Lithia Motors - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

LITHIA MOTORS, INC.

(Exact name of registrant as specified in its charter)

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   ý        No  o

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

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

LITHIA MOTORS, INC.

FORM 10-Q

INDEX

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PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

The accompanying notes are an integral part of these condensed consolidated balance sheets.

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LITHIA MOTORS, INC. AND SUBSIDIARIES

 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except  per share amounts)

(Unaudited)

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

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LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

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

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LITHIA MOTORS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The financial information included herein as of June 30, 2004 and for the three and six-month periods ended June 30, 2004 and 2003 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are 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, 2003 is derived from our 2003 Annual Report on Form 10-K.  The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2003 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 parts.  Detail of inventory is as follows (in thousands):

Note 3. 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:

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Also excluded from the three and six month periods ended June 30, 2004 are 2,255,314 shares of Class A common stock issuable upon conversion of our outstanding convertible debt.  See Note 10.  However, should EITF 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings Per Share,” be approved, such shares may be required to be included in our diluted EPS calculation and would require prior period EPS calculations to be restated, as applicable.  We are unable to predict, at this time, if EITF 04-8 will be approved as it is currently written.

Note 4.  Comprehensive Income

Comprehensive income includes the change in hedging instruments that are reflected in stockholders’ 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 5.  Acquisitions

The following acquisitions were made in the first six months of 2004.  For information on the acquisition made in July 2004, see Note 13. Subsequent Events.

•                  In January 2004, we acquired one Chrysler and Jeep store in Reno, Nevada, which has anticipated annual revenues of approximately $55.0 million.  The store has been renamed Lithia Chrysler Jeep of Reno.

•                  In March 2004, we acquired one Chevrolet store in Helena, Montana, which has anticipated annual revenues of approximately $40.0 million.  The store has been renamed Chevrolet of Helena.

•                  In April 2004, we acquired Tony Chevrolet of Anchorage and Tony Chevrolet of Wasilla, Alaska, which have anticipated combined annual revenues of approximately $125 million.  The stores have been renamed Chevrolet of South Anchorage and Chevrolet of Wasilla, respectively.

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 and no portion of the purchase price was paid with our equity securities.

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The purchase price for the above acquisitions was allocated as follows (in thousands):

Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances based on information received regarding the valuation of such assets.

Note 6.  Dividend Payments

Cash dividends at the rate of $0.07 per common share, which totaled approximately $1.3 million, were paid on March 19, 2004 to shareholders of record on March 5, 2004 and on May 21, 2004 to shareholders of record on May 7, 2004.

Note 7.  U.S. Bank Agreement Amendment

In February 2004, our U.S. Bank N.A. agreement was amended to provide for a $50.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2006. Previously, the amount available under this line of credit was $35.0 million and with expiration on January 31, 2005.

Note 8.  DaimlerChrysler Agreement Amendment

In June 2004, our DaimlerChrysler Services North America LLC and Toyota Motor Credit revolving credit agreement was amended as follows:

•                  The revolving commitment amount was decreased from $200 million to $150 million following our successful convertible debt offering in May 2004; and

•                  The termination date of the agreement was extended to May 1, 2007 from February 25, 2006 and has an option to extend the termination date to May 1, 2008.

Note 9.  Interest Rate Swaps

In March 2004, we entered into the following new interest rate swaps with U.S. Bank Dealer Commercial Services to effectively change the variable rate cash flow exposure on a portion of our flooring debt to fixed rate cash flows:

•                  effective March 9, 2004 - a five year, $25 million interest rate swap at a fixed rate of 3.25% per annum, variable rate adjusted on the 1^st and 16^th of each month;

•                  effective March 18, 2004 - a five year, $25 million interest rate swap at a fixed rate of 3.10% per annum, variable rate adjusted on the 1^st and 16^th of each month.

Note 10.  Debt Offering

In May 2004, we sold $85 million of 2.875% senior subordinated convertible notes due 2014 through a Rule 144A offering to qualified institutional buyers. We will also pay contingent interest on the notes during any six-month interest period beginning May 1, 2009, in which the trading price of the notes for a specified period of time equals or exceeds 120% of the principal amount of the notes.  Net proceeds from this offering were approximately $82.5 million and were used to pay down our working capital and used vehicle line and new vehicle flooring notes payable. The notes are convertible into shares of our Class A common stock at a price of $37.69 per share upon the satisfaction of certain conditions and upon the occurrence of certain events as follows:

•                  if, prior to May 1, 2009, and during any calendar quarter, the closing sale price of our common stock exceeds 120% of the conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter;

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•                  if, after May 1, 2009, the closing  sale price of our common stock exceeds 120% of the conversion price;

•                  if, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each day of such period was less than 98% of the product of the closing sale price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the notes;

•                  if the notes have been called for redemption; or

•                  upon certain specified corporate events.

