicle, subject to certain limitations, for sixty days from the date of purchase. In addition, each dealership offers customers the opportunity to purchase extended warranties, which are provided by third parties, on used car sales.

Over time, we intend to grow our used vehicle sales by:

 

   

maintaining high quality inventory across all price ranges and all classes of used vehicles, including factory certified as well as traditional non-certified used vehicles:

 

   

providing competitive prices to our customers;

 

   

executing our marketing initiatives; and

 

   

increasing our focus on training.

Parts, Service and Collision Repair

We refer to the parts, service and collision repair area of our business as “fixed operations”. We sell parts and provide maintenance and repair service at all of our franchised dealerships, primarily for the vehicle brands sold at those dealerships. In addition, as of December 31, 2007, we maintained 24 free-standing collision repair centers either on the premises of, or in close proximity to, our dealerships. Our dealerships and collision repair centers collectively operate 2,828 service bays. Parts, service and collision repair centers accounted for approximately 12.3% of our total revenues and 40.8% of our total gross profit as of December 31, 2007.

Historically, fixed operations revenues have been more stable than vehicle sales. Industry-wide, parts and service revenues have consistently increased over time primarily due to the increased cost of maintaining vehicles, the added technical complexity of vehicles and the increased number of vehicles on the road. We believe the variety and quality of extended service plans available for both new and used vehicles in recent years have seen progressive expansion and improvement. Our fixed operations business benefits from the service work generated through the sale of extended service contracts to customers who purchase new and used vehicles from us because customers tend to service their vehicles at the same location where they purchase extended warranty contracts. For the year ended December 31, 2007, warranty work accounted for 19.6% of our parts and service revenue.

Historically, the automotive repair industry has been highly fragmented. We believe, however, that the increased use of advanced technology in vehicles has made it difficult for independent repair shops to have the expertise to perform major or technical repairs, especially as such repairs relate to luxury and mid-line imports which comprise a majority of our new vehicle retail sales. Additionally, all manufacturers require warranty work to be performed only at franchised dealerships. As a result, unlike independent service stations or independent and superstore used car dealerships with service operations, our franchised dealerships are qualified to perform work covered by manufacturer warranties on increasingly technologically complex motor vehicles. We use variable rate compensation structures designed to reflect the difficulty and sophistication of different types of repairs to compensate employees working in parts and service.

 

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One of our major goals is to retain each vehicle purchaser as a long-term customer of our parts and service departments. Currently, we estimate that approximately 30% of customers return to our dealerships for other services after the vehicle warranty expires. Therefore, we believe that significant opportunity for growth exists in our maintenance service business. Each dealership has systems in place to track customer maintenance records and to notify owners of vehicles purchased at the dealership when their vehicles are due for periodic services. In 2006, we implemented additional customer retention initiatives and expanded our service offerings to essentially make the fixed operations business at our stores a “one stop” shop. Service and repair activities are an integral part of our overall approach to customer service. From selling tires to utilizing state-of-the-art diagnostic equipment, our fixed operations business offers our customers all the services needed to maintain their vehicles.

In order to grow our fixed operations business over the years, we have consistently added technicians and other employees to our service centers to ensure that our customers continue to receive excellent service. We maintained growth in this line of our business in 2007 due to initiatives in 2006 and our investment in human capital in past years. In 2007, we continued to execute our business plan of advancing our customer pay business by offering our customers a “one-stop” shopping experience. We continued to train our staff, including service advisors, on menu-selling and customer service skills. We have also added Business Development Centers in some of our stores to drive customer retention. At these Business Development Centers, we have staff dedicated to maintaining periodic contact with our customers. Furthermore, we have continued to add equipment to our service centers that help our technicians identify issues with our customers’ vehicles and promote incremental service sales if those customers decide to resolve such issues at our stores.

We expect our fixed operations sales to continue to grow as we (i) invest in additional service capacity, (ii) upgrade equipment, (iii) expand our product offerings, (iv) capitalize on our regional training programs, and (v) add service advisors and skilled technicians to meet anticipated future demand, especially from the increased market share of the mid-line import and luxury import brands.

Finance and Insurance

We refer to the finance and insurance area of our business as F&I. We arrange for third party financing of the sale or lease of new and used vehicles to customers. We arranged customer financing on approximately 64% of the vehicles we sold during the year ended December 31, 2007. These transactions result in commissions being paid to us by the third party lenders, including manufacturer captive finance subsidiaries. As a general matter, we do not retain liability for the credit risk associated with these purchase and lease transactions after the completion of the transactions. However, we may be required to repay the finance company certain commissions if a customer prepays the retail installment sales contract, typically during a specified time period following the sale. Our finance and insurance business generated approximately 2.8% of our total revenues and 18.2% of our total gross profit for the year ended December 31, 2007.

To date, we have entered into “preferred lender agreements” with 18 lenders. Under the terms of the preferred lender agreements, each lender has agreed to provide a marketing fee to us above the standard commission for each loan that our dealerships place with that lender. Furthermore, many of the insurance products we sell result in additional underwriting profits and investment income based on portfolio performance.

We receive favorable pricing on these products from our vendors as a result of our size and sales volume. We earn sales-based commissions on substantially all of these products and may be charged back (“chargebacks”) for these commissions in the event a finance contract is cancelled within the first 90 days or if a non-finance contract is canceled prior to its maturity. We incur minimal risk related to chargebacks of our commissions; however, we do not bear any risk related to loan payments, insurance payments or investment performance, which are borne by third parties. These commissions are subject to cancellation, in certain circumstances, if the customer were to cancel the contract. In addition, we completed the rollout of a training program in 2007 for the certification all of our F&I managers, sales managers and sales associates in legal and ethical compliance matters. As of December 31, 2007, all of our finance service managers, sales managers and sales associates with an employment history with the company for 12 months or more, were certified, and any such manager or associate who joined the company during 2007 was in the process of being certified.

Recent Developments

During 2007, we were granted two Smart Car franchises. Our Smart Car franchise in St. Louis, Missouri, commenced operations on January 2, 2008 and our Smart Car franchise in Tampa, Florida, is expected to commence operations in the second quarter of 2008.

In January 2008, our board of directors declared a $0.225 per share cash dividend. This was the seventh consecutive quarter that a dividend was paid.

 

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In January 2008, we sold four franchises (three dealership locations) for proceeds of $2.7 million, resulting in a $0.2 million loss on the sales.

Business Strategy

Focus on Premier Brand Mix, Strategic Markets and Diversification

We classify our franchise sales into luxury, mid-line import, mid-line domestic, value, and heavy trucks. Luxury and mid-line imports together accounted for approximately 83% of our new light vehicle retail revenues for the year ended December 31, 2007. Over the last two decades, luxury and mid-line imports have gained market share at the expense of mid-line domestic brands. Luxury and mid-line import vehicles have delivered more desirable vehicle models and have demonstrated greater resilience to downturns in the economy, garnered higher customer loyalty and presented more attractive service and used car opportunities. The mid-line import brands are generally viewed as more fuel efficient and continue to be in higher demand during times when gas prices are high.

 

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The following table reflects the franchises and the share of new retail vehicle revenue represented by each class of franchise as of December 31, 2007:

 

Class/Franchise

   Number of
Franchises as of
December 31, 2007
   % of New Light
Vehicle Retail
Revenue for the
Year Ended
December 31, 2007
 

Light Vehicles

     

Luxury

     

BMW

   9    8 %

Acura

   6    5  

Mercedes-Benz

   5    9  

Lincoln

   4    2  

Volvo

   4    1  

Cadillac

   3    1  

Infiniti

   4    4  

Lexus

   3    7  

Audi

   2    1  

Porsche

   1    *  

Jaguar

   1    *  

Land Rover

   1    *  
           

Total Luxury

   43    38 %

Mid-Line Import

     

Honda

   14    23 %

Nissan

   12    13  

Toyota

   4    8  

Mazda

   1    *  

MINI

   2    *  

Volkswagen(c)

   2    1  
           

Total Mid-Line Import

   35    45 %

Mid-Line Domestic

     

Chevrolet

   5    4 %

GMC

   4    1  

Pontiac

   4    1  

Chrysler(a)

   4    1  

Ford

   4    6  

Mercury

   4    1  

Buick

   3    *  

Jeep(a)

   3    1  

Dodge

   3    1  
           

Total Mid-Line Domestic

   34    16 %

Value

     

Hyundai

   1    1 %

Kia(b)

   3    *  
           

Total Value

   4    1 %
           

Total Light Vehicles

   116    100 %
         

Heavy Trucks

     

Hino

   2   

Isuzu

   1   

International Trucks

   2   

IC Bus

   1   

Workhorse

   1   

Peterbilt

   1   
       

Total Heavy Trucks

   8   
       

TOTAL

   124   
       

 

* Franchise accounted for less than 1% of new retail vehicle revenue for the year ended December 31, 2007.
(a) Includes a pending divestiture as of December 31, 2007, which was sold in the first quarter of 2008.

 

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(b) Includes two pending divestitures as of December 31, 2007, which were completed in the first quarter of 2008.
(c) Includes a pending divestiture as of December 31, 2007.

Asbury’s geographic coverage encompassed 22 different metropolitan markets at 93 locations in 11 states as of December 31, 2007, including: Arkansas, California, Florida, Georgia, Mississippi, Missouri, New Jersey, North Carolina, South Carolina, Texas and Virginia. New vehicle sales revenue is diversified among manufacturers and for the year ended December 31, 2007, the following manufacturers represented 79% of our new light vehicle retail revenue: Honda (23%), Nissan (13%), Mercedes-Benz (9%), Toyota (8%), BMW (8%), Lexus (7%), Ford (6%) and Acura (5%). We believe that our broad geographic coverage as well as diversification among manufacturers decreases our exposure to regional economic downturns and manufacturer-specific risks such as warranty issues or production disruption. See “Risk Factors—Risk Factors Related to our Dependence on Vehicle Manufacturers—Adverse conditions affecting the manufacturers may negatively impact our profitability” for a list of such manufacturer-specific risks.

Each of our dealerships maintains a strong local brand that has been enhanced through local advertising over many years. We believe our cultivation of strong local brands is beneficial because consumers prefer to interact with a locally recognized brand. By placing franchises in one geographic location under a single, local brand, we expect to generate advertising synergies and retain customers even as they purchase and service different automobile brands.

Maintain Flexible Cost Structure and Emphasize Expense Control

We continually focus on controlling expenses and expanding margins at our existing dealerships and those that are integrated into our operations upon acquisition. We categorize our cost structure in three groups, which are variable, semi-variable and fixed. Variable costs include incentive-based compensation, vehicle carrying costs, and other variable costs. Salespeople, sales managers, service managers, parts managers, service advisors, service technicians and the majority of other non-clerical dealership personnel are paid a commission. The majority of our general manager compensation and virtually all salesperson compensation is tied to profits of the dealership. In addition the bonus portion of our salaried employee’s compensation is tied to our net income. Fixed costs include rent, utilities and depreciation expense. Semi-variable expenses include base salaries, outside services, travel and entertainment expenses, advertising and loaner vehicle amortization. We believe we can further manage these types of costs by capitalizing on best practices among our dealerships, standardization of compensation plans, controlled oversight and accountability, and centralized processing systems.

Focus on Higher Margin Products and Services

While new vehicle sales are critical to drawing customers to our dealerships, fixed operations, used vehicle retail sales, and finance and insurance generally provide significantly higher profit margins and account for the majority of our profitability. In addition, we have discipline-specific executives at both the corporate and regional levels who focus on increasing the penetration of current services and expanding the breadth of our offerings to customers. While each of our dealership general managers has flexibility to respond effectively to local market conditions, including market specific advertising and management of inventory mix, each pursues an integrated strategy, as directed from our centralized management team at our corporate office, to grow these higher margin businesses to enhance profitability and stimulate organic growth.

 

   

Fixed Operations. We offer parts, perform vehicle service work and operate collision repair centers, all of which provide important sources of recurring revenue with high gross profit margins. We intend to expand this higher-margin business and increase this cost absorption rate by adding new service bays and increasing capacity utilization of existing service bays. To help ensure high levels of customer satisfaction within our parts, service and collision repair operations, we continue to add skilled technicians and service advisors to our operations. In addition, given the increased sophistication of vehicles, our repair operations provide detailed expertise and state-of-the-art diagnostic equipment that we believe independent repair shops cannot adequately provide. Our repair operations also provide manufacturer warranty work that must be done at certified franchise dealerships, rather than through independent dealers.

 

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Used Vehicles. We sell used vehicles at all of our franchised dealerships. Used vehicle sales include the sale of used vehicles to individual retail customers and the sale of used vehicles to other dealers at auction. We intend to grow our used vehicle business by maintaining high quality inventory across all price ranges, providing competitive prices, continuing to enhance our marketing initiatives by focusing our efforts on marketing new vehicles through the Internet and building customer confidence in our vehicle inventory through our used car certification program.

 

   

Finance and Insurance. In the past two years, we have increased our finance and insurance revenues by offering a broad range of conventional finance and lease alternatives to fund the purchase of new and used vehicles. Moreover, continued in-depth sales training and certification efforts and innovative computer technologies have and will serve as important tools in growing our finance and insurance profitability. We have increased dealership generated finance and insurance revenue per vehicle retailed (“PVR”) to approximately $997 for the year ended December 31, 2007, from $907 for the year ended December 31, 2006. We have successfully increased our dealership generated finance and insurance revenue PVR each year since our inception, with 2007 being another record year. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Information.”

Local Management of Dealership Operations and Centralized Administrative and Strategic Functions

We believe that local management of dealership operations enables our retail network to provide market-specific responses to sales, customer service and inventory requirements. Our dealerships are operated as distinct profit centers in which the general managers are responsible for the operations, personnel and financial performance of their dealerships as well as other day-to-day operations. Our local management teams’ familiarity with their markets enables them to effectively run day-to-day operations, market to customers and recruit new employees. The general manager of each dealership is supported by a management team consisting, in most cases, of a new vehicle sales manager, a used vehicle sales manager, a finance and insurance manager, and a fixed operations manager. This management structure is complemented by regionally centralized technology and financial controls, as well as sharing market intelligence throughout the organization. See “Business Strategy—Experienced Corporate and Dealership Management” below for a discussion of the incentive-based pay system for management at our corporate office and at our dealerships.

Our corporate headquarters are located in New York, New York. The corporate office is responsible for the capital structure of the business and its expansion and operating strategy. The implementation of our operational strategy rests with each dealership management team based on the policies and procedures established and promulgated by the corporate office. Furthermore, we employ professional management practices in all aspects of our operations, including information technology and employee training. Our dealership operations are complemented by regionally centralized technology and strategic and financial controls, as well as shared market intelligence throughout the organization. Corporate and dealership management utilize computer-based management information systems to monitor each dealership’s sales, profitability and inventory on a regular basis.

While in the past we have used various companies to provide our dealer management systems, in October 2007, we executed an agreement with DealerTrack Holdings, Inc. (“DealerTrack”), with the intent that the DealerTrack’s Arkona dealer management system will become our sole dealer management system. By moving toward a single dealer management system through which all our dealerships will process information, we expect that the result will be a more efficient retail operation that will, in turn, translate to a better experience for our customers. Moreover, once all of our dealerships convert to, and are running on, the Arkona dealer management system, we expect to achieve a reduction of over $3.7 million of our current annual data processing costs.

