UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-14733
LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)
Oregon
93-0572810
(State or other jurisdiction of incorporation
or organization)
(I.R.S. Employer Identification No.)
150 N. Bartlett Street, Medford, Oregon
97501
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code: 541-776-6401
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 [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class A common stock without par value
23,735,715
Class B common stock without par value
2,562,231
(Class)
(Outstanding at July 31, 2015)
INDEX
Page
Item 1.
Financial Statements
Consolidated Balance Sheets (Unaudited) – June 30, 2015 and December 31, 2014
Consolidated Statements of Operations (Unaudited) – Three and Six Months Ended June 30, 2015 and 2014
Consolidated Statements of Comprehensive Income (Unaudited) – Three and Six Months Ended June 30, 2015 and 2014
Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2015 and 2014
Condensed Notes to Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II - OTHER INFORMATION
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
Signatures
LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)
(Unaudited)
June 30,
December 31,
2015
2014
Assets
Current Assets:
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts of $1,866 and $2,191
Inventories, net
Other current assets
Assets held for sale
Total Current Assets
Property and equipment, net of accumulated depreciation of $128,528 and $117,679
Goodwill
Franchise value
Other non-current assets
Total Assets
Liabilities and Stockholders' Equity
Current Liabilities:
Floor plan notes payable
Floor plan notes payable: non-trade
Current maturities of long-term debt
Trade payables
Accrued liabilities
Deferred income taxes
Liabilities related to assets held for sale
Total Current Liabilities
Long-term debt, less current maturities
Deferred revenue
Other long-term liabilities
Total Liabilities
Stockholders' Equity:
Preferred stock - no par value; authorized 15,000 shares; none outstanding
Class A common stock - no par value; authorized 100,000 shares; issued and outstanding 23,742 and 23,671
Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 2,562 and 2,562
Additional paid-in capital
Accumulated other comprehensive loss
Retained earnings
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
See accompanying notes to consolidated financial statements.
Consolidated Statements of Operations
(In thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
Revenues:
New vehicle
Used vehicle retail
Used vehicle wholesale
Finance and insurance
Service, body and parts
Fleet and other
Total revenues
Cost of sales:
Total cost of sales
Gross profit
Asset impairments
Selling, general and administrative
Depreciation and amortization
Operating income
Floor plan interest expense
Other interest expense
Other (expense) income, net
Income from continuing operations before income taxes
Income tax provision
Income from continuing operations, net of income tax
Income from discontinued operations, net of income tax
Net income
Basic income per share from continuing operations
Basic income per share from discontinued operations
Basic net income per share
Shares used in basic per share calculations
Diluted income per share from continuing operations
Diluted income per share from discontinued operations
Diluted net income per share
Shares used in diluted per share calculations
Consolidated Statements of Comprehensive Income
Other comprehensive income, net of tax:
Gain on cash flow hedges, net of tax expense of $94, $81, $181, and $174 respectively
Comprehensive income
Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Stock-based compensation
Loss on disposal of other assets
Gain on disposal of franchise
Excess tax benefit from share-based payment arrangements
(Increase) decrease (net of acquisitions and dispositions):
Trade receivables, net
Inventories
Other assets
Increase (decrease) (net of acquisitions and dispositions):
Other long-term liabilities and deferred revenue
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Capital expenditures
Proceeds from sales of assets
Cash paid for other investments
Cash paid for acquisitions, net of cash acquired
Proceeds from sales of stores
Net cash used in investing activities
Cash flows from financing activities:
Borrowings on floor plan notes payable, net: non-trade
Borrowings on lines of credit
Repayments on lines of credit
Principal payments on long-term debt, scheduled
Principal payments on long-term debt and capital leases, other
Proceeds from issuance of long-term debt
Proceeds from issuance of common stock
Repurchase of common stock
Dividends paid
Net cash provided by financing activities
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid during the period for interest
Cash paid during the period for income taxes, net
Supplemental schedule of non-cash activities:
Debt issued in connection with acquisitions
Floor plan debt paid in connection with store disposals
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Interim Financial Statements
Basis of Presentation
These condensed Consolidated Financial Statements contain unaudited information as of June 30, 2015 and for the three- and six-month periods ended June 30, 2015 and 2014. The unaudited interim financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by accounting principles generally accepted in the United States of America for annual financial statements are not included herein. In management’s opinion, these unaudited financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the information when read in conjunction with our 2014 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2014 is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2015. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2014 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.
Reclassifications
Certain reclassifications of amounts previously reported have been made to the accompanying consolidated financial statements to maintain consistency and comparability between periods presented.
These reclassifications had no impact on previously reported net income.
Note 2. Accounts Receivable
Accounts receivable consisted of the following (in thousands):
June 30, 2015
December 31, 2014
Contracts in transit
Trade receivables
Vehicle receivables
Manufacturer receivables
Auto loan receivables
Other receivables
Less: Allowances
Less: Long-term portion of accounts receivable, net
Total accounts receivable, net
Accounts receivable classifications include the following:
●
Contracts in transit are receivables from various lenders for the financing of vehicles that we have arranged on behalf of the customer and are typically received within five to ten days of selling a vehicle.
Trade receivables are comprised of amounts due from customers, lenders for the commissions earned on financing and others for commissions earned on service contracts and insurance products.
Vehicle receivables represent receivables for the portion of the vehicle sales price paid directly by the customer.
Manufacturer receivables represent amounts due from manufacturers, including holdbacks, rebates, incentives and warranty claims.
Auto loan receivables include amounts due from customers related to retail sales of vehicles and certain finance and insurance products.
Interest income on auto loan receivables is recognized based on the contractual terms of each loan and is accrued until repayment, charge-off or repossession. Direct costs associated with loan originations are capitalized and expensed as an offset to interest income when recognized on the loans. All other receivables are recorded at invoice and do not bear interest until they are 60 days past due.
The allowance for doubtful accounts is estimated based on our historical write-off experience and is reviewed monthly. Consideration is given to recent delinquency trends and recovery rates. Account balances are charged against the allowance after all appropriate means of collection have been exhausted and the potential for recovery is considered remote. The annual activity for charges and subsequent recoveries is immaterial.
The long-term portion of accounts receivable, net, was included as a component of other non-current assets in the Consolidated Balance Sheets.
Note 3. Inventories
The components of inventories, net, consisted of the following (in thousands):
New vehicles
Used vehicles
Parts and accessories
Total inventories
Note 4. Goodwill and Franchise Value
The changes in the carrying amounts of goodwill are as follows (in thousands):
Domestic
Import
Luxury
Consolidated
Balance as of December 31, 2013(1)
Additions through acquisitions
Balance as of December 31, 2014(1)
Reduction related to divestiture
Balance as of June 30, 2015(1)
(1)
Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.
The changes in the carrying amounts of franchise value are as follows (in thousands):
Franchise Value
Balance as of December 31, 2013
Transfers to assets held for sale
Balance as of December 31, 2014
Balance as of June 30, 2015
Note 5. Stockholders’ Equity
Reclassification From Accumulated Other Comprehensive Loss
The reclassification from accumulated other comprehensive loss was as follows (in thousands):
Affected Line Item in the
Consolidated Statements
of Operations
Loss on cash flow hedges
Taxes
Loss on cash flow hedges, net
See Note 8 for more details regarding our derivative contracts.
