Lithia Motors - 10-Q quarterly report FY

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

(Mark One)

Commission file number: 000-21789

LITHIA MOTORS, INC.

Registrant’s telephone number, including area code: 541-776-6899

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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LITHIA MOTORS, INC.
FORM 10-Q
INDEX

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

LITHIA MOTORS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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LITHIA MOTORS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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LITHIA MOTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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LITHIA MOTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation
The financial information included herein as of March 31, 2003 and for the three-month periods ended March 31, 2003 and 2002 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2002 is derived from our 2002 Annual Report on Form 10-K. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2002 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note 2. Inventories
Inventories are valued at the lower of market value or cost, using the specific identification method for vehicles and the first-in first-out (FIFO) method of accounting for parts (collectively, the FIFO method). Detail of inventory is as follows (in thousands):

Note 3. Stock-Based Compensation
We account for stock options using the intrinsic value method as prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Pursuant to Statement of Financial Accounting Standards (SFAS) No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure,” which we adopted in December 2002, we have computed, for pro forma disclosure purposes, the impact on net income and net income per share as if we had accounted for our stock-based compensation plans in accordance with the fair value method prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation” as follows:

To determine the fair value of stock-based awards granted, we used the Black-Scholes option pricing model and the following weighted average assumptions:

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Note 4. Supplemental Cash Flow Information
Supplemental disclosure of cash flow information is as follows (in thousands):

Note 5. Earnings Per Share
Following is a reconciliation of basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts):

Potentially dilutive securities that are not included in the diluted EPS calculations because they would be antidilutive are as follows:

Note 6. Comprehensive Income
Comprehensive income includes the fair value of cash flow hedging instruments that are reflected in shareholders’ equity instead of net income and unrealized gains and losses on investments. The following table sets forth the calculation of comprehensive income for the periods indicated (in thousands):

Note 7. Acquisitions
The following acquisitions were made in the first quarter of 2003. For information on the acquisition made in April 2003, see Note 11. Subsequent Events.

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The above acquisitions were accounted for under the purchase method of accounting. Pro forma results of operations assuming the above acquisitions occurred at the beginning of the respective periods are as follows (in thousands, except per share amounts):

There are no future contingent payouts related to any of the above acquisitions. The purchase price for the above acquisitions was allocated as follows (in thousands):

We anticipate that approximately 100% of the goodwill acquired in the above acquisitions will be deductible for tax purposes over the period of 15 years.

Note 8. DaimlerChrysler Agreement
In February 2003 we entered into a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC totaling up to $200 million, which expires in February 2006, with interest due monthly.

The credit line with DaimlerChrysler Services is cross-collateralized and secured by cash and cash equivalents, new and used vehicle and parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

The financial covenants in the agreement with DaimlerChrysler Services require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels.

Our previous facility with Ford Motor Credit Company was terminated and paid off on February 25, 2003.

Note 9. Recent Accounting Pronouncements
In July 2002, the FASB approved SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS No. 146 specifies that a company will

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record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The adoption of SFAS No. 146 on January 1, 2003 did not have any effect on our financial position or results of operations.

In March 2003, the Emerging Issues Task Force (EITF) issued EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” EITF 02-16 primarily applies to floorplan interest credits and advertising credits received by us from auto manufacturers and specifies the timing of and appropriate classification of such items in our statement of operations. We recognize floorplan interest credits as a reduction to cost of goods sold as related vehicles are sold and recognize advertising credits as a credit to advertising expense. The adoption of EITF 02-16 on January 1, 2003 did not have any effect on our results of operations or financial position.

Note 10. Reclassification
In the fourth quarter of 2002, we reclassified documentation fees from finance and insurance income to new and used vehicle revenue, as appropriate, in order to bring our reporting in line with industry practice. The resulting effect was a reduction of approximately $100 per vehicle of finance and insurance income and an increase in new and retail used vehicle gross margins of between 20 and 50 basis points. Accordingly, the finance and insurance sales per retail unit, revenue by product line and gross margin percentage disclosures have been recalculated for the first three quarters of 2002. Net income was not affected by this reclassification.

In addition, reclassifications related to the reclassification of contracts in transit to a separate line item on the balance sheet from cash and cash equivalents have been made to the 2002 financial statements to be consistent with the 2003 presentation.

Note 11. Subsequent Events

U.S. Bank Agreement Amendment
In April 2003, our U.S. Bank N.A. agreement was amended to provide for a $35.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2005. Previously, the amount available under this line of credit was $27.5 million and it expired January 31, 2004.

Acquisitions
The following acquisition was made subsequent to March 31, 2003:

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements and Risk Factors
Some of the statements in this Form 10-Q constitute forward-looking statements. In some cases, 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-Q 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.

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Some of the important factors that could cause actual results to differ from our expectations are discussed in Exhibit 99.3 to our 2002 Annual Report on Form 10-K.

Although 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.

