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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 


 

FORM 10-Q

 


 

(Mark One)

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2004

 

OR

 

o 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.)

 

 

 

360 E. Jackson Street, Medford, Oregon

 

97501

(Address of principal executive offices)

 

(Zip Code)

 

 

 

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

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý              No  o

 

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

 

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

 

Class A common stock without par value

15,138,124

Class B common stock without par value

3,762,231

(Class)

(Outstanding at November 3, 2004)

 

 



 

LITHIA MOTORS, INC.
FORM 10-Q
INDEX

 

PART I - FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets – September 30, 2004 (unaudited) and December 31, 2003

 

 

 

 

 

Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2004 and 2003 (unaudited)

 

 

 

 

 

Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2004 and 2003 (unaudited)

 

 

 

 

 

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 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

Item 6.

Exhibits

 

 

 

Signatures

 

 

1



 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

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

 

 

 

September 30,
2004

 

December 31,
2003

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

39,129

 

$

74,408

 

Contracts in transit

 

52,014

 

44,709

 

Trade receivables, net of allowance for doubtful accounts of $399 and $413

 

41,099

 

42,199

 

Notes receivable, current portion, net of allowance for doubtful accounts of $41 and $49

 

70

 

208

 

Inventories, net

 

500,273

 

445,281

 

Vehicles leased to others, current portion

 

5,092

 

5,747

 

Prepaid expenses and other

 

5,457

 

3,392

 

Assets held for sale

 

12,163

 

20,408

 

Deferred income taxes

 

1,734

 

585

 

Total Current Assets

 

657,031

 

636,937

 

 

 

 

 

 

 

Land and buildings, net of accumulated depreciation of $7,315 and $5,683

 

208,246

 

164,676

 

Equipment and other, net of accumulated depreciation of $23,943 and $18,315

 

70,382

 

62,637

 

Goodwill

 

238,611

 

207,027

 

Other intangible assets, net of accumulated amortization of $57 and $39

 

42,183

 

28,946

 

Other non-current assets

 

4,315

 

2,559

 

Total Assets

 

$

1,220,768

 

$

1,102,782

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Flooring notes payable

 

$

410,116

 

$

378,961

 

Current maturities of long-term debt

 

5,999

 

14,299

 

Trade payables

 

27,623

 

24,402

 

Accrued liabilities

 

55,954

 

46,164

 

Liabilities held for sale

 

3,431

 

13,045

 

Total Current Liabilities

 

503,123

 

476,871

 

 

 

 

 

 

 

Used vehicle flooring facility

 

17,000

 

56,267

 

Real estate debt, less current maturities

 

124,775

 

80,159

 

Other long-term debt, less current maturities

 

136,522

 

98,308

 

Deferred revenue

 

752

 

875

 

Other long-term liabilities

 

11,721

 

7,235

 

Deferred income taxes

 

31,987

 

24,141

 

Total Liabilities

 

825,880

 

743,856

 

 

 

 

 

 

 

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 15,055 and 14,693

 

213,765

 

208,187

 

Class B common stock - no par value authorized 25,000 shares; issued and outstanding 3,762 and 3,762

 

468

 

468

 

Additional paid-in capital

 

1,588

 

1,231

 

Accumulated other comprehensive income (loss)

 

(108

)

(1,468

)

Retained earnings

 

179,175

 

150,508

 

Total Stockholders' Equity

 

394,888

 

358,926

 

Total Liabilities and Stockholders' Equity

 

$

1,220,768

 

$

1,102,782

 

 

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

 

2



 

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

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

New vehicle sales

 

$

451,005

 

$

411,358

 

$

1,204,823

 

$

1,083,697

 

Used vehicle sales

 

198,534

 

196,280

 

572,626

 

559,468

 

Service, body and parts

 

74,617

 

67,849

 

215,796

 

185,366

 

Finance and insurance

 

28,029

 

25,071

 

76,158

 

67,959

 

Fleet and other

 

3,708

 

882

 

6,606

 

4,822

 

Total revenues

 

755,893

 

701,440

 

2,076,009

 

1,901,312

 

Cost of sales

 

631,327

 

588,636

 

1,729,270

 

1,598,282

 

Gross profit

 

124,566

 

112,804

 

346,739

 

303,030

 

Selling, general and administrative

 

90,362

 

83,904

 

264,114

 

237,718

 

Depreciation - buildings

 

734

 

543

 

2,053

 

1,483

 

Depreciation and amortization - other

 

2,520

 

1,961

 

7,244

 

5,406

 

Income from continuing operations

 

30,950

 

26,396

 

73,328

 

58,423

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Floorplan interest expense

 

(4,498

)

(3,324

)

(12,237

)

(10,542

)

Other interest expense

 

(2,464

)

(1,496

)

(6,361

)

(4,448

)

Other expense, net

 

(502

)

(243

)

(1,199

)

(645

)

 

 

(7,464

)

(5,063

)

(19,797

)

(15,635

)

Income from continuing operations before income taxes

 

23,486

 

21,333

 

53,531

 

42,788

 

Income taxes

 

9,159

 

8,491

 

20,877

 

17,030

 

Income before discontinued operations

 

14,327

 

12,842

 

32,654

 

25,758

 

Income (loss) from discontinued operations, net of income tax expense (benefit) of $91, $26, $86 and $(128)

 

143

 

39

 

135

 

(193

)

Net income

 

$

14,470

 

$

12,881

 

$

32,789

 

$

25,565

 

 

 

 

 

 

 

 

 

 

 

Basic income per share from continuing operations

 

$

0.76

 

$

0.70

 

$

1.74

 

$

1.41

 

Basic income (loss) per share from discontinued operations

 

0.01

 

0.00

 

0.01

 

(0.01

)

Basic net income per share

 

$

0.77

 

$

0.70

 

$

1.75

 

$

1.40

 

 

 

 

 

 

 

 

 

 