Any declaration and payment of a dividend in excess of $0.08 per share per quarter will result in an adjustment in the conversion rate for the notes.

The notes are redeemable at our option beginning May 6, 2009 at the redemption price of 100% of the principal amount plus any accrued interest.  The holders of the notes can require us to repurchase all or some of the notes on May 1, 2009 and upon certain events constituting a fundamental change. A fundamental change is any transaction or event in which all or substantially all of our common stock is exchanged for, converted into, acquired for, or constitutes solely the right to receive, consideration that is not all, or substantially all, common stock that is listed on, or immediately after the transaction or event, will be listed on, a United States national securities exchange.

We filed a registration statement on Form S-3 with the Securities and Exchange Commission on July 26, 2004 covering the resale of the notes and the common stock issuable upon conversion of the notes.

Note 11.  Amendments to Stock Plans

At our Annual Shareholders Meeting in April 2004, our shareholders approved amendments to our stock plans as follows:

•                  the number of shares of our common stock issuable pursuant to our 2003 Stock Incentive Plan were increased to 2.2 million from 1.2 million; and

•                  the number of shares of our common stock issuable pursuant to our 1998 Employee Stock Purchase Plan were increased to 1.75 million from 1.5 million.

Note 12.  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 (in thousands):

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

Note 13.  Subsequent Events

Acquisition

The following acquisition was made subsequent to June 30, 2004:

•                  In July 2004, we acquired one Toyota store in Odessa, Texas, which has anticipated annual revenues of approximately $20.0 million.  The store has been renamed Lithia Toyota of Odessa.

Dividend

In July 2004, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.08 per share for the second quarter of 2004.  The dividend, which will total approximately $1.5 million, will be paid on August 16, 2004 to shareholders of record on August 2, 2004.

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

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. Some of the important factors that could cause actual results to differ from our expectations are discussed in Exhibit 99.1 to our 2003 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 August 1, 2004, we offered 25 brands of new vehicles through 152 franchises in 83 stores in the Western United States and over the Internet.  As of August 1, 2004, we operated 16 stores in Oregon, 13 in California, 11 in Washington, 9 in Texas, 7 in Idaho, 7 in Colorado, 6 in Nevada, 6 in Alaska, 3 in Montana, 2 in South Dakota, 2 in Nebraska and 1 in Oklahoma.  We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance for our automotive customers.

Historically, new vehicle sales have accounted for over half of our total revenues but less than one-third of total gross profit.  We are continuing with a volume-based strategy for our new vehicle sales that we initiated in 2002. Through an advertising campaign called “Driving America” that is centered on “Promo Pricing,” we have been able to gain new vehicle market share in many of our markets.  This strategy complements the goal of most auto manufacturers, which have continued to offer a high level of cash or other incentives on purchases.

For the second half of 2004, we expect that manufacturers will continue to offer incentives on new vehicle sales through a combination of rebates and low interest rate loans to consumers. We plan to continue with our volume-based new vehicle strategy in most of our stores.  As the economy and the incentive environment change, we expect to change our new vehicle sales strategy to adjust to any new conditions.

Competition from new vehicles with heavy manufacture incentives in the past two years has had a strong negative impact on the used vehicle market.  This trend continued in the first half of 2004, and is likely to continue throughout the rest of 2004.  We have implemented new procedures in the used vehicle business to help offset this negative impact as follows:

•                  We have begun conducting our own local used vehicle auctions in select markets and managing the disposal of used vehicles at larger auctions.  We no longer allow stores to dispose of their excess inventories on their own.  The process is centralized and controlled at the management level; and

•                  We have initiated our “Used Vehicle Promo Pricing” strategy, which markets vehicles with a $99 down payment and then groups vehicles by payment level.  Vehicles are marked with clear and understandable pricing, which reduces haggling and speeds up the sale process.  This strategy resolves the three biggest issues of price, down payment and monthly payment for our customers and sales people in a simple way.

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Results of Continuing Operations

Certain revenue, gross margin and gross profit information by product line was as follows:

(1)                                  Excludes wholesale used vehicle sales, representing 4.5%, 5.1%, 4.8% and 5.3% of total revenues, respectively,  and a gross margin contribution of 1.0%, (0.1)%, 0.9% and (0.2)%, respectively, for the three and six month periods ended June 30, 2004 and 2003.