General
We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of May 5, 2003, we offered 24 brands of new vehicles through 136 franchises in 73 stores in the western United States and over the Internet. As of May 5, 2003, we operate 16 stores in Oregon, 12 in California, 10 in Washington, 7 in Texas, 7 in Idaho, 7 in Colorado, 5 in Nevada, 3 in South Dakota, 3 in Alaska, 2 in Nebraska and 1 in Montana. We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing and insurance for our automotive customers. Over 75% of our stores are located in cities where our store does not compete directly with any other franchised dealers selling the same brand.

During an economic downturn, customers tend to shift towards the purchase of more reasonably priced new vehicle models or used vehicles. Many customers decide to delay purchasing a new vehicle and instead repair existing vehicles. In addition, manufacturers typically offer increased dealer and customer incentives during an economic downturn in order to support new vehicle sales volume. These factors generally lead to less volatility in earnings for automobile retailers than for automobile manufacturers.

Historically, new vehicle sales have accounted for approximately 50% of our total revenues but less than 30% of total gross profit. The most recent three-month period was characterized by a very strong incentive environment, which led to higher than normal new vehicle sales for the period. We emphasize sales of higher margin products, which generate over 70% of our gross profits. Our revenues and gross profit by product line were as follows:

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The following table sets forth selected condensed financial data, expressed as a percentage of total revenues for the periods indicated.

Results of Operations

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Revenues. Total revenues increased 11.3% in the first quarter of 2003 compared to the first quarter of 2002 primarily as a result of acquisitions. An increase in same store new vehicle revenues of 7.7% and same store finance and insurance revenues of 7.3% in the first quarter of 2003 compared to the first quarter of 2002 were offset by declines in same store used vehicle revenues of 14.5% and same store service and parts revenues of 2.6%. The increase in new vehicle same store revenues of 7.7% compares favorably to an industry decline in new vehicle sales of over 4% for the first quarter of 2003. We estimate that the combined new and used vehicle market in the areas where we operate was down more than 10% in the first quarter of 2003 compared to the same period last year. Slowing economies in our markets and higher than normal new vehicle inventories at the end of 2002, coupled with a strong new vehicle incentive environment, spurred our aggressive approach to new vehicle sales in the first quarter of 2003. The aggressive company-wide marketing campaign was based on the “Driving America” theme aimed at increasing market share in order to secure a long-term customer base for future parts and service business and repeat and referral business. The used vehicle business was weak due to competition from highly incentivized new vehicles within the overall weaker total vehicle market. The service and parts business has been negatively impacted in the past couple of years by substantial improvements in the quality of domestic vehicles, resulting in less warranty work. We improved our finance and insurance penetration rate to 77% of all new and used retail units in the first quarter of 2003 compared to 75% in the same period last year. We also achieved 41% service contract penetration in the first quarter of 2003 compared to 40% in the same quarter of 2002 and 34% lifetime oil and filter service product penetration compared to 29% in the same periods, respectively.

During the first quarter of 2003, manufacturers offered, and are continuing to offer, incentives, including low interest rates and rebates, in order to attract new vehicle buyers. The availability of cash rebates and zero percent and low interest rate financing has also enhanced our ability to sell finance, warranty and insurance products and services. Our finance and insurance sales per retail unit increased 9.3% to $938 per retail vehicle in the first quarter of 2003 compared to the first quarter of 2002.

Gross Profit. Gross profit increased due to increased total revenues, offset in part by a lower overall gross profit percentage. Certain incentives and rebates received from manufacturers, including floorplan interest credits, are recorded as a reduction to cost of goods sold at the time of vehicle sale. Gross profit margins achieved were as follows:

The decrease in the overall gross profit margin in the first quarter of 2003 compared to the first quarter of 2002 is primarily a result of four factors:

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These factors were partially offset by an increase in the gross margins achieved on our retail used vehicle sales and on our finance and insurance products in the first quarter of 2003 compared to 2002.

Selling, General and Administrative Expense. Selling, general and administrative expense includes salaries and related personnel expenses, facility lease expense, advertising, legal, accounting, professional services and general corporate expenses. Selling, general and administrative expense increased due to increased selling, or variable, expenses related to the increase in revenues and the number of locations. As a percentage of revenue, selling, general and administrative expense increased 30 basis points in the first quarter of 2003 compared to the first quarter of 2002 due partially to higher advertising and sales compensation expenses related to our aggressive new vehicle marketing.

Income from Operations. Operating margins decreased 60 basis points, in the first quarter of 2003 compared to the first quarter of 2002 due to the decrease in the overall gross margin percentage and increased operating expenses as a percentage of revenue as discussed above.

Floorplan Interest Expense. The increase in floorplan interest expense in the first quarter of 2003 compared to the first quarter of 2002 is primarily due to an approximately $974,000 increase in expense as a result of an increase in the average outstanding balances of our floorplan facilities, mainly due to acquisitions. In addition, an increase in flooring rates was responsible for $181,000 of the increase and additional expense from interest rate swaps was responsible for $210,000 of the increase. These increases were offset in part by a decrease in the LIBOR rate in the first quarter of 2003 compared to the first quarter of 2002.

