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Item 1. Business
Forward Looking Statements
Certain statements under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-K involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Item 1A. of this Form 10-K.
While we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. Any forward looking statement speaks only as of the date on which it is made. We assume no obligation to update or revise any forward looking statement.
Overview
We are a leading operator of automotive franchises and a retailer of new and used vehicles and services. As of February 24, 2012, we offered 25 brands of new vehicles and all brands of used vehicles in 86 stores in the United States and online at Lithia.com. We sell new and used cars and light trucks and replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance.
Our dealerships are primarily located throughout the Western and Midwestern regions of the United States. We target mid-sized regional markets for domestic and import franchises and metropolitan markets for luxury franchises. We believe this strategy enables brand exclusivity with minimal competition from other dealerships with the same franchise in the market.
The following table sets forth information about stores that were part of our continuing operations as of December 31, 2011:
State
Number of
Stores
Percent of
2011 Revenue
Texas
14
24%
Oregon
20
California
11
10
Washington
8
Alaska
7
9
Montana
Idaho
5
6
Iowa
Nevada
4
North Dakota
3
2
New Mexico
1
Total
85
100%
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Business Strategy and Operations
Our mission statement is: “Driven by our employees and preferred by our customers, Lithia is the leading automotive retailer in each of our markets.” We offer customers personal, convenient, flexible hometown service combined with the large company advantages of selection, competitive pricing, broad access to financing, consistent service, competence and guarantees. We strive for diversification in our products, services, brands and geographic locations to insulate us from market risk and to maintain profitability. We have developed a centralized support structure to reduce store level administrative functions. This allows store personnel to focus on providing a positive customer experience. With our management information systems, our emphasis on standardized operating practices and administrative functions performed centrally in Medford, Oregon, we seek to gain economies of scale from our dealership network.
Our overall strategy is to target mid-sized and rural markets for domestic and import brands and metropolitan markets for luxury brands. We offer a variety of luxury, import and domestic new vehicle brands and models, reducing our dependence on any one manufacturer and our susceptibility to changing consumer preferences. Encompassing economy and luxury cars, sports utility vehicles (SUVs), crossovers, minivans and light trucks, we believe our brand mix is well-suited to what people want in the markets we serve. For example, in the rural, agricultural markets, as opposed to metropolitan markets, we believe more consumers prefer trucks or SUVs, and a larger percentage of customers choose domestic vehicles.
We have centralized many administrative functions to streamline store level operations. Accounts payable, accounts receivable, credit and collections, accounting and taxes, payroll and benefits, information technology, legal, human resources, personnel development, treasury, cash management, advertising and marketing are all centralized at our corporate headquarters. The reduction of administrative functions at our stores allows our local managers to focus on customer-facing opportunities to generate increased revenues and gross profit. Our operations are supported by our dedicated training and personnel development program, which shares best practices across our dealership network and seeks to develop our store management talent.
Operations are structured to promote an entrepreneurial environment at the dealership level. Each store’s general manager and department managers, with assistance from regional and corporate management, are responsible for developing retail models that perform in their communities. They are the leaders in driving dealership operations, personnel development, manufacturer relationships, store culture and financial performance.
During 2011, we focused on the following areas to achieve our mission:
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increasing revenues in all business lines;
capturing a greater percentage of overall new vehicle sales in our local markets;
increasing sales of manufacturer certified pre-owned used vehicles; three to seven years old, lower-mileage vehicles; and value autos to reach additional customers;
diversifying our franchise mix through acquisitions;
increasing our return to investors through dividends and strategic share buy backs;
utilizing prudent cash management, including investing capital to produce accretive returns; and
reducing our exposure to pending debt maturities by renewing and extending debt instruments.
We believe our cost structure is aligned with current industry sales levels and is positioned to be leveraged as vehicle sales levels continue to improve. Our selling, general and administrative (“SG&A”) expense as a percentage of gross profit improved to 71.6% in 2011 compared to 78.6% in 2010. The 2011 results included a $6.3 million gain on the sale of property in California. Adjusting for this gain and other pro forma items, our adjusted SG&A expense as a percentage of gross profit in 2011 was 72.9%.
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We also measure the leverage of our cost structure by evaluating throughput, which is calculated as the incremental percentage of gross profit retained after deducting SG&A expense. For the years ended December 31, 2011 and 2010, our incremental throughput was 58.1% and 42.9%, respectively. Adjusting for the gain on the sale of property in California and other non-core items, our adjusted throughput in 2011 was 49.3%.
We believe we are well positioned to improve our SG&A expense leverage as vehicle sales levels continue to improve. As sales volume increases and we gain leverage in our cost structure, we anticipate achieving metrics of SG&A as a percentage of gross profit in the low 70% range and incremental throughput of approximately 50%.
We continuously evaluate our portfolio of franchises, divesting stores that are not expected to meet our financial return requirements while selectively acquiring attractive stores in our target markets. In the past three years, we generated $52.5 million in cash by divesting stores that did not meet our financial return expectations. Additionally, in 2011 and 2010, we spent $84.2 million in cash on acquisitions which increase revenue and diversify our portfolio.
New Vehicles
In 2011, we sold 43,273 new vehicles, generating 24% of our gross profit for the year. New vehicle sales also have the potential to create incremental profit opportunities through manufacturer incentives, resale of trade-in vehicles, sale of third-party financing, vehicle service and insurance contracts, and future service and repair work.
In 2011, we represented 26 domestic and import brands ranging from economy to luxury cars, sport utility vehicles, crossovers, minivans and light trucks.
Manufacturer
2011 Total Revenue
2011 New Vehicle Revenue
2011 New Vehicle Gross Profit
Chrysler, Jeep, Dodge
17.1%
32.4%
29.9%
Chevrolet, Cadillac, Saab
8.9
16.8
15.8
Toyota, Scion
5.6
10.5
10.4
BMW, Mini
5.3
10.1
9.3
Honda, Acura
2.9
7.1
Ford, Lincoln
3.3
6.2
5.0
Subaru
2.2
4.2
3.7
Hyundai
2.1
3.9
6.1
Volkswagen, Audi
1.1
2.6
Nissan
1.4
2.7
3.1
Mercedes, smart
2.0
4.7
Kia
0.4
0.8
0.9
Porsche
0.7
Mazda
0.2
0.3
0.5
Suzuki
*
Total
52.9%
100.0%