 

Shares used in basic per share calculations

 

18,818

 

18,338

 

18,730

 

18,234

 

 

 

 

 

 

 

 

 

 

 

Diluted income per share from continuing operations

 

$

0.75

 

$

0.69

 

$

1.71

 

$

1.40

 

Diluted income (loss) per share from discontinued operations

 

0.01

 

0.00

 

0.00

 

(0.01

)

Diluted net income per share

 

$

0.76

 

$

0.69

 

$

1.71

 

$

1.39

 

 

 

 

 

 

 

 

 

 

 

Shares used in diluted per share calculations

 

19,121

 

18,708

 

19,127

 

18,430

 

 

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

 

3



 

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

 

 

 

Nine months ended September 30,

 

 

 

2004

 

2003

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

32,789

 

$

25,565

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

9,297

 

6,889

 

Depreciation and amortization from discontinued operations

 

 

517

 

Compensation expense related to stock option issuances

 

192

 

144

 

(Gain) loss on sale of assets

 

984

 

(656

)

Loss on sale of vehicles leased to others

 

109

 

136

 

Gain on sale of franchise

 

(914

)

(275

)

Deferred income taxes

 

6,029

 

4,288

 

Equity in (income) loss of affiliate

 

 

13

 

(Increase) decrease, net of effect of acquisitions:

 

 

 

 

 

Trade and installment contract receivables, net

 

1,394

 

(2,194

)

Contracts in transit

 

(7,305

)

(1,139

)

Inventories

 

(770

)

37,538

 

Prepaid expenses and other

 

(968

)

2,244

 

Other noncurrent assets

 

171

 

380

 

Increase (decrease), net of effect of acquisitions:

 

 

 

 

 

Flooring notes payable

 

(13,817

)

(17,470

)

Trade payables

 

3,080

 

4,306

 

Accrued liabilities

 

10,655

 

17,406

 

Other long-term liabilities and deferred revenue

 

4,147

 

(2,578

)

Net cash provided by operating activities

 

45,073

 

75,114

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Notes receivable issued

 

(16

)

(58

)

Principal payments received on notes receivable

 

775

 

371

 

Capital expenditures:

 

 

 

 

 

Non-financeable

 

(7,807

)

(3,712

)

Financeable

 

(31,640

)

(18,598

)

Proceeds from sale of assets

 

870

 

441

 

Expenditures for vehicles leased to others

 

(5,607

)

(4,626

)

Proceeds from sale of vehicles leased to others

 

1,425

 

832

 

Cash paid for acquisitions, net of cash acquired

 

(62,662

)

(48,256

)

Cash from sale of franchises

 

2,226

 

252

 

Distribution from affiliate

 

 

33

 

Net cash used in investing activities

 

(102,436

)

(73,321

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings (repayments) on lines of credit

 

(94,018

)

25,842

 

Principal payments on long-term debt and capital leases

 

(11,805

)

(2,983

)

Proceeds from issuance of long-term debt

 

129,069

 

7,688

 

Debt issuance costs

 

(2,550

)

 

Repurchase of common stock

 

(13

)

(215

)

Proceeds from issuance of common stock

 

5,523

 

3,457

 

Dividends paid

 

(4,122

)

(1,283

)

Net cash provided by financing activities

 

22,084

 

32,506

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(35,279

)

34,299

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Beginning of period

 

74,408

 

15,932

 

End of period

 

$

39,129

 

$

50,231

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

Cash paid for income taxes

 

$

14,035

 

$

3,966

 

Cash paid for interest

 

17,854

 

15,391

 

 

 

 

 

 

 

Supplemental Schedule of Non-Cash Transactions:

 

 

 

 

 

Debt issued in connection with acquisitions

 

$

12,000

 

$

 

Flooring debt assumed in connection with acquisitions

 

41,050

 

30,474

 

Assets acquired through real estate exchange

 

 

1,987

 

 

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

 

4



 

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

 

Note 1. Basis of Presentation

The financial information included herein as of September 30, 2004 and for the three and nine-month periods ended September 30, 2004 and 2003 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods.  The financial information as of December 31, 2003 is derived from our 2003 Annual Report on Form 10-K.  The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2003 Annual Report on Form 10-K.  The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

 

Note 2. Inventories

Inventories are valued at the lower of market value or cost, using the specific identification method for vehicles and parts.  Detail of inventory is as follows (in thousands):

 

 

 

September 30,
2004

 

December 31,
2003

 

New and program vehicles

 

$

389,685

 

$

355,937

 

Used vehicles

 

87,385

 

68,747

 

Parts and accessories

 

23,203

 

20,597

 

 

 

$

500,273

 

$

445,281

 

 

Note 3. Earnings Per Share

Following is a reconciliation of the shares used for our basic earnings per share (“EPS”) and diluted EPS (in thousands).

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Shares used for basic EPS

 

18,818

 

18,338

 

18,730

 

18,234

 

Dilutive effect of stock options calculated using the treasury stock method

 

303

 

370

 

397

 

196

 

Shares used for diluted EPS

 

19,121

 

18,708

 

19,127

 

18,430

 

 

 

 

 

 

 

 

 

 

 

Potential common shares excluded from diluted EPS since their effect would be antidilutive:

 

 

 

 

 

 

 

 

 

Stock options

 

327

 

20

 

327

 

609

 

 

Also excluded from the three and nine month periods ended September 30, 2004 are 2,255,314 shares of Class A common stock issuable upon conversion of our outstanding convertible debt.  See Note 10.  However, in October 2004, the Financial Accounting Standards Board (“FASB”) ratified a consensus position of the Emerging Issues Task Force, EITF 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings Per Share,” which will require the inclusion of the 2,255,314 shares in our diluted per share calculations in the future and the restatement of any prior period in which the contingently convertible debt was outstanding.  This new rule becomes effective for reporting periods ending on or after December 15, 2004. See also Note 13. New Accounting Pronouncements.