Other Interest Expense. Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle line of credit and equipment related notes. The decrease in other interest expense resulted from $382,000 of savings due to lower interest rates in the first quarter of 2003 compared to the first quarter of 2002, offset in part by a 4.7% increase in average outstanding balances.

Income Tax Expense. Our effective tax rate was 38.8% in the first quarter of 2003 compared to 38.6% in the first quarter of 2002. Our effective tax rate may be affected in the future by the mix of asset acquisitions compared to corporate acquisitions, as well as by the mix of states where our stores are located.

Net Income. Net income decreased as a result of the lower gross margin percentage, higher operating expenses and higher floorplan interest expense, offset in part by increased revenues.

Seasonality and Quarterly Fluctuations
Historically, our sales have been lower in the first and fourth quarters of each year due to consumer purchasing patterns during the holiday season, inclement weather and the reduced number of business days during the holiday season. As a result, financial performance may be lower during the first and fourth quarters than during the other quarters of each fiscal year. We believe that interest rates, levels of consumer debt and consumer confidence, as well as general economic conditions, also contribute to fluctuations in sales and operating results. Historically, the timing, performance and frequency of acquisitions has been the largest contributor to fluctuations in our operating results from quarter to quarter.

Liquidity and Capital Resources
Our principal needs for capital resources are to finance acquisitions and capital expenditures, as well as for working capital. We have relied primarily upon internally generated cash flows from operations, borrowings under our credit agreements and the proceeds from public equity offerings to finance operations and expansion.

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Our inventories increased to $468.5 million at March 31, 2003 from $445.9 million at December 31, 2002 due primarily to acquisitions. Accordingly, our new and used flooring notes payable increased to $458.1 million at March 31, 2003 from $427.6 million at December 31, 2002. Our days supply of new vehicles decreased by approximately 10 days at March 31, 2003 compared to December 31, 2002. We believe that our new and used vehicle inventories are at appropriate levels going into the second quarter. The second quarter typically represents the second strongest sales environment of the year.

Primarily as a result of the acquisition of three stores in the first quarter of 2003, our goodwill and other intangibles increased $8.9 million to $215.1 million at March 31, 2003 compared to $206.2 million at December 31, 2002.

In June 2000, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our Class A common stock. Through April 2003, we have purchased a total of 59,400 shares under this program and may continue to do so from time to time in the future as conditions warrant.

In February 2003 we entered into a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC totaling up to $200 million, which expires in February 2006, with interest due monthly.

Our previous facility with Ford Motor Credit Company was terminated and paid off on February 25, 2003.

The credit line with DaimlerChrysler Services is cross-collateralized and secured by cash and cash equivalents, new and used vehicle and parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

The financial covenants in our agreement with DaimlerChrysler Services require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels. At March 31, 2003, we were in compliance with all of the covenants of this agreement.

Toyota Motor Credit Corporation, Ford Motor Credit and General Motors Acceptance Corporation have agreed to floor all of our new vehicles for their respective brands with DaimlerChrysler Services serving as the primary lender for substantially all other brands. These new vehicle lines are secured by new vehicle inventory of the relevant brands.

We also have a real estate line of credit with Toyota Motor Credit totaling $40 million, which expires in May 2005. This line of credit is secured by the real estate financed under this line of credit.

In April 2003, our U.S. Bank N.A. agreement was amended to provide for a $35.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2005. Previously, the amount available under this line of credit was $27.5 million and it expired January 31, 2004.

Interest rates on all of the above facilities ranged from 2.78% to 4.05% at March 31, 2003. Amounts outstanding on the lines at March 31, 2003 together with amounts remaining available under such lines were as follows (in thousands):

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At March 31, 2003, our long-term debt and lease commitments were as follows (in thousands):

At March 31, 2003, we had capital commitments of approximately $13.3 million for the construction of two new store facilities, an addition to one existing facility and the remodel of three facilities. The two new facilities will be a Ford store in Boise, Idaho, a body shop in Boise, Idaho. We have already incurred $2.5 million for these commitments and anticipate incurring the remaining $13.3 million during the remaining three quarters of 2003. We expect to pay for the construction out of existing cash balances until completion of the projects, at which time we anticipate securing long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended.

Critical Accounting Policies

We reaffirm our critical accounting policies as described in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 31, 2003.

Recent Accounting Pronouncements

See Note 9 of Notes to Consolidated Financial Statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our reported market risks or risk management policies since the filing of our 2002 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 31, 2003.

Item 4. Controls and Procedures

Disclosure Controls and Procedures
Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15b under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.

Internal Controls and Procedures
There were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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PART II — OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

(b) Reports on Form 8-K

The following reports of Form 8-K were filed during the quarter ended March 31, 2003:

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002" -->

CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Sidney B. DeBoer, certify that:

Date: May 14, 2003

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CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Jeffrey B. DeBoer, certify that:

Date: May 14, 2003

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