| AUTONATION INC /FL ITEM 1A RISK FACTORS Our business, financial condition, results of operations, cash flows and prospects, and the prevailing market price and performance of our common stock, may be adversely affected by a number of factors, including the matters discussed below |
| Certain statements and information set forth in this Annual Report on Form 10-K, as well as other written or oral statements made from time to time by us or by our authorized officers on our behalf, constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995 |
| We intend for our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 |
| You should note that our forward-looking statements speak only as of the date of this Annual Report on Form 10-K or when made and we undertake no duty or obligation to update or revise our forward-looking statements, whether as a result of new information, future events or otherwise |
| Although we believe that the expectations, plans, intentions and projections reflected in our forward-looking statements are reasonable, such statements are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements |
| The risks, uncertainties and other factors that our stockholders and prospective investors should consider include, but are not limited to, the following: We are dependent upon the success and continued financial viability of the vehicle manufacturers and distributors with which we hold franchises |
| The success of our stores is dependent on vehicle manufacturers in several key respects |
| First, we rely exclusively on the various vehicle manufacturers for our new vehicle inventory |
| Our ability to sell new vehicles is dependent on a vehicle manufacturer’s ability to produce and allocate to our stores an attractive, high quality and desirable product mix at the right time in order to satisfy customer demand |
| Second, manufacturers generally support their franchisees by providing direct financial assistance in various areas, including, among others, inventory financing assistance and advertising assistance |
| Third, manufacturers provide product warranties and, in some cases, service contracts, to customers |
| Our stores perform warranty and service contract work for vehicles under manufacturer product warranties and service contracts, and direct bill the 11 _________________________________________________________________ [54]Table of Contents manufacturer as opposed to invoicing the store customer |
| At any particular time, we have significant receivables from manufacturers for warranty and service work performed for customers |
| In addition, we rely on manufacturers to varying extents for original equipment manufactured replacement parts, training, product brochures and point of sale materials, and other items for our stores |
| The core brands of vehicles that we sell, representing more than 90prca of the number of new vehicles that we sold in 2005, are manufactured by Ford, General Motors, DaimlerChrysler, Toyota, Nissan, Honda and BMW In particular, our General Motors Corporation and Ford Motor Company stores represented over 37prca of our new vehicle revenue in 2005 |
| We are subject to a concentration of risk in the event of financial distress, including potential bankruptcy, of a major vehicle manufacturer such as General Motors or Ford |
| In the event of a bankruptcy by a vehicle manufacturer, among other things: (i) the manufacturer could attempt 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 significant receivables that are due from such manufacturer and we may be subject to preference claims relating to payments made by such manufacturer prior to bankruptcy, (iii) we may not be able to obtain financing for our new vehicle inventory, or arrange financing for our customers for their vehicle purchases and leases, with such manufacturer’s captive finance subsidiary, which may cause us to finance our new vehicle inventory, and arrange financing for our customers, with alternate finance sources on less favorable terms, and (iv) consumer demand for such manufacturer’s products could be materially adversely affected |
| These events may result in a partial or complete write-down of our goodwill, intangible franchise rights with respect to any terminated franchises, and/or receivables due from such manufacturers |
| In addition, vehicle manufacturers may be adversely impacted by economic downturns or recessions, significant declines in the sales of their new vehicles, increases in interest rates, declines in their credit ratings, labor strikes or similar disruptions (including within their major suppliers), supply shortages or rising raw material costs, rising employee benefit costs, adverse publicity that may reduce consumer demand for their products (including due to bankruptcy), product defects, vehicle recall campaigns, litigation, poor product mix or unappealing vehicle design, or other adverse events |
| These and other risks could materially adversely affect any manufacturer and impact its ability to profitably design, market, produce or distribute new vehicles, which in turn could materially adversely affect our business, results of operations, financial condition, shareholders’ equity, cash flows and prospects |
| The automotive retailing industry is sensitive to changing economic conditions and various other factors |
| Our business and results of operations are substantially dependent on new vehicle sales levels in the United States and in our particular geographic markets and the level of gross profit margins that we can achieve on our sales of new vehicles, all of which are very difficult to predict |
| We believe that many factors affect industry-wide sales of new vehicles and retailers’ gross profit margins, including consumer confidence in the economy, the level of manufacturers’ excess production capacity, manufacturer incentives (and consumers’ reaction to such offers), intense industry competition, interest rates, the prospects of war, other international conflicts or terrorist attacks, severe weather conditions, the level of personal discretionary spending, product quality, affordability and innovation, fuel prices, credit availability, unemployment rates, the number of consumers whose vehicle leases are expiring, and the length of consumer loans on existing vehicles |