Repurchases of Class A Common Stock
In August 2011, our Board of Directors authorized the repurchase of up to 2,000,000 shares of our Class A common stock and, on July 20, 2012, our Board of Directors authorized the repurchase of 1,000,000 additional shares of our Class A common stock. Through June 30, 2015, we have repurchased 1,598,723 shares under this program at an average price of $35.56 per share. Of this amount, 98,947 shares were repurchased during the first six months of 2015 at an average price of $100.29 per share for a total of $9.9 million. As of June 30, 2015, 1,401,277 shares remained available for repurchase pursuant to this program. The authority to repurchase does not have an expiration date.
In addition, during the first six months of 2015, we repurchased 77,438 shares at an average price of $88.45 per share, for a total of $6.9 million, related to tax withholdings associated with the vesting of restricted stock units (“RSUs”). The repurchase of shares related to tax withholdings associated with stock awards does not reduce the number of shares available for repurchase as approved by our Board of Directors.
Dividends
Dividends paid on our Class A and Class B common stock were as follows:
Three Months Ended
Six Months Ended
Dividend amount per share
Total amount of dividend (in thousands)
See Note 14 for a discussion of a dividend related to our second quarter 2015 financial results.
Note 6. Deferred Compensation and Long-Term Incentive Plan
We offer a deferred compensation and long-term incentive plan (the “LTIP”) to provide certain employees the ability to accumulate assets for retirement on a tax-deferred basis. We may make discretionary contributions to the LTIP. Discretionary contributions vest over one to seven years depending on the employee’s age and position. Additionally, a participant may defer a portion of his or her compensation and receive the deferred amount upon certain events, including termination or retirement. The following is a summary related to our LTIP (dollars in thousands):
Compensation expense
Discretionary contribution
Guaranteed annual return
As of June 30, 2015 and December 31, 2014, the balance due to participants was $16.0 million and $14.2 million, respectively, and was included as a component of accrued liabilities and other long-term liabilities in the Consolidated Balance Sheets.
Note 7. Fair Value Measurements
Factors used in determining the fair value of our financial assets and liabilities are summarized into three broad categories:
Level 1 – quoted prices in active markets for identical securities;
Level 2 – other significant observable inputs, including quoted prices for similar securities, interest rates, prepayment spreads, credit risk; and
Level 3 – significant unobservable inputs, including our own assumptions in determining fair value.
The inputs or methodology used for valuing financial assets and liabilities are not necessarily an indication of the risk associated with investing in them.
We use the income approach to determine the fair value of our interest rate swap using observable Level 2 market expectations at each measurement date and an income approach to convert estimated future cash flows to a single present value amount (discounted) assuming that participants are motivated, but not compelled, to transact. Level 2 inputs for the swap valuation are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates and credit risk at commonly quoted intervals). Mid-market pricing is used as a practical expedient for fair value measurements. Key inputs, including the cash rates for very short term borrowings, futures rates for up to two years and LIBOR swap rates beyond the derivative maturity, are used to predict future reset rates to discount those future cash flows to present value at the measurement date.
Inputs are collected from Bloomberg on the last market day of the period and used to determine the rate used to discount the future cash flows. The valuation of the interest rate swap also takes into consideration estimates of our own, as well as the counterparty’s, risk of non-performance under the contract. See Note 8 for more details regarding our derivative contracts.
We estimate the value of our equity-method investment that is recorded at fair value on a non-recurring basis based on a market valuation approach. We use prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets. Because these valuations contain unobservable inputs, we classified the measurement of fair value of our equity-method investment as Level 3.
We estimate the value of long-lived assets that are recorded at fair value based on a market valuation approach. We use prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets, as well as our historical experience in divestitures, acquisitions and real estate transactions. Additionally, we may use a cost valuation approach to value long-lived assets when a market valuation approach is unavailable. Under this approach, we determine the cost to replace the service capacity of an asset, adjusted for physical and economic obsolescence. When available, we use valuation inputs from independent valuation experts, such as real estate appraisers and brokers, to corroborate our estimates of fair value. Real estate appraisers’ and brokers’ valuations are typically developed using one or more valuation techniques including market, income and replacement cost approaches. Because these valuations contain unobservable inputs, we classified the measurement of fair value of long-lived assets as Level 3.
There were no changes to our valuation techniques during the six-month period ended June 30, 2015.
Assets and Liabilities Measured at Fair Value
Following are the disclosures related to our assets and (liabilities) that are measured at fair value (in thousands):
Fair Value at June 30, 2015
Level 1
Level 2
Level 3
Measured on a recurring basis:
Derivative contracts, net
Measured on a non-recurring basis:
Equity-method investment
Long-lived assets held and used:
Certain buildings and improvements
Fair Value at December 31, 2014
Based on operating losses recognized by the equity-method investment, we determined that an impairment of our investment had occurred. Accordingly, we performed a fair value calculation for this investment and determined that a $4.1 million and an $8.3 million impairment, respectively, was required to be recorded as asset impairments in our Consolidated Statements of Operations for the three and six months ended June 30, 2015. See Note 11.
Long-lived assets classified as held and used are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. An estimate of future undiscounted net cash flows associated with the long-lived assets is used to determine if the carrying value of the assets is recoverable. An impairment charge is recorded if the carrying value of the asset is determined to not be recoverable and exceeds its fair value. Due to changes in the expected future use for certain properties, we evaluated the future undiscounted net cash flows for each property. It was determined the carrying value was not recoverable and exceeded the estimated fair value. As a result of this evaluation, we recorded $2.0 million of impairment charges associated with these properties in the second quarter of 2015.
Fair Value Disclosures for Financial Assets and Liabilities
We determined the carrying value of cash equivalents, accounts receivable, trade payables, accrued liabilities and short-term borrowings approximate their fair values because of the nature of their terms and current market rates of these instruments. We believe the carrying value of our variable rate debt approximates fair value.
We have fixed rate debt and calculate the estimated fair value of our fixed rate debt using a discounted cash flow methodology. Using estimated current interest rates based on a similar risk profile and duration (Level 2), the fixed cash flows are discounted and summed to compute the fair value of the debt. As of June 30, 2015, this debt had maturity dates between November 2016 and October 2034. A summary of the aggregate carrying values and fair values of our long-term fixed interest rate debt is as follows (in thousands):
Carrying value
Fair value
Note 8. Derivative Financial Instrument
From time to time, we enter into interest rate swaps to fix a portion of our interest expense. We do not enter into derivative instruments for any purpose other than to manage interest rate exposure to fluctuations in the one-month LIBOR benchmark. That is, we do not engage in interest rate speculation using derivative instruments.
As of June 30, 2015, we had a $25 million interest rate swap outstanding with U.S. Bank Dealer Commercial Services. This interest rate swap matures on June 15, 2016 and has a fixed rate of 5.587% per annum. The variable rate on the interest rate swap is the one-month LIBOR rate. At June 30, 2015, the one-month LIBOR rate was 0.19% per annum, as reported in the Wall Street Journal.
Typically, we designate all interest rate swaps as cash flow hedges and, accordingly, we record the change in fair value for the effective portion of these interest rate swaps in comprehensive income rather than net income until the underlying hedged transaction affects net income. If a swap is no longer designated as a cash flow hedge and the forecasted transaction remains probable or reasonably possible of occurring, the gain or loss recorded in accumulated other comprehensive loss is recognized in income as the forecasted transaction occurs. If the forecasted transaction is probable of not occurring, the gain or loss recorded in accumulated other comprehensive loss is recognized in income immediately. See Note 7.
The estimated amount that we expect to reclassify from accumulated other comprehensive loss to net income within the next twelve months is $1.0 million at June 30, 2015.