(2)                                  Reported net of estimated cancellations.

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

(1)  The percentages may not add due to rounding.

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The following tables set forth the changes in our operating results from continuing operations in the three and six month periods ended June 30, 2004 compared to the three and six month periods ended June 30, 2003:

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Revenues

Total revenues increased 6.6% and 10.0%, respectively, in the three and six month periods ended June 30, 2004 compared to the same periods of 2003, as a result of acquisitions and increases in the average new and used vehicle sales prices. These increases were offset by same-store sales declines of 5.3% and 2.0%, respectively, for the three and six month periods ended June 30, 2004 compared to the same periods of 2003.  Same-store sales percentage increases (decreases) were as follows:

Same-store sales are calculated by dealership comparing only those months that contain full-month operating data.

New vehicle same store sales were down in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 due to an unusually strong second quarter in 2003, which experienced double digit sales growth.  Used vehicle same store sales have been negatively affected  in the same periods by continued manufacturer incentives on new vehicles.  Although same store sales have declined in the current periods, we have experienced an increase in gross margins in both new and used vehicles compared to the same periods last year.

The increases in same-store service, body and parts revenue resulted from increases in the customer retail business with our manufacturer warranty business remaining relatively stable.  Our focus on service advisor training has also contributed to the increases in same-store sales. Improvements in the quality of Chrysler, General Motors, Ford and Toyota vehicles have resulted in declines in warranty work for these brands. Other brands, however, continue to demonstrate increases in same-store warranty sales.

Fleet and other sales include both fleet sales and fees received for delivering vehicles on behalf of the manufacturer, the U.S. military, rent-a-car companies or leasing companies.  In 2003 we decided to not focus on fleet sales due to their low margins.  This has resulted in a decrease in total fleet and other sales, but an increase in the gross margin percentage due to a higher percentage of fee income compared to fleet income.

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Penetration rates for certain products were as follows:

Gross Profit

Gross profit increased $14.2 million and $31.9 million, respectively, in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 due to increased total revenues as well as increases in our overall gross margin. Gross margins achieved were as follows:

* “bp” stands for basis points (one hundred basis points equals one percent).

The increases in the overall gross profit margin in the first half of 2004 compared to the first half of 2003 were primarily a result of improvements in the margins achieved on our used vehicle business as well as an increase in our high margin service and parts revenue as a percentage of total revenue.

New vehicle gross margins increased primarily due to internal directives communicated to our stores to attain a sales target closer to the manufacturer suggested retail price.

We have been able to improve the margins on our used vehicle sales primarily due to the strategies discussed above regarding the auctioning of our used vehicles and our “Used Vehicle Promo Pricing.” Total same-store gross profit for the second quarter and first half of 2004 increased from the comparable periods of 2003.

Our focus on margin improvement in the wholesale parts business was the major contributor to the improved gross margins in the service and parts department.

Selling, General and Administrative Expense

Selling, general and administrative (“SG&A”) expense includes salaries and related personnel expenses, facility lease expense, advertising (net of manufacturer cooperative advertising credits), legal, accounting, professional services and general corporate expenses.  Selling, general and administrative expense increased $9.0 million and $19.9 million, respectively, in the three and six month periods ended June 30, 2004 compared to same periods of 2003, and increased 60 basis points and 40 basis points, respectively, as a percentage of revenue.  The increases in dollars spent are due to increased selling, or variable, expenses related to the increases in revenues and the number of locations.  SG&A as a percentage of sales will increase when the service and parts revenue contribution increases relative to total sales due to its higher SG&A component.  Because of this, a more important gauge is the trend of SG&A as a percentage of gross profit, which has decreased for the same periods.

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Depreciation and Amortization

Depreciation and amortization increased $0.8 million and $1.7 million, respectively, in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 due to the addition of property and equipment related to our acquisitions, as well as leasehold improvements to existing facilities.

Income from Operations

Operating margins improved by 50 basis points in both the three and six month periods ended June 30, 2004 to 3.6% and 3.2%, respectively, from 3.1% and 2.7%, respectively, in the comparable periods of 2003.  The increases are due to the improved overall gross profit margins as discussed above, partially offset by higher operating expenses as a percentage of revenue.