We believe the application of professional management practices provides us with a competitive advantage over many independent dealerships. We regularly examine our operations in order to identify areas for improvement and disseminate best practices company-wide.

 

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Investment in Human Capital

We recognize that our ability to control the growth of our new vehicle sales is limited by external factors, including the manufacturers’ ability to develop new vehicle models, manufacturer rebates and incentives, consumer confidence, gas prices, interest rates, the availability of credit for consumers and other economic factors. Growth in our fixed operations business is dependent on our ability to generate long-term customer relationships and having our customers return to our stores for service and repairs. Our finance and insurance business is dependent on our ability to arrange financing for our customers through third party lenders. In each revenue source of our business, our ability to capture the customer and “close the deal” will enable us to generate revenue. In our effort to seek continued growth in all of our revenue sources and set us apart from our competitors, we invest in the education and growth of our employees.

Over the past three years, we have implemented programs to certify our finance and insurance managers, our new and used sales managers and our sales force in the areas of compliance and ethics. These employees either attend classes or seminars on compliance and ethics as such topics relate to the automotive retailing industry, and more specifically, finance and insurance for the finance and insurance managers, and are then required to pass a written examination on these subjects in order to receive certification. The employees are required to maintain their certification annually, which keeps their knowledge of compliance and ethics current. Furthermore, we believe that by certifying these employees, we build the knowledge base of our employees, which improves morale and performance.

In addition, in three of our four regions, we have a regional training program for our fixed operations employees that addresses various aspects of our fixed operations business, including tire sales and oil sales. Our fixed operation employees are trained so that they can offer new car clinics and service clinics to our customers. We believe that by increasing the knowledge base of our fixed operations employees, we not only build their confidence and increase their performance, but also provide better experience for our customers as they interact with those employees. We believe that a customer who has a positive experience with one of our employees will be a repeat customer, which will lead to the continued growth of our business. We will implement similar training programs in our fourth region during 2008.

Our corporate and regional executives have also benefited from attending a management training program to assist them in setting and reaching goals, both personally and professionally, and the effective management of their staff. Through exposure to such training programs, we empower our corporate and regional executive team to work together more efficiently in the management of the business and its employees. We believe that a motivated management team will have a direct, positive effect on its staff. With a highly-motivated and goal-oriented workforce, we believe that we can generate above average corporate performance.

Experienced Corporate and Dealership Management

We have a corporate management team that has served in prominent leadership positions.

Charles R. Oglesby, has served as our President and Chief Executive Officer since May 2007. Prior to serving as President and Chief Executive Officer, Mr. Oglesby served as our Senior Vice President and Chief Operating Officer from September 2006 to May 2007. Mr. Oglesby served as the Chief Executive Officer of our South Region from August 2004 until March 2007. Mr. Oglesby originally joined us as President and Chief Executive Officer of Asbury Automotive Arkansas, L.L.C. in February 2002. Prior to joining our company, Mr. Oglesby served as President of the First America Automotive Group in San Francisco, California.

J. Gordon Smith has served as our Senior Vice President and Chief Financial Officer since September 2003. He joined us following over 26 years with General Electric Company (“GE”). During his last twelve years at GE he served as Chief Financial Officer for three of GE’s commercial finance businesses: Corporate Financial Services, Commercial Equipment Finance and Capital Markets.

We believe that our leadership at the store level represents some of the best talent in the industry. Our regional executives and store general managers are proven leaders in their local markets and have many years of experience in the automotive retail industry. In addition, our continued focus on college recruiting, training, development, and retention is designed to maintain our talented management pool. See “Business Strategy—Investment in Human Capital” above for further description of certain of our training programs.

We tie compensation of our senior dealership management to performance by relying upon an incentive-based pay system. We compensate our general managers based on dealership profitability, and our department managers and salespeople are similarly compensated based upon departmental profitability and individual performance.

 

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Continued Growth Through Targeted Acquisitions

Acquisitions continue to be part of our growth strategy. In the past, we have focused our acquisition strategy on establishing a presence in new markets through the purchase of multiple individual franchises or through the acquisition of large, profitable and well-managed dealership groups with leading market positions. Our present strategy is to become the leader in every market in which we currently operate. As such, we intend to evaluate “tuck-in” acquisitions, or acquisitions in existing regions, that complement our current dealerships.

Tuck-in acquisitions are typically re-branded immediately after acquisition and operate thereafter under our respective local brand name. By focusing on geographic and brand diversity, we seek to manage economic risk and drive growth and profitability. Because we own dealerships of all major brands and avoid significant concentration with one manufacturer, we are well-positioned to respond to changing customer preferences. We believe that these tuck-in acquisitions have facilitated, and will continue to facilitate, our regional operating efficiencies and cost savings. In addition, we have generally been able to improve the gross profit of tuck-in acquisitions within twelve months following the acquisition. We believe this is due to a number of factors respective to the acquisition, including:

 

   

improvements in the number of finance and insurance products sold per vehicle retailed;

 

   

greater utilization of service bays acquired in the acquisition;

 

   

improved management practices; and

 

   

enhanced unit sales volumes related to the strength of our local brand names.

We will also continuously examine opportunities to acquire large dealership groups or to enter new markets as such opportunities become available. In 2007, we availed ourselves of such an opportunity by acquiring a BMW franchise in Princeton, New Jersey, which is outside the regions in which we have historically operated.

Commitment to Customer Service

We are focused on providing a high level of customer service to meet the needs of an increasingly sophisticated and demanding automotive consumer. We design our dealership service business to meet the needs of our customers and establish relationships that will result in both repeat business and additional business through customer referrals. Furthermore, we provide our dealership managers with incentives to employ more efficient selling approaches, engage in extensive follow-up to develop long-term relationships with customers and extensively train our sales staff to be able to meet customer needs.

We continually evaluate innovative ways, and implement new technology, to improve the buying experience for our customers, and believe that our ability to share best practices across our dealerships gives us an advantage over independent dealerships. For example, our customer relations management tool facilitates communications with our customers before, during and after the sale. Our “Auto Exchange” system continues to be our Used Car Inventory Management tool. These tools are installed in most of our regions and are designed to drive the performance of our employees and enhance customer service. See also the discussion above under “Business Strategy—Local Management of Dealer Operations and Centralized Administrative and Strategic Functions” for a discussion of our expectation that the use of the Arkona dealer management system will improve the customer experience.

In addition, our dealerships regard service and repair operations as an integral part of the overall approach to customer service, providing an opportunity to foster ongoing relationships and improve customer loyalty. We continue to add skilled technicians and service advisors to our operations to ensure that our customers continue to receive excellent service. We intend to invest in the human capital necessary to ensure that this aspect of our business continues to expand.

Marketing

Our advertising and marketing efforts are focused at the local market level, with the aim of building our business with a broad base of repeat, referral and new customers. Our primary advertising medium is local newspapers, followed by the Internet, radio, television, direct mail, and the yellow pages. In addition, we also use electronic mail to assist our marketing efforts and to stay in contact with our customers.

The automotive retail industry has traditionally used locally produced, largely non-professional materials for advertising, often developed under the direction of each dealership’s general manager. However, we have chosen to create common marketing materials for our brand names using professional advertising agencies. Our corporate sales and marketing department helps oversee and share creative materials and general marketing best

 

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practices across our dealerships. Our total company marketing expense was $49.8 million for the year ended December 31, 2007, which translates into an average of $306 per retail vehicle sold. In addition, manufacturers’ direct advertising spending in support of their brands has historically been a significant component of the total amount spent on new car advertising in the United States.

Management Information Systems

We consolidate financial, accounting and operational data received from our dealerships nationwide through a private communication network. The data from the dealerships is gathered and processed through their individual dealer management system. Currently, each of our dealerships use dealer management system software from ADP, Inc., Reynolds & Reynolds, Co. or DealerTrack. In October 2007, we entered into an agreement with DealerTrack to convert all of our dealerships to the Arkona dealer management system. Pursuant to the terms of such contract, we intend to complete the roll-out of the Arkona dealer management system to all of our dealerships within approximately three years. The information from the dealer systems is aggregated at our corporate headquarters to create a consolidated view of the business using Hyperion financial products.

Our information technology approach enables us to quickly integrate and aggregate the information from a new acquisition. By creating a connection over our private network between the dealer management system and corporate Hyperion financial products, corporate management can quickly view the financial, accounting and operational data of the newly acquired dealership. Hyperion’s products allow us to review operating and financial data at a variety of levels. For example, from our headquarters, management can review the performance of any specific department (e.g., parts and services) at any particular dealership. This system also allows us to quickly compile and monitor our consolidated financial results.

Competition

In new vehicle sales, our dealerships compete primarily with other franchised dealerships in their regions. We do not have any cost advantage in purchasing new vehicles from the manufacturers. Instead, we rely on advertising and merchandising, sales expertise, service reputation, strong local brand names and location of our dealerships to sell new vehicles. Our used vehicle operations compete with other franchised dealers, independent used car dealers, internet-based vehicle brokers and private parties for supply and resale of used vehicles. See “Risk Factors—Risks Related to Competition—Substantial competition in automobile sales may adversely affect our profitability.”

We compete with other franchised dealers to perform warranty repairs and with other automobile dealers and franchised and independent service centers for non-warranty repair and routine maintenance business. We compete with other automobile dealers, service stores and auto parts retailers in our parts operations. We believe that the principal competitive factors in parts and service sales are the use of factory-approved replacement parts, price, the familiarity with a manufacturer’s brands and models, and the quality of customer service. A number of regional and national chains as well as some competing franchised dealers may offer certain parts and services at prices lower than our prices.

In arranging financing for our customers’ vehicle purchases, we compete with a broad range of financial institutions. In addition, financial institutions are now offering finance and insurance products through the Internet, which may reduce our profits on these items. We believe that the principal competitive factors in providing financing are convenience, interest rates and flexibility in contract length.

We compete with other national dealer groups and individual investors for acquisitions. Some of our competitors may have greater financial resources and the market may increase acquisition pricing of target dealerships. See “Risk Factors – Risks Related to our Acquisition Strategy –There is competition to acquire automotive dealerships, and we may not be able to fully implement our growth through acquisition strategy if attractive targets are acquired by competing buyers or if the market drives prices to the point where an acceptable rate of return is not achievable.”

 

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Dealer and Framework Agreements

Each of our dealerships operates pursuant to a dealer agreement between the dealership and the manufacturer (or in some cases the distributor) of each brand of new vehicles sold and/or serviced at the dealership. Our typical dealer agreement specifies the locations at which the dealer has the right and obligation to sell the manufacturer’s vehicles and related parts and products and/or to perform certain approved services. Each dealer agreement also governs the use of the manufacturer’s trademarks and service marks.

The allocation of new vehicles among dealerships is subject to the discretion of the manufacturer, and generally does not guarantee the dealership exclusivity within a given territory. Most dealer agreements impose requirements on virtually every aspect of the dealer’s operations. For example, most of our dealer agreements contain provisions and standards related to:

 

   

inventories of new vehicles and manufacturer replacement parts;

 

   

the maintenance of minimum net working capital and in some cases minimum net worth;

 

   

the achievement of certain sales and customer satisfaction targets;

 

   

advertising and marketing practices;

 

   

facilities, signs, products offered to customers;

 

   

dealership management;

 

   

personnel training;

 

   

information systems; and

 

   

dealership monthly and annual financial reporting.

In addition to requirements under dealer agreements, we are subject to additional provisions contained in supplemental agreements, framework agreements, dealer addenda and manufacturers’ policies, collectively referred to as “framework agreements.” Framework agreements impose additional requirements similar to those discussed above. Such agreements also define other standards and limitations, including:

 

   

company-wide performance criteria;

 

   

capitalization requirements;

 

   

limitations on changes in our ownership or management;

 

   

limitations on the number of a particular manufacturer’s franchises owned by us;

 

   

restrictions or prohibitions on our ability to pledge the stock of certain of our subsidiaries; and

 

   

conditions for consent to proposed acquisitions, including sales and customer satisfaction criteria as well as limitations on the total local, regional and national market share percentage that would be represented by a particular manufacturer’s franchises owned by us after giving effect to a proposed acquisition.

Some dealer agreements and framework agreements grant the manufacturer the right to purchase its dealerships from us under certain circumstances, including the occurrence of an extraordinary corporate transaction without the manufacturer’s prior consent or a material breach of the framework agreement. Some of our dealer agreements and framework agreements also give the manufacturer a right of first refusal if we propose to sell any dealership representing the manufacturer’s brands to a third party. These agreements may also attempt to limit the protections available under state dealer laws and require us to resolve disputes through binding arbitration.

Provisions for Termination or Non-renewal of Dealer and Framework Agreements. Certain of our dealer agreements expire after a specified period of time, ranging from one year to six years, while other of our agreements have a perpetual term. We expect to renew expiring agreements in the ordinary course of business. However, typical dealer agreements give the manufacturer the right to terminate or the option of non-renewal of the dealer agreements under certain circumstances, including:

 

   

insolvency or bankruptcy of the dealership;

 

   

failure to adequately operate the dealership or to maintain required capitalization levels;

 

   

impairment of the reputation or financial condition of the dealership;

 

   

change of control of the dealership without manufacturer approval;

 

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failure to complete facility upgrades required by the manufacturer or agreed to by the dealer; or

 

   

material breach of other provisions of a dealer agreement.

See “Risk Factors—Risk Factors Related to Our Dependence on Vehicle Manufacturers—If we fail to obtain renewals of one or more of our dealer agreements on favorable terms, if certain of our franchises are terminated, or if certain manufacturers’ rights under their agreements with us are triggered, our operations may be adversely affected,” for a further discussion of the risks related to the termination or non-renewal of our dealer and framework agreements. While our dealer agreements may be terminated or not renewed for the reasons listed above, it is possible to negotiate a waiver of termination or non-renewal with the manufacturer.

Regulations

We operate in a highly regulated industry. Under various state laws each of our dealerships must obtain a license in order to establish, operate or relocate a dealership or operate an automotive repair service. In addition, we are subject to federal, state and local laws regulating the conduct of our business including advertising; motor vehicle and retail installment sales practices; leasing; sales of finance, insurance and vehicle protection products; truth in lending; deceptive trade practices; consumer protection and disclosure; consumer privacy; money laundering; environmental; land use and zoning; health and safety and employment practices. Our business is also subject to laws and regulations generally relating to corporate entities. We actively make efforts to assure we are in compliance with these laws and related regulations. See “Risk Factors—Risks Related to the Automotive Retail Industry—Our operations are subject to substantial laws and regulation and related claims and proceedings, any of which could adversely affect our business and financial results.”

We benefit from the protection of state dealer laws which limit a manufacturer’s ability to terminate or refuse to renew a franchise agreement; provide dealers with protest rights with respect to the addition of dealerships within proscribed geographic areas; and protect dealers against manufacturers unreasonably withholding consent to proposed changes in ownership of dealerships. However, some framework agreements attempt to limit the protection of state dealer laws. See “Risk Factors—Risks Related to Our Dependence On Vehicle Manufacturers—If state dealer laws that protect automotive retailers are repealed or weakened or superseded by our framework agreements with manufacturers, our dealerships will be more susceptible to termination, non-renewal or renegotiation of their dealer agreements.”