The fair value of our derivative instruments was included in our Consolidated Balance Sheets as follows (in thousands):
Balance Sheet Information
Derivatives Designated as
Hedging Instruments
Location in Balance Sheet
Interest Rate Swap Contract
Fair Value of Liability Derivatives
The effect of derivative instruments on our Consolidated Statements of Operations was as follows (in thousands):
Derivatives in Cash
Flow Hedging
Relationships
Amount of Gain
Recognized in
Accumulated OCI
(Effective Portion)
Location of Loss
Reclassified from
into Income
Amount of Loss
Recognized in Income
on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
Three Months Ended June 30, 2015
Floor plan
interest expense
Three Months Ended June 30, 2014
Six Months Ended June 30, 2015
Six Months Ended June 30, 2014
See also Note 8.
Note 9. Assets Held for Sale and Discontinued Operations
Assets Held for Sale
We classify an asset group as held for sale if we have ceased operations at that location or the store meets the criteria required by U.S. generally accepted accounting standards as follows:
our management team, possessing the necessary authority, commits to a plan to sell the store;
the store is available for immediate sale in its present condition;
an active program to locate buyers and other actions that are required to sell the store are initiated;
a market for the store exists and we believe its sale is likely within one year;
active marketing of the store commences at a price that is reasonable in relation to the estimated fair market value; and
our management team believes it is unlikely changes will be made to the plan or the plan to dispose of the store will be withdrawn.
As of December 31, 2014, we had two Import stores classified as held for sale. During the first six months of 2015, we completed the sale of both of these Import stores, and recognized a gain of $5.9 million as a component of selling, general and administrative on our Consolidated Statements of Operations for the six months ended June 30, 2015.
As of June 30, 2015, we no longer had any stores classified as held for sale. Assets held for sale included the following (in thousands):
Property, plant and equipment
Intangible assets
Liabilities related to assets held for sale included the following (in thousands):
Discontinued Operations and the Sales of Stores
In the third quarter of 2014, we early-adopted guidance that redefined discontinued operations. As a result, we determined that individual stores which met the criteria for held for sale after our adoption date would no longer qualify for classification as discontinued operations. We had previously reclassified a store’s operations to discontinued operations in our Consolidated Statements of Operations, on a comparable basis for all periods presented, provided we did not expect to have any significant continuing involvement in the store’s operations after its disposal.
Certain financial information related to discontinued operations and sales of stores was as follows (in thousands):
Revenue
Pre-tax loss from discontinued operations
Net gain on disposal activities
Income tax expense
Income from discontinued operations, net of income tax expense
Goodwill and other intangible assets disposed of
Cash generated from disposal activities
Floor plan debt paid in connection with disposal activities
Note 10. Net Income Per Share of Class A and Class B Common Stock
We compute net income per share of Class A and Class B common stock using the two-class method. Under this method, basic net income per share is computed using the weighted average number of common shares outstanding during the period excluding unvested common shares subject to repurchase or cancellation. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options and unvested restricted shares subject to repurchase or cancellation. The dilutive effect of outstanding stock options and other grants is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares.
Except with respect to voting and transfer rights, the rights of the holders of our Class A and Class B common stock are identical. Under our Restated Articles of Incorporation, the Class A and Class B common stock must share equally in any dividends, liquidation proceeds or other distribution with respect to our common stock and the Articles of Incorporation can only be amended by a vote of the shareholders. Additionally, Oregon law provides that amendments to our Articles of Incorporation that would adversely alter the rights, powers or preferences of a given class of stock, must be approved by the class of stock adversely affected by the proposed amendment. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. Because the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis.
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):
Basic EPS from Continuing Operations
Class A
Class B
Numerator:
Income from continuing operations applicable to common stockholders
Distributed income applicable to common stockholders
Basic undistributed income from continuing operations applicable to common stockholders
Denominator:
Weighted average number of shares outstanding used to calculate basic income per share
Basic income per share from continuing operations applicable to common stockholders
Basic distributed income per share from continuing operations applicable to common stockholders
Basic undistributed income per share from continuing operations applicable to common stockholders
Diluted EPS from Continuing Operations
Reallocation of distributed income as a result of conversion of dilutive stock options
Reallocation of distributed income due to conversion of Class B to Class A common shares outstanding
Diluted distributed income applicable to common stockholders
Undistributed income from continuing operations applicable to common stockholders
Reallocation of undistributed income as a result of conversion of dilutive stock options
Reallocation of undistributed income due to conversion of Class B to Class A
Diluted undistributed income from continuing operations applicable to common stockholders
Weighted average number of shares outstanding used to calculate basic income per share from continuing operations
Weighted average number of shares from stock options
Conversion of Class B to Class A common shares outstanding
Weighted average number of shares outstanding used to calculate diluted income per share from continuing operations
Diluted income per share from continuing operations applicable to common stockholders
Diluted distributed income per share from continuing operations applicable to common stockholders
Diluted undistributed income per share from continuing operations applicable to common stockholders
Diluted EPS
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive
Note 11. Equity-Method Investment
In October 2014, we acquired a 99.9% membership interest in a limited liability company managed by U.S. Bancorp Community Development Corporation with an initial equity contribution of $4.1 million. We made additional equity contributions to the entity of $5.7 million and $11.4 million, respectively, in the three and six-month periods ended June 30, 2015. We are obligated to make $49.8 million of contributions to the entity over a two-year period ending October 2016, $15.5 million of which had been paid as of June 30, 2015.
This investment generates new markets tax credits under the New Markets Tax Credit Program (“NMTC Program”). The NMTC Program was established by Congress in 2000 to spur new or increased investments into operating businesses and real estate projects located in low-income communities.
While U.S. Bancorp Community Development Corporation exercises management control over the limited liability company, due to the economic interest we hold in the entity, we determined our ownership portion of the entity was appropriately accounted for using the equity method.
The following amounts related to this equity-method investment were recorded in our Consolidated Balance Sheets (in thousands):
Carrying value, recorded as a component of other non-current assets
Present value of obligation associated with future equity contributions, recorded as a component of accrued liabilities and other long-term liabilities
The following amounts related to this equity-method investment were recorded in our Consolidated Statements of Operations (in thousands):
Asset impairments to write investment down to fair value
Our portion of the partnership’s operating losses
Non-cash interest expense related to the amortization of the discounted fair value of future equity contributions
Tax benefits and credits generated
Note 12. Segments
While we have determined that each individual store is an operating segment, we have aggregated our operating segments into three reportable segments based on their economic similarities: Domestic, Import and Luxury.
Our Domestic segment is comprised of retail automotive franchises that sell new vehicles manufactured by Chrysler, General Motors and Ford. Our Import segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by Honda, Toyota, Subaru, Nissan and Volkswagen. Our Luxury segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by BMW, Mercedes-Benz and Lexus. The franchises in each segment also sell used vehicles, parts and automotive services, and automotive finance and insurance products.
Corporate and other is comprised of our stand-alone collision center; unallocated corporate overhead expenses, such as corporate personnel costs, certain interest expense and depreciation expense, and retrospective commissions for certain finance and insurance transactions that we arrange under agreements with third parties.
We define our chief operating decision maker (“CODM”) to be certain members of our executive management group. Historical and forecasted operational performance is evaluated on a store-by-store basis and on a consolidated basis by the CODM. We derive the operating results of the segments directly from our internal management reporting system. The accounting policies used to derive segment results are substantially the same as those used to determine our consolidated results. Management measures the performance of each operating segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to allocate resources to, each of the operating segments.