 

5



 

Note 4.  Comprehensive Income

Comprehensive income includes the change in hedging instruments that are reflected in stockholders’ equity instead of net income and unrealized gains and losses on investments.  The following table sets forth the calculation of comprehensive income for the periods indicated (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Net income

 

$

14,470

 

$

12,881

 

$

32,789

 

$

25,565

 

Unrealized gain (loss) on investments, net, subsequently realized

 

 

14

 

 

8

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

Net derivative gains (losses), net of tax effect of $1,466, $(189), $379 and $809, respectively

 

(2,292

)

412

 

(641

)

(1,103

)

Reversal of net derivative losses previously disclosed. This component has been recognized in our statements of operations as incremental interest expense, net of tax effect of $(411), $(393), $(1,280) and $(1,086), respectively

 

642

 

594

 

2,001

 

1,642

 

Total comprehensive income

 

$

12,820

 

$

13,901

 

$

34,149

 

$

26,112

 

 

Note 5.  Acquisitions

The following acquisitions were made in the first nine months of 2004.  For information on the acquisition made in October 2004, see Note 15. Subsequent Events.

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

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

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

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

                  In September 2004, we acquired a Chrysler Dodge Jeep and a Honda store in Great Falls, Montana, which have anticipated combined annual revenue of approximately $40 million.  The stores have been renamed Lithia Chrysler Dodge Jeep of Great Falls and Honda of Great Falls, respectively.

 

The above acquisitions were accounted for under the purchase method of accounting.  Pro forma results of operations assuming the above acquisitions occurred as of January 1, 2003 are as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Total revenues

 

$

764,151

 

$

778,067

 

$

2,126,112

 

$

2,091,103

 

Net income

 

14,710

 

15,256

 

33,110

 

29,567

 

Basic earnings per share

 

0.78

 

0.83

 

1.77

 

1.62

 

Diluted earnings per share

 

0.77

 

0.82

 

1.73

 

1.60

 

 

6



 

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.

 

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

 

Inventories

 

$

47,215

 

Other current assets

 

385

 

Property and equipment

 

24,151

 

Goodwill

 

31,865

 

Other intangible assets – franchise value

 

13,105

 

Total assets acquired

 

116,721

 

 

 

 

 

Flooring notes payable

 

41,050

 

Other current liabilities

 

489

 

Other non-current liabilities

 

288

 

Total liabilities acquired

 

41,827

 

Net assets acquired

 

$

74,894

 

 

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

 

Note 6.  Dividend Payments

Cash dividends at the rate of $0.07 per common share, which totaled approximately $1.3 million, were paid on March 19, 2004 to shareholders of record on March 5, 2004 and on May 21, 2004 to shareholders of record on May 7, 2004.  In addition, a cash dividend at the rate of $0.08 per common share, which totaled approximately $1.5 million, was paid on August 16, 2004 to shareholders of record on August 2, 2004.

 

Note 7.  U.S. Bank Agreement Amendment

In February 2004, our U.S. Bank N.A. agreement was amended to provide for a $50.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2006. Previously, the amount available under this line of credit was $35.0 million with expiration on January 31, 2005.  At September 30, 2004, we had $50.0 million outstanding on this line of credit.

 

Note 8.  DaimlerChrysler and Toyota Motor Credit Agreement Amendment

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

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

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

 

At September 30, 2004, we had $17.0 million outstanding on this credit agreement.

 

Note 9.  Interest Rate Swaps

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

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

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

 

At September 30, 2004, we had a total of $175.0 million of interest rate swaps outstanding, which are accounted for as cash flow hedges. The fair value of our interest rate swap agreements represents the estimated receipts or payments that would be made to terminate the agreements.  These amounts are recorded as deferred gains or losses in our consolidated balance sheet with the offset recorded in

 

7



 

accumulated other comprehensive income, net of tax.  The amount of deferred gains and (losses) at September 30, 2004 were $1.1 million and $(1.2) million, respectively.  Because the critical terms of the interest rate swaps and the underlying debt obligations are the same, there was no ineffectiveness recorded in interest expense.

 

Note 10.  Debt Offering

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

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

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

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

                  if the notes have been called for redemption; or

                  upon certain specified corporate events.

 

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

 

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

 

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

 

Note 11.  Amendments to Stock Plans

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

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

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

 

Note 12.  Repurchase of Class A Common Stock

On September 14, 2004, we repurchased 600 shares of our Class A common stock at a price of $21.00 per share, for a total purchase price of $12,600.

 

8



 

 

Note 13.  New Accounting Pronouncements

In October 2004, the FASB ratified EITF 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings Per Share.”  Upon final approval of EITF 04-8, we will be required to include 2,255,314 shares of common stock issuable upon conversion of our outstanding convertible debt in our diluted earnings per share calculations.  The new accounting rules become effective for periods ending on or after December 15, 2004 and diluted EPS in prior periods in which the convertible debt was outstanding will be restated.  Diluted EPS would have been $0.70 per share and $1.65 per share, respectively, in the three and nine month periods ended September 30, 2004 had the new rules been in effect as of September 30, 2004.  Adoption of this accounting statement change will not affect our net income, cash flows or basic earnings per share.