| Significant increases in interest rates, in particular, could significantly impact industry new vehicle sales and vehicle affordability due to the direct relationship between higher rates and higher monthly loan payments, a critical factor for many vehicle buyers |
| Sales of certain new vehicles, particularly larger trucks and sports utility vehicles that historically have provided us with higher gross margins, also could be impacted adversely by further significant increases in fuel prices, which rose dramatically during 2005 |
| The length of consumer auto loans has increased recently and leasing of vehicles has decreased, which may result in customers deferring vehicle purchases in the future |
| Our new vehicle sales may differ from industry sales, including due to particular economic conditions and other factors in the geographic markets in which we operate |
| A significant decrease in new vehicle sales levels in the United States (or in our particular geographic markets) during 2006 as compared to 2005, or a decrease in new vehicle gross profit margins, could cause our actual earnings results to differ materially from our prior results and projected trends |
| Economic conditions and the other factors described above also may materially 12 _________________________________________________________________ [55]Table of Contents adversely impact our sales of used vehicles, finance and vehicle protection products, vehicle service and parts and repair services |
| Our new vehicle sales are impacted by the consumer incentive and marketing programs of vehicle manufacturers |
| Most vehicle manufacturers use incentive and marketing programs to spur consumer demand for their vehicles, such as 0prca financing and manufacturer employee pricing offers |
| These sales incentive programs are often not announced in advance and therefore can be difficult to plan for when ordering inventory |
| In addition, certain manufacturers offer extended product warranties or free service programs to consumers |
| From time to time, manufacturers modify and discontinue these dealer assistance and consumer incentive and marketing programs, which could have a significant adverse effect on our new vehicle and aftermarket product sales, consolidated results of operations and cash flows |
| Adverse weather events can disrupt our business |
| Our stores are concentrated in states and regions in the United States, including primarily Florida, Texas and California, in which actual or threatened natural disasters and severe weather events (such as hurricanes, earthquakes and hail storms) may disrupt our store operations, which may adversely impact our business, results of operations, financial condition and cash flows |
| In addition to business interruption, the automotive retailing business is subject to substantial risk of property loss due to the significant concentration of property values at store locations |
| Although we have, subject to certain limitations and exclusions, substantial insurance, we cannot assure you that we will not be exposed to uninsured or underinsured losses that could have a material adverse effect on our business, financial condition, results of operations or cash flows |
| We are subject to restrictions imposed by, and significant influence from, vehicle manufacturers that may adversely impact our business, financial condition, results of operations, cash flows and prospects, including our ability to acquire additional stores |
| Vehicle manufacturers and distributors with whom we hold franchises have significant influence over the operations of our stores |
| The terms and conditions of our framework, franchise and related agreements and the manufacturers’ interests and objectives may, in certain circumstances, conflict with our interests and objectives |
| For example, manufacturers can set performance standards with respect to sales volume, sales effectiveness and customer satisfaction, and can influence our ability to acquire additional stores, the naming and marketing of our stores, the operations of our e-commerce sites, our selection of store management, the condition of our store facilities, product stocking and advertising spending levels, and the level at which we capitalize our stores |
| Manufacturers may also have certain rights to restrict our ability to provide guaranties of our operating companies, pledges of the capital stock of our subsidiaries and liens on their assets, which could adversely impact our ability to obtain financing for our business and operations on favorable terms or at desired levels |
| From time to time, we are precluded under agreements with certain manufacturers from acquiring additional franchises, or subject to other adverse actions, to the extent we are not meeting certain performance criteria at our existing stores (with respect to matters such as sales volume, sales effectiveness and customer satisfaction) until our performance improves in accordance with the agreements, subject to applicable state franchise laws |
| Manufacturers also have the right to establish new franchises or relocate existing franchises, subject to applicable state franchise laws |
| The establishment or relocation of franchises in our markets could have a material adverse effect on the financial condition, results of operations, cash flows and prospects of our stores in the market in which the franchise action is taken |
| Our framework, franchise and related agreements also grant the manufacturer the right to terminate or compel us to sell our franchise for a variety of reasons (including uncured performance deficiencies, any unapproved change of ownership or management or any unapproved transfer of franchise rights), subject to state laws |
| From time to time, certain major manufacturers assert sales and customer satisfaction performance deficiencies under the terms of our framework and franchise agreements at a limited number of our stores |