Certain financial information on a segment basis is as follows (in thousands):
Corporate and other
Segment income*:
*Segment income is defined as operating income less floor plan interest expense.
Floor plan interest expense:
Total assets:
Note 13. Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued accounting standards update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which amends the accounting guidance related to revenues. This amendment will replace most of the existing revenue recognition guidance when it becomes effective. The new standard, as amended in July 2015, is effective for fiscal years beginning after December 15, 2017 and entities are allowed to adopt the standard as early as annual periods beginning after December 15, 2016, and interim periods therein. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect this amendment will have on our consolidated financial statements and related disclosures and believe the financial impact is not material. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
In June 2014, the FASB issued ASU 2014-12, “Compensation – Stock Compensation (Topic 718).” ASU 2014-12 addresses accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. ASU 2014-12 indicates that, in such situations, the performance target should be treated as a performance condition and, accordingly, the performance target should not be reflected in estimating the grant-date fair value of the award. Instead, compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. We do not expect the adoption of ASU 2014-12 to have a material effect on our financial position, results of operations or cash flows.
In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810).” ASU 2015-02 amends guidance regarding the consolidation of certain legal entities. ASU 2015-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We do not expect the adoption of ASU 2015-02 to have any effect on our financial position, results of operations or cash flows.
In April 2015, the FASB issued ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30).” ASU 2015-03 amends guidance in order to simplify the presentation of debt issuance costs. ASU 2015-03 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted for financial statements that have not been previously issued. We do not expect the adoption of ASU 2015-03 to have any effect on our financial position, results of operations or cash flows.
Note 14. Subsequent Events
Common Stock Dividend
On July 20, 2015, our Board of Directors approved a dividend of $0.20 per share on our Class A and Class B common stock related to our second quarter 2015 financial results. The dividend will total approximately $5.3 million and will be paid on August 21, 2015 to shareholders of record on August 7, 2015.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements and Risk Factors
Certain statements under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “project”, “outlook,” “target”, “may,” “will,” “would,” “should,” “seek,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “likely,” “goal,” “strategy,” “future,” “maintain,” and “continue” or the negative of these terms or other comparable terms. Examples of forward-looking statements in this Form 10-Q include, among others, statements we make regarding:
Future market conditions;
Expected operating results, such as improved store performance; maintaining incremental throughput between 45% and 50%; continued improvement of SG&A as a percentage of gross profit and all projections;
Anticipated continued success, integration and growth of DCH;
Anticipated ability to capture additional market share; ability to find accretive acquisitions; and additions of dealership locations to the company’s portfolio in the future;
Anticipated availability of liquidity from our unfinanced operating real estate; and
Anticipated levels of capital expenditures in the future.
The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results to materially differ from the results expressed or implied by these statements. Certain important factors that could cause actual results to differ from our expectations are discussed in Part II - Other Information, Item 1A in this Form 10-Q and in the Risk Factors section of our 2014 Annual Report on Form 10-K, as supplemented and amended from time to time in Quarterly Reports on Form 10-Q and our other filings with the Securities and Exchange Commission.
By their nature, forward-looking statements involve risks and uncertainties because they relate to events that depend on circumstances that may or may not occur in the future. You should not place undue reliance on these forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. We assume no obligation to update or revise any forward-looking statement.
Overview
We are a leading operator of automotive franchises and a retailer of new and used vehicles and related services. As of July 31, 2015, we offered 31 brands of new vehicles and all brands of used vehicles in 129 stores in the United States and online at Lithia.com and DCHauto.com. We sell new and used cars and replacement parts; provide vehicle maintenance, warranty, paint and repair services; arrange related financing; and sell service contracts, vehicle protection products and credit insurance.
Our dealerships are located across the United States. We seek domestic, import and luxury franchises in cities ranging from mid-sized regional markets to metropolitan markets. We evaluate all brands for expansion opportunities provided the market is large enough to support adequate new vehicle sales to justify the required capital investment.
Our mission statement is: “Driven by our employees and preferred by our customers, Lithia is the leading automotive retailer in each of our markets.” We offer customers personal, convenient, flexible personalized service combined with the large company advantages of selection, competitive pricing, broad access to financing, and warranties. We strive for diversification in our products, services, brands and geographic locations to insulate us from market risk and to maintain profitability. We have developed a centralized support structure to reduce store level administrative functions. This allows store personnel to focus on providing a positive customer experience. With our management information systems and centrally-performed administrative functions in Medford, Oregon, and regional accounting processing centers, we seek to gain economies of scale from our dealership network.
Results of Continuing Operations
For the three months ended June 30, 2015 and 2014, we reported income from continuing operations, net of tax, of $51.2 million, or $1.93 per diluted share, and $35.2 million, or $1.34 per diluted share, respectively.
For the six months ended June 30, 2015 and 2014, we reported income from continuing operations, net of tax, of $91.9 million, or $3.47 per diluted share, and $59.9 million, or $2.27 per diluted share, respectively.
Discontinued Operations
In the third quarter of 2014, we early-adopted guidance that redefined discontinued operations. As a result, we determined that individual stores that met the criteria for held for sale after our adoption date would no longer qualify for classification as discontinued operations. We had previously reclassified a store’s operations to discontinued operations in our Consolidated Statements of Operations, on a comparable basis for all periods presented, provided we did not expect to have any significant continuing involvement in the store’s operations after its disposal.
We realized income from discontinued operations, net of tax, of $3.1 million, or $0.11 per diluted share for the three months ended June 30, 2014 and $3.2 million, or $0.12 per diluted share, for the six months ended June 30, 2014. See Note 9 of the Condensed Notes to Consolidated Financial Statements for additional information.
Key Revenue and Gross Profit Metrics
Key performance metrics for revenue and gross profit were as follows (dollars in thousands):
Three months endedJune 30, 2015
Revenues
Percent of
Total Revenues
Gross Profit
Margin
Percent of Total
Finance and insurance(1)
Three months endedJune 30, 2014
Six months endedJune 30, 2015
Six months endedJune 30, 2014
Commissions reported net of anticipated cancellations.
Same Store Operating Data
In 2014, we acquired 36 stores. As a result, we experienced significant growth in the first six months of 2015 compared to the same period in 2014. We believe that same store comparisons are an important indicator of our financial performance. Same store measures demonstrate our ability to grow revenues in our existing locations. As a result, same store measures have been integrated into the discussion below.
Same store measures reflect results for stores that were operating in each comparison period and only include the months when operations occurred in both periods. For example, a store acquired in May 2014 would be included in same store operating data beginning in June 2015, after its first full complete comparable month of operation. The second quarter operating results for the same store comparisons would include results for that store in only the period of June for both comparable periods.
New Vehicle Revenue and Gross Profit
Increase
% Increase
(Dollars in thousands, except per unit amounts)
(Decrease)
Reported
Gross margin
(60)
Retail units sold
Average selling price per retail unit
Average gross profit per retail unit
Same store
(50)
A basis point is equal to 1/100th of one percent.
New vehicle sales increased 65.5% and 69.3%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014 primarily driven by the acquisition of 27 stores from the DCH Auto Group in the fourth quarter of 2014. On a same store basis, new vehicle sales increased 7.7% and 9.4%, respectively, primarily due to unit volume growth of 5.7% and 7.0%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods in 2014. Same store unit sales increased in all reportable segments in the 2015 periods compared to the comparable 2014 periods as follows:
Three months ended
compared to the
same period of 2014
National growth in
the three months ended
Six months ended
the six months ended
Overall
Our unit volume growth rate for the 2015 periods was higher than the national average for our domestic and import stores, while growth in our luxury stores was flat for the three months ended June 30, 2015. We continue to focus on increasing our share of overall new vehicle sales within our markets.