 

Note 14.  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):

 

Three Months Ended September 30,

 

2004

 

2003

 

Net income, as reported

 

$

14,470

 

$

12,881

 

Add – Stock-based employee compensation expense included in reported net income, net of related tax effects

 

25

 

25

 

Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects

 

(625

)

(547

)

Net income, pro forma

 

$

13,870

 

$

12,359

 

Basic net income per share:

 

 

 

 

 

As reported

 

$

0.77

 

$

0.70

 

Pro forma

 

$

0.74

 

$

0.67

 

Diluted net income per share:

 

 

 

 

 

As reported

 

$

0.76

 

$

0.69

 

Pro forma

 

$

0.73

 

$

0.67

 

 

Nine Months Ended September 30,

 

2004

 

2003

 

Net income, as reported

 

$

32,789

 

$

25,565

 

Add – Stock-based employee compensation expense included in reported net income, net of related tax effects

 

75

 

74

 

Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects

 

(1,809

)

(1,604

)

Net income, pro forma

 

$

31,055

 

$

24,035

 

Basic net income per share:

 

 

 

 

 

As reported

 

$

1.75

 

$

1.40

 

Pro forma

 

$

1.66

 

$

1.32

 

Diluted net income per share:

 

 

 

 

 

As reported

 

$

1.71

 

$

1.39

 

Pro forma

 

$

1.64

 

$

1.32

 

 

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

 

Three and Nine Months Ended September 30,

 

2004

 

2003

 

Risk-free interest rate

 

0.93 - 3.25

%

2.5 - 3.0

%

Expected dividend yield

 

1.04 - 1.42

%

0 - 1.7

%

Expected lives - 2001 Plan

 

5.4 years

 

7.7 - 8 years

 

- Purchase Plan

 

3 months

 

3 months

 

Expected volatility

 

28.11 - 43.32

%

45.63 - 46.79

%

 

9



 

Note 15.  Subsequent Events

 

Acquisition

The following acquisitions were made subsequent to September 30, 2004:

                  In October 2004, we acquired a Chrysler and a Jeep franchise in Santa Rosa, California, with anticipated annual revenue of approximately $10 million.  These franchises have been combined with our existing Dodge store in Santa Rosa.  The store is now named Lithia Chrysler Dodge Jeep of Santa Rosa.

                  In October 2004, we acquired a BMW store in Anchorage, Alaska, which has anticipated annual revenue of approximately $15 million.  The store is now named BMW of Anchorage.

                  In November 2004, we acquired a Chrysler Jeep Dodge franchise in Santa Fe, New Mexico, with anticipated annual revenue of approximately $30 million.  The store is now named Lithia Chrysler Jeep Dodge of Santa Fe.

 

Dividend

In October 2004, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.08 per share for the third quarter of 2004.  The dividend, which will total approximately $1.5 million, will be paid on November 15, 2004 to shareholders of record on November 1, 2004.

 

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

 

Forward-Looking Statements

 

Some of the statements in this Form 10-Q constitute forward-looking statements.  In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Exhibit 99.1 to our 2003 Annual Report on Form 10-K.

 

Although we believe that the 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.

 

General

 

We are a leading operator of automotive franchises and retailer of new and used vehicles and services.  As of November 5, 2004, we offered 25 brands of new vehicles through 161 franchises in 85 stores in the Western United States and over the Internet.  As of November 5, 2004, we operated 16 stores in Oregon, 11 in California, 11 in Washington, 9 in Texas, 7 in Idaho, 7 in Colorado, 7 in Alaska, 6 in Nevada, 5 in Montana, 2 in South Dakota, 2 in Nebraska, 1 in Oklahoma 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.

 

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

 

10



 

For the remainder of 2004, we expect that manufacturers will continue to offer incentives on new vehicle sales through a combination of rebates and low interest rate loans to consumers.

 

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.  This trend continued in the first three quarters of 2004, and is expected to continue throughout the rest of 2004.  We have implemented new procedures in the used vehicle business to help offset this negative impact as follows:

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

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

 

Results of Continuing Operations

 

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

 

Three Months Ended September 30, 2004

 

Percent of
Total Revenues

 

Gross
Margin

 

Percent of Total
Gross Profit

 

New vehicles

 

59.7

%

7.9

%

28.6

%

Retail used vehicles(1)

 

22.0

 

14.1

 

18.8

 

Service, body and parts

 

9.9

 

48.5

 

29.1

 

Finance and insurance(2)

 

3.7

 

99.8

 

22.5

 

Fleet and other.

 

0.5

 

7.4

 

0.2

 

 

Three Months Ended September 30, 2003

 

Percent of
Total Revenues

 

Gross
Margin

 

Percent of Total
Gross Profit

 

New vehicles

 

58.6

%

7.6

%

27.8

%

Retail used vehicles(1)

 

23.5

 

14.6

 

21.4

 

Service, body and parts

 

9.7

 

47.2

 

28.4

 

Finance and insurance(2)

 

3.6

 

99.9

 

22.2

 

Fleet and other.

 

0.1

 

17.0

 

0.1

 

 

Nine Months Ended September 30, 2004

 

Percent of
Total Revenues

 

Gross
Margin

 

Percent of Total
Gross Profit

 

New vehicles

 

58.0

%

7.8

%

27.3

%

Retail used vehicles(1)

 

23.0

 

14.3

 

19.6

 

Service, body and parts

 

10.4

 

48.2

 

30.0

 

Finance and insurance(2)

 

3.7

 

99.6

 

21.9

 

Fleet and other.

 

0.3

 

13.5

 

0.3

 

 

Nine Months Ended September 30, 2003

 

Percent of
Total Revenues

 

Gross
Margin

 

Percent of Total
Gross Profit

 

New vehicles

 

57.0

%

7.6

%

27.3

%

Retail used vehicles(1)

 

24.5

 

13.9

 

21.2

 

Service, body and parts

 

9.7

 

47.2

 

28.9

 

Finance and insurance(2)

 

3.6

 

99.7

 

22.4

 

Fleet and other..

 

0.3

 

17.3

 

0.3

 

 


(1)        Excludes wholesale used vehicle sales, representing 4.2%, 4.5%, 4.6% and 4.9% of total revenues, respectively, and a gross margin contribution of 0.8%, 0.1%, 0.9% and (0.1)%, respectively, for the three and nine month periods ended September 30, 2004 and 2003.

(2)        Reported net of estimated cancellations.