Floorplan Interest Expense

Floorplan interest expense increased $0.5 million in both the three and six month periods ended June 30, 2004 compared to the same periods of 2003.  A $612,000 and $825,000 increase, respectively, was the result of increases in the average outstanding balances of our floorplan facilities, mainly due to acquisitions, and increases of $287,000 and $487,000, respectively, resulting from our interest rate swaps were partially offset by decreases in the LIBOR and the prime rates in the three and six month periods ended June 30, 2004 compared to the same periods of 2003.

Other Interest Expense

Other interest expense includes interest on our convertible notes, debt incurred related to acquisitions, real estate mortgages, our used vehicle line of credit and equipment related notes. Other interest expense increased $0.6 million and $0.9 million, respectively, in the three and six month periods ended June 30, 2004 compared to the same periods of 2003. Changes in the weighted average interest rate on our debt in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 increased other interest expense by approximately $8,000 and $161,000, respectively, and changes in the average outstanding balances resulted in increases of approximately $585,000 and $784,000, respectively.  Interest expense related to the $85.0 million of convertible notes that were issued in May 2004 totals approximately $748,000 per quarter, which consists of $611,000 of contractual interest and $137,000 of amortization of debt issuance costs.

Income Tax Expense

Our effective tax rate was 39.0% in the first six months of 2004 compared to 39.8% in the first six months of 2003. 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.

Income from Continuing Operations

Income from continuing operations as a percentage of revenue increased in the three and six month periods ended June 30, 2004 compared to same periods of 2003 as a result of improvements in gross margins being offset in part by increased operating expenses as discussed above.

Discontinued Operations

During 2003, we decided to sell certain stores and related franchises. We did not dispose of any stores during the first six months of 2004. At June 30, 2004, we had $16.5 million of assets classified as assets held for sale on our balance sheet related to one store we intend to sell during 2004. The assets primarily include inventory and property, plant and equipment.  Liabilities held for sale of $3.3 million at June 30, 2004 represent new vehicle flooring notes payable related to the store held for sale.

We continually monitor the performance of each of our stores and make determinations to sell based on return on capital criteria.

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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 in certain of our markets and the reduced number of business days during the holiday season.  As a result, financial performance is expected to 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. Acquisitions have also been a contributor to fluctuations in our operating results from quarter to quarter.

Free Cash Flow

Our free cash flow, defined as net income from continuing operations plus depreciation minus dividends and non-financeable capital expenditures, was approximately $16.7 million and $14.3 million, respectively, in the first six months of 2004 and 2003.  Management believes that free cash flow is an important metric for evaluating the strength and viability of our business model. The reconciliation of net income to free cash flow is as follows (in thousands):

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 and private debt offerings to finance operations and expansion. In addition, in May 2004, we closed an $85.0 million private debt offering. We believe that our available cash, cash equivalents, available lines of credit, cash received from our debt offering in May 2004 and cash flows from operations will be sufficient to meet our anticipated operating expenses and capital requirements for at least 24 to 36 months from June 30, 2004.

Our inventories increased to $604.4 million at June 30, 2004 from $445.3 million at December 31, 2003 due primarily to acquisitions and our decision to purchase a greater stock of 2004 vehicles going into the third quarter in order to take advantage of the anticipated strong incentive environment for the 2004 models as the 2005 models are introduced.  Our new and used flooring notes payable increased to $514.8 million at June 30, 2004 from $435.2 million at December 31, 2003 due to acquisitions.  New vehicles are financed at approximately 100% and used vehicles are financed at approximately 80% of cost. Our days supply of new vehicles increased by approximately 9 days at June 30, 2004 compared to December 31, 2003. Our days supply of used vehicles increased by approximately 5 days at June 30, 2004 compared to December 31, 2003.  We believe that our new and used vehicle inventories are at appropriate levels at this time.

Assets of discontinued operations held for sale include inventory and property, plant and equipment related to one store held for sale and are recorded on our balance sheet at the lower of book value or estimated fair market value, less applicable selling costs.

As a result of the acquisition of four stores in the first six months of 2004, our goodwill and other intangibles increased $37.4 million to $273.4 million at June 30, 2004, compared to $236.0 million at December 31, 2003.

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In January and April 2004, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.07 per share for the fourth quarter of 2003 and the first quarter of 2004, respectively, which totaled approximately $1.3 million each.  In July 2004, our Board of Directors declared a dividend on our Class A and Class B common stock of $0.08 per share for the second quarter of 2004, which will total approximately $1.5 million.  We anticipate recommending to the Board of Directors the approval of a cash dividend each quarter.