New vehicle gross profit increased 50.8% and 54.2%, respectively, for the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014, primarily driven by the acquisition of the DCH Auto Group in the fourth quarter of 2014. On a same store basis, new vehicle gross profit decreased 0.2% and increased 1.8%, respectively, for the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014. In the three-month period ended June 30, 2015, lower gross profit per unit and gross margins resulted in a slight decline in gross profits. In the six-month period ended June 30, 2015, gross profit increases were due to a greater number of vehicles sold, offset by lower gross profit per unit and gross margins.
With our volume-based strategy, on a same store basis, the average gross profit per new retail unit decreased $126, or 5.6%, and $110, or 4.9%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014. We believe our volume-based strategy creates additional used vehicle trade-in opportunities, finance and insurance sales and future service work, which will generate incremental business in future periods that will more than offset the lower new vehicle gross profit per unit that has occurred with the pursuit of a volume-based strategy.
Used Vehicle Retail Revenue and Gross Profit
Retail revenue
Retail gross profit
Retail gross margin
(140)
(80)
(110)
Used vehicle retail sales are a strategic focus for organic growth. We offer three categories of used vehicles: manufacturer certified pre-owned vehicles; core vehicles, or late-model vehicles with lower mileage; and value autos, or vehicles with over 80,000 miles. Additionally, our volume-based strategy for new vehicle sales increases the organic opportunity to convert vehicles acquired via trade to retail used vehicle sales.
Same store sales increased in all three categories of used vehicles as follows:
Certified pre-owned vehicles
Core vehicles
Value autos
On an annualized average as of June 30, 2015 and 2014, each of our stores sold 59 and 55 retail used vehicle units, respectively, per month. We continue to target increasing sales to 75 units per store per month.
Used retail vehicle gross profit increased 42.3% and 43.9%, respectively, for the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014, primarily driven by the acquisition of the DCH Auto Group in the fourth quarter of 2014. On a same store basis, gross profit increased 9.6% and 10.2%, respectively, for the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014. These increases were mainly related to increased unit volume. The unit volume growth was driven by a mix shift toward certified pre-owned and core vehicles, which have higher average selling prices and lower gross margins than value autos.
Used Vehicle Wholesale Revenue and Gross Profit
Decrease
Wholesale revenue
Wholesale gross profit
Wholesale gross margin
(130
Wholesale units sold
Average selling price per wholesale unit
(70
(50
(20
Wholesale transactions are vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to inventory age or other factors. Wholesale vehicles are typically sold at or near inventory cost and do not comprise a meaningful component of our gross profit.
Finance and Insurance
%
Average finance and insurance per retail unit
The increases in total finance and insurance revenue were primarily due to higher unit volume, as a result of the acquisition of the DCH Auto Group in the fourth quarter of 2014. On a same store basis, the increases were due to higher unit volume sales and an increase in the average finance and insurance revenue earned per unit. Trends in penetration rates for total new and used retail vehicles sold are detailed below:
Service contracts
Lifetime lube, oil and filter contracts
We believe the availability of credit is one of the key indicators of our ability to retail automobiles, as we arrange financing on almost 80% of the vehicles we sell and believe a significant amount of the vehicles we do not arrange financing for are financed elsewhere. To evaluate the availability of credit, we categorize our customers based on their Fair, Isaac and Company (FICO) credit score.
The distribution by credit score for the customers we arranged financing for was as follows:
FICO Score Range
Prime
680
Non-prime
Sub-prime
619
We continued to see the availability of consumer credit expand in the first six months of 2015 compared to the same period of 2014.
Service, Body and Parts Revenue and Gross Profit
Three Months EndedJune 30,
(Dollars in thousands)
Customer pay
Warranty
Wholesale parts
Body shop
Total service, body and parts
Service, body and parts gross profit
Service, body and parts gross margin
60
30
10
Our service, body and parts sales grew in all areas except same store body shop in the six-month period ended June 30, 2015 compared to the same periods of 2014. There are more late-model vehicles in operation as new vehicle sales volumes have been increasing since 2010. We believe this increase in units in operation will benefit our service, body and parts sales in the coming years as more late-model vehicles age, necessitating repairs and maintenance.
We focus on retaining customers by offering competitively priced routine maintenance and through our marketing efforts. We increased our same store customer pay business 7.2% and 8.1%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods in 2014.
Same store warranty sales increased 26.6% and 28.9%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014, primarily due to significant numbers of vehicle recalls. Additionally, we continue to see increases due to the growing number of units in operation. Routine maintenance, such as oil changes, offered by certain brands, including BMW, Toyota and General Motors, for two to four years after a vehicle is sold, provides for future work as consumers return to the franchised dealer for this ‘prepaid’ maintenance item.
Increases in same-store warranty work by segment were as follows:
Wholesale parts represented 16.6% and 17.3%, respectively, of our same store service, body and parts revenue mix in the three- and six-month periods ended June 30, 2015 and 17.5% and 18.2%, respectively, in the same periods of 2014. Same store wholesale parts grew 4.4% and 4.8%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014, primarily due to targeting fleet and mechanical wholesale accounts.
Body shop represented 8.2% and 8.4%, respectively, of our same store service, body and parts revenue mix in the three- and six-month periods ended June 30, 2015, and 8.9% and 9.3%, respectively, in the same periods of 2014. Same store body shop increased 1.2% and decreased 0.7%, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014. During the first quarter of 2015, our body shops were impacted by a milder winter in the Pacific Northwest in 2015 where the majority of our body shops are located.
Same store service, body and parts gross profit increased 10.6% in both the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014, which is in line with our revenue growth. Our gross margins were consistent in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014.
Segments
Certain financial information by segment is as follows:
NM
NM – not meaningful.
Retail new vehicle unit sales:
Allocated to management
A summary of financial information for our Domestic segment follows:
Segment income
Retail new vehicle unit sales
Improvements in our Domestic operating results in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014 were primarily a result of the improvements in all revenue categories as discussed above, overall improvements in the economy, acquisitions and overall growth in the market share of our Chrysler stores, which comprised 19% of our total overall new vehicle unit sales and over 50% of our Domestic segment revenue in the three- and six-month periods ended June 30, 2015. We acquired six Domestic locations in 2014.
A summary of financial information for our Import segment follows:
Improvements in our Import operating results in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014 were primarily a result of the improvements in all revenue categories as discussed above, overall improvements in the economy and a strategic focus to diversify our dependence on Domestic brands through the acquisition of Import branded stores. We added 21 import locations in 2014. As of June 30, 2015, Honda and Toyota were our largest brands, representing 23% and 19% of our total overall new vehicle unit sales in the first six months of 2015, respectively.
A summary of financial information for our Luxury segment follows:
Improvements in our Luxury operating results in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014 were primarily a result of the improvements in all revenue categories as discussed above, overall improvements in the economy and a strategic focus to diversify our dependence on Domestic brands through the acquisition of Luxury branded stores. We added nine luxury locations in 2014.
Asset Impairments
Asset impairments recorded as a component of continuing operations consist of the following (in thousands):
Equity investments
Long-lived assets
For the three and six months ended June 30, 2015, we recorded asset impairments of $4.1 million and $8.3 million, respectively, associated with our equity-method investment in a limited liability company that participates in the New Markets Tax Credit Program (“NMTC Program”). The equity-method investment generates operating losses on a quarterly basis and, accordingly, we will be required to assess the investment for other than temporary impairment on a quarterly basis. The investment provides a return in the form of tax credits. We recorded a reduction to our income tax provision of $7.7 million and $14.9 million, respectively, related to tax credits under the NMTC Program in the three- and six-month periods ended June 30, 2015. See Note 11 of Condensed Notes to Consolidated Financial Statements elsewhere in this Form 10-Q for additional information.
In the second quarter of 2015, we recorded $2.0 million of impairment charges associated with certain properties. As the expected future use of these facilities changed, the long-lived assets were tested for recoverability and were determined to have a carrying value exceeding the fair value of these properties.
Selling, General and Administrative Expense (“SG&A”)
SG&A includes salaries and related personnel expenses, advertising (net of manufacturer cooperative advertising credits), rent, facility costs, and other general corporate expenses.
Personnel
Advertising
Rent
Facility costs
Other
Total SG&A
As a % of gross profit
50
120
(10)
SG&A expense increased $70.1 million and $139.9 million in the three- and six-month periods ended June 30, 2015 compared to the same periods in 2014. SG&A as a percentage of gross profit was 65.7% and 65.2%, respectively, for the three months ended June 30, 2015 and 2014, and 67.8% and 67.9%, respectively, for the six months ended June 30, 2015 and 2014.
These increases in SG&A expense were primarily driven by increased variable cost associated with increased sales volume and store count, offset by a gain of $2.6 million and $5.9 million, respectively, associated with the sale of one store and two stores, respectively, in the three and six months ended June 30, 2015. Additionally, the first quarter of 2014 includes non-core charges of $3.9 million related to a reserve associated with a lawsuit filed in 2006 and settled in 2013, a loss reserve for a hailstorm in Texas and a reserve for a contract assumed in an acquisition. The second quarter of 2014 includes non-core charges of $0.2 million related to acquisition expenses for the acquisition of DCH Auto Group.
SG&A expense adjusted for non-core charges was as follows (in thousands):
Adjusted facility costs
Adjusted total SG&A
140
210
See “Non-GAAP Reconciliations” for more details of the non-GAAP reconciliation.
Due to the effects of the integration of DCH Auto Group, which we acquired in October 2014, we expect SG&A expense to increase in 2015 compared to pre-acquisition levels.
We also measure the leverage of our cost structure by evaluating throughput, which is the incremental percentage of gross profit retained after deducting SG&A expense.
% of Change in
Change
SG&A expense
Throughput contribution
Throughput, excluding non-core gains of $2.6 million and $5.9 million, respectively, for the three- and six-month periods ended June 30, 2015 and non-core charges of $0.2 million and $4.1 million, respectively, for the three- and six-month periods ended June 30, 2014, was as follows:
See “Non-GAAP Reconciliations” for more details.
Throughput contributions for newly opened or acquired stores reduce overall throughput because, in the first year of operation, a store’s throughput is equal to the inverse of its SG&A as a percentage of gross profit. For example, a store which achieves SG&A as a percentage of gross profit of 70% will have throughput of 30% in the first year of operation.
We opened two new stores and acquired 33 stores since June 30, 2014. Adjusting for these locations and the adjustments discussed above, our throughput contribution on a same store basis was 25.9% and 35.8%, respectively for the three- and six-month periods ended June 30, 2015. We continue to target a same store throughput contribution in a range of 45% to 50%.
Depreciation and Amortization
Depreciation and amortization is comprised of depreciation expense related to buildings, significant remodels or improvements, furniture, tools, equipment and signage and amortization of certain intangible assets, including trade name, customer lists and non-compete agreements.
Depreciation and amortization increased $4.5 million and $8.7 million, respectively, for the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014. A majority of these increases was due to our acquisition activity since June 30, 2014. Additionally, we purchased previously leased facilities, built new facilities subsequent to the acquisition of stores and invested in improvements at our facilities and replacement of equipment. These investments increase the amount of depreciable assets and amortizable expenses. In the full year of 2014 and the first six months of 2015, we had capital expenditures of $86.0 million and $48.0 million, respectively.
Operating Income
Operating income as a percentage of revenue, or operating margin, was as follows:
Operating margin
Operating margin adjusted for non-core charges(1)
(1) See “Non-GAAP Reconciliations” for more details.
Due to the effects of the integration of the DCH Auto Group, which has a lower operating efficiency than our other stores, we expect our operating margin to be in the low 4% range throughout 2015. We continue to focus on cost control, which allows us to leverage our cost structure in an environment of improving sales and aspire to increase our operating margin to our historical level.
Floor Plan Interest Expense and Floor Plan Assistance
Floor plan interest expense increased $1.4 million and $3.1 million, respectively, in the three- and six-month periods ended June 30, 2015 compared to the same periods of 2014 primarily as a result of increase in the average outstanding balances on our floor plan facilities due to our increase in vehicle sales as discussed above.
Floor plan assistance is provided by manufacturers to support store financing of new vehicle inventory. Under accounting standards, floor plan assistance is recorded as a component of new vehicle gross profit when the specific vehicle is sold. However, because manufacturers provide this assistance to offset inventory carrying costs, we believe a comparison of floor plan interest expense to floor plan assistance is a useful measure of the efficiency of our new vehicle sales relative to stocking levels.
The following tables detail the carrying costs for new vehicles and include new vehicle floor plan interest net of floor plan assistance earned.
Floor plan interest expense (new vehicles)
Floor plan assistance (included as an offset to cost of sales)
Net new vehicle carrying costs
Other Interest Expense
Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle inventory financing facility and our revolving line of credit.
Mortgage interest
Other interest
Capitalized interest
Total other interest expense
Other interest expense increased $3.1 million and $6.0 million, respectively, in the first three and six months of 2015 compared to the same periods of 2014 primarily due to higher volumes of borrowing on our credit facility and higher mortgage interest due to additional mortgage financings, partially offset by increased capitalized interest in the six-month period.
Other (Expense) Income, Net
Other (expense) income, net primarily includes interest income and the gains and losses related to an equity-method investment.
Income Tax Expense
Our effective income tax rate was 32.3% and 31.1% for the three- and six-month periods ended June 30, 2015 compared to 38.4% and 38.8%, respectively, in the comparable periods of 2014. For the full year of 2015, we forecast our income tax rate to be approximately 32.5%.
Our effective income tax rate in the first six months of 2015 was positively affected by new markets tax credits that are generated through our equity-method investment with U.S. Bancorp Community Development Corporation. Excluding the non-core tax attributes associated with the treatment of the tax credits generated through this investment and adjusting for other non-core items, our effective income tax rate was 39.0% in the three- and six-month periods ended June 30, 2015. Excluding this investment and adjusting for other non-core items, we forecast our income tax rate to be 39.3% for the full year 2015.
Non-GAAP Reconciliations
We believe each of the non-GAAP financial measures below improves the transparency of our disclosures, provides a meaningful presentation of our results from the core business operations because they exclude adjustments for items not related to our ongoing core business operations and other non-cash adjustments, and improves the period-to-period comparability of our results from the core business operations. Our management uses these measures in conjunction with GAAP financial measures to assess our business, including our compliance with covenants in our credit facility and in communications with our Board of Directors concerning financial performance. These measures should not be considered an alternative to GAAP measures.