 

11



 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

Lithia Motors, Inc. (1)

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

New vehicles

 

59.7

%

58.6

%

58.0

%

57.0

%

Used vehicles

 

26.2

 

28.0

 

27.6

 

29.4

 

Service, body and parts

 

9.9

 

9.7

 

10.4

 

9.7

 

Finance and insurance

 

3.7

 

3.6

 

3.7

 

3.6

 

Fleet and other

 

0.5

 

0.1

 

0.3

 

0.3

 

Total revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

Gross profit

 

16.5

 

16.1

 

16.7

 

15.9

 

Selling, general and administrative expenses

 

12.0

 

12.0

 

12.7

 

12.5

 

Depreciation and amortization

 

0.4

 

0.4

 

0.4

 

0.4

 

Income from operations

 

4.1

 

3.8

 

3.5

 

3.1

 

Floorplan interest expense

 

0.6

 

0.5

 

0.6

 

0.6

 

Other interest expense

 

0.3

 

0.2

 

0.3

 

0.2

 

Other expense, net

 

0.1

 

 

0.1

 

 

Income from continuing operations before taxes

 

3.1

 

3.0

 

2.6

 

2.3

 

Income tax expense

 

1.2

 

1.2

 

1.0

 

0.9

 

Income from continuing operations

 

1.9

%

1.8

%

1.6

%

1.4

%

 


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

 

The following tables set forth the changes in our operating results from continuing operations in the three and nine-month periods ended September 30, 2004 compared to the three and nine month periods ended September 30, 2003 (dollars in thousands):

 

 

 

Three Months Ended
September 30,

 

Increase
(Decrease)

 

%
Increase
(Decrease)

 

 

 

2004

 

2003

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

New vehicle sales

 

$

451,005

 

$

411,358

 

$

39,647

 

9.6

%

Used vehicle sales

 

198,534

 

196,280

 

2,254

 

1.1

 

Service, body and parts

 

74,617

 

67,849

 

6,768

 

10.0

 

Finance and insurance

 

28,029

 

25,071

 

2,958

 

11.8

 

Fleet and other

 

3,708

 

882

 

2,826

 

320.4

 

Total revenues

 

755,893

 

701,440

 

54,453

 

7.8

 

Cost of sales

 

631,327

 

588,636

 

42,691

 

7.3

 

Gross profit

 

124,566

 

112,804

 

11,762

 

10.4

 

Selling, general and administrative

 

90,362

 

83,904

 

6,458

 

7.7

 

Depreciation and amortization

 

3,254

 

2,504

 

750

 

30.0

 

Income from operations

 

30,950

 

26,396

 

4,554

 

17.3

 

Floorplan interest expense

 

(4,498

)

(3,324

)

1,174

 

35.3

 

Other interest expense

 

(2,464

)

(1,496

)

968

 

64.7

 

Other, net

 

(502

)

(243

)

259

 

106.6

 

Income from continuing operations before taxes

 

23,486

 

21,333

 

2,153

 

10.1

 

Income tax expense

 

9,159

 

8,491

 

668

 

7.9

 

Income from continuing operations

 

$

14,327

 

$

12,842

 

$

1,485

 

11.6

%

 

 

 

 

 

 

 

 

 

 

New units sold

 

16,012

 

15,358

 

654

 

4.3

%

Average selling price per new vehicle

 

$

28,167

 

$

26,785

 

$

1,382

 

5.2

 

 

 

 

 

 

 

 

 

 

 

Used units sold - retail

 

10,845

 

11,492

 

(647

)

(5.6

)

Average selling price per retail used vehicle

 

$

15,330

 

$

14,361

 

$

969

 

6.7

 

 

 

 

 

 

 

 

 

 

 

Used units sold – wholesale

 

6,154

 

6,980

 

(826

)

(11.8

)

Average selling price per wholesale used vehicle

 

$

5,246

 

$

4,477

 

$

769

 

17.2

 

 

 

 

 

 

 

 

 

 

 

Finance and insurance income per retail unit

 

$

1,044

 

$

934

 

$

110

 

11.8

%

 

12



 

 

 

Nine Months Ended
September 30,

 

Increase
(Decrease)

 

%
Increase
(Decrease)

 

 

 

2004

 

2003

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

New vehicle sales

 

$

1,204,823

 

$

1,083,697

 

$

121,126

 

11.2

%

Used vehicle sales

 

572,626

 

559,468

 

13,158

 

2.4

 

Service, body and parts

 

215,796

 

185,366

 

30,430

 

16.4

 

Finance and insurance

 

76,158

 

67,959

 

8,199

 

12.1

 

Fleet and other

 

6,606

 

4,822

 

1,784

 

37.0

 

Total revenues

 

2,076,009

 

1,901,312

 

174,697

 

9.2

 

Cost of sales

 

1,729,270

 

1,598,282

 

130,988

 

8.2

 

Gross profit

 

346,739

 

303,030

 

43,709

 

14.4

 

Selling, general and administrative

 

264,114

 

237,718

 

26,396

 

11.1

 

Depreciation and amortization

 

9,297

 

6,889

 

2,408

 

35.0

 

Income from operations

 

73,328

 

58,423

 

14,905

 

25.5

 

Floorplan interest expense

 

(12,237

)

(10,542

)

1,695

 

16.1

 

Other interest expense

 

(6,361

)

(4,448

)

1,913

 

43.0

 

Other, net

 

(1,199

)

(645

)

554

 

85.9

 

Income from continuing operations before taxes

 

53,531

 

42,788

 

10,743

 

25.1

 

Income tax expense

 

20,877

 

17,030

 

3,847

 

22.6

 

Income from continuing operations

 

$

32,654

 

$

25,758

 

$

6,896

 

26.8

%

 

 

 

 

 

 

 

 

 

 

New units sold

 

43,255

 

41,088

 

2,167

 

5.3

%

Average selling price per new vehicle

 

$

27,854

 

$

26,375

 

$

1,479

 

5.6

 