In June 2000, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our Class A common stock.  Through July 2004, 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.  However, the recent change in the tax law tends to equalize the benefits of dividends and share repurchases as a means to return capital or earnings to shareholders. As a result, we believe it is now advantageous to shareholders to have a dividend in place.  With the dividend, we are able to offer an immediate and tangible return to our shareholders without reducing our already limited market float, which occurs when we repurchase shares.

We have a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC and Toyota Motor Credit, as amended in June 2004, totaling up to $150 million, which expires May 1, 2007 with an option to extend to May 1, 2008, with interest due monthly.  This credit facility is cross-collateralized and secured by cash and cash equivalents, new and used vehicles that are not specifically financed by other lenders, parts inventories, accounts receivable, intangible assets and equipment.  We pledged to DaimlerChrysler Services and Toyota Motor Credit 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 and Toyota Motor Credit 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 June 30, 2004, we were in compliance with all of the covenants of this agreement.

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

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

We have a credit facility with U.S. Bank N.A., which provides for a $50.0 million revolving line of credit for leased vehicles and equipment purchases and expires January 31, 2006.

Interest rates on all of the above facilities ranged from 3.11% to 4.12% at June 30, 2004.  Amounts outstanding on the lines at June 30, 2004 together with amounts remaining available under such lines were as follows (in thousands):

*  There are no formal limits on the new and program vehicle lines with certain lenders.

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In May 2004, we sold $85 million of 2.875% senior subordinated convertible notes due 2014 through a Rule 144A offering to qualified institutional buyers. We will also pay contingent interest on the notes during any six-month interest period beginning May 1, 2009, in which the trading price of the notes for a specified period of time equals or exceeds 120% of the principal amount of the notes.  Net proceeds from this offering were approximately $82.5 million and were used to pay down our working capital and used vehicle line and new vehicle flooring notes payable. The notes are convertible into shares of our Class A common stock at a price of $37.69 per share upon the satisfaction of certain conditions and upon the occurrence of certain events as follows:

•                  if, prior to May 1, 2009, and during any calendar quarter, the closing sale price of our common stock exceeds 120% of the conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter;

•                  if, after May 1, 2009, the closing  sale price of our common stock exceeds 120% of the conversion price;

•                  if, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each day of such period was less than 98% of the product of the closing sale price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the notes;

•                  if the notes have been called for redemption; or

•                  upon certain specified corporate events.

Any declaration and payment of a dividend in excess of $0.08 per share per quarter will result in an adjustment in the conversion rate for the notes.

The notes are redeemable at our option beginning May 6, 2009 at the redemption price of 100% of the principal amount plus any accrued interest.  The holders of the notes can require us to repurchase all or some of the notes on May 1, 2009 and upon certain events constituting a fundamental change. A fundamental change is any transaction or event in which all or substantially all of our common stock is exchanged for, converted into, acquired for, or constitutes solely the right to receive, consideration that is not all, or substantially all, common stock that is listed on, or immediately after the transaction or event, will be listed on, a United States national securities exchange.

We filed a registration statement on Form S-3 with the Securities and Exchange Commission on July 26, 2004 covering the resale of the notes and the common stock issuable upon conversion of the notes.

We had capital commitments of $11.2 million at June 30, 2004 for the construction of one new facility, additions to three existing facilities and the remodel of two facilities.  The new facility will be for our Chevrolet dealership in Fairbanks, Alaska. We have already incurred $3.3 million for these projects, with an additional $8.7 million expected to be incurred during the remainder of 2004 and the remaining $2.5 million to be incurred in 2005. 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 and Use of Estimates

We reaffirm our critical accounting policies and use of estimates as described in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 15, 2004, except for the addition of the following that only applies to our quarterly filings.

Executive Bonuses

We make certain estimates, judgments and assumptions regarding the likelihood of our attainment, and the level thereof, of the annual bonus criteria under our 2004 Discretionary Executive Bonus Program in order to record bonus expense on a quarterly basis. We accrue the estimated year-end expense on an accelerated basis in the first, second and third quarters based on bonus attainment expectations.  These estimates, judgments and assumptions are made quarterly based on available

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information and take into consideration the historical seasonality of our business and current trends.  If actual year-end results differ materially from our estimates, the amount of bonus expense recorded in a particular quarter could be significantly over or under estimated.

Item 3.           Quantitative and Qualitative Disclosures About Market Risk

Other than the addition of $85.0 million of fixed rate debt during the second quarter of 2004, there have been no material changes in our reported market risks or risk management policies since the filing of our 2003 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2004.

Item 4.           Controls and Procedures

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting