Item 1A. Risk Factors
Item 1A. Risk Factors
The following risks have had or in the future could have a material adverse effect on our business and results of operations.
Market and Industry Risks
Demand for and pricing of our products and services may be adversely impacted by economic conditions and other factors.
The automotive retail industry, and especially new vehicle unit sales, is influenced by general economic conditions, particularly consumer confidence, the level of personal discretionary spending, interest rates, exchange rates, fuel prices, technology and business model changes, supply conditions, consumer transportation preferences, unemployment rates and credit availability. During economic downturns, retail new vehicle sales typically experience periods of decline characterized by oversupply and weakened demand. In addition, consumer spending can be materially and adversely impacted by periods of economic uncertainty as was experienced in the second quarter of 2020, as a result of the lockdowns imposed following the spread of the COVID-19 pandemic, or consumer concern about manufacturer viability.
Economic conditions can also have a significant impact on our borrowing rates. The majority of our floorplan notes payable, mortgages and other debt are benchmarked to LIBOR, which can be highly volatile as a result of changing economic conditions. Although we utilize derivative instruments to partially mitigate our exposure to interest rate fluctuations, significant increases in LIBOR or other variable interest rates could have a material adverse impact on our interest expense due to the significance of our debt and floorplan balances. Additionally, our LIBOR-based contracts will be impacted by the expected transition away from LIBOR after 2021. Refer to Item 7A. Quantitative and Qualitative Disclosures About Market Risk for further discussion of the LIBOR transition and additional analysis regarding our interest rate sensitivity.
A significant portion of our vehicles purchased by customers are financed. Tightening of the credit markets and credit conditions may decrease the availability of automotive loans and leases and adversely impact our new and used vehicle sales and margins. In particular, if sub-prime finance companies apply higher credit standards or if there is a decline in the overall availability of credit in the sub-prime lending market, the ability of consumers to purchase vehicles could be limited, which could have a material adverse effect on our business and results of operations.
In addition, local economic, competitive and other conditions affect the performance of our dealerships. Our results of operations depend substantially on general economic conditions and spending habits in those regions of the U.S. where we maintain most of our operations.
Changes in consumer demand towards fuel efficient vehicles and electric vehicles could adversely affect our new and used vehicle sales volumes, parts and service revenues and our results of operations.
Volatile fuel prices have affected and may continue to affect consumer preferences in connection with the purchase of our vehicles. Rising fuel prices result in consumers less likely to purchase larger, more expensive vehicles, such as sports utility vehicles or luxury automobiles, and more likely to purchase smaller, less expensive and more fuel efficient vehicles. Conversely, lower fuel prices could have the opposite effect. Sudden changes in customer preferences make maintenance of an optimal mix of large and small vehicle inventory a challenge. Further increases or sharp declines in fuel prices could have a material adverse effect on our business and results of operations.
13
Changes in fuel prices, government support, improvements in electric vehicles and more electric vehicle options have increased the customer demand for more fuel efficient vehicles and electric vehicles. With a potential increase in demand by consumers for electric-powered vehicles, our manufacturers will need to adapt their product plans and production capabilities accordingly to meet these demands. As more electric vehicles potentially enter the market, and internal combustion or diesel engine vehicle production is reduced, it may be necessary to adapt to such changes by selling and servicing these units effectively in order to meet consumer demands and support the profitability of our dealerships. If maintenance costs of electric-powered vehicles were to substantially decrease, this could have a material adverse effect on our parts and service revenues. If consumer demand increases for fuel efficient vehicles or electric vehicles and our manufacturers are not able to adapt and produce vehicles that meet the customer demands or we are unable to align with the manufacturers of these vehicles, such events could adversely affect our new and used vehicle sales volumes, parts and service revenue and our results of operations.
Vehicle technology advancements and changes in consumer vehicle ownership preferences could adversely affect our new and used vehicle sales volumes, parts and service revenues and our results of operations.
Vehicle technology advancements are occurring at an accelerating pace. This includes driver assist functionality, autonomous vehicle development, rideshare and vehicle co-ownership business models. Many in the automotive industry believe that in the near future vehicles will be available to the automotive consumer at low usage costs, which may entice many vehicle owners, particularly in larger, highly populated areas, to abandon individual car ownership in favor of multiple co-ownership ride-sharing opportunities. An increased popularity in the ride-sharing subscription business model could adversely affect our new and used vehicle sales volumes, parts and service revenue and results of operations.
We are subject to risks associated with our dependence on manufacturer business relationships and agreements.
The success of our dealerships is dependent on vehicle manufacturers whom we rely exclusively on for our new vehicle inventory. Our ability to sell new vehicles is dependent on a vehicle manufacturer’s ability to produce and allocate to our dealerships an attractive, high quality and desirable product mix at the right time in order to satisfy customer demand. Manufacturers generally support their franchisees by providing direct financial assistance in various areas, including, among others, incentives, floorplan assistance and advertising assistance. A discontinuation or change in our manufacturers’ warranty and incentive programs could adversely affect our business. Manufacturers also provide product warranties and, in some cases, service contracts to customers. Our dealerships perform warranty and service contract work for vehicles under manufacturer product warranties and service contracts and we bill the manufacturer directly as opposed to invoicing the customer. In addition, we rely on manufacturers for various financing programs, OEM replacement parts, training, up-to-date product design, development of advertising materials and programs and other items necessary for the success of our dealerships.
Vehicle manufacturers may be adversely impacted by economic downturns or recessions, significant declines in the sales of their new vehicles, increases in interest rates, adverse fluctuations in currency exchange rates, declines in their credit ratings, reductions in access to capital or credit, labor strikes or similar disruptions (including within their major suppliers), supply shortages, rising raw material costs, rising employee benefit costs, adverse publicity that may reduce consumer demand for their products, including due to bankruptcy, product defects, litigation, ability to keep up with technology and business model changes, poor product mix or unappealing vehicle design, governmental laws and regulations, natural disasters or other adverse events. In particular, all our OEMs are investing material amounts to develop electric and autonomous vehicles. These investments could cause financial strain on our OEMs or fail to deliver attractive vehicles for customers which could lead to adverse impacts on our business. The OEMs are also impacted by the COVID-19 pandemic’s impact on the economy, factory production, parts shortages, including semiconductor chips, and other disruptions. These and other risks could materially adversely affect the financial condition of any manufacturer and impact its ability to profitably design, market, produce or distribute new vehicles, which in turn could have a material adverse effect on our business, results of operations and financial condition.
Additionally, many U.S. manufacturers of vehicles, parts and supplies are dependent on imported products and raw materials in their production. Any significant increase in existing tariffs on such goods and raw materials, or implementation of new tariffs, could adversely affect our profits on the vehicles we sell.
14
If we are unable to enter into new franchise agreements with manufacturers in connection with dealership acquisitions or maintain or renew our existing franchise agreements on favorable terms, our operations may be significantly impaired.
We are dependent on our relationships with manufacturers, which exercise a great degree of influence over our operations through the franchise agreements. Our franchise agreements may be terminated or not renewed by the manufacturer for a variety of reasons, including any unapproved changes of ownership or management, sales and customer satisfaction performance deficiencies and other material breaches of the franchise agreements. Manufacturers may also have a right of first refusal if we seek to sell dealerships. Additionally, we cannot guarantee that the terms of any renewals will be as favorable to us as our current agreements. If such an instance occurs, although we are generally protected by automotive dealership franchise laws requiring “good cause” be shown for such termination, we cannot guarantee that the termination of the franchise will not be successful.
A manufacturer may also limit the number of its dealerships that we may own or the number that we may own in a particular geographic area. Delays in obtaining, or failing to obtain, manufacturer approvals and franchise agreements for dealership acquisitions could adversely affect our acquisition program. From time to time, we have not met all of the manufacturers’ requirements to make acquisitions and have received requests to dispose of certain of our dealerships. In the event one or more of our manufacturers sought to prohibit future acquisitions, or imposed requirements to dispose of one or more of our dealerships, our acquisition and growth strategy could be adversely affected. Moreover, our franchise agreements do not give us the exclusive right to sell a manufacturer’s product within a given geographic area. Subject to state laws in the U.S. that are generally designed to protect dealers, a manufacturer may grant another dealer a franchise to start a new dealership near one of our locations, or an existing dealership may move its dealership to a location that would more directly compete against us. The location of new dealerships near our existing dealerships could have a material and adverse effect on our operations and reduce the profitability of our existing dealerships. Furthermore, if current manufacturers or future manufacturers are not required to conduct their business in accordance with state franchise laws and thereby circumvent the current dealer-network to sell directly to the customer, our results of operations may be materially and adversely affected.
Substantial competition in automotive sales and services could adversely impact our sales and our margins.
The automotive retail industry is highly competitive. Within our markets we are subject to competition from franchised automotive dealerships and other businesses as it relates to new and used vehicles, parts and service as well as acquisitions. We also face competition in arranging financing for our customers’ vehicle purchases from a broad range of financial institutions. Additionally, we do not have any cost advantage in purchasing new vehicles from vehicle manufacturers, and our franchise agreements do not grant us the exclusive right to sell a manufacturer’s product within a given geographic area. Increased competition can adversely impact our sales volumes and margins as well as our ability to acquire dealerships.
Please see Item 1. Business — Competition for further discussion of competition in our industry.
The U.K.’s withdrawal from the EU may have a negative effect on some global economic conditions, financial markets and our business, which could adversely affect our U.K. revenue and results of operations.
On June 23, 2016, British citizens voted on a referendum in favor of Brexit. The U.K. formally exited the EU on January 31, 2020, however the future terms of the U.K.’s relationship with the EU remain uncertain. Such uncertainty was diminished on December 24, 2020, as the U.K. and the EU reached agreement in principle on the terms of the EU-U.K. Trade and Cooperation Agreement (the “EU-U.K. Agreement”), which became provisionally applicable on January 1, 2021 and applies through the earlier of (1) February 28, 2021 or some other date decided by the Partnership Council (comprising representatives of the EU and the U.K.) or (2) the EU-U.K. Agreement’s entry into force. The EU-U.K. Agreement covers economic and security co-operation, has a single overarching governance framework, and includes trade in goods and in services, digital trade, intellectual property, public procurement, aviation and road transport, energy, fisheries, social security co-ordination, law enforcement and judicial co-operation in criminal matters, thematic co-operation, participation in EU programs, institutional arrangements, dispute settlement and safeguards. The scope of the EU-U.K. Agreement is narrower than the pre-Brexit trade framework, and the effects of Brexit will depend in part on any further agreements the U.K. makes to retain access to EU markets or to compensate elsewhere with agreements with other global markets. Accordingly, Brexit could adversely affect U.K. and European market conditions, could contribute to instability in some global financial and foreign exchange markets, including continued volatility in the value of the GBP or otherwise adversely affect trading agreements or similar cross-border cooperation arrangements (whether economic, tax, legal, regulatory or otherwise) beyond the date of Brexit. More specifically, it could lead to:
• Exchange Rate Fluctuations: a decrease in sales or revenues attributable to increased retail prices of new vehicles imported from other countries in Europe and due to a weaker pound exchange rate and volatility in the currencies in which we transact our business;
15
• Supply Risk: potential increase in supply chain risk for automotive retailers and manufacturers due to the U.K. no longer being party to the EU’s free trade agreements, however, the U.K. is able to enter into new free trade agreements with the countries;
• Loss of Franchise Protections: potential future loss of franchise protection laws as provided under EU Block Exemption. The EU-U.K. Agreement envisages cooperation and coordination between the respective competition authorities and certain block exceptions currently remain in effect under domestic U.K. law, as amended to apply to the U.K. competition framework; however, these may be revoked, extended or further amended by U.K. law;
• Economic Risk: the U.K. economy may be negatively impacted, resulting in a decrease to our revenues;
• Fiscal Risk: the new Rules of Origin apply to goods imported into the U.K from the EU or exported from the U.K to the EU might lead to the imposition of increased customs taxes and duties;
• Labor Risk: the loss of free movement of employees between the U.K. and EU may impact the hiring and movement of employees and may subject companies to local labor laws and efforts required to relocate U.K. operations or use EU subsidiaries; and
• Data Privacy Risk: inability or increased risk in transferring personal data from the U.K. to the EU after expiry of the six month bridging mechanism in the EU-U.K. Agreement that enables personal data to continue to flow cross-border from the European Economic Area to the U.K. if the U.K. does not receive a decision from the European Commission that permits such transfers to continue the same as pre-Brexit.