 

 

 

 

 

 

 

 

 

 

Used units sold - retail

 

31,875

 

32,036

 

(161

)

(0.5

)

Average selling price per retail used vehicle

 

$

14,981

 

$

14,516

 

$

465

 

3.2

 

 

 

 

 

 

 

 

 

 

 

Used units sold – wholesale

 

17,961

 

19,921

 

(1,960

)

(9.8

)

Average selling price per wholesale used vehicle

 

$

5,295

 

$

4,740

 

$

555

 

11.7

 

 

 

 

 

 

 

 

 

 

 

Finance and insurance income per retail unit

 

$

1,014

 

$

929

 

$

85

 

9.2

%

 

Revenues

Total revenues increased 7.8% and 9.2%, respectively, in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003, as a result of acquisitions and increases in the average new and used vehicle sales prices. These increases were offset by same-store retail sales declines of 4.2% and 2.9%, respectively, for the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003.  Same-store sales percentage increases (decreases) were as follows:

 

 

 

Three months ended
September 30, 2004 vs.
three months ended
September 30, 2003

 

Nine months ended
September 30, 2004 vs.
nine months ended
September 30, 2003

 

New vehicles

 

(3.6

)%

(2.2

)%

Retail used vehicles

 

(7.5

)

(7.2

)

Service, body and parts

 

(1.4

)

3.0

 

Finance and insurance

 

0.3

 

0.5

 

Total retail sales

 

(4.2

)

(2.9

)

 

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

 

New vehicle same store sales were down in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003 due to a slower sales environment and that during the same periods last year, new vehicle same store sales were strong.  Used vehicle same store sales have been negatively affected in the same periods by continued manufacturer incentives on new vehicles. Although same store sales have declined in the current periods, we have experienced an increase in gross margins in new vehicles in the three and nine month periods of 2004 compared to the same periods last year. Margins on our retail used vehicles have increased in the nine months

 

13



 

ended September 30, 2004 compared to the same period of 2003 and are above our historical averages for both the three and nine month periods of 2004.

 

While same-store service, body and parts revenue was down in the three months ended September 30, 2004 compared to the three months ended September 30, 2003, it remains up for the year to date period as a result of our continued focus on service-advisor training and our Lifetime Oil Program.  We continue to experience positive same-store sales growth in the customer-pay side of the business. Conversely, improvements in the quality of Chrysler, General Motors, Ford and Toyota vehicles, which comprise more than 80% of our total new vehicle sales, have resulted in declines in warranty work for these brands. Other brands continue to demonstrate increases in same-store warranty sales.

 

Fleet and other sales include both fleet sales and fees received for delivering vehicles on behalf of the manufacturer, the U.S. military, rent-a-car companies or leasing companies.

 

Penetration rates for certain products were as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Finance and insurance

 

79

%

73

%

77

%

74

%

Service contracts

 

43

 

42

 

43

 

41

 

Lifetime oil and filter change

 

34

 

34

 

36

 

34

 

 

Gross Profit

Gross profit increased $11.8 million and $43.7 million, respectively, in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003 due to increased total revenues as well as increases in our overall gross margin. Gross margins achieved were as follows:

 

 

 

Three Months Ended September 30,

 

Lithia
Margin Change*

 

 

 

2004

 

2003

 

 

New vehicles

 

7.9

%

7.6

%

30bp

 

Retail used vehicles

 

14.1

 

14.6

 

(50

)

Service and parts

 

48.5

 

47.2

 

130

 

Finance and insurance

 

99.8

 

99.9

 

(10

)

Overall

 

16.5

 

16.1

%

40

 

 

 

 

Nine Months Ended September 30,

 

Lithia
Margin Change*

 

 

 

2004

 

2003

 

 

New vehicles

 

7.8

%

7.6

%

20bp

 

Retail used vehicles

 

14.3

 

13.9

 

40

 

Service and parts

 

48.2

 

47.2

 

100

 

Finance and insurance

 

99.6

 

99.7

 

(10

)

Overall

 

16.7

 

15.9

%

80

 

 


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

 

The increase in the overall gross profit margin in the first nine months of 2004 compared to the first nine months of 2003 was a result of improvements in the margins achieved on our new and used vehicle businesses as well as an our service and parts business.  Additionally, the increase in our high-margin service and parts revenue as a percentage of total revenue also positively affected our gross margins.

 

Due to the slower new vehicle sales environment in 2004, we have implemented internal directives aimed at generating more gross profit per vehicle sold.  We were able to achieve improved margins on our new vehicles in both the three and nine month periods ended September 30, 2004 compared to

 

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the same periods of 2003. This compares to a higher volume, lower margin strategy that was in place in 2003.

 

In 2004, we have been able to improve the margins on our used vehicle sales primarily due to the strategies discussed above regarding the auctioning of undesired used vehicles and our “Used Vehicle Promo Pricing” for our retail sales.

 

However, the decrease in used vehicle gross margins in the three month period ended September 30, 2004 compared to the three month period ended September 30, 2003 was primarily due to the fact that, in the third quarter of 2003, margins on used vehicles were at historical highs.  Gross margins achieved on used vehicles in both the three and nine month periods ended September 30, 2004 are above our historical averages.

 

Our focus on service advisor training, which has led to gains in sales of higher margin service items, and cost saving initiatives across all service, parts and body shop business lines has led to the improved gross margins in this area.

 

Selling, General and Administrative Expense

Selling, general and administrative (“SG&A”) expense includes salaries and related personnel expenses, facility lease expense, advertising (net of manufacturer cooperative advertising credits), legal, accounting, professional services and general corporate expenses. Selling, general and administrative expense increased $6.5 million and $26.4 million, respectively, in the three and nine-month periods ended September 30, 2004 compared to same periods of 2003.  The increases in dollars spent are due to increased selling, or variable, expenses related to the increases in revenues and the number of locations. SG&A as a percentage of sales will increase when the service and parts revenue contribution increases relative to total sales due to its higher SG&A component.  Because of this, a better gauge is the trend of SG&A as a percentage of gross profit. SG&A as a percentage of gross profit has improved 190 and 220 basis points, respectively, for the three and nine-month periods ended September 30, 2004 compared to same periods of 2003.

