Lithia Motors - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

For the transition period from            to           

Commission file number: 001-14733

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           Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes ý     Noo

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

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(Unaudited)

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, 2005 and for the three and six-month periods ended June 30, 2005 and 2004 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, 2004 is derived from our 2004 Annual Report on Form 10-K.  The interim condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in our 2004 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. The cost of used vehicle inventories includes the cost of any equipment added, reconditioning and transportation (in thousands).

Note 3. Earnings Per Share

Following is a reconciliation of the income from continuing operations and weighted average shares used for our basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts).

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(1)          The 2004 amounts have been restated for the effects of applying EITF 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings Per Share.”

Note 4.  Comprehensive Income

Comprehensive income includes the change in 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):

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Note 5.  Acquisitions

The following acquisitions were made in the first six months of 2005.

•                  In January 2005, we acquired a Chrysler and Jeep franchise in Concord, California.  The franchises were added to our Dodge store in that market.  The store is now named Lithia Chrysler Jeep Dodge of Concord.

•                  In January 2005, we acquired a Chrysler franchise in Eugene, Oregon.  The franchise was added to our Dodge store in that market.  The stores name is now Lithia Chrysler Dodge of Eugene.

•                  In February 2005, we acquired a Chrysler, Jeep, Dodge, Dodge Truck store in Omaha, Nebraska.  The store has anticipated annualized revenues of $110 million.  The store was renamed Lithia Chrysler Jeep Dodge of Omaha.

•                  In April 2005, we acquired a Chrysler, Dodge, Dodge Truck store in Eureka, California.  The store has anticipated annualized revenues of $28 million.  The store was renamed Lithia Chrysler Dodge of Eureka.

•                  In May 2005, we acquired a Chrysler, Jeep, Dodge, Dodge Truck store in Butte, Montana.  The store has anticipated annualized revenues of $26 million.  The store was renamed Lithia Chrysler Dodge Jeep of Butte.

The above acquisitions were accounted for under the purchase method of accounting.  Pro forma results of operations assuming all of the 2005 and the previously disclosed 2004 acquisitions occurred as of January 1, 2004 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. During the first six months of 2005 we acquired the fourteen franchises and three stores discussed above for $26.0 million, which included $10.0 million of goodwill and $3.7 million of other intangible assets. Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances based on pending information received regarding the valuation of such assets.

Note 6.  Dividend Payments

Cash dividends at the rate of $0.08 per common share, which totaled approximately $1.5 million, were paid on March 14, 2005 related to the fourth quarter of 2004 and on May 20, 2005 related to the first quarter of 2005.

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Note 7.  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):

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

During the second quarter of 2005, we modified our employee stock purchase plan to eliminate the look-back feature and, accordingly, the fair value of such grants is equal to the 15% purchase discount on the date of grant.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” which requires companies to recognize in their income statement the grant-date fair value of stock options and other equity-based compensation issued to employees.  Originally, the FASB had determined that the new rules would be effective for the first interim or annual period beginning after June 15, 2005. However, in April 2005, the Securities and Exchange Commission amended SFAS 123R

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to be effective for the first annual period beginning after June 15, 2005.  Accordingly, we will adopt SFAS No. 123R in our first quarter of 2006. We do not expect the results of SFAS No. 123R to be significantly different than those of applying SFAS No. 123.  SFAS No. 123R will not have any effect on our cash flows.

Note 8.  Unearned Compensation

Unearned compensation includes the value of restricted stock issued to employees for which vesting provisions have not yet been met.  The unearned compensation will be recognized over the vesting periods of up to five years.

Note 9.  Discontinued Operations

During the first six months of 2005, we classified one dealership as a discontinued operation.  We had additional discontinued operations during 2004.  As of June 30, 2005, the amount of goodwill and other intangible assets disposed of related to the 2005 discontinued operation was $4.4 million.  Certain other financial information related to discontinued operations was as follows (in thousands):

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

Interest expense is allocated to stores classified as discontinued operations for actual flooring interest expense directly related to the new vehicles in the store.  Interest expense related to the used vehicle line of credit is allocated based on total used vehicle inventory of the store, and interest expense related to the equipment line of credit is allocated based on the amount of fixed assets.

Note 10. Reclassifications

During the first quarter of 2005, we reclassified bank fees and bank card charges, net of cash discounts earned, from other income (expense) to selling, general and administrative expense.  The effect on the three and six months ended June 30, 2004 was to decrease other expense by $637,000 and $1.2 million, respectively, and increase selling, general and administrative by like amounts.

Note 11.  Subsequent Event

Dividend

In July 2005, our Board of Directors approved a 50% increase in the dividend on our Class A and Class B common stock to $0.12 per share.  The dividend, which will total approximately $2.3 million, will be paid on August 19, 2005 to shareholders of record on August 5, 2005.

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 99.1 to this Quarterly Report on Form 10-Q.

Although we believe that the assumptions underlying 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.

Overview

We are a leading operator of automotive franchises and retailer of new and used vehicles and services.  As of August 5, 2005, we offered 25 brands of new vehicles through 176 franchises in 88 stores in the Western United States and over the Internet.  As of August 5, 2005, we operated 16 stores in Oregon, 12 in California, 11 in Washington, 9 in Texas, 7 in Idaho, 7 in Colorado, 7 in Alaska, 7 in Montana, 6 in Nevada, 3 in Nebraska, 2 in South Dakota and 1 in New Mexico. 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.

Our auto-retail model is focused on acquiring average performing new vehicle franchised stores and then integrating and improving them.  Our goal is to maximize the operations of all four departments of every store we acquire.  We have had success with this strategy since our initial public offering in late 1996.  While our strategy has not changed over the last eight years, our ability to integrate and improve the stores that we acquire has increased dramatically. We have also developed a better process for identifying acquisition targets that fit our operating model.  Our cash position, substantial lines of credit, plus an experienced and well-trained staff are all available to facilitate our continued growth as the opportunities develop.

In keeping with this model, we acquired a total of three stores and fourteen additional franchises from January 1, 2005 through August 5, 2005 with total estimated annual revenues of approximately $200 million.

Historically, new vehicle sales have accounted for over half of our total revenues but less than one-third of total gross profit.  We use a volume-based strategy for new vehicle sales that was initiated in 2002. This strategy complements the goal of most auto manufacturers, which have continued to offer a high level of cash or other incentives to automotive customers.

For the remainder of 2005, we expect that manufacturers will continue to offer incentives on new vehicle sales through a combination of employee pricing, rebates, low interest rate loans to consumers or repricing strategies.

Since the beginning of 2002, the used vehicle market has been negatively impacted by strong competition from the new vehicle market, with heavy manufacturer incentives in the form of cash rebates and low interest financing. In the first quarter of 2005, the used vehicle market showed positive signs as a result of constrained industry supply, which led to improvements in retail pricing and margins.  In the second quarter of 2005, we experienced an increase in trade-ins of quality used vehicles in connection with the General Motors “employee pricing” program.  We have implemented new procedures in the used vehicle business, which have also demonstrated positive results for our used vehicle business:

•                  We have begun conducting our own local used vehicle auctions in select markets and managing the disposal of used vehicles at larger auctions.  The process is centralized and controlled at the management level.

•                  We utilize a “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 our sales personnel in a simple way.

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In addition, as a complement to our ongoing used vehicle operation at each store, we use specialists in our support services group to increase the acquisition of used vehicles.  We believe that this will help bolster sales volumes in the 3 to 7 year old vehicle range.

Results of Continuing Operations

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

(1)          Includes retail and wholesale used vehicles.

(2)          Reported net of anticipated 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, 2005 compared to the three and six month periods ended June 30, 2004:

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FloorplanInterest Expense

Floorplan interest expense increased $2.1 million and $3.7 million, respectively, in the three and six month periods ended June 30, 2005 compared to the same periods of 2004. A $424,000 and $962,000 increase, respectively, was the result of increases in the average outstanding balances of our floorplan facilities, mainly due to acquisitions, and increases of $2.5 million and $4.1 million, respectively, resulted from increases in the average interest rates on our floorplan facilities.  These increases were partially offset by decreases of $847,000 and $1.3 million, respectively, related to our interest rate swaps.

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 $0.9 million and $2.0 million, respectively, in the three and six month periods ended June 30, 2005 compared to the same periods of 2004. Changes in the weighted average interest rate on our debt in the three and six month periods ended June 30, 2005 compared to the same periods of 2004 increased other interest expense by approximately $265,000 and $589,000, respectively, and changes in the average outstanding balances resulted in increases of approximately $665,000 and $1.4 million, respectively. Our average interest rate increased at only about half the pace of market interest rates due to our hedging strategies. Interest expense related to the $85.0 million of convertible notes that were issued in May 2004 totals approximately $764,000 per quarter, which consists of $611,000 of contractual interest and $153,000 of amortization of debt issuance costs.

Income Tax Expense

Our effective tax rate was 39.3% in the first six months of 2005 compared to 39.0% in the first six months of 2004. 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, 2005 compared to same periods of 2004 as a result of improvements in gross margins and operating expenses as discussed above.

Discontinued Operations

During the first six months of 2005, we classified one dealership as a discontinued operation.  We had additional discontinued operations during 2004.  As of June 30, 2005, the amount of goodwill and other intangible assets disposed of related to the 2005 discontinued operation was $4.4 million.  Certain financial information related to discontinued operations was as follows (in thousands):

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

Interest expense is allocated to stores classified as discontinued operations for actual flooring interest expense directly related to the new vehicles in the store.  Interest expense related to the used vehicle line of credit is allocated based on total used vehicle inventory of the store, and interest expense related to the equipment line of credit is allocated based on the amount of fixed assets.

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