Any of these effects of Brexit, and others we cannot anticipate, could materially adversely affect our business, consolidated financial position, results of operations and cash flows.
The impairment of our goodwill and/or indefinite-lived intangibles could have a material adverse effect on our results of operations.
We assess goodwill and other indefinite-lived intangibles for impairment on an annual basis, or more frequently when events or circumstances indicate that an impairment may have occurred. Performance issues at individual dealerships, as well as adverse retail automotive industry and economic trends, increase the risk of an impairment charge, which could have a material adverse impact on our results of operations. During the year ended December 31, 2020, we recorded goodwill impairment charges to our Brazil region of $10.7 million. No goodwill impairments were recorded during the year ended December 31, 2019 and 2018. During the years ended December 31, 2020, 2019 and 2018, we recorded $20.8 million, $19.0 million and $38.7 million , respectively, of impairment of intangible franchise rights. We may be required to record additional impairment charges if the COVID-19 pandemic continues, and we cannot accurately predict the amount and timing of any additional impairment charge at this time, however, any such impairment charge could have an adverse effect on our results of operations. Refer to Note 11. Intangible Franchise Rights and Goodwill within our Notes to Consolidated Financial Statements for further discussion of impairment.
Our inability to acquire and integrate successful new dealerships into our business could adversely affect the growth of our revenues and earnings.
Growth in our revenues and earnings partially depends on our ability to acquire new dealerships and successfully integrate those dealerships into our existing operations. We cannot guarantee that we will be able to identify and acquire dealerships in the future. In addition, we cannot guarantee that any acquisitions will be successful or on terms and conditions consistent with past acquisitions. Restrictions by our manufacturers, as well as covenants contained in our debt instruments, may directly or indirectly limit our ability to acquire additional dealerships. In addition, increased competition for acquisitions may develop, which could result in fewer acquisition opportunities available to us and/or higher acquisition prices. And, some of our competitors may have greater financial resources than us.
In addition, managing and integrating additional dealerships into our existing mix of dealerships may result in substantial costs, diversion of our management’s attention, delays or other operational or financial problems. Acquisitions involve a number of special risks, including, among other things:
• incurring significantly higher capital expenditures and operating expenses;
• failing to integrate the operations and personnel of the acquired dealerships;
• entering new markets with which we are not familiar;
• incurring undiscovered liabilities at acquired dealerships, generally, in the case of stock acquisitions;
• disrupting our ongoing business;
• failing to retain key personnel of the acquired dealerships;
16
• impairing relationships with employees, manufacturers and customers; and
• incorrectly valuing acquired entities.
Operational Risks
The global outbreak of the COVID-19 pandemic, which has disrupted all of our dealership operations, has, and could continue to have a material adverse affect on our business, results of operations and cash flows.