 

Depreciation and Amortization

Depreciation and amortization increased $750,000 and $2.4 million, respectively, in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003 due to the addition of property and equipment and intangibles related to our acquisitions, as well as leasehold improvements to existing facilities.

 

Income from Operations

Operating margins improved by 30 basis points and 40 basis points in the three and nine-month periods ended September 30, 2004, respectively, to 4.1% and 3.5%, respectively, from 3.8% and 3.1%, respectively, in the comparable periods of 2003.  The increases are due to the improved overall gross profit margins as discussed above.

 

Floorplan Interest Expense

Floorplan interest expense increased $1.2 million and $1.7 million, respectively, in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003.  These increases resulted from a $609,000 and a $1.4 million increase, respectively, in the average outstanding balances of our floorplan facilities, mainly due to acquisitions, and increases of $65,000 and $553,000, respectively, resulting from our interest rate swaps.  In addition in the three-month period ended September 30, 2004, an increase in the average interest rates charged on our facilities increased floorplan interest expense by $501,000 compared to the three-month period ended September 30, 2003.  However, in the nine-month period ended September 30, 2004, average interest rates were lower compared to the nine-month period ended September 30, 2003, resulting in a $291,000 decrease to floorplan interest for the period.

 

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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 $1.0 million and $1.9 million, respectively, in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003. Changes in the weighted average interest rate on our debt in the three and nine-month periods ended September 30, 2004 compared to the same periods of 2003 increased other interest expense by approximately $144,000 and $330,000, respectively, and changes in the average outstanding balances resulted in increases of approximately $856,000 and $1.6 million, respectively.  Interest expense related to the $85.0 million of convertible notes that were issued in May 2004 totals approximately $741,000 per quarter, which consists of $611,000 of contractual interest and $130,000 of amortization of debt issuance costs.

 

Income Tax Expense

Our effective tax rate was 39.0% in the first nine months of 2004 compared to 39.8% in the first nine months of 2003. Our effective tax rate may be affected in the future by the mix of asset acquisitions compared to corporate acquisitions, as well as by the mix of states where our stores are located.

 

Income from Continuing Operations

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

 

Discontinued Operations

 

During 2003, we decided to sell certain stores and related franchises. During the third quarter of 2004, we disposed of one of the franchise included with the store we had held for sale.  At September 30, 2004, we had $12.2 million of assets classified as assets held for sale on our balance sheet primarily related to the remaining franchise of the one store we intend to sell during 2004. The assets primarily include inventory and property, plant and equipment. Liabilities held for sale of $3.4 million at September 30, 2004 represent new vehicle flooring notes payable related to the store held for sale.

 

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

 

Seasonality and Quarterly Fluctuations

 

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

 

Liquidity and Capital Resources

 

Our principal needs for capital resources are to finance acquisitions and capital expenditures, as well as for working capital. We have relied primarily upon internally generated cash flows from operations, borrowings under our credit agreements and the proceeds from public equity and private debt offerings to finance operations and expansion. In addition, in May 2004, we closed an $85.0 million private debt offering. We believe that our available cash, cash equivalents, available lines of credit, cash received from our debt offering in May 2004 and cash flows from operations will be sufficient to

 

16



 

meet our anticipated operating expenses and capital requirements for at least 24 to 36 months from September 30, 2004.

 

Our inventories increased to $500.3 million at September 30, 2004 from $445.3 million at December 31, 2003 due primarily to acquisitions and our decision to purchase a greater stock of 2004 vehicles going into the third quarter in order to take advantage of the anticipated strong incentive environment for the 2004 models as the 2005 models are introduced.  Our new and used flooring notes payable decreased to $427.1 million at September 30, 2004 from $435.2 million at December 31, 2003 due to a decrease in days supply, offset in part by acquisitions.  New vehicles are financed at approximately 100% and used vehicles are financed at approximately 80% of cost. Our days supply of new vehicles decreased by approximately 7 days at September 30, 2004 compared to December 31, 2003 and by approximately 16 days compared to June 30, 2004. Our days supply of used vehicles increased by approximately 11 days at September 30, 2004 compared to December 31, 2003 and increased approximately 6 days compared to June 30, 2004 as a result of continued weakness in the used vehicle market.  We believe that our new and used vehicle inventories are at appropriate levels at this time.

 

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

 

As a result of the acquisition of 7 stores in the first nine months of 2004, our goodwill and other intangibles increased $44.8 million to $280.8 million at September 30, 2004, compared to $236.0 million at December 31, 2003.

 

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

 

In June 2000, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our Class A common stock. Through September 2004, we have purchased a total of 60,000 shares under this program and may continue to do so from time to time in the future as conditions warrant.  However, the recent change in the tax law tends to equalize the benefits of dividends and share repurchases as a means to return capital or earnings to shareholders. As a result, we believe it is now advantageous to shareholders to have a dividend in place.  With the dividend, we are able to offer an immediate and tangible return to our shareholders without reducing our already limited market float, which occurs when we repurchase shares.

 

We have a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC and Toyota Motor Credit Corporation, as amended in June 2004, totaling up to $150 million, which expires May 1, 2007 with an option to extend to May 1, 2008, with interest due monthly.  This credit facility is cross-collateralized and secured by cash and cash equivalents, new and used vehicles that are not specifically financed by other lenders, parts inventories, accounts receivable, intangible assets and equipment.  We pledged to DaimlerChrysler Services and Toyota Motor Credit the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

 

The financial covenants in our agreement with DaimlerChrysler Services and Toyota Motor Credit require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels.   At September 30, 2004, we were in compliance with all of the covenants of this agreement.