The following tables reconcile certain reported non-GAAP measures to the most comparable GAAP measure from our Consolidated Statements of Operations (dollars in thousands, except per share amounts):
As reported
Disposal
gain on sale
of stores
Asset
impairment
Adjusted
Asset impairment
Operating income (loss)
Other (expense) income
Income (loss) from continuing operations before income taxes
Income tax (provision) benefit
Income (loss) from continuing operations, net of income tax
Diluted income (loss) per share from continuing operations
Diluted share count
Acquisition
expenses
Tax
attributes
Income from operations
Net income from continuing operations
Diluted earnings per share from continuing operations
Disposal gain on sale of stores
Reserve adjustments
Acquisition expenses
Tax attribute
Liquidity and Capital Resources
We manage our liquidity and capital resources to fund our operating, investing and financing activities. We rely primarily on cash flows from operations and borrowings under our credit facilities as the main sources for liquidity. We use those funds to invest in capital expenditures, increase working capital and fulfill contractual obligations. Remaining funds are used for acquisitions, debt retirement, cash dividends, share repurchases and general business purposes.
Available Sources
Below is a summary of our available funds (in thousands):
As of June 30,
Available credit on the Credit Facility
Total current available funds
Estimated funds from unfinanced real estate
Total estimated available funds
Cash flows generated by operating activities and from our credit facility are our most significant sources of liquidity. We also have the ability to raise funds through mortgaging real estate. As of June 30, 2015, our unencumbered owned operating real estate had a book value of $154.0 million. Assuming we can obtain financing on 75% of this value, we estimate we could have obtained additional funds of approximately $115.5 million at June 30, 2015; however, no assurances can be provided that the appraised value of these properties will match or exceed their book values or that this capital source will be available on terms acceptable to us.
In addition to the above sources of liquidity, potential sources include the placement of subordinated debentures or loans, the sale of equity securities and the sale of stores or other assets. We evaluate all of these options and may select one or more of them depending on overall capital needs and the availability and cost of capital, although no assurances can be provided that these capital sources will be available in sufficient amounts or with terms acceptable to us.
Information about our cash flows, by category, is presented in our Consolidated Statements of Cash Flows. The following table summarizes our cash flows (in thousands):
Operating Activities
Cash provided by operating activities for the six months ended June 30, 2015 compared to the same period of 2014 increased $33.5 million, primarily as a result of increased profitability and improved trade receivables collections, partially offset by increased inventory purchases.
Borrowings from and repayments to our syndicated lending group related to our new vehicle inventory floor plan financing are presented as financing activities. To better understand the impact of changes in inventory and the associated financing, we also consider our net cash provided by operating activities adjusted to include cash activity associated with our new vehicle credit facility and excluding cash activity associated with acquired inventory.
Adjusted net cash provided by operating activities is presented below (in thousands):
Increase (Decrease)
in Cash Flow
Net cash provided by (used in) operating activities – as reported
Add: Net borrowings on floor plan notes payable, non-trade
Net cash provided by operating activities – adjusted
Inventories are the most significant component of our cash flow from operations. As of June 30, 2015, our new vehicle days supply was 65, or three days higher than our days supply as of December 31, 2014. Our days supply of used vehicles was 54 days as of June 30, 2015, or one day higher than our days supply as of December 31, 2014. We calculate days supply of inventory based on current inventory levels, excluding in-transit vehicles, and a 30-day historical cost of sales level. We have continued to focus on managing our unit mix and maintaining an appropriate level of new and used vehicle inventory.
Investing Activities
Net cash used in investing activities totaled $50.2 million and $107.4 million, respectively, for the six-month periods ended June 30, 2015 and 2014. Cash flows from investing activities relate primarily to capital expenditures, acquisition and divestiture activity and sales of property and equipment.
Below are highlights of significant activity related to our cash flows from investing activities (in thousands):
Below is a summary of our capital expenditure activities (in thousands):
Post-acquisition capital improvements
Facilities for open points
Purchases of previously leased facilities
Existing facility improvements
Maintenance
Total capital expenditures
Many manufacturers provide assistance in the form of additional incentives or assistance if facilities meet manufacturer image standards and requirements. We expect that certain facility upgrades and remodels will generate additional manufacturer incentive payments.
We expect to make a portion of our future capital expenditures to upgrade facilities that we recently acquired. This additional capital investment is contemplated in our initial evaluation of the investment return metrics applied to each acquisition and is usually associated with manufacturer image standards and requirements.
We expect to make capital expenditures in 2015 of approximately $110 million for capital improvements at recently acquired stores, purchases of land for expansion of existing stores, facility image improvements, purchases of store facilities, purchases of previously leased facilities and replacement of equipment.
Acquisitions
In the first six months of 2015, we acquired a smart franchise which was added to one of our existing stores. We acquired seven stores in the first six months of 2014.
We focus on acquiring stores at opportunistic purchase prices that meet our return thresholds and strategic objectives. We look for acquisitions that diversify our brand and geographic mix as we continue to evaluate our portfolio to minimize exposure to any one manufacturer and achieve financial returns.
We evaluate potential capital investments based on certain criteria, primarily associated with targeted rates of return on assets and return on our net equity investment.
Other Investments
Our cash paid associated with other investments increased $11.8 million in the six months ended June 30, 2015 compared to the same period in 2014 mainly associated with our equity investment related to the NMTC Program.
Financing Activities
Net cash provided by financing activities totaled $14.4 million and $116.2 million for six-month periods ended June 30, 2015 and 2014, respectively.
Net cash provided by financing activities, adjusted for borrowing on floor plan facilities: non-trade was as follows (in thousands):
Cash provided by financing activities, as reported
Adjust: cash provided by borrowings on floor plan notes payable: non-trade
Cash (used in) provided by financing activities, as adjusted
Below are highlights of significant activity related to our cash flows from financing activities, excluding net borrowings on floor plan notes payable: non-trade, which are discussed above:
Net borrowings (repayments) on lines of credit
Principal payments on long-term debt, unscheduled
Repurchases of common stock
Borrowing and Repayment Activity
During the first six months of 2015, we had net repayments of $45.4 million associated with our lines of credit. We raised net mortgage proceeds of $50.2 million during the first six months of 2015, which were used to pay down our line of credit, increasing availability on our credit facility.
Our debt to total capital ratio, excluding floor plan notes payable, was 45.9% at June 30, 2015 compared to 31.2% at June 30, 2014. We partially funded our 2014 acquisition activity, including the DCH Auto Group acquisition, with additional debt.
Equity Transactions
Under the share repurchase program authorized by our Board of Directors and repurchases associated with stock compensation activity, we repurchased 176,385 shares of our Class A common stock at an average price of $95.09 per share in the first six months of 2015. As of June 30, 2015, we had 1,401,277 shares available for repurchase under our share repurchase program. The authority to repurchase does not have an expiration date.
In the first six months of 2015, we declared and paid dividends on our Class A and Class B common stock as follows:
Date
dividend paid
Dividend amount
per share
Total amount of
dividend (in thousands)
March 2015
May 2015
Management evaluates performance and makes a recommendation to the Board of Directors on dividend payments on a quarterly basis.
Summary of Outstanding Balances on Credit Facilities and Long-Term Debt
Below is a summary of our outstanding balances on credit facilities and long-term debt (in thousands):
Outstanding
as of
Remaining Available
Floor plan note payable: non-trade
Used vehicle inventory financing facility
Revolving lines of credit
Real estate mortgages
Other debt
Total debt
As of June 30, 2015, we had a $1.25 billion new vehicle floor plan commitment as part of our credit facility.
(2)
The amount available on the credit facility is limited based on a borrowing base calculation and fluctuates monthly.
(3)
Available credit is based on the borrowing base amount effective as of June 30, 2015. This amount is reduced by $7.4 million for outstanding letters of credit.
Credit Facility
We have a $1.7 billion revolving syndicated credit facility. This syndicated credit facility is comprised of 16 financial institutions, including seven manufacturer-affiliated finance companies. Our credit facility provides for up to $1.25 billion in new vehicle inventory floor plan financing, up to $150 million in used vehicle inventory floor plan financing and a maximum of $300 million in revolving financing for general corporate purposes, including acquisitions and working capital. This credit facility may be expanded to $1.85 billion total availability, subject to lender approval.
We may request a reallocation of any unused portion of our credit facility provided that the used vehicle inventory floor plan commitment does not exceed $250 million, the revolving financing commitment does not exceed $300 million, and the sum of those commitments plus the new vehicle inventory floor plan financing commitment does not exceed the total aggregate financing commitment. All borrowings from, and repayments to, our lending group are presented in the Consolidated Statements of Cash Flows as financing activities.
The new vehicle floor plan commitment is collateralized by our new vehicle inventory. Our used vehicle inventory financing facility is collateralized by our used vehicle inventory that has been in stock for less than 180 days. Our revolving line of credit is secured by our outstanding receivables related to vehicle sales, unencumbered vehicle inventory, other eligible receivables, parts and accessories and equipment.
We have the ability to deposit up to $50 million in cash in Principal Reduction (PR) accounts associated with our new vehicle inventory floor plan commitment. The PR accounts are recognized as offsetting credits against outstanding amounts on our new vehicle floor plan commitment and would reduce interest expense associated with the outstanding principal balance. As of June 30, 2015, we had no balances in our PR accounts.
If the outstanding principal balance on our new vehicle inventory floor plan commitment, plus requests on any day, exceeds 95% of the loan commitment, a portion of the revolving line of credit must be reserved. The reserve amount is equal to the lesser of $15.0 million or the maximum revolving line of credit commitment less the outstanding balance on the line less outstanding letters of credit. The reserve amount will decrease the revolving line of credit availability and may be used to repay the new vehicle floor plan commitment balance.
The interest rate on the credit facility varies based on the type of debt, with the rate of one-month LIBOR plus 1.25% for new vehicle floor plan financing, one-month LIBOR plus 1.50% for used vehicle floor plan financing; and a variable interest rate on the revolving financing ranging from the one-month LIBOR plus 1.25% to 2.50%, depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment, excluding the effects of our interest rate swaps, was 1.4% at June 30, 2015. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 1.7% and 2.2%, respectively, at June 30, 2015.
Under the terms of our credit facility we are subject to financial covenants and restrictive covenants that limit or restrict our incurring additional indebtedness, making investments, selling or acquiring assets and granting security interests in our assets.
Under our credit facility, we are required to maintain the ratios detailed in the following table:
Debt Covenant Ratio
Requirement
As of
Current ratio
Not less than 1.10 to 1
1.24 to 1
Fixed charge coverage ratio
Not less than 1.20 to 1
3.21 to 1
Leverage ratio
Not more than 5.00 to 1
1.97 to 1
Funded debt restriction
Not to exceed $600 million
$414.4 million
As of June 30, 2015, we were in compliance with all covenants. We expect to remain in compliance with the financial and restrictive covenants in our credit facility and other debt agreements. However, no assurances can be provided that we will continue to remain in compliance with the financial and restrictive covenants.
If we do not meet the financial and restrictive covenants and are unable to remediate or cure the condition or obtain a waiver from our lenders, a breach would give rise to remedies under the agreement, the most severe of which are the termination of the agreement, acceleration of the amounts owed and the seizure and sale of our assets comprising the collateral for the loans. A breach would also trigger cross-defaults under other debt agreements.
Floor Plan Notes Payable
We have floor plan agreements with manufacturer-affiliated finance companies for vehicles that are designated for use as service loaners. The variable interest rates on these floor plan notes payable commitments vary by manufacturer. At June 30, 2015, $45.5 million was outstanding on these arrangements. Borrowings from, and repayments to, manufacturer-affiliated finance companies are classified as operating activities in the Consolidated Statements of Cash Flows.
Real Estate Mortgages and Other Debt
We have mortgages associated with our owned real estate. Interest rates related to this debt ranged from 1.7% to 5.0% at June 30, 2015. The mortgages are payable in various installments through October 2034. As of June 30, 2015, we had fixed interest rates on 80% of our outstanding mortgage debt.
Our other debt includes capital leases, sellers’ notes and our equity contribution obligations associated with the new markets tax credit equity investment. The interest rates associated with our other debt ranged from 2.0% to 9.0% at June 30, 2015. This debt, which totaled $36.5 million at June 30, 2015, is due in various installments through January 2024.
Recent Accounting Pronouncements
See Note 13 of the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Use of Estimates
There have been no material changes in the critical accounting policies and use of estimates described in our 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2015.
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 second and third quarters of each fiscal year. More recently, our franchise diversification and cost control efforts have moderated the significance of our seasonality. We believe that interest rates, levels of consumer debt, consumer confidence and manufacturer sales incentives, as well as general economic conditions, also contribute to fluctuations in sales and operating results.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
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 2014 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 2, 2015.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Item 1A. Risk Factors
Except for the risk factor set forth below, there have been no material changes from the risk factors previously disclosed in our 2014 Annual Report on Form 10-K. The information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed in that report, which was filed with the Securities and Exchange Commission on March 2, 2015.
We may not be able to utilize certain income tax benefits.
Our ability to utilize the income tax benefits and credits generated by our equity investments intended to generate new market tax credits (NMTC) depends on compliance with NMTC program requirements, which we do not control. Our ability to utilize NMTC, and other deferred tax assets, also depends on our generating sufficient taxable income from operations in the future. The inability to utilize the income tax benefits could have a material adverse impact on our business, results of operations, financial condition and cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We repurchased the following shares of our Class A common stock during the second quarter of 2015:
Total number
of shares
purchased
Average price
paid per share
Total number of
shares purchased
as part of publicly
announced plan(1)
Maximum number
of shares that may
yet be purchased
under the plans
April 1 to April 30
May 1 to May 31
June 1 to June 30
Total
In 2011 and 2012, our Board of Directors authorized the repurchase of up to a total of 3,000,000 shares of our Class A common stock. Through June 30, 2015, we have repurchased 1,598,723 shares at an average price of $35.47 per share. This authority to repurchase shares does not have an expiration date or a maximum aggregate dollar amount for repurchases.
Item 6. Exhibits
The following exhibits are filed herewith and this list is intended to constitute the exhibit index:
3.1
Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999 (incorporated by reference to exhibit 3.1 to our Form 10-K for the year ended December 31, 1999).
3.2
2013 Amended and Restated Bylaws of Lithia Motors, Inc. (incorporated by reference to exhibit 3.1 to Form 8-K dated August 20, 2013 and filed with the Securities and Exchange Commission on August 26, 2013).
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
32.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
32.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
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.
Date: July 31, 2015
By: /s/ Christopher S. Holzshu
Christopher S. Holzshu
Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial Officer)
By: /s/ John F. North III
John F. North III
Vice President
(Principal Accounting Officer)
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