Environmental Matters

We are subject to a wide range of environmental laws and regulations, including those governing discharges into the air and water, the storage of petroleum substances and chemicals, the handling and disposal of wastes and the remediation of contamination. As with automobile dealerships generally, and service and parts and collision repair center operations in particular, our business involves the generation, use, handling and disposal of hazardous or toxic substances and wastes. Operations involving the management of wastes are subject to requirements of the Federal Resource Conservation and Recovery Act and comparable state statutes. Pursuant to these laws, federal and state environmental agencies have established approved methods for handling, storage, treatment, transportation and disposal of regulated substances and wastes with which we must comply.

Our business also involves the use of above ground and underground storage tanks. Under applicable laws and regulations, we are responsible for the proper use, maintenance and abandonment of our regulated storage tanks and for remediation of subsurface soils and groundwater impacted by releases from existing or abandoned storage tanks. In addition to these regulated tanks, we own, operate, or have otherwise closed in place other underground and above ground devices or containers (such as automotive lifts and service pits) that may not be classified as regulated tanks, but which could or may have released stored materials into the environment, thereby potentially obligating us to clean up any soils or groundwater resulting from such releases.

We are also subject to laws and regulations governing remediation of contamination at or from our facilities or at facilities where we send hazardous or toxic substances or wastes for treatment, recycling or disposal. The Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, also known as the “Superfund” law, and similar state statutes, imposes liability for the entire cost of a cleanup, without regard to fault or the legality of the original conduct, on those that are considered to have contributed to the release of a “hazardous substance.” Responsible parties include the owner or operator of the site or sites where the release occurred and companies that disposed or arranged for the disposal of the hazardous substances released at such sites. These responsible parties also may be liable for damages to natural resources. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the release of hazardous substances. Currently, we are not aware of any material “Superfund” or other remedial liabilities to which we are subject.

 

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Further, the Federal Clean Water Act and comparable state statutes prohibit discharges of pollutants into regulated waters without the necessary permits, require containment of potential discharges of oil or hazardous substances and require preparation of spill contingency plans. We are not aware of any non-compliance with the wastewater discharge requirements, requirements for the containment of potential discharges and spill contingency planning or other environmental laws applicable to our operations.

Environmental laws and regulations are very complex and it has become difficult for businesses that routinely handle hazardous and non-hazardous wastes to achieve and maintain full compliance with all applicable environmental laws. From time to time we experience incidents and encounter conditions that will not be in compliance with environmental laws and regulations. However, none of our dealerships has been subject to any material environmental liabilities in the past, nor do we know of any fact or condition that would result in any material environmental liabilities being incurred in the future. Nevertheless, environmental laws and regulations and their interpretation and enforcement are changed frequently and we believe that the trend of more expansive and stricter environmental legislation and regulations is likely to continue. As a result, there can be no assurance that compliance with environmental laws or regulations or the future discovery of unknown environmental conditions will not require additional expenditures by us, or that such expenditures would not be material. Our operations are subject to substantial laws and regulations and related claims and proceedings, any of which could adversely affect our business and financial results.”

Employees

As of December 31, 2007, we employed approximately 8,300 people. We believe our relationship with our employees is favorable. We do not have employees that are represented by a labor union. In the future, we may acquire additional businesses that have unionized employees. Certain of our facilities are located in areas of high union concentration, and such facilities are susceptible to union-organizing activity. In addition, because of our dependence on vehicle manufacturers, we may be affected adversely by labor strikes, work slowdowns and walkouts at vehicle manufacturers’ production facilities and transportation modes.

Insurance

Because of their vehicle inventory and the nature of the automotive retail business, automobile retail dealerships generally require significant levels of insurance covering a broad variety of risks. Our insurance program includes multiple umbrella policies with a total per occurrence and aggregate limit of $100.0 million. We also have directors and officers insurance, real property insurance, comprehensive coverage for our vehicle inventory, garage liability and employee dishonesty insurance.

 

Item 1A. Risk Factors

In addition to the other information in this report, you should consider carefully the following risk factors when evaluating our business.

RISK FACTORS RELATED TO OUR DEPENDENCE ON VEHICLE MANUFACTURERS

If we fail to obtain renewals of one or more of our dealer agreements on favorable terms, if certain of our franchises are terminated, or if certain manufacturers’ rights under their agreements with us are triggered, our operations may be adversely affected.

Each of our dealerships operates under the terms of a dealer agreement with the manufacturer (or manufacturer-authorized distributor) of each new vehicle brand it carries and/or is authorized to service. Our dealerships may obtain new vehicles from manufacturers, service vehicles, sell new vehicles and display vehicle manufacturers’ trademarks only to the extent permitted under dealer agreements. As a result of the terms of our dealer, framework and related agreements and our dependence on these franchise rights, manufacturers exercise a great deal of control over our day-to-day operations and the terms of these agreements govern key aspects of our operations, acquisition strategy and capital spending.

Our franchise agreements may be terminated or not renewed by manufacturers for a number of reasons, and many of the manufacturers have the right to direct us to divest our dealerships if there is a default under the franchise agreement, an unapproved change of control, or other unapproved events. We cannot assure you we will be able to renew any of our existing dealer agreements or that we will be able to obtain renewals on favorable terms. Most of our dealer agreements also provide the manufacturer with the right of first refusal to

 

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purchase from us any franchise we seek to sell. Our results of operations may be materially and adversely affected to the extent that our franchise rights become compromised or our operations restricted due to the terms of our dealer agreements or if we lose franchises representing a significant source of our revenues.

Our failure to meet manufacturer consumer satisfaction, financial or sales performance requirements may adversely affect our ability to acquire new dealerships and our profitability.

Many manufacturers attempt to measure customers’ satisfaction with their experience in our sales and service departments through rating systems that are generally known in the automotive retailing industry as consumer satisfaction indexes (“CSI”). CSI ratings are in addition to the right of manufacturers to monitor the financial and sales performance of dealerships. At the time we acquire a dealership or enter into a new dealership or framework agreement, several manufacturers establish sales or performance criteria for that dealership, in some cases in the form of a business plan. These criteria have been modified by various manufacturers from time to time in the past, and we cannot assure you that they will not be further modified or replaced by different criteria in the future. Some of our dealerships have had difficulty from time to time meeting these standards. We cannot assure you that we will be able to comply with these standards in the future.

In addition, manufacturers may use these criteria as factors in evaluating applications for acquisitions. A manufacturer may refuse to consent to our acquisition of one of its franchises if it determines our dealerships do not comply with its performance standards. This may impede our ability to execute our acquisition strategy and hinder our ability to grow. See also, “Risk Factors Related to our Dependence on Vehicle Manufacturers—Manufacturers’ restrictions on acquisitions may limit our future growth and impact our profitability.” In addition, we receive payments and incentives from certain manufacturers based, in part, on CSI scores, and future payments may be materially reduced or eliminated if our CSI scores decline.

The reorganization or bankruptcy of one or more of the manufacturers could have a material adverse affect on our operations.

Certain manufacturers have incurred substantial operating losses in recent periods. Sustained periods of poor financial performance by a manufacturer may force it to seek to reorganize or to seek protection from creditors in bankruptcy. A reorganization by a manufacturer may, among other things, result in a delay in the introduction of new or competitive makes or models, an elimination of certain makes or models or dealership locations, a disruption in delivery or availability of service or parts, a delay or failure to reimburse us for warranty work and holdback receivables, or a disruption in vehicle deliveries to our dealerships. If an attempted reorganization proves unsuccessful for the manufacturer, the continued financial distress could result in the cessation of its operations.

In the event of a bankruptcy by a vehicle manufacturer, among other things: (i) the manufacturer could seek to terminate all or certain of our franchises, and we may not receive adequate compensation for them, (ii) we may not be able to collect some or all of our receivables that are due from such manufacturer and we may be subject to preference claims relating to payments to us made by such manufacturer prior to bankruptcy, (iii) it may increase our cost to obtain financing for our new vehicle inventory with such manufacturer’s captive finance subsidiary, which may cause us to finance our new vehicle inventory with alternate finance sources on less favorable terms, and (iv) consumer demand for such manufacturer’s products could be materially adversely affected, especially if costs related to improving such manufacturer’s poor financial condition are imputed to the price of its products.

The occurrence of any one or more of the above-mentioned events could have a material adverse affect on our day-to-day operations. Furthermore, such events could result in a partial write-down of our manufacturer franchise rights (to the extent that we have recorded them) or our receivables, and a partial write-down of our goodwill. See also “Risk Factors—Risk Factors Related to our Dependence on Vehicle Manufacturers—Adverse conditions affecting the manufacturers may negatively impact our revenues and profitability.”

Manufacturers’ restrictions on acquisitions may limit our future growth and impact our profitability.

We are generally required to obtain manufacturer consent before we can acquire any additional dealerships. In addition, many of our dealer and framework agreements require that we meet certain customer service and sales performance standards as a condition to additional dealership acquisitions. We cannot assure you that we will meet these performance standards or that manufacturers will consent to future acquisitions, which may deter us from being able to take advantage of market opportunities and restrict our ability to expand our business. The process of applying for and obtaining manufacturer consents can take a significant amount of time, generally 60 to 90 days or more. Delays in consummating acquisitions caused by this process may negatively affect our ability to acquire dealerships that we believe will produce acquisition synergies and integrate well into our overall growth strategy. In addition, manufacturers typically establish minimum capital requirements for each of their

 

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dealerships on a case-by-case basis. As a condition to granting consent to a proposed acquisition, a manufacturer may require us to remodel and upgrade our facilities and capitalize the subject dealership at levels we would not otherwise choose, causing us to divert our financial resources from uses that management believes may be of higher long-term value to us. Furthermore, the exercise by manufacturers of their right of first refusal to acquire a dealership may prevent us from acquiring dealerships that we have identified as important to our growth, thereby having an adverse affect on our ability to grow through acquisitions.

Many vehicle manufacturers place limits on the total number of franchises that any group of affiliated dealerships may own. Certain manufacturers place limits on the number of franchises or share of total brand vehicle sales maintained by an affiliated dealership group on a national, regional or local basis, as well as limits on store ownership in contiguous markets. If we reach these limits, we may be prevented from making further acquisitions, which could affect our growth.

If state dealer laws that protect automotive retailers are repealed, weakened or superseded by our framework agreements with manufacturers, our dealerships will be more susceptible to termination, non-renewal or renegotiation of their dealer agreements.

Applicable state dealer laws generally provide that a manufacturer may not terminate or refuse to renew a dealer agreement unless it has first provided the dealer with written notice setting forth “good cause” and stating the grounds for termination or non-renewal. Some 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. Though unsuccessful to date, manufacturers’ lobbying efforts may lead to the repeal or revision of state dealer laws. We have framework agreements with certain of our manufacturers. Among other provisions, these agreements attempt to limit the protections available to dealers under state dealer laws. If dealer laws are repealed in the states in which we operate, manufacturers may be able to terminate our franchises without providing advance notice, an opportunity to cure or a showing of good cause. Without the protection of state dealer laws, it may also be more difficult for our dealers to renew their dealer agreements upon expiration. See “Business—Dealer and Framework Agreements—Regulations.”

Our dealerships depend upon vehicle sales and, therefore, their success depends in large part upon customer demand for the particular vehicle lines they carry.

The success of our dealerships depends in large part on the overall success of the vehicle lines they carry. Historically, we have generated most of our revenue through new vehicle sales. New vehicle sales also tend to lead to sales of higher-margin products and services such as finance and insurance products and parts and services. Although we have sought to limit our dependence on any one vehicle brand, we have focused our new vehicle sales operations on mid-line import and luxury brands.

For the year ended December 31, 2007, brands representing 5% or more of our revenues from new vehicle retail sales were as follows:

 

Brand

   % of Total New
Light Vehicle
Retail Sales
 

Honda

   23 %

Nissan

   13 %

Mercedes-Benz

   9 %

Toyota

   8 %

BMW

   8 %

Lexus

   7 %

Ford

   6 %

Acura

   5 %

No other brand accounted for more than 5% of our total new vehicle retail sales revenue for the year ended December 31, 2007.

If we fail to obtain a desirable mix of popular new vehicles from manufacturers, our profitability will be negatively impacted.

We depend on manufacturers to provide us with a desirable mix of popular new vehicles. Typically, popular vehicles produce the highest profit margins but tend to be the most difficult to obtain from manufacturers. Manufacturers generally allocate their vehicles among their franchised dealerships based on the sales history of each dealership and in some instances on the level of capital expenditures. If our dealerships experience prolonged sales slumps, those manufacturers will cut back their allotments of popular vehicles to our dealerships and new vehicle sales and profits may decline.

 

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If automobile manufacturers decrease or discontinue incentive programs, our sales volumes may be adversely affected.

Our dealerships benefit from certain sales incentives, warranties and other programs of our manufacturers that are intended to promote and support new vehicle sales. Some key incentive programs include:

 

   

customer rebates on new vehicles;

 

   

dealer incentives on new vehicles;

 

   

special financing or leasing terms; and

 

   

warranties on new and used vehicles.

Manufacturers often make many changes to their incentive programs during each year. A reduction or discontinuation of key manufacturers’ incentive programs may reduce our new vehicle unit sales and related revenue.

Adverse conditions affecting the manufacturers of the vehicles that we sell may negatively impact our revenues and profitability.

Our ability to successfully market vehicles to the public depends to a great extent on aspects of our manufacturers’ operations. Conditions which negatively affect our manufacturers in the following areas could similarly have an adverse affect on our revenues and profitability:

 

   

financial condition;

 

   

marketing efforts;

 

   

vehicle design;

 

   

production capabilities;

 

   

reputation for quality;

 

   

management; and

 

   

labor relations.

Manufacturers’ restrictions regarding a change in our stock ownership may result in the termination or forced sale of our franchises, which may adversely impact the value of our common stock.

Some of our dealer agreements and framework agreements with manufacturers prohibit transfers of any ownership interests of a dealership or, in some cases, its parent, without manufacturer consent. Our agreements with some manufacturers provide that, under certain circumstances, we may lose the franchise (either through termination or forced sale) if a person or entity acquires an ownership interest in us above a specified level or if a person or entity acquires the right to vote a specified level of our common stock without the approval of the applicable manufacturer. Violations by our stockholders of these ownership restrictions are generally outside of our control and may result in the termination or non-renewal of our dealer and framework agreements or forced sale of one or more franchises, which may have a material adverse effect on us. These restrictions may also prevent or deter prospective acquirers from acquiring control of us and, therefore, may adversely impact the value of our common stock.

RISKS RELATED TO COMPETITION

Substantial competition in automobile sales and services may adversely affect our profitability.

The automotive retail and service industry is highly competitive with respect to price, service, location and selection. Our competition includes:

 

   

franchised automobile dealerships in our markets that sell the same or similar new and used vehicles;

 

   

privately negotiated sales of used vehicles;

 

   

Internet-based used vehicle brokers that sell used vehicles to consumers;

 

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service center chain stores; and

 

   

independent service and repair shops.

We do not have any cost advantage in purchasing new vehicles from manufacturers. We typically rely on advertising, merchandising, sales expertise, service reputation and dealership location to sell new and used vehicles. Our dealer agreements do not grant us the exclusive right to sell a manufacturer’s product within a given geographic area. Our revenues or profitability may be materially and adversely affected if competing dealerships expand their market share or additional franchises are awarded in our markets.

RISKS RELATED TO THE AUTOMOTIVE RETAIL INDUSTRY

Our business will be harmed if overall consumer demand suffers from a significant or sustained downturn.