| While we believe that we will be able to renew all of our franchise agreements, we cannot guarantee that all of our franchise agreements will be renewed or that the terms of the renewals will be favorable to us |
| We cannot 13 _________________________________________________________________ [56]Table of Contents assure you that our stores will be able to comply with manufacturers’ sales, customer satisfaction and other performance requirements in the future, which may affect our ability to acquire new stores or renew our franchise agreements, or subject us to other adverse actions, including termination or compelled sale of a franchise, any of which could have a material adverse effect on our financial condition, results of operations, cash flows and prospects |
| In addition, we have granted certain manufacturers the right to acquire, at fair market value, our automotive dealerships franchised by that manufacturer in specified circumstances in the event of our default under the indenture for our senior unsecured notes due 2008 or the credit agreement for our revolving credit facility |
| We are subject to numerous legal and administrative proceedings, which, if the outcomes are adverse to us, could materially adversely affect our business, results of operations, financial condition, cash flows and prospects |
| We are involved, and will continue to be involved, in numerous legal proceedings arising out of the conduct of our business, including litigation with customers, employment-related lawsuits, class actions, purported class actions and actions brought by governmental authorities |
| Many of our Texas dealership subsidiaries have been named in three class action lawsuits brought against the Texas Automobile Dealers Association (“TADA”) and approximately 700 new vehicle stores in Texas that are members of the TADA The three actions allege that since January 1994 Texas dealers have deceived customers with respect to a vehicle inventory tax and violated federal antitrust and other laws as well |
| In April 2002, in two actions (which have been consolidated) the state court certified two classes of consumers on whose behalf the action would proceed |
| In the federal antitrust case, in March 2003, the federal court conditionally certified a class of consumers |
| We and the other dealership defendants appealed the ruling to the Fifth Circuit Court of Appeals, which on October 5, 2004 reversed the class certification order and remanded the case back to the federal district court for further proceedings |
| In February 2005, we and the plaintiffs in each of the cases agreed to settlement terms |
| The state settlement, which was approved preliminarily by the state court on December 27, 2005, is contingent upon final court approval, the hearing for which is currently scheduled for June 2006 |
| The claims against us in federal court also would be settled contingent upon final approval in the state action |
| The estimated expense of the settlements is not a material amount and includes our stores issuing coupons for discounts off future vehicle purchases, refunding cash in certain circumstances, and paying attorneys’ fees and certain costs |
| Under the terms of the settlements, our stores would be permitted to continue to itemize and pass through to the customer the cost of the inventory tax |
| If the settlements are not finally approved, we would then vigorously assert available defenses in connection with the TADA lawsuits |
| Further, we may have certain rights of indemnification with respect to certain aspects of these lawsuits |
| However, an adverse resolution of the TADA lawsuits could result in the payment of significant costs and damages and negatively impact our ability to itemize and pass through to the customer the cost of the tax in the future, which could have a material adverse effect on our business, results of operations, financial condition, cash flows and prospects |
| In addition to the foregoing cases, we also are a party to numerous other legal proceedings that arose in the conduct of our business |
| We do not believe that the ultimate resolution of these matters will have a material adverse effect on our business, results of operations, financial condition or cash flows |
| However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition, cash flows and prospects |
| Our operations, including, without limitation, our sales of finance, insurance and vehicle protection products, are subject to extensive governmental laws, regulation and scrutiny |
| If we are found to be in violation of any of these laws or regulations, or if new laws or regulations are enacted that adversely affect our operations, our business, operating results and prospects could suffer |
| The automotive retailing industry, including our facilities and operations, is subject to a wide range of federal, state and local laws and regulations, such as those relating to motor vehicle sales, retail installment sales, leasing, sales of finance, insurance and vehicle protection products, licensing, consumer protection, 14 _________________________________________________________________ [57]Table of Contents consumer privacy, escheatment, money laundering, environmental, health and safety, wage-hour, anti-discrimination and other employment practices |
| Specifically with respect to motor vehicle sales, retail installment sales, leasing, and the sale of finance, insurance and vehicle protection products at our stores, we are subject to various laws and regulations, the violation of which could subject us to consumer class action or other lawsuits or governmental investigations and adverse publicity, in addition to administrative, civil or criminal sanctions |
| The violation of other laws and regulations to which we are subject also can result in administrative, civil or criminal sanctions against us, which may include a cease and desist order against the subject operations or even revocation or suspension of our license to operate the subject business, as well as significant fines and penalties |