 

17



 

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

 

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

 

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

 

Interest rates on all of the above facilities ranged from 3.49% to 4.59% at September 30, 2004.  Amounts outstanding on the lines at September 30, 2004 together with amounts remaining available under such lines were as follows (in thousands):

 

 

 

Outstanding at
September 30, 2004

 

Remaining Availability as
of September 30, 2004

 

New and program vehicle lines

 

$

410,116

 

$

 

*

Working capital and used vehicle line

 

17,000

 

133,000

 

Real estate line

 

 

40,000

 

Equipment/leased vehicle line

 

50,000

 

 

 

 

$

477,116

 

$

173,000

*


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

 

In May 2004, we sold $85.0 million of 2.875% senior subordinated convertible notes due 2014 through a Rule 144A offering to qualified institutional buyers. We will also pay contingent interest on the notes during any six-month interest period beginning May 1, 2009, in which the trading price of the notes for a specified period of time equals or exceeds 120% of the principal amount of the notes.  Net proceeds from this offering were approximately $82.5 million and were used to pay down our working capital and used vehicle line and new vehicle flooring notes payable. The notes are convertible into shares of our Class A common stock at a price of $37.69 per share upon the satisfaction of certain conditions and upon the occurrence of certain events as follows:

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

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

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

                  if the notes have been called for redemption; or

                  upon certain specified corporate events.

 

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

 

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

 

18



 

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

 

We had capital commitments of $16.7 million at September 30, 2004 for the construction of four new facility, additions to two existing facilities and the remodel of two facilities.  The new facilities will be for our Chevrolet dealership in Fairbanks, Alaska, our Toyota dealership in Springfield, Oregon and our Chevrolet and Hyundai dealerships in Odessa, Texas. We have already incurred $7.8 million for these projects, with an additional $7.9 million expected to be incurred during the fourth quarter of 2004 and the remaining $8.8 million to be incurred in 2005. We expect to pay for the construction out of existing cash balances until completion of the projects, at which time we anticipate securing long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended.

 

Subsequent to September 30, 2004 and through the filing of this Form 10-Q, we had used $11.5 million of cash for acquisitions.

 

Critical Accounting Policies and Use of Estimates

 

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

 

Executive Bonuses

We make certain estimates, judgments and assumptions regarding the likelihood of our attainment, and the level thereof, of the annual bonus criteria under our 2004 Discretionary Executive Bonus Program in order to record bonus expense on a quarterly basis. We accrue the estimated year-end expense on a pro-rata basis throughout the year based on bonus attainment expectations.  These estimates, judgments and assumptions are made quarterly based on available information and take into consideration the historical seasonality of our business and current trends.  If actual year-end results differ materially from our estimates, the amount of bonus expense recorded in a particular quarter could be significantly over or under estimated.

 

New Accounting Pronouncements

 

See Note 13. of Notes to Consolidated Financial Statements.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

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

 

The fair market value of our long-term fixed interest rate debt is subject to interest rate risk.  Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise.  The interest rate changes affect the fair market value of our long-term debt, but do not impact earnings or cash flows. Based on open market trades, we determined that our $85.0 million of long-term convertible fixed interest rate debt issued in May 2004 had a fair market value of approximately $77.9 million at September 30, 2004.

 

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Item 4.  Controls and Procedures

 

Disclosure Controls and Procedures

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

 

Internal Control Over Financial Reporting

There has been 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.

 

PART II - OTHER INFORMATION

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

We repurchased the following shares of our Class A common stock during the third quarter of 2004:

 

 

 

Total number
of shares
purchased

 

Average
price paid
per share

 

Total number of
shares purchased
as part of publicly
announced plan

 

Maximum number
of shares that may
yet be purchased
under the plan

 

July 1 to July 31

 

 

 

 

 

August 1 to August 31

 

 

 

 

 

September 1 to September 30

 

600

 

$

21.00

 

60,000

 

940,000

 

Total

 

600

 

$

21.00

 

60,000

 

940,000

 

 

The plan to repurchase up to a total of 1.0 million shares of our Class A common stock was approved by our Board of Directors in June 2000 and does not have an expiration date.

 

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 (filed as Exhibit 3.1 to Form 10-K filed March 30, 2000 and incorporated herein by reference).

 

3.2

Bylaws (filed as Exhibit 3.2 to Form S-1, Registration Statement No. 333-14031, as declared effective by the Securities and Exchange Commission on December 18, 1996 and incorporated herein by reference).

 

4.1

Indenture dated May 4, 2004, between Lithia motors, Inc. and U.S. Bank National Association, as Trustee, relating to 2.875% Convertible Senior Subordinated Notes due 2014 (filed as Exhibit 4.1 to Form 10-Q filed May 10, 2004 and incorporated herein by reference).

 

10.3

Modification No. 3, dated as of February 20, 2004, to Amended and Restated Revolving Loan and Security Agreement and Notes Secured by Deed of Trust (filed as Exhibit 10.3 to Form 10-Q filed May 10, 2004 and incorporated herein by reference).

 

10.4

Third Amendment, dated as of June 30, 2004, to Credit Agreement dated February 25, 2003, between DaimlerChrysler Services North America LLC, as Agent and Lithia Motors, Inc. (filed as Exhibit 10.4 to Form 10-Q filed August 6, 2004 and incorporated herein by reference).

 

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.

 

20



 

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:  November 9, 2004

LITHIA MOTORS, INC.

 

 

 

 

 

By

/s/ JEFFREY B. DEBOER

 

 

Jeffrey B. DeBoer

 

Senior Vice President and

 

Chief Financial Officer

 

(Principal Financial Officer)

 

 

 

 

 

By

/s/ LINDA A. GANIM

 

 

Linda A. Ganim

 

Vice President and Chief Accounting Officer

 

(Principal Accounting Officer)

 

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