Our business is heavily dependent on consumer demand and preferences. Our revenues will be materially and adversely affected if there is a significant or sustained downturn in overall levels of consumer spending. 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, credit availability and interest rates. The current economic climate in the United States and future recessions may have a material adverse effect on our retail business, particularly sales of new and used automobiles. In addition, significant or sustained increases in gasoline prices may lead to a reduction in automobile purchases or a shift in buying patterns from luxury or SUV models (which typically provide higher profit margins to retailers) to smaller, more economical vehicles (which typically have lower margins).

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

Our performance is also subject to local economic, competitive and other conditions prevailing in our various geographic areas. Our dealerships currently are located in the Atlanta, Austin, Chapel Hill, Charlotte, Charlottesville, Dallas-Fort Worth, Fayetteville, Fort Pierce, Fresno, Greensboro, Greenville, Houston, Jackson, Jacksonville, Little Rock, Los Angeles, Orlando, Princeton, Richmond, Sacramento, St. Louis and Tampa markets and the results of our operations therefore depend substantially on general economic conditions and consumer spending levels in those areas.

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

The automobile industry is subject to seasonal variations in revenues. Demand for automobiles is generally lower during the first and fourth quarters of each year. Accordingly, we expect our revenues and operating results generally to be lower in our first and fourth quarters than in our second and third quarters. If conditions surface during the second or third quarters that weaken automotive sales, such as severe weather in the geographic areas in which our dealerships operate, war, high fuel costs, depressed economic conditions or similar adverse conditions, our revenues for the year will be disproportionately adversely affected.

Our business may be adversely affected by import product restrictions, foreign trade risks and currency valuations that may impair our ability to sell foreign vehicles or parts profitably.

A portion of our new vehicle business involves the sale of vehicles, parts or vehicles composed of parts that are manufactured outside the United States. As a result, our operations are subject to customary risks of importing merchandise, including import duties, exchange rates, trade restrictions, work stoppages and general political and socio-economic conditions in other countries. The United States or the countries from which our products are imported may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duties or tariffs, which may affect our operations and our ability to purchase imported vehicles and/or parts at reasonable prices. The relative weakness of the U.S. dollar against foreign currencies may adversely affect our cost of purchase of certain vehicles, which may also result in an increase in the retail price of such vehicles, which could discourage consumers from purchasing such vehicles. This could adversely impact our profitability.

 

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A decline of available financing may adversely affect our sales of vehicles and the results of our finance and insurance business.

The majority of vehicle buyers finance their purchases, particularly those seeking to purchase used vehicles. If there is a decline in the availability of credit or an increase in the cost to consumers for such credit, the ability of consumers to purchase vehicles could be limited, resulting in a decline in our vehicle sales. Retail sales of used vehicles generally have higher gross margins than new vehicles. A decline in our vehicle sales could have a material adverse effect on our revenues and an adverse effect on our profitability.

RISKS RELATED TO OUR ACQUISITION STRATEGY

If we are unable to acquire and successfully integrate additional dealerships, we will be unable to realize desired results from our growth through acquisition strategy and acquired operations will drain resources from comparatively profitable operations.

We believe that the automobile retailing industry is a mature industry whose sales are significantly impacted by the prevailing economic climate in local markets. Accordingly, we believe that our future growth depends in part on our ability to manage expansion, control costs in our operations and acquire and integrate acquired dealerships into our organization. In pursuing our strategy of acquiring other dealerships, we face risks commonly encountered with growth through acquisitions. These risks include, but are not limited to:

 

   

failing to obtain manufacturers’ consents to acquisitions of additional franchises;

 

   

incurring significant transaction related costs for both completed and failed acquisitions;

 

   

incurring significantly higher capital expenditures and operating expenses;

 

   

failing to integrate the operations and personnel of the acquired dealerships and impairing relationships with employees;

 

   

incurring undisclosed liabilities at acquired dealerships;

 

   

disrupting our ongoing business and diverting our management resources to newly acquired dealerships; and

 

   

impairing relationships with manufacturers and customers as a result of changes in management.

We may not adequately anticipate all the demands that our growth will impose on our personnel, procedures and structures, including our financial and reporting control systems, data processing systems and management structure. Moreover, our failure to retain qualified management personnel at any acquired dealership may increase the risk associated with integrating the acquired dealership. If we cannot adequately anticipate and respond to these demands, we may fail to realize acquisition synergies and our resources will be focused on incorporating new operations into our structure rather than on areas that may be more profitable. See also “Risk Factors Related to our Dependence on Vehicle Manufacturers—Manufacturers’ restrictions on acquisitions may limit our future growth and impact our profitability.”

There is competition to acquire automotive dealerships, and we may not be able to fully implement our growth through acquisition strategy if attractive targets are acquired by competing buyers or if the market drives prices to the point where an acceptable rate of return is not achievable.

We believe that the United States automotive retailing market is fragmented and offers many potential acquisition candidates that meet our target criteria. However, we compete with several other national, regional and local dealer groups, and other strategic and financial buyers, some of which may have greater financial resources. Competition for attractive acquisition targets may result in fewer acquisition opportunities for us, and increased acquisition costs. We will have to forego acquisition opportunities to the extent that we cannot negotiate acquisitions on acceptable terms.

OTHER RISKS RELATED TO OUR BUSINESS

Failure to comply with certain covenants in our debt and lease agreements could adversely affect our ability to conduct our business and adversely affect our compliance with our Committee Credit Facility.

We have certain debt service obligations. As of December 31, 2007, we had total debt of $482.3 million, excluding floor plan notes payable and the effects of our fair value hedge on our 8% Notes. In addition, we and our subsidiaries have the ability to obtain additional debt from time to time to finance acquisitions, real property purchases, capital expenditures or for other purposes, subject to the restrictions contained in our Committed Credit Facility and the indentures governing our 8% Notes and our 7.625% Notes. We will have substantial debt service obligations, consisting of required cash payments of principal and interest, for the foreseeable future.

 

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In addition, we have operating and financial restrictions and covenants in our debt instruments, including our Committed Credit Facility and the indentures under our 8% Notes and our 7.625% Notes. These place restrictions on, among other things, our ability to incur additional indebtedness, to create liens or other encumbrances, and to make certain payments (including dividends and repurchases of our shares and investments). Our Committed Credit Facility requires us to maintain certain financial ratios. Our ability to comply with these ratios may be affected by events beyond our control. A breach of any of the covenants in our debt instruments or our inability to comply with the required financial ratios could result in an event of default, which, if not cured or waived, could have a material adverse effect on us. In the event of any default under our Committed Credit Facility, the payment of all outstanding borrowings could be accelerated, together with accrued and unpaid interest and other fees, and we would be required to apply our available cash to repay these borrowings or could be prevented from making debt service payments on our 8% Notes, our 7.625% Notes, and our 3% Notes, any of which would be an event of default under the respective indentures for such Notes. In addition, as a result of entering into a number of sale-leaseback agreements, a number of our dealerships are located on properties that we lease. Each of the leases governing such properties has certain covenants with which we must comply.

The loss of key personnel may adversely affect our business.

Our success depends to a significant degree upon the continued contributions of our management team. Manufacturer dealer or framework agreements may require the prior approval of the applicable manufacturer before any change is made in dealership general managers. The loss of the services of one or more of these key employees may materially impair the profitability of our operations.

In addition, we may need to hire additional managers as we expand. Potential acquisitions are viable to us only if we are able to retain experienced managers or obtain replacement managers should the owner or manager of the acquired dealership not continue to manage the business. 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 may adversely affect the ability of our dealerships to conduct their operations in accordance with the standards set by us or the manufacturers.

We depend on our executive officers as well as other key personnel. Most of our key personnel not are bound by employment agreements, and those with employment agreements are bound only for a limited period of time. Further, we do not maintain “key man” life insurance policies on any of our executive officers or key personnel. If we are unable to retain our key personnel, we may be unable to successfully develop and implement our business plans.

Our capital costs and our results of operations may be materially and adversely affected by changes in interest rates.

We generally finance our purchases of new vehicle inventory and have the ability to finance the purchase of used vehicle inventory using floor plan credit facilities under which we are charged interest at floating rates. In addition, we have the ability to obtain capital for general corporate purposes, dealership acquisitions and property purchases and improvements under predominantly floating interest rate credit facilities. Therefore, our interest expense from variable rate debt will rise with increases in interest rates. In addition, a significant rise in interest rates may also have the effect of depressing demand in the interest rate sensitive aspects of our business, particularly new and used vehicle sales, because many of our customers finance their vehicle purchases. As a result, rising interest rates may have the effect of simultaneously increasing our costs and reducing our revenues. Given our debt composition as of December 31, 2007, each one percent increase in market interest rates would increase our total annual interest expense, including floor plan interest, by $5.5 million.

We receive interest credit assistance from certain automobile manufacturers, which is reflected as a reduction in the cost of inventory on the balance sheet and is recognized as a reduction in cost of sales. Although we can provide no assurance as to the amount of future floor plan credits, it is our expectation, based on historical experience that an increase in prevailing interest rates would result in increased interest credit assistance from certain automobile manufacturers. Our operations are subject to substantial laws and regulations and related claims and proceedings, any of which could adversely affect our business and financial results.

We are subject to a wide range of federal, state and local laws and regulations, including local licensing requirements. These laws regulate the conduct of our business, including motor vehicle and retail installment sales practices; leasing; sales of finance, insurance and vehicle protection products; truth in lending; deceptive

 

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trade practices; consumer protection; consumer privacy; money laundering; advertising; land use and zoning; health and safety and employment practices. Environmental laws and regulations govern, among other things, discharges into the air and water, storage of petroleum substances and chemicals, the handling and disposal of wastes and remediation of contamination arising from spills and releases. If we or our employees at the individual dealerships violate or are alleged to violate these laws and regulations, we could be subject to individual or consumer class actions, administrative, civil or criminal actions investigations or actions and adverse publicity. Such actions could expose us to substantial monetary damages and legal defense costs, injunctive relief and criminal and civil fines and penalties, including suspension or revocation of our licenses and franchises to conduct dealership operations. Some jurisdictions regulate finance fees and administrative or document fees that may be charged in connection with vehicle sales, which could restrict our ability to generate revenue from these activities

Future changes in financial accounting standards or practices or existing taxation rules or practices may affect our reported results of operations.

A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may affect our reporting of transactions completed before the change is effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practices have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, in December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141R “Business Combinations,” to provide greater transparency to the information that a reporting entity provides in its financial reports about a business combination and its effects. A substantial change brought about by SFAS No. 141R is the requirement to expense all acquisition related costs in pre-acquisition periods. SFAS No. 141R is effective for fiscal periods beginning after December 15, 2008. We expect that the adoption of SFAS No. 141R will negatively impact our income before taxes by $0.1 million to $0.3 million per acquisition.

During 2007, the FASB issued, but subsequently repealed, FSP–ABA 14-a, which was a proposal to change the accounting for convertible debt that may be settled in cash upon conversion. Should the FASB decided to issue FSP-ABA 14-a, such proposal would cause an increase to our interest expense by $4.1 million in 2009.

 

Item 1B. Unresolved Staff Comments

None

 

Item 2. Properties

We lease our corporate headquarters, which is located at 622 Third Avenue, 37th Floor, New York, New York. In addition, as of December 31, 2007, we had 124 franchises situated in 93 dealership locations throughout eleven states. As of December 31, 2007, we leased 81 of these locations and owned the remainder. We have two locations in North Carolina, one location in Mississippi and one location in St. Louis where we lease the land but own the building facilities. These locations are included in the leased column of the table below. In addition, we operate 24 collision repair centers. We lease 16 of these collision repair centers and own the remainder.

 

     Dealerships     Collision Repair
Centers
     Owned    Leased     Owned    Leased

Coggin Automotive Group

   3    17 (a)(b)   3    4

Courtesy Autogroup

   1    9 (d)   2    —  

Crown Automotive Company

   3    16 (c)   —      2

David McDavid Auto Group

   —      7     —      5

Gray-Daniels Auto Family

   1    6     —      1

Nalley Automotive Group

   —      15     3    1

California Dealerships

   —      4     —      —  

Northpoint Auto Group

   —      6     —      2

Plaza Motor Company

   4    1     —      1
                    

Total

   12    81     8    16
                    

 

(a) Includes one dealership that leases a new vehicle facility and operates a separate used vehicle facility that is owned.

 

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(b) Includes two pending divestitures as of December 31, 2007, which were completed in the first quarter of 2008.
(c) Includes two pending divestitures as of December 31, 2007.
(d) Includes one pending divestiture as of December 31, 2007.

 

Item 3. Legal Proceedings

From time to time, we and our dealerships are named in claims, including class action claims, involving the manufacture and sale or lease of motor vehicles, including but not limited to the charging of administrative fees, the operation of dealerships, contractual disputes and other matters arising in the ordinary course of our business. With respect to certain of these claims, the manufacturers of motor vehicles or the sellers of dealerships that we have acquired have indemnified us. We do not expect that any potential liability from these claims will materially affect our financial condition, liquidity, results of operations or financial statement disclosures.

As previously reported, we were involved in a breach of contract action in Arkansas state court that commenced on or about February 24, 2004, relating to amounts allegedly due the parties from whom we purchased assets in the pilot “Price 1” program. We discontinued this program in the third quarter of 2003. Patric Brosh, Mark Lunsford, Mel Anderson and their companies, NCAS, L.L.C. and New Century Auto Sales Corporation, sought damages in excess of $23.0 million for purported breach of their Purchase Agreement and Employment Agreements due to discontinuation of the pilot “Price 1” program. On May 14, 2007, we received a jury verdict that we had no liability to the plaintiffs under the agreements and the case was dismissed in its entirety. Plaintiffs did not appeal the judgment against them. We have appealed the court’s denial of our application to recover our attorneys’ fees.

 

Item 4. Submission of Matters to a Vote of Security Holders

None.

 

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PART II

 

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

Our common stock is traded on the New York Stock Exchange (the “NYSE”) under the symbol “ABG”. Quarterly information concerning (i) our high and low closing sales price per share of our common stock as reported by the NYSE and (ii) the cash dividends that we paid to our stockholders, in 2007 and 2006, is as follows:

 

     High    Low    Dividend
               (per share)

Fiscal Year Ended December 31, 2006

        

First Quarter

   $ 20.55    $ 16.11    $ —  

Second Quarter

     22.15      19.27      —  

Third Quarter

     21.37      20.00      0.20

Fourth Quarter

     26.08      20.65      0.20

Fiscal Year Ended December 31, 2007

        

First Quarter

   $ 28.50    $ 22.94    $ 0.20

Second Quarter

     29.82      24.22      0.20

Third Quarter

     25.29      19.01      0.225

Fourth Quarter

     21.27      14.84      0.225

On February 27, 2008, the last reported sale price of our common stock on the New York Stock Exchange was $15.00 per share, and there were approximately 81 record holders of our common stock.

On January 31, 2008, our board of directors declared a $0.225 per share cash dividend payable on February 29, 2008 to stockholders of record as of the close of business on February 8, 2008. This was the seventh consecutive quarter that a dividend was paid.