The global outbreak of the COVID-19 pandemic had a material adverse impact on our business, including all of our markets in the U.S., U.K. and Brazil. Extraordinary and wide-ranging actions taken by governmental authorities to reduce the spread of the virus, including mandates for many individuals to substantially restrict daily activities and for many businesses to curtail or cease normal operations, significantly reduced the operating capacity of all of our dealerships in the U.S., U.K. and Brazil beginning in mid-March 2020. As the restrictions eased during the latter part of 2020, we continued to experience disruptions from reduced capacity and departmental shutdowns as a result of COVID-19 outbreaks and quarantines impacting our employees. Depending on future developments, the COVID-19 pandemic may continue to disrupt our operations and adversely affect our financial condition and results of operations.
Refer to Item 1. Business for further discussion of the impact of the COVID-19 pandemic on each of our regions and our response to date.
A cybersecurity breach, including loss of confidential information or a breach of personally identifiable information (“PII”) about our customers or employees, could negatively affect operations and result in high costs.
In the ordinary course of business, we receive significant PII about our customers and our employees. A security incident to obtain such information could be caused by malicious insiders and third parties using sophisticated, targeted methods to circumvent firewalls, encryption and other security defenses, including hacking, fraud, trickery, or other forms of deception. Although many companies across many industries are affected by malicious efforts to obtain access to PII, the automotive dealership industry has been a particular target of identity thieves. The techniques used by cyber attackers change frequently and may be difficult to detect for long periods of time. We have implemented security measures that are designed to detect and protect against cyberattacks. Despite these measures and any additional measures we may implement or adopt in the future, our facilities and systems, and those of our third-party service providers, are vulnerable to security breaches, computer viruses, lost or misplaced data, programming errors, scams, burglary, human errors, acts of vandalism, or other events. Some of our third-party service providers have experienced security breaches, although we have not been significantly impacted. If an unauthorized party is successful in obtaining confidential information of our dealerships or our customers or disrupting our operations through a cyberattack, it can increase costs of doing business, negatively affect customer satisfaction and loyalty, expose us to negative publicity, result in individual claims or consumer class actions, administrative, and civil or criminal investigations or actions, any of which could have a material adverse effect on our business, results of operations or financial condition.
In addition, we are subject to numerous laws and regulations designed to protect information of clients, customers, employees and other third parties that we collect and maintain. See Item 1. Business — Governmental Regulations for information on our risks related to compliance with such laws and regulations.
Our insurance does not fully cover all of our operational risks, and changes in the cost of insurance or the availability of insurance could materially increase our insurance costs or result in a decrease in our insurance coverage.
The operation of automobile dealerships is subject to a broad variety of risks. While we have insurance on our real property, comprehensive coverage for our vehicle inventory, general liability insurance, workers’ compensation insurance, employee dishonesty coverage, cybersecurity breach insurance, employment practices liability insurance, pollution coverage and errors and omissions insurance in connection with vehicle sales and financing activities, we are self-insured for a portion of our potential liabilities. We purchase insurance policies for worker’s compensation, liability, auto physical damage, property, pollution, employee medical benefits and other risks consisting of large deductibles and/or self-insured retentions.
In certain instances, our insurance may not fully cover an insured loss depending on the magnitude and nature of the claim. Additionally, changes in the cost of insurance or the availability of insurance in the future could substantially increase our costs to maintain our current level of coverage or could cause us to reduce our insurance coverage and increase the portion of our risks that we self-insure.
The insurance companies that underwrite our insurance require that we secure certain of our obligations for self-insured exposures with collateral. Our collateral requirements are set by the insurance companies and, to date, have been satisfied by posting surety bonds, letters of credit and/or cash deposits. Our collateral requirements may change from time to time based on, among other things, our total insured exposure and the related self-insured retention assumed under the policies. We are subject to potential premium cost fluctuations with the annual renewal of these programs.
17
Natural disasters and adverse weather events can disrupt our business and may adversely impact our results of operations, financial condition and cash flows.