| We currently devote significant resources to comply with applicable federal, state and local regulation of health, safety, environmental, zoning and land use regulations, and we may need to spend additional time, effort and money to keep our existing or acquired facilities in compliance therewith |
| Legislative or similar measures have recently been enacted or pursued in certain states in which we operate to limit the fees that dealerships may earn in connection with arranging financing for vehicle purchasers, to require disclosure to consumers of the fees that stores earn to arrange financing and to enact other additional regulations with respect to various aspects of our business, including with respect to the sale of used vehicles and finance and insurance products |
| Recent litigation against certain vehicle manufacturers’ captive finance subsidiaries alleging discriminatory lending practices has resulted in settlements, and may result in future settlements, that could reduce the fees earned by our stores in connection with the origination of consumer loans |
| The enactment of laws and regulations that materially impair or restrict our finance and insurance or other operations could have a material adverse effect on our business, results of operations, financial condition, cash flows and prospects |
| Our ability to grow our business may be limited by our ability to acquire automotive stores on favorable terms or at all |
| The automotive retail industry is a mature industry |
| Accordingly, the growth of our automotive retail business since our inception has been primarily attributable to acquisitions of franchised automotive dealership groups |
| As described above, manufacturer approval of our proposed acquisitions generally is subject to our compliance with applicable performance standards (including with respect to matters such as sales volume, sales effectiveness and customer satisfaction) or established acquisition limits, particularly regional and local market limits |
| In addition, in the current environment, it has been difficult to identify dealership acquisitions in our core markets that meet our return on investment targets |
| As a result, we cannot assure you that we will be able to acquire stores selling desirable automotive brands at desirable locations in our key markets or that any such acquisitions can be completed on favorable terms or at all |
| Acquisitions involve a number of risks, many of which are unpredictable and difficult to quantify or assess, including, among other matters, risks relating to known and unknown liabilities of the acquired business and projected operating performance |
| We are subject to interest rate risk in connection with our vehicle floorplan payable, revolving credit facility and mortgage facility that could have a material adverse effect on our profitability |
| The LIBOR-based interest rates under our revolving credit facility, mortgage facility and certain of our floorplan notes payable all increased in 2005, and we anticipate that such rates will increase further in 2006 |
| Our net inventory carrying benefit (floorplan interest expense net of floorplan assistance that we receive from automotive manufacturers) has decreased in recent years and we expect to have a net inventory carrying cost in 2006 |
| We cannot assure you that a significant increase in interest rates would not have a material adverse effect on our business, financial condition, results of operations or cash flows |
| Our revolving credit facility and the indenture relating to our senior unsecured notes contain certain restrictions on our ability to conduct our business |
| The indenture relating to the 9prca senior unsecured notes due August 2008 and the credit agreement relating to our revolving credit facility contain numerous financial and operating covenants that limit the discretion of our management with respect to various business matters |
| These covenants place significant restrictions on, among other things, our ability to incur additional indebtedness, to create liens or other encumbrances, to make certain payments (including dividends and repurchases of our shares) and invest- 15 _________________________________________________________________ [58]Table of Contents ments, and to sell or otherwise dispose of assets and merge or consolidate with other entities |
| Our revolving credit facility also requires us to meet certain financial ratios and tests that may require us to take action to reduce debt or act in a manner contrary to our business objectives |
| A failure by us to comply with the obligations contained in our revolving credit facility or the indenture could result in an event of default under our revolving credit facility or the indenture, which could permit acceleration of the related debt and acceleration of debt under other instruments that may contain cross-acceleration or cross-default provisions |
| If any debt is accelerated, our liquid assets may not be sufficient to repay in full such indebtedness and our other indebtedness |
| In addition, we have granted certain manufacturers the right to acquire, at fair market value, our automotive stores franchised by that manufacturer in specified circumstances in the event of our default under the indenture for our senior unsecured notes due August 2008 or the credit agreement for our revolving credit facility |
| We must test our intangible assets for impairment at least annually, which may result in a material, non-cash write down of goodwill or franchise rights and could have a material adverse impact on our results of operations and shareholders’ equity |
| Goodwill and indefinite-lived intangibles are subject to impairment assessments at least annually (or more frequently when events or circumstances indicate that an impairment may have occurred) by applying a fair-value based test |
| Our principal intangible assets are goodwill and our rights under our franchise agreements with vehicle manufacturers |
| These impairment assessments may result in a material, non-cash write-down of goodwill or franchise values |
| An impairment would have a material adverse impact on our results of operations and shareholders’ equity |