The repurchase of stock and payment of dividends are subject to certain limitations under the terms of our 8% Notes, 7.625% Notes and Committed Credit Facility. Such limits are increased each quarter by 50% of our net income and decreased by any dividend payments or share repurchases during the period. As of December 31, 2007, our ability to repurchase shares of our outstanding common stock or pay cash dividends was limited to $16.1 million under the most restrictive provision. Any future change in our dividend policy will be made at the discretion of our board of directors and will depend on then applicable contractual restrictions contained in our financing credit facilities and other agreements, our results of operations, earnings, capital requirements and other factors considered relevant by our board of directors.

 

Period

   Total Number of
Shares
Purchases
   Average Price
Paid per
Share
   Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
   Maximum Number of
Shares that May Yet be
Purchased Under the
Plans or Program (1)

10/01/07-10/31/07

   382,100    $ 19.76    382,100    980,000

11/01/07-11/30/07

   —      $ —      —      980,000

12/01/07-12/31/07

   —      $ —      —      980,000
                   

Total

   382,100    $ 19.76    382,100    980,000
                   

 

(1) On August 13, 2007, we announced that our board of directors authorized the repurchase of up to 2.0 million shares of the Company’s common stock. This share repurchase program is to be completed by the end of 2008. The 10b5-1 trading plan under which we have been repurchasing our shares of common stock was adopted on August 21, 2007.

 

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PERFORMANCE GRAPH

The following graph furnished by the Company shows the value as of December 31, 2007, of a $100 investment in the Company’s common stock made on March 14, 2002, as compared with similar investments based on (i) the value of the S & P 500 Index (with dividends reinvested) and (ii) the value of a market-weighted Peer Group Index composed of the common stock of AutoNation, Inc., Sonic Automotive, Inc., Group 1 Automotive, Inc., Penske Automotive Group, Inc. and Lithia Motors, Inc., in each case on a “total return” basis assuming reinvestment of dividends. The market-weighted Peer Group Index values were calculated from the beginning of the performance period. The stock performance shown below is not necessarily indicative of future performance.

LOGO

 

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Item 6. Selected Financial Data

The accompanying income statement data for the years ended December 31, 2006, 2005, 2004, and 2003 have been reclassified to reflect the status of our discontinued operations as of December 31, 2007.

 

     For the Years Ended December 31,  

Income Statement Data:

   2007     2006     2005     2004     2003  
     (in thousands, except per share data)  

Revenues:

          

New vehicle

   $ 3,385,225     $ 3,425,074     $ 3,267,935     $ 2,945,728     $ 2,510,751  

Used vehicle

     1,462,920       1,443,899       1,315,907       1,151,738       1,030,733  

Parts, service and collision repair

     702,633       670,520       626,443       556,666       476,624  

Finance and insurance, net

     162,189       154,894       146,566       128,426       107,922  
                                        

Total revenues

     5,712,967       5,694,387       5,356,851       4,782,558       4,126,030  

Cost of sales

     4,823,523       4,823,609       4,549,899       4,061,596       3,496,470  
                                        

Gross profit

     889,444       870,778       806,952       720,962       629,560  

Selling, general and administrative expenses

     (685,632 )     (663,856 )     (627,146 )     (569,921 )     (489,040 )

Depreciation and amortization

     (21,492 )     (20,061 )     (19,441 )     (17,989 )     (17,474 )

Other operating (expense) income, net

     (958 )     1,485       (552 )     690       1,461  
                                        

Income from operations

     181,362       188,346       159,813       133,742       124,507  

Other income (expense):

          

Floor plan interest expense

     (43,107 )     (40,533 )     (27,597 )     (18,372 )     (14,253 )

Other interest expense

     (39,245 )     (44,185 )     (40,841 )     (39,053 )     (39,932 )

Interest income

     4,336       5,111       966       744       444  

Loss on extinguishment of long-term debt

     (18,523 )     (1,144 )     —         —         —    
                                        

Total other expense, net

     (96,539 )     (80,751 )     (67,472 )     (56,681 )     (53,741 )
                                        

Income before income taxes

     84,823       107,595       92,341       77,061       70,766  

Income tax expense

     30,537       40,506       34,573       28,721       26,891  
                                        

Income from continuing operations

     54,286       67,089       57,768       48,340       43,875  

Discontinued operations, net of tax

     (3,331 )     (6,340 )     3,313       1,733       (28,688 )
                                        

Net income

   $ 50,955     $ 60,749     $ 61,081     $ 50,073     $ 15,187  
                                        

Income from continuing operations per common share:

          

Basic

   $ 1.67     $ 2.02     $ 1.77     $ 1.49     $ 1.34  
                                        

Diluted

   $ 1.63     $ 1.97     $ 1.76     $ 1.48     $ 1.34  
                                        

Cash dividends declared per common share

   $ 0.85     $ 0.40       —         —         —    
                                        

 

     As of December 31,

Balance Sheet Data:

   2007    2006    2005    2004    2003
     (in thousands)

Working Capital

   $ 320,755    $ 412,009    $ 346,954    $ 295,496    $ 259,784

Inventories

     769,992      775,313      709,791      761,557      650,397

Total assets

     2,016,300      2,030,837      1,930,800      1,897,959      1,814,279

Floor plan notes payable

     673,951      700,777      614,382      650,948      602,167

Long-term debt

     473,851      454,010      472,427      492,536      557,408

Total shareholders’ equity

     584,225      611,833      547,766      481,732      434,825

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

We are one of the largest automotive retailers in the United States, operating 124 franchises (93 dealership locations) in 22 metropolitan markets within 11 states as of December 31, 2007. We offer an extensive range of automotive products and services, including new and used vehicles, vehicle maintenance, replacement parts, collision repair services, and financing, insurance and service contracts. We offer 35 domestic and foreign brands of new vehicles, including six heavy truck brands. We also operate 24 collision repair centers that serve our markets.

Our retail network is currently organized into primarily four regions and includes nine locally branded dealership groups: (i) Florida (comprising our Coggin dealerships, operating primarily in Jacksonville, Fort Pierce and Orlando, and our Courtesy dealerships operating in Tampa), (ii) West (comprising our McDavid dealerships operating throughout Texas, our North Point dealerships operating in Little Rock, Arkansas and our California dealerships operating in Los Angeles, Sacramento and Fresno), (iii) Mid-Atlantic (comprising our Crown dealerships operating in New Jersey, North Carolina, South Carolina and Virginia) and (iv) South (comprising our Nalley dealerships operating in Atlanta, Georgia). Our Plaza dealerships operating in St. Louis, Missouri and our Gray Daniels dealerships operating in Jackson, Mississippi remain standalone operations. We will continue to acquire single point dealerships or small dealership groups in our existing market areas, as well as large luxury franchises outside our existing markets, to grow our business, increase the number of vehicle brands we offer and to create a larger gross profit base over which to spread overhead costs,

Our revenues are derived primarily from four offerings: (i) the sale of new vehicles to individual retail customers (“new retail”) and the sale of new vehicles to commercial customers (“fleet”) (the terms “new retail” and “fleet” being collectively referred to as “new”); (ii) the sale of used vehicles to individual retail customers (“used retail”) and the sale of used vehicles to other dealers at auction (“wholesale”) (the terms “used retail” and “wholesale” being collectively referred to as “used”); (iii) maintenance and collision repair services and the sale of automotive parts at retail and wholesale (collectively referred to as “fixed operations”); and (iv) the arrangement of vehicle financing and the sale of various insurance and warranty products (collectively referred to as “F&I”). We evaluate the results of our new and used vehicle sales based on unit volumes and gross profit per vehicle retailed (“PVR”), our fixed operations based on aggregate gross profit, and F&I based on dealership generated F&I PVR. We assess the organic growth of our revenue and gross profit by comparing the year-to-year results of stores that we have operated for at least twelve months.

The organic growth of our company is dependent upon the execution of our balanced automotive retailing and service business strategy as well as our strong brand mix, which is heavily weighted towards luxury and mid-line import brands. Sales of vehicles have historically fluctuated with general macroeconomic conditions, including consumer confidence, availability of consumer credit and fuel prices. We believe that any future negative trends in new vehicle sales will be mitigated by (i) the stability of our fixed operations, (ii) our variable cost structure and (iii) our advantageous brand mix. Historically, our brand mix has been less affected by market volatility than the U.S. automobile industry as a whole. We expect the recent industry-wide gain in market share of the luxury and mid-line import brands to continue in the near future.

Our gross profit margin varies with our revenue mix. The sale of new vehicles generally results in lower gross profit margin than used vehicle sales and revenues generated from our fixed operations business. As a result, when used vehicle and fixed operations revenue increases as a percentage of total revenue, we expect our overall gross profit margin to increase. We continue to implement new initiatives specifically designed to accelerate the growth of our high margin businesses and to leverage our selling, general and administrative (“SG&A”) expense structure.

SG&A expenses consist primarily of fixed and incentive-based compensation, advertising, rent, insurance, utilities and other customary operating expenses. A significant portion of our selling expenses is variable (such as sales commissions), or controllable expenses (such as advertising), generally allowing our cost structure to adapt to changes in the retail environment. We evaluate commissions paid to salespeople as a percentage of retail vehicle gross profit and all other SG&A expenses in the aggregate as a percentage of total gross profit.

Our operations are generally subject to seasonal variations as we tend to generate more revenue and operating income in the second and third quarters than in the first and fourth quarters of the calendar year. Generally, the seasonal variations in our operations are caused by factors relating to weather conditions, changes in manufacturer incentive programs, model changeovers and consumer buying patterns, among other things. Over the past several years, certain automobile manufacturers have used a combination of vehicle pricing and financing incentive programs to generate increased customer demand for new vehicles. We anticipate that the manufacturers will continue to use these incentive programs in the near future to drive demand for their product offerings.

 

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RESULTS OF OPERATIONS

Year Ended December 31, 2007, Compared to Year Ended December 31, 2006

 

     For the Years Ended December 31,              
     2007     % of
Gross
Profit
    2006     % of
Gross
Profit
    Increase
(Decrease)
    %
Change
 
     (In thousands)  

REVENUES:

            

New vehicle

   $ 3,385,225       $ 3,425,074       (39,849 )   (1 )%

Used vehicle

     1,462,920         1,443,899       19,021     1 %

Parts, service and collision repair

     702,633         670,520       32,113     5 %

Finance and insurance, net

     162,189         154,894       7,295     5 %
                        

Total revenues

     5,712,967         5,694,387       18,580     —   %
                        

COST OF SALES

     4,823,523         4,823,609       (86 )   —   %
                        

GROSS PROFIT

     889,444     100 %     870,778     100 %   18,666     2 %

OPERATING EXPENSES:

            

Selling, general and administrative

     (685,632 )   (77 )%     (663,856 )   (76 )%   21,776     3 %

Depreciation and amortization

     (21,492 )   (3 )%     (20,061 )   (2 )%   1,431     7 %

Other operating (expense) income, net

     (958 )   —   %     1,485     —   %   (2,443 )   (165 )%
                                

Income from operations

     181,362     20 %     188,346     22 %   (6,984 )   (4 )%

OTHER INCOME (EXPENSE):

            

Floor plan interest expense

     (43,107 )   (5 )%     (40,533 )   (5 )%   2,574     6 %

Other interest expense

     (39,245 )   (4 )%     (44,185 )   (5 )%   (4,940 )   (11 )%

Interest income

     4,336     —   %     5,111     —   %   (775 )   (15 )%

Loss on extinguishment of long-term debt

     (18,523 )   (2 )%     (1,144 )   —   %   17,379     NM  %
                                

Total other expense, net

     (96,539 )   (11 )%     (80,751 )   (10 )%   15,788     20 %
                                

Income before income taxes

     84,823     10 %     107,595     12 %   (22,772 )   (21 )%

INCOME TAX EXPENSE

     30,537     4 %     40,506     4 %   (9,969 )   (25 )%
                                

INCOME FROM CONTINUING OPERATIONS

     54,286     6 %     67,089     8 %   (12,803 )   (19 )%

DISCONTINUED OPERATIONS, net of tax

     (3,331 )   —   %     (6,340 )   (1 )%   (3,009 )   (47 )%
                                

NET INCOME

   $ 50,955     6 %   $ 60,749     7 %   (9,794 )   (16 )%
                        

Income from continuing operations per common share—Diluted

   $ 1.63       $ 1.97       (0.34 )   (17 )%
                        

Net income per common share—Diluted

   $ 1.53       $ 1.78       (0.25 )   (14 )%
                        

 

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     For the Years Ended
December 31,
    Increase
(Decrease)
    %
Change
 
     2007     2006      
     (In thousands, except for unit and PVR data)  

Revenue:

        

Light vehicle—same store

   $ 5,292,834     $ 5,271,823     $ 21,011     —   %

Acquisitions

     115,560       —        
                    

Total light vehicle

     5,408,394       5,271,823       136,571     3 %

Heavy truck

     304,573       422,564       (117,991 )   (28 )%
                    

Total revenue

   $ 5,712,967     $ 5,694,387     $ 18,580     —   %
                    

Gross Profit:

        

Light vehicle—same store

   $ 840,363     $ 836,001     $ 4,362     1 %

Acquisitions

     17,555       —        
                    

Total light vehicle

     857,918       836,001       21,917     3 %

Heavy truck

     31,526       34,777       (3,251 )   (9 )%
                    

Total gross profit

   $ 889,444     $ 870,778     $ 18,666     2 %
                    

Retail Units:

        

Light vehicle—same store

     155,394       159,246       (3,852 )   (2 )%

Acquisitions

     3,187       —        
                    

Total light vehicle

     158,581       159,246       (665 )   —   %

Heavy truck

     4,054       5,986       (1,932 )   (32 )%
                    

Total retail units

     162,635       165,232       (2,597 )   (2 )%
                    

New light vehicle revenue PVR

   $ 30,600     $ 30,204       396     1 %
                    

New vehicle revenue PVR

   $ 31,635     $ 31,806       (171 )   (1 )%
                    

New light vehicle gross profit PVR

   $ 2,308     $ 2,311       (3 )   —   %
                    

New vehicle gross profit PVR

   $ 2,326     $ 2,315       11     —   %
                    

Used light vehicle revenue PVR

   $ 18,200     $ 17,711       489     3 %
                    

Used vehicle revenue PVR

   $ 18,330     $ 17,841       489     3 %
                    

Used light vehicle gross profit PVR

   $ 2,098     $ 2,162       (64 )   (3 )%
                    

Used vehicle gross profit PVR

   $ 2,084     $ 2,159       (75 )   (3 )%
                    

Light vehicle dealership generated F&I PVR

   $ 1,017     $ 935       82     9 %
                    

Dealership generated F&I PVR

   $ 997     $ 907       90     10 %
                    

New light vehicle retail gross margin

     7.5 %     7.7 %     (0.2 )%   (3 )%
                    

New vehicle retail gross margin

     7.4 %     7.3 %     0.1 %   1 %
                    

Used light vehicle retail gross margin

     11.5 %     12.2 %     (0.7 )%   (6 )%
                    

Used vehicle retail gross margin

     11.4 %     12.1 %     (0.7 )%   (6 )%
                    

Light vehicle fixed operations gross margin

     53.6 %     52.7 %     0.9 %   2 %
                    

Fixed operations gross margin

     51.7 %     50.7 %     1.0 %   2 %
                    

Total light vehicle gross margin

     15.9 %     15.9 %     —   %   —   %
                    

Total gross margin

     15.6 %     15.3 %     0.3 %   2 %
                    

 

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Net income decreased $9.8 million (16%) during the 2007 period as a result of a $12.8 million (19%) decrease in income from continuing operations, partially offset by a $3.0 million (47%) decrease in net losses from discontinued operations.