Some of our dealerships are concentrated in states and regions in the U.S., U.K. and Brazil, in which actual or threatened natural disasters and severe weather events (such as hurricanes, earthquakes, snow storms, flooding and hail storms) have in the past, and may in the future, disrupt our dealership operations. A disruption in our operations may adversely impact our business, results of operations, financial condition and cash flows. In addition to business interruption, the automotive retailing business is subject to substantial risk of property loss due to the significant concentration of property value at dealership locations. Natural disasters and severe weather events have in the past and may in the future impair the value of our dealership property. Although we have, subject to certain limitations and exclusions, substantial insurance, including business interruption insurance, we may be exposed to uninsured losses that could have a material adverse effect on our business, results of operations and financial condition. For example, in 2019 Tropical Storm Imelda caused catastrophic flooding in Beaumont, Texas, resulting in $11.9 million in damages not covered by insurance. In 2017, Hurricane Harvey caused catastrophic flooding in Houston, Texas, one of our primary markets, resulting in $14.7 million in damages not covered by insurance. Additionally, should we suffer significant losses in a short period of time, we run the risk that our premiums and/or deductibles could increase, which could adversely affect our business.
Risks associated with our international operations could have a material adverse effect on our business, results of operations and financial condition.
We have operations outside the U.S., including the U.K. and Brazil. As a result, we face political and economic risks and uncertainties with respect to our international operations. These risks may include the following, but are not limited to:
• wage inflation in emerging markets;
• legal uncertainties, timing delays and expenses associated with tariffs, labor matters, import or export licenses and other trade barriers;
• transparency issues in general and, more specifically, the U.S. Foreign Corrupt Practices Act of 1974, as amended, the U.K. Bribery Act and other anti-corruption compliance laws and issues;
• inability to obtain or preserve franchise rights in the foreign countries in which we operate; and
• fluctuations in foreign currency translations within our financial statements driven by exchange rate volatility.
Legal, Regulatory and Compliance Risks
We are subject to automotive and other laws and regulations, which, if we are found to have violated, may adversely affect our business and results of operations.
We operate in a highly regulated industry. A number of laws and regulations applicable to automotive companies affect our business and conduct, including, but not limited to, our sales, operations, financing, insurance, advertising and employment practices. Other rules such as franchise laws and regulations, consumer protection laws and other extensive laws and regulations apply to new and used motor vehicle dealers. Additionally, in every jurisdiction in which we operate, we must obtain various permits and licenses in order to conduct our businesses. Any failure to comply with these laws and regulations may result in the assessment of administrative, civil or criminal penalties, the imposition of investigatory remedial obligations or the issuance of injunctions limiting or prohibiting our operations.
Refer to Item 1. Business — Governmental Regulations for further discussion of automotive and other laws and regulations impacting our business.
Operational risks associated with environmental laws and regulations may expose us to significant costs and liabilities.
Our business activities in the U.S., U.K. and Brazil are subject to stringent federal, regional, state and local laws, regulations and other controls governing specific health and safety criteria to address worker protection, the release of materials into the environment or otherwise relating to environmental protection. These laws, regulations and controls may impose numerous obligations upon our operations including the acquisition of permits to conduct regulated activities, the imposition of restrictions on where or how to manage or dispose of used products and wastes, the occurrence of capital expenditures to limit or prevent releases of such material and the imposition of substantial liabilities for pollution resulting from our operations or attributable to former operations. Our compliance with these regulations may expose us to significant costs and liabilities.
Additionally, vehicle manufacturers in the U.S., U.K. and Brazil are subject to varying guidelines, laws and regulations adopted by their applicable governmental and administrative agencies, which include GHG emissions and CAFE standards in the U.S. Such standards may affect our manufacturers’ ability to produce cost effective vehicles, which may have a material adverse effect on our sales.
18
Refer to Item 1. Business — Governmental Regulations for further discussion of environmental and regulations impacting our business.
Item 1B. Unresolved Staff Comments
None.