Our income from continuing operations during 2007 and 2006 was impacted by several items shown below (collectively referred to as “2007 Adjusting Items”). We believe that an alternative comparison of our income from continuing operations (“adjusted income from continuing operations”), which is not defined by Generally Accepted Accounting Principles (“GAAP”), can be made by adjusting for items that are not core dealership operating items and should not be considered when forecasting our future results. These 2007 Adjusting items are excluded by management when comparing actual results to forecasted results and are generally not included in external financial estimates of our business.

The non-GAAP measure adjusted income from continuing operations contains material limitations. Although we believe that corporate generated F&I gross profit, retirement benefits expenses, abandoned strategic project expenses, secondary stock offering expenses, losses from the extinguishment of long-term debt and legal settlement claims arising in, and before, the year 2003, are infrequent, and although we do not expect to recognize these items in the future, we cannot assure you that we will not recognize them in the future. Our income from continuing operations may not be comparable with income from continuing operations of other companies to the extent that other companies recognize similar items in income from continuing operations and do not provide disclosure of the amounts. In order to compensate for these limitations we also review the related GAAP measures. In addition, these non-GAAP measures are not defined by GAAP and our definition of each measure may differ from, and therefore may not be comparable to, similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. These non-GAAP measures should not be considered in isolation, or as a substitute for analysis of our operating results as reported under GAAP. Please refer to “Reconciliation of Non-GAAP Financial Information” on page 61 of this report for more information.

 

     For the Years Ended
December 31,
    Increase
(Decrease)
    %
Change
 
     2007    2006      
     (In thousands)              

Income from continuing operations, as reported

   $ 54,286    $ 67,089     $ (12,803 )   (19 )%

Loss on extinguishment of long-term debt, net of tax

     11,577      717      

Retirement benefits expenses, net of tax

     1,844      —        

Legal settlements expense

     1,569       

Secondary stock offering expenses*

     270      1,073      

Corporate generated F&I gain, net of tax

     —        (2,130 )    

Gain on sale of a franchise, net of tax

     —        (1,565 )    

Abandoned strategic project expenses, net of tax

     —        1,039      
                   

Adjusted income from continuing operations

   $ 69,546    $ 66,223     $ 3,323     5 %
                   

 

* Secondary offering expenses are not deductible for tax purposes; therefore, no tax benefit has been reflected.

The following discussion excludes the impact of the 2007 Adjusting items as we believe that excluding these items provides a more accurate representation of our year over year core dealership performance. Despite a challenging retail sales and overall weak economic environment in the second half of 2007, our adjusted income from continuing operations increased $3.3 million (5%) as compared to the 2006 period. Contributing to this increase in adjusted income from continuing operations was increased fixed operations and F&I gross profit of $23.0 million (7%) and $7.3 million (5%), respectively, partially offset by (i) our used vehicle operations, which generated $9.1 million (7%) less gross profit during 2007 as compared to 2006, due to a 70 basis point decrease in gross margin, primarily as a result of a softening economic environment in the second half of 2007, and (ii) a 30 basis point increase in our adjusted selling, general and administrative expense (“SG&A”) as a percentage of adjusted gross profit. In addition, our other interest expense decreased $4.9 million (11%) due to a lower average effective interest rate on our long-term debt as a result of our long-term debt refinancing, which was substantially completed during the first quarter of 2007 and finalized in the second quarter of 2007.

The $18.6 million increase in total revenue was primarily a result of a $32.1 million (5%) increase in fixed operations revenue, a $19.0 million (1%) increase in used vehicle revenue and a $7.3 million (5%) increase in F&I, partially offset by a $39.8 million (1%) decrease in new vehicle revenue. The increase in used vehicle revenue includes $30.3 million of used vehicle revenue from dealership acquisitions, a $3.8 million (1%) increase in same store wholesale revenue, partially offset by a $15.1 million (1%) decrease in same store retail revenue.

 

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The $39.8 million (1%) decrease in new vehicle revenue includes a $116.9 million (35%) decrease in heavy truck revenue, an $8.3 million decrease in same store light vehicle retail revenue, partially offset by a $68.6 million increase of new vehicle revenue from dealership acquisitions, and a $16.7 million (11%) increase in same store fleet revenue.

The $18.7 million (2%) increase in total gross profit was primarily a result of a $23.0 million (7%) increase in fixed operations gross profit, and a $7.3 million (5%) increase in F&I gross profit, partially offset by a $9.1 million (7%) decrease in used vehicle gross profit. Our total gross profit margin increased 30 basis points to 15.6%.

New Vehicle—

 

     For the Years Ended December 31,          Increase
(Decrease)
    %
Change
 
     2007          2006           
     (In thousands, except for unit and PVR data)  

Revenue:

              

New retail revenue—same store(1)

              

Luxury

   $ 1,093,328    35 %   $ 1,064,687    33 %   28,641     3 %

Mid-line import

     1,345,433    42 %     1,353,366    41 %   (7,933 )   (1 )%

Mid-line domestic

     466,300    15 %     498,627    15 %   (32,327 )   (6 )%

Value

     32,624    1 %     29,270    1 %   3,354     11 %
                      

Total light vehicle retail revenue—same store

     2,937,685        2,945,950      (8,265 )   —   %

Heavy trucks

     216,374    7 %     333,283    10 %   (116,909 )   (35 )%
                      

Total new retail revenue—same store(1)

     3,154,059    100 %     3,279,230    100 %   (125,174 )   (4 )%

New retail revenue—acquisitions

     68,621        —         
                      

Total new retail revenues

     3,222,680        3,279,233      (56,553 )   (2 )%
                      

Fleet revenue—same store(1)

     162,545        145,841      16,704     11 %

Fleet revenue—acquisitions

     —          —         
                      

Total fleet revenue

     162,545        145,841      16,704     11 %
                      

New vehicle revenue, as reported

   $ 3,385,225      $ 3,425,0743      (39,849 )   (1 )%
                      

New retail units:

              

New retail units—same store(1)

              

Luxury

     23,169    23 %     23,418    23 %   (249 )   (1 )%

Mid-line import

     55,274    55 %     55,380    54 %   (106 )   —   %

Mid-line domestic

     16,049    16 %     17,324    17 %   (1,275 )   (7 )%

Value

     1,646    2 %     1,412    1 %   234     17 %
                      

Total light vehicle retail units—same store

     96,138        97,534      (1,396 )   (1 )%

Heavy trucks

     3,625    4 %     5,566    5 %   (1,941 )   (35 )%
                      

Total new retail units— same store(1)

     99,763    100 %     103,100    100 %   (3,337 )   (3 )%

New retail units—acquisitions

     2,108        —         
                      

Retail units—actual

     101,871        103,100      (1,229 )   (1 )%

Fleet units—actual

     7,756        7,501      255     3 %
                      

Total new units—actual

     109,627        110,601      (974 )   (1 )%
                      

Total light vehicle units—same store

     103,894        105,035      (1,141 )   (1 )%

Total light vehicle units—acquisitions

     2,108        —         
                      

Total light vehicle units

     106,002        105,035      967     (1 )%
                      

New revenue PVR—same store(1)

   $ 31,616      $ 31,806      (190 )   (1 )%
                      

New revenue PVR—actual

   $ 31,635      $ 31,806      (171 )   (1 )%
                      

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

 

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Table of Contents
     For the Years Ended
December 31,
          Increase
(Decrease)
    %
Change
 
     2007           2006            
     (In thousands, except for PVR data)  

Gross profit:

            

New retail gross profit—same store(1)

            

Luxury

   $ 85,803     37 %   $ 87,233     37 %   (1,430 )   (2 )%

Mid-line import

     98,585     43 %     98,050     41 %   535     1 %

Mid-line domestic

     35,067     15 %     38,175     16 %   (3,108 )   (8 )%

Value

     1,878     1 %     1,913     1 %   (35 )   (2 )%
                        

Total light vehicle retail gross profit—same store

     221,333         225,371       (4,038 )   (2 )%

Heavy trucks

     10,263     4 %     13,336     5 %   (3,073 )   (23 )%
                        

Total new retail gross profit—same store(1)

     231,596     100 %     238,707     100 %   (7,111 )   (3 )%

New retail gross profit—acquisitions

     5,405         —          
                        

Total new retail gross profit

     237,001         238,707       (1,706 )   (1 )%
                        

Fleet gross profit—same store(1)

     3,117         4,030       (913 )   (23 )%

Fleet gross profit—acquisitions

     —           —          
                        

Total fleet gross profit

     3,117         4,030       (913 )   (23 )%
                        

New vehicle gross profit, as reported

   $ 240,118       $ 242,737       (2,619 )   (1 )%
                        

New gross profit PVR—same store(1)

   $ 2,321       $ 2,315       6     —   %
                        

New gross profit PVR—actual

   $ 2,326       $ 2,315       11     —   %
                        

New retail gross margin—same store(1)

     7.3 %       7.3 %     —   %   —   %
                        

New retail gross margin—actual

     7.4 %       7.3 %     0.1 %   1 %
                        

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

The $39.8 million (1%) decrease in new vehicle revenue was primarily a result of a $116.9 million (35%) decrease in heavy truck revenue. The decrease in heavy truck revenue was as a result of a 35% decrease in unit sales due to (i) changes in emission laws in January 2007, which pulled forward demand for heavy trucks into 2006 and (ii) a weaker freight hauling market during 2007. Same store light vehicle retail revenue decreased $8.3 million during a challenging retail sales and overall weak economic environment, particularly in the second half of 2007, primarily as a result of a 7% decrease in same store unit sales from mid-line domestic brands as these brands continue to lose market share to mid-line import and luxury brands. In addition, same store retail revenue from our mid-line import brands decreased 1% on flat same store unit sales as manufacturer incentive programs in the prior year resulted in a challenging comparison. However, our same store retail revenue from our luxury brands increased $28.6 million (3%), driven by a 4% increase in revenue PVR as a result of a shift towards higher priced luxury models as luxury brands continue to offer attractive products.

The $2.6 million (1%) decrease in new vehicle gross profit was due to (i) a $3.1 million (8%) decrease in same store gross profit from the sale of mid-line domestic brands, primarily as a result of a 7% decrease in same store unit sales, (ii) a $3.1 million (23%) decrease in heavy truck gross profit as a result of a 35% decrease in heavy truck unit sales and (iii) a $1.4 million (2%) decrease in gross profit from our luxury brands. These decreases in same store gross profit were partially offset by $5.4 million of gross profit from dealerships acquired during 2007.

We expect 2008 to be a challenging retail environment and as a result we expect it to be difficult to maintain our current new vehicle revenue and gross profit levels; however, we expect our light vehicle unit sales to outperform industry-wide U.S. light vehicle unit sales, as we believe the luxury and mid-line import brands will continue to increase market share. In addition, we expect heavy trucks unit sales, revenue and gross profit to continue to decrease in the first half of 2008 as compared to the prior year period, as a result of the adverse impact of the new emission laws on heavy truck demand and a weaker freight hauling market.

 

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Used Vehicle—

 

     For the Years Ended
December 31,
    Increase
(Decrease)
    %
Change
 
     2007     2006      
     (In thousands, except for unit and PVR data)  

Revenue:

        

Retail revenues—same store(1)

        

Light vehicle

   $ 1,077,598     $ 1,092,961     $ (15,363 )   (1 )%

Heavy trucks

     15,760       15,513       247     2 %
                    

Total used retail revenues—same store(1)

     1,093,358       1,108,474       (15,116 )   (1 )%

Retail revenues—acquisitions

     20,470       —        
                    

Total used retail revenues

     1,113,828       1,108,474       5,354     —   %
                    

Wholesale revenues—same store(1)

     339,234       335,425       3,809     1 %

Wholesale revenues—acquisitions

     9,858       —        
                    

Total wholesale revenues

     349,092       335,425       13,667     4 %
                    

Used vehicle revenue, as reported

   $ 1,462,920     $ 1,443,899       19,021     1 %
                    

Gross profit:

        

Retail gross profit—same store(1)

        

Light vehicle

   $ 124,408     $ 133,424     $ (9,016 )   (7 )%

Heavy trucks

     16       693       (677 )   (98 )%
                    

Total used retail gross profit—same store(1)

     124,424       134,117       (9,693 )   (7 )%

Retail gross profit—acquisitions

     2,201       —        
                    

Total used retail gross profit

     126,625       134,117       (7,492 )   (6 )%
                    

Wholesale gross profit—same store(1)

     (2,487 )     (1,070 )     (1,417 )   (132 )%

Wholesale gross profit—acquisitions

     (142 )     —        
                    

Total wholesale gross profit

     (2,629 )     (1,070 )     (1,559 )   (146 )%
                    

Used vehicle gross profit, as reported

   $ 123,996     $ 133,047       (9,051 )   (7 )%
                    

Used retail units—same store(1)

        

Light vehicle

   $ 59,256     $ 61,712       (2,456 )   (4 )%

Heavy trucks

     429       420       9     2 %
                    

Total used retail units—same store(1)

     59,685       62,132       (2,447 )   (4 )%
                    

Used retail units—acquisitions

     1,079       —        
                    

Used retail units—actual

     60,764       62,132       (1,368 )   (2 )%
                    

Used revenue PVR—same store(1)

   $ 18,319     $ 17,841       478     3 %
                    

Used revenue PVR—actual

   $ 18,330     $ 17,841       489     3 %
                    

Used gross profit PVR—same store(1)

   $ 2,085     $ 2,159       (74 )   (3 )%
                    

Used gross profit PVR—actual

   $ 2,084     $ 2,159       (75 )   (3 )%
                    

Used retail gross margin—same store(1)

     11.4 %     12.1 %     (0.7 )%   (6 )%
                    

Used retail gross margin—actual

     11.4 %     12.1 %     (0.7 )%   (6 )%
                    

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

The $19.0 million (1%) increase in used vehicle revenue includes $30.3 million from dealership acquisitions and a $3.8 million (1%) increase in same store wholesale revenue, partially offset by a $15.1 million (1%) decrease in same store retail revenue. The $9.1 million (7%) decrease in used vehicle gross profit was primarily a result of a $9.7 million (7%) decrease in retail gross profit. Our comparison from the prior year continues to be difficult as we have benefited in recent years from (i) targeted initiatives, including the building of experienced used vehicle teams, (ii) our investments in technology to better value trade-ins and improve inventory management and (iii) strong used vehicle sales in the 2006 period in Houston and Mississippi in the aftermath of hurricane Katrina. In addition, we have experienced reduced used vehicle sales to sub-prime customers as a result of the weakening economy and tighter lending practices, particularly in the second half of 2007. We are closely managing our sub-prime business and continue to believe there is opportunity to improve our used vehicle profitability by offering appropriately priced used vehicle inventory.

 

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The strong used vehicle wholesale environment during the second and third quarters significantly increased the cost to acquire used vehicle inventory, increasing pressure on our used retail margins and used retail unit sales in the second half of 2007. In addition, we believe used vehicle customers were attracted to competitively priced mid-line import and mid-line domestic new vehicles as a result of manufacturer incentive programs.

During the third quarter of 2007, we began a strategic initiative to realign our inventory to (i) serve the broader used vehicle market and (ii) lower our inventory in response to the slower retail environment. Although our same store wholesale losses increased $1.4 million during 2007 and our retail margins decreased 6% while lowering our used vehicle inventory by 13%, we believe our used vehicle inventory is better aligned with customer demand. We expect that this improvement in our used vehicle inventory should mitigate the impact of the slower automotive retail selling season and challenging economic environment on our used vehicle performance. In addition, we continue to focus on the growth of all used vehicle product offerings including factory certified, traditional and cash cars. We expect used vehicle unit sales to decrease by 5% to 8% in 2008 as compared to 2007.

Fixed Operations—

 

     For the Years Ended
December 31,
    Increase
(Decrease)
   %
Change
 
     2007     2006       
     (In thousands)  

Revenue:

         

Light vehicle—same store(1)

   $ 625,585     $ 608,804     $ 16,781    3 %

Heavy trucks

     63,095       61,716       1,379    2 %
                     

Total revenue—same store(1)

     688,680       670,520       18,160    3 %
                     

Revenues—acquisitions

     13,953       —         
                     

Parts, service and collision repair revenue, as reported

   $ 702,633     $ 670,520     $ 32,113    5 %
                     

Gross profit:

         

Light vehicle—same store(1)

   $ 335,390     $ 320,541     $ 14,849    5 %

Heavy trucks

     20,319       19,559       760    4 %
                     

Total gross profit—same store(1)

     355,709       340,100       15,609    5 %
                     

Gross profit—acquisitions

     7,432       —         
                     

Parts, service and collision repair gross profit, as reported

   $ 363,141     $ 340,100     $ 23,041    7 %
                     

Parts, service and collision repair gross margin

     51.7 %     50.7 %     1.0    2 %
                     

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

The $32.1 million (5%) increase in fixed operations revenues and $23.0 million (7%) increase in fixed operations gross profit was primarily due to a 8% and 10% increase in our “customer pay” parts and service revenue and gross profit, respectively. We continue to experience decreases in our warranty business as warranty revenue and gross profit decreased $1.6 million (1%) and $1.0 million (2%), respectively, as a result of improvements in the quality of vehicles produced in recent years, which has decreased our warranty repair work. As a result, we have focused on our customer pay business and expect our fixed operations sales to continue to grow as we (i) continue to invest in additional service capacity, (ii) upgrade equipment, (iii) improve customer retention and customer satisfaction, (iv) capitalize on our regional training programs and (v) add service advisors and skilled technicians to meet anticipated future demand, especially from the increased market share of the luxury import and mid-line import brands. In addition, we expect to recognize improved fixed operations gross profit in the future from heavy trucks as a result of the addition of service capacity and as the customers who purchased vehicles prior to the emission law changes begin to bring their vehicles in for maintenance and repairs.

 

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Finance and Insurance, net—

 

     For the Years Ended
December 31,
   Increase
(Decrease)
   %
Change
 
     2007    2006      
     (In thousands, except for PVR data)  

Dealership generated F&I, net—same store(1)

           

Light vehicle

   $ 158,626    $ 148,908    $ 9,718    7 %

Heavy trucks

     905      901      4    —   %
                   

Dealership generated F&I, net—same store(1)

     159,531      149,809      9,722    6 %
                   

Dealership generated F&I—acquisitions

     2,658      —        
                   

Dealership generated F&I, net

     162,189      149,809      12,380    8 %

Corporate generated F&I

     —        1,685      

Corporate generated F&I gain

     —        3,400      
                   

Finance and insurance, net as reported

   $ 162,189    $ 154,894    $ 7,295    5 %
                   

Dealership generated F&I PVR- same store(2)

   $ 1,001    $ 907    $ 94    10 %
                   

Dealership generated F&I PVR- actual

   $ 997    $ 907    $ 90    10 %
                   

F&I PVR-actual

   $ 997    $ 937    $ 60    6 %
                   

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.
(2) Refer to “Reconciliation of Non-GAAP Financial Information” on page 61 of this report for further discussion regarding dealership generated F&I profit PVR.

We evaluate our F&I performance on a PVR basis by dividing our total F&I gross profit by the number of retail vehicles sold during the period. During 2003, we renegotiated a contract with one of our third-party F&I product providers, which resulted in the recognition of $1.7 million of income in 2006 that was not attributable to retail vehicles sold during that year. In addition, during 2006 we recognized a $3.4 million corporate generated F&I gain (corporate generated F&I and corporate generated F&I gain being collectively referred to as the “2007 Adjusting items”) from the sale of our remaining interest in a pool of extended service contracts, which was the source of our corporate generated F&I. We believe that an alternative comparison of our F&I (“dealership generated F&I”), can be made by adjusting for items that are not core dealership operating items and should not be considered when forecasting our future results. These 2007 Adjusting items are excluded by management when comparing actual results to forecasted results and are generally not included in external financial estimates of our business.

However, this non-GAAP measure has material limitations, including the fact that although we believe the recognition of corporate generated F&I and corporate generated F&I gains are infrequent and that we do not expect to recognize these items in the future, we cannot assure you that we will not recognize similar amounts of F&I in the future. In addition, these non-GAAP measures are not defined by GAAP and our definition of each measure may differ from and therefore may not be comparable to similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. In order to compensate for these limitations we also review the related GAAP measures. These non-GAAP measures should not be considered in isolation, or as a substitute for analysis of our operating results as reported under GAAP. Please refer to “Reconciliation of Non-GAAP Financial Information” on page 61 of this report for further discussion regarding dealership generated F&I.

F&I increased $7.3 million (5%) during 2007. Included in F&I for the year ended December 31, 2006, was a $3.4 million corporate generated gain related to sale of our remaining interest in a pool of extended service contracts and $1.7 million related to corporate generated F&I.

Dealership generated F&I increased $12.4 million (8%) as a result of a $90 increase in dealership generated F&I PVR, partially offset by a 2% decrease in retail unit sales. The increase in dealership generated F&I PVR was attributable to (i) increased customer acceptance rates on sales of our aftermarket products and services, (ii) lengthening in finance contract terms during 2007, (iii) improved F&I performance of the bottom third of our stores and (iv) the performance of F&I retrospective programs. Overall F&I performance is dependant on retail unit sales and F&I PVR and we anticipate F&I PVR will increase in the future as a result of (a) the improvement of the F&I operations at our lower-performing franchises and (b) as to the continued refinement and enhancement the menu of products we offer our customers.

 

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Selling, General and Administrative—

 

     For the Year Ended December 31,     % of
Gross Profit
Increase
    % of Gross
Profit %
 
           % of Gross           % of Gross      
     2007     Profit     2006     Profit     (Decrease)     Change  
     (Dollars in thousands)                    

Personnel costs

   $ 312,769     35.1 %   $ 310,470     35.6 %   (0.5 )   (1 )%

Sales compensation

     98,316     11.1 %     99,370     11.4 %   (0.3 )   (3 )%

Share-based compensation

     5,942     0.7 %     4,955     0.6 %   0.1     17 %

Outside services

     62,784     7.1 %     53,854     6.2 %   0.9     15 %

Advertising

     49,839     5.6 %     48,345     5.6 %   —       —   %

Rent

     57,078     6.4 %     52,682     6.0 %   0.4     7 %

Utilities

     18,492     2.1 %     17,855     2.1 %   —       —   %

Insurance

     15,039     1.7 %     13,788     1.6 %   0.1     6 %

Other

     65,373     7.3 %     62,537     7.1 %   0.2     3 %
                        

Selling, general and administrative

   $ 685,632     77.1 %   $ 663,856     76.2 %   0.9     1 %

Adjustments to SG&A:

            

Legal settlements expense

     (2,511 )       —          
                        

Adjusted selling, general and administrative

   $ 683,121     76.8 %   $ 663,856     76.2 %   0.6     1 %
                        

Gross Profit

   $ 889,444       $ 870,778        

Adjustments to Gross Profit:

            

Corporate generated F&I gain

     —           (3,400 )      
                        

Adjusted gross profit

   $ 889,444     76.8 %   $ 867,378     76.5 %   0.3 %   —   %
                        

SG&A expense as a percentage of gross profit was 77.1% for 2007, as compared to 76.2% for 2006. Included in SG&A expense during 2007 was $2.5 million of legal claims arising in, and before, the year 2003. Included in gross profit during 2006 was a $3.4 million corporate generated F&I gain related to the sale of our remaining interest in a pool of extended service contracts. We believe that an alternative comparison of our selling, general and administrative expense as a percentage of gross profit (“adjusted SG&A as a percentage of adjusted gross profit”), can be made by adjusting for items that are not core dealership operating items and should not be considered when forecasting our future results. These 2007 Adjusting items are excluded by management when comparing actual results to forecasted results and are generally not included in external financial estimates of our business.

However, this non-GAAP measure has material limitations including the fact that although we believe the recognition of legal settlements expense and corporate generated F&I gains are infrequent and that we do not expect to recognize corporate generated F&I gains in the future, we cannot assure you that we will not recognize similar amounts in the future. In addition, these non-GAAP measures are not defined by GAAP and our definition of each measure may differ from and therefore may not be comparable to similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. In order to compensate for these limitations we also review the related GAAP measures. These non-GAAP measures should not be considered in isolation, or as a substitute for analysis of our operating results as reported under GAAP. Please refer to “Reconciliation of Non-GAAP Financial Information” for further discussion regarding adjusted SG&A expense as a percentage of adjusted gross profit.

Excluding the $2.5 million of legal settlements expense during 2007 and the $3.4 million corporate generated F&I gain during 2006, adjusted SG&A expense as percentage of adjusted gross profit increased 30 basis points to 76.8%. The 30 basis point increase was primarily a result of the de-leveraging impact on our cost structure from the decline in vehicle sales volumes as well as increased outside service expense and a 40 basis point increase in rent expense, partially offset by decreased personnel expense and sales compensation expense. We have implemented several expense control initiatives including more efficient advertising practices, personnel reductions and revised compensation structures. The impact of these initiatives was partially offset by increased

 

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rent expense from dealership acquisitions and the expansion of our service capacity. SG&A expense as a percentage of gross profit is heavily dependent on our retail operations and therefore, we believe it will be difficult to maintain our current SG&A expense as a percentage of gross profit in 2008, in what we expect to be a challenging retail environment.

Other Operating (Expense) Income

Other Operating (Expense) Income includes amounts that were previously classified as Other Non-Operating Income (Expense) and Selling, General and Administrative on our Consolidated Statements of Income for the year ended December 31, 2006. The amounts include gains and losses from the sale of property and equipment, income derived from sub-lease arrangements and other non-core dealership related items. Included in Other Operating (Expense) Income during 2007 included $3.0 million of retirement benefits expenses associated with the retirement of our former CEO, and $0.3 million associated with a secondary stock offering, for which we did not receive any proceeds. Other Operating Income (Expense) during 2006 included a $2.6 million gain on the sale of a franchise that was not placed into discontinued operations, because we expect that increased cash flows of our current operations will replace those of the sold franchise.

Depreciation and Amortization—

The $1.4 million (7%) increase in depreciation and amortization expense was a result of property and equipment acquired during 2007 and 2006.

Other Income (Expense)—

The $2.6 million (6%) increase in floor plan interest expense was primarily attributable to higher average inventory levels during 2007 and to a lesser extent higher interest rates during 2007 as compared to 2006.

The $4.9 million (11%) decrease in other interest expense was primarily attributable to a lower effective rate on our long-term debt as a result of our long-term debt refinancing, which was substantially completed in the first quarter of 2007 and finalized in the second quarter of 2007.

We recognized an $18.5 million loss in connection with our long-term debt refinancing. The $18.5 million loss includes (i) a $12.9 million premium on the repurchase of the 9% Notes and 8% Notes, (ii) $5.5 million of costs associated with a pro-rata write-off of unamortized debt issuance costs related to our 9% Notes and 8% Notes, and (iii) $0.1 million of costs associated with a pro-rata write-off of the unamortized value of our terminated fair value swap associated with the 8% Notes.

During the 2006 period, we recognized a $1.1 million loss on the extinguishment of $17.6 million of our 8% Notes.

Income Tax Expense—

The $10.0 million (25%) decrease in income tax expense was a result of (i) a $22.8 million (21%) decrease in our income before income taxes, (ii) $0.4 million related to the reversal of a deferred tax asset valuation allowance related to a tax benefit we now expect to realize and (iii) $0.6 million related to tax credits recognized for employing individuals in the areas affected by Hurricane Katrina. We anticipate that our effective tax rate will be between 37.8% and 38.3% in 2008.

 

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Discontinued Operations—

 

     For the Year Ended
December 31, 2007
    For the Year Ended
December 31, 2006
 
     Sold     Pending
Disposition
    Total     Sold(b)     Pending
Disposition(a)
   Total  
     (Dollars in thousands)  

Franchises

     2       4       6       12       3      15  
                                               

Net operating losses from sold or closed franchises, net of tax

   $ (1,551 )     —       $ (1,551 )   $ (4,661 )   $ —      $ (4,661 )

Net operating income (loss) from franchises held for sale, net of tax

     —         (460 )     (460 )     —         60      60  

Net divestiture income (expense), including net gain on sale of franchises, net of tax

     (1,320 )     —         (1,320 )     (1,739 )     —        (1,739 )
                                               

Discontinued operations, net of tax

   $ (2,871 )   $ (460 )   $ (3,331 )   $ (6,400 )   $ 60    $ (6,340 )
                                               

 

(a) Businesses were pending disposition as of December 31, 2007.
(b) Businesses were sold between January 1, 2006 and December 31, 2007.

During the 2007 period, we sold two franchises (two dealership locations), and as of December 31, 2007, we were actively pursuing the sale of five franchises (four franchises are classified as discontinued operations). The $3.3 million, net of tax, loss from discontinued operations for the 2007 period is a result of (i) $1.3 million, net of tax, of divestiture expense associated with the sale of the two franchises mentioned above, (ii) $0.4 million of operating losses associated with franchises held for sale as of December 31, 2007 and (iii) $1.6 million, net of tax, of net operating losses of sold franchises. The $6.3 million, net of tax, loss from discontinued operations for the 2006 period, includes (i) $4.7 million, net of tax, of operating losses of franchises sold or closed in 2007 and 2006, (ii) $0.1 million of net operating income from franchises held for sale as of December 31, 2007 and (iii) $1.7 million, net of tax, of net divestiture expense associated with franchises sold during the 2006 period.

 

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RESULTS OF OPERATIONS

Year Ended December 31, 2006, Compared to Year Ended December 31, 2005

 

     For the Years Ended December 31,              
     2006     % of Gross
Profit
    2005     % of Gross
Profit
    Increase
(Decrease)
    %
Change
 
     (In thousands)  

REVENUES:

            

New vehicle

   $ 3,425,074       $ 3,267,935         157,139     5 %

Used vehicle

     1,443,899         1,315,907         127,992     10 %

Parts, service and collision repair

     670,520         626,443         44,077     7 %

Finance and insurance, net

     154,894         146,566         8,328     6 %
                        

Total revenues

     5,694,387         5,356,851         337,536     6 %
                        

COST OF SALES

     4,823,609         4,549,899         273,710     6 %
                        

GROSS PROFIT

     870,778     100 %     806,952     100 %     63,826     8 %

OPERATING EXPENSES:

            

Selling, general and administrative

     (663,856 )   (76 )%     (627,146 )   (78 )%     36,710     6 %

Depreciation and amortization

     (20,061 )   (2 )%     (19,441 )   (2 )%     620     3 %

Other operating income (expense), net.

     1,485     —   %     (552 )   —         2,037     369 %
                                

Income from operations

     188,346     22 %     159,813     20 %     28,533     18 %

OTHER INCOME (EXPENSE):

            

Floor plan interest expense

     (40,533 )   (5 )%     (27,597 )   (4 )%     12,936     47 %

Other interest expense

     (44,185 )   (5 )%     (40,841 )   (5 )%     3,344     8 %

Interest income

     5,111     —   %     966     —   %     4,145     429 %

Loss on extinguishment of long-term debt

     (1,144 )   —   %     —       —   %     (1,144 )   —   %
                                

Total other expense, net

     (80,751 )   (10 )%     (67,472 )   (9 )%     (13,279 )   20 %
                                

Income before income taxes

     107,595     12 %     92,341     11 %     15,254     17 %

INCOME TAX EXPENSE

     40,506     4 %     34,573     4 %     5,933     17 %
                                

INCOME FROM CONTINUING OPERATIONS

     67,089     8 %     57,768     7 %     9,321     16 %

DISCONTINUED OPERATIONS, net of tax

     (6,340 )   (1 )%     3,313     1 %     (9,653 )   (291 )%
                                

NET INCOME

   $ 60,749     7 %   $ 61,081     8 %     (332 )   (1 )%
                        

Income from continuing operations per commons share—Diluted

   $ 1.97       $ 1.76       $ 0.21     12 %
                        

Net income per common share—Diluted

   $ 1.78       $ 1.86       $ (0.08 )   (4 )%
                        

 

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     For the Years Ended
December 31,
    Increase
(Decrease)
    %
Change
 
     2006     2005      
     (In thousands, except for unit and PVR data)  

Revenue:

        

Light vehicle—same store

   $ 5,224,140     $ 5,041,628     $ 182,512     4 %

Acquisitions

     47,683       —        
                    

Total light vehicle

     5,271,823     $ 5,041,628       230,195     5 %

Heavy truck

     422,564       315,223       107,341     34 %
                    

Total revenue

   $ 5,694,387     $ 5,356,851     $ 337,536     6 %
                    

Gross Profit:

        

Light vehicle—same store

   $ 829,498     $ 778,030     $ 51,468     7 %

Acquisitions

     6,503       —        
                    

Total light vehicle

     836,001       778,030       57,971     7 %

Heavy truck

     34,777       28,922       5,855     20 %
                    

Total gross profit

   $ 870,778     $ 806,952     $ 63,826     8 %
                    

Retail Units:

        

Light vehicle—same store

     157,699       155,216       2,483     2 %

Acquisitions

     1,547       —        
                    

Total light vehicle

     159,246       155,216       4,030     3 %

Heavy truck

     5,986       4,567       1,419     31 %
                    

Total retail units

     165,232       159,783       5,449     3 %
                    

New light vehicle revenue PVR

   $ 30,204     $ 29,897       307     1 %
                    

New vehicle revenue PVR

   $ 31,806     $ 30,972       834     3 %
                    

New light vehicle gross profit PVR

   $ 2,310     $ 2,215       95     4 %
                    

New vehicle gross profit PVR

   $ 2,315     $ 2,206       109     5 %
                    

Used light vehicle revenue PVR

   $ 17,711     $ 16,861       850     5 %
                    

Used vehicle revenue PVR

   $ 17,841     $ 16,994       847     5 %
                    

Used light vehicle gross profit PVR

   $ 2,162     $ 1,987       175     9 %
                    

Used vehicle gross profit PVR

   $ 2,159     $ 1,988       171     9 %
                    

Light vehicle dealership generated F&I PVR

   $ 927     $ 909       18     2 %
                    

Dealership generated F&I PVR

   $ 907     $ 887       20     2 %
                    

New light vehicle retail gross margin

     7.6 %     7.4 %     0.2 %   3 %
                    

New vehicle retail gross margin

     7.3 %     7.1 %     0.2 %   3 %
                    

Used light vehicle retail gross margin

     12.2 %     11.8 %     0.4 %   3 %
                    

Used vehicle retail gross margin

     12.1 %     11.7 %     0.4 %   3 %
                    

Light vehicle fixed operations gross margin

     52.7 %     52.6 %     0.1 %   —   %
                    

Fixed operations gross margin

     50.7 %     50.7 %     —   %   —   %
                    

Total light vehicle gross margin

     15.9 %     15.4 %     0.5 %   3 %
                    

Total gross margin

     15.3 %     15.1 %     0.2 %   1 %
                    

 

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Net income decreased $0.3 million (1%) during the 2006 period as a result of a $9.7 million increase in net losses from discontinued operations, partially offset by a $9.3 million increase in income from continuing operations.

Our income from continuing operations during 2006 and 2005 was impacted by several items shown below (collectively referred to as “Adjusting Items”). We believe that an alternative comparison of our income from continuing operations (“adjusted income from continuing operations”), as used by management to compare actual results to budgeted results, can be made by adjusting for these items based on the fact that we believe these items are not core dealership operating items and should not be considered when forecasting our future results.

The non-GAAP measure adjusted income from continuing operations contains material limitations. Although we believe that corporate generated F&I gross profit, abandoned strategic project expenses, secondary stock offering expenses and losses from the extinguishment of long-term debt are infrequent, and although we do not expect to recognize these items in the future, we cannot assure you that we will not recognize them in the future. Our income from continuing operations may not be comparable with income from continuing operations of other companies to the extent that other companies recognize similar items in income from continuing operations and do not provide disclosure of the amounts. In addition, these non-GAAP measures are not defined by GAAP and our definition of each measure may differ from and therefore may not be comparable to similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. In order to compensate for these limitations we also review the related GAAP measures. These non-GAAP measures should not be considered in isolation, or as a substitute for analysis of our operating results as reported under GAAP. Please refer to “Reconciliation of Non-GAAP Financial Information” for more information.

 

     For the Years Ended
December 31,
   Increase
(Decrease)
   %
Change
 
     2006     2005      
     (In thousands)            

Income from continuing operations, as reported

   $ 67,089     $ 57,768    $ 9,321    16 %

Share-based compensation expense, net of tax

     3,105       —        

Corporate generated F&I gain, net of tax

     (2,130 )     —        

Gain on sale of a franchise, net of tax

     (1,565 )     —        

Secondary stock offering expenses*

     1,073       —        

Abandoned strategic project expenses, net of tax

     1,039       —        

Loss on extinguishment of long-term debt, net of tax

     717       —        

Net reorganization expenses, net of tax

     —         484      
                    

Adjusted income from continuing operations

   $ 69,328     $ 58,252    $ 11,076    19 %
                    

 

* Secondary offering expenses are not deductible for tax purposes; therefore, no tax benefit has been reflected.

The following discussion excludes the impact of the Adjusting Items as we believe that excluding these items provides a more accurate representation of our year over year core dealership performance. The $11.1 million (19%) increase in adjusted income from continuing operations was a result of several factors, including (i) $22.7 million (7%) increase fixed operations gross profit and a $15.9 million (14%) increase in used vehicle gross profit as a result of our continued focus on our high margin businesses; (ii) the performance of our new retail business, which delivered a $15.6 million (7%) increase in gross profit; and (iii) expense control initiatives that reduced personnel and advertising costs, which together contributed to a 110 basis point of the overall 170 basis point improvement in adjusted SG&A expenses as a percentage of adjusted gross profit. These factors were partially offset by a 47% increase in floor plan interest expense as a result of a 170 basis point increase in short-term interest rates.

The $0.3 billion increase in total revenue was primarily a result of a $0.2 billion (5%) increase in new vehicle revenue and a $0.1 billion (10%) increase in used vehicle revenue. The increase in new vehicle revenue was a result of a $99.8 million (43%) increase in heavy truck revenue and a $57.8 million (4%) increase in same store new retail revenue from our mid-line import brands, partially offset by a $58.3 million (11%) decrease in same store new retail revenue from our mid-line domestic brands. The increase in used vehicle revenue was primarily a result of a $108.2 million (11%) increase in used retail revenue.

The $63.8 million (8%) increase in total gross profit was as a result of a $22.7 million (7%) increase in fixed operations gross profit, a $16.9 million (7%) increase in new vehicle gross profit and a $15.9 million (14%) increase in used vehicle gross profit. Our total gross profit margin increased 20 basis points to 15.3%.

 

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New Vehicle—

 

     For the Years Ended December 31,          Increase
(Decrease)
    Change  
     2006          2005           
     (In thousands, except for unit and PVR data)  

Revenue:

              

New retail revenue—same store(1)

              

Luxury

   $ 1,064,707    33 %   $ 1,055,344    34 %   9,363     1 %

Mid-line import

     1,345,260    42 %     1,287,430    41 %   57,830     4 %

Mid-line domestic

     471,589    15 %     529,868    17 %   (58,279 )   (11 )%

Value

     28,459    1 %     26,936    1 %   1,523     6 %
                      

Total light vehicle retail revenue—same store

     2,910,015        2,899,578      10,437     —   %

Heavy trucks

     333,222    9 %     233,446    7 %   99,776     43 %
                      

Total new retail revenue—same store(1)

     3,243,237    100 %     3,133,024    100 %   110,213     4 %

New retail revenue—acquisitions

     35,996        —         
                      

Total new retail revenues

     3,279,233        3,133,024      146,209     5 %
                      

Fleet revenue—same store(1)

     144,903        134,911      9,992     7 %

Fleet revenue—acquisitions

     938        —         
                      

Total fleet revenue

     145,841        134,911      10,930     8 %
                      

New vehicle revenue, as reported

   $ 3,425,074      $ 3,267,935      157,139     5 %
                      

New retail units:

              

New retail units—same store(1)

              

Luxury

     23,418    23 %     23,803    24 %   (385 )   (2 )%

Mid-line import

     55,043    54 %     53,216    53 %   1,827     3 %

Mid-line domestic

     16,415    16 %     18,582    18 %   (2,167 )   (12 )%

Value

     1,376    1 %     1,386    1 %   (10 )   (1 )%
                      

Total light vehicle retail units— same store

     96,252        96,987      (735 )   (1 )%

Heavy trucks

     5,566    6 %     4,171    4 %   1,395     33 %
                      

Total new retail units—same store(1)

     101,818    100 %     101,158    100 %   660     1 %

New retail units—acquisitions

     1,282        —         
                      

Retail units—actual

     103,100        101,158      1,942     2 %

Fleet units—actual

     7,501        6,646      855     13 %
                      

Total new units—actual

     110,601        107,804      2,797     3 %
                      

Total light vehicle units — same store(1)(2)

     103,753        103,633      120     —   %

Total light vehicle units — acquisitions (2)

     1,282        —         
                      

Total light vehicle units — actual(2)

     105,035        103,633      1,402     1 %
                      

New revenue PVR—same store(1)

   $ 31,853      $ 30,972      881     3 %
                      

New revenue PVR—actual

   $ 31,806      $ 30,972      834     3 %
                      

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

 

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     For the Years Ended December 31,     Increase
(Decrease)
    Change  
     2006           2005            
     (In thousands, except for PVR data)  

Gross profit:

            

New retail gross profit—same store(1)

            

Luxury

   $ 87,224     37 %   $ 85,848     39 %   1,376     2 %

Mid-line import

     97,659     41 %     88,799     40 %   8,860     10 %

Mid-line domestic

     36,244     15 %     38,343     17 %   (2,099 )   (5 )%

Value

     1,872     1 %     1,819     1 %   53     3 %
                        

Total light vehicle retail gross profit—same store

     222,999         214,809       8,190     4 %

Heavy trucks

     13,366     6 %     8,331     3 %   5,035     60 %
                        

Total new retail gross profit—same store(1)

     236,365     100 %     223,140     100 %   13,225     6 %

New retail gross profit—acquisitions

     2,342         —          
                        

Total new retail gross profit

     238,707         223,140       15,567     7 %
                        

Fleet gross profit—same store(1)

     4,010         2,676       1,334     50 %

Fleet gross profit—acquisitions

     20         —          
                        

Total fleet gross profit

     4,030         2,676       1,354     51 %
                        

New vehicle gross profit, as reported

   $ 242,737       $ 225,816       16,921     7 %
                        

New gross profit PVR—same store(1)

   $ 2,321       $ 2,206       115     5 %
                        

New gross profit PVR—actual

   $ 2,315       $ 2,206       109     5 %
                        

New retail gross margin—same store(1)

     7.3 %       7.1 %     0.2 %   3 %
                        

New retail gross margin—actual

     7.3 %       7.1 %     0.2 %   3 %
                        

 

(1) Same store amounts include the results of dealerships for the identical months for each period presented in the comparison, commencing with the first full month in which the dealership was owned by us.

The $0.2 billion (5%) increase in new vehicle revenue was primarily a result of a $99.8 million (43%) increase in heavy truck revenue. The increase in heavy truck revenue was as a result of a 33% increase in unit sales from changes in emission laws that became effective in January 2007, which pulled forward demand for heavy trucks into 2006. Same store new retail revenue from our mid-line import brands increased $57.8 million (4%), which was offset by a $58.3 million (11%) decrease in new retail revenue from our mid-line domestic brands as these brands continued to lose market share. New vehicle revenues excluding heavy trucks (“light vehicle”) were flat at $2.9 billion during the 2006 period, compared with the 2005 period. Our total same store light vehicle unit sales were flat, outperforming the overall U.S. light vehicle industry, which decreased 3%.

The $16.9 million (7%) increase in new vehicle gross profit was due to (i) an $8.1 million (4%) increase in same store light vehicle retail gross profit and (ii) $5.0 million (60%) increase in heavy truck gross profit. Our same store gross profit from mid-line import brands increased $8.9 million (10%) as a result of a 6% increase in gross profit PVR as we were able to capitalize on manufacturer incentive programs. The increase in heavy truck gross profit was a result of a 33% increase in heavy truck unit sales and a 20% increase in heavy truck gross profit PVR. These increases were partially offset by same store gross profit from our mid-line import brands, which decreased $2.1 million (5%) as these brands continued to lose market share.

 

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Used Vehicle—

 

     For the Years Ended
December 31,
    Increase
(Decrease)
    %
Change
 
     2006     2005      
     (In thousands, except for unit and PVR data)  

Revenue:

        

Retail revenues—same store(1)

        

Light vehicle

   $ 1,088,979     $ 981,795     $ 107,184     11 %

Heavy trucks

     15,513       14,498       1,015     7 %
                    

Total used retail revenues—same store(1)

     1,104,492       996,293       108,199     11 %
                    

Retail revenues—acquisitions

     3,982       —        
                    

Total used retail revenues

     1,108,474       996,293       112,181     11 %
                    

Wholesale revenues—same store(1)

     334,367       319,614       14,753     5 %

Wholesale revenues—acquisitions

     1,058       —        
                    

Total wholesale revenues

     335,425       319,614       15,811     5 %
                    

Used vehicle revenue, as reported

   $ 1,443,899     $ 1,315,907     $ 127,992     10 %
                    

Gross profit:

        

Retail gross profit—same store(1)

        

Light vehicle

   $ 132,863     $ 115,709     $ 17,154     15 %

Heavy trucks

     693       856       (163 )   (19 )%
                    

Total used retail gross profit—same store(1)

     133,556       116,565       16,991     15 %
                    

Retail gross profit—acquisitions

     561       —        
    <