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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

 

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(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, 2014

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

 

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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

 

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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		23,545,648
Class B common stock without par value		2,562,231
(Class)		(Outstanding at August 8, 2014)

 

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LITHIA MOTORS, INC.

FORM 10-Q

INDEX 

 

PART I - FINANCIAL INFORMATION		Page
Item 1.	Financial Statements
	Consolidated Balance Sheets (Unaudited) – June 30, 2014 and December 31, 2013	2
	Consolidated Statements of Operations (Unaudited) – Three and Six Months Ended June 30, 2014 and 2013	3
	Consolidated Statements of Comprehensive Income (Unaudited) – Three and Six Months Ended June 30, 2014 and 2013	4
	Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2014 and 2013	5
	Condensed Notes to Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 4.	Controls and Procedures	40
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 6.	Exhibits	41
Signatures		42

  

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

(Unaudited)

 

 

		June 30,				December 31,
		2014				2013
Assets
Current Assets:
Cash and cash equivalents		$	28,203			$	23,686
Accounts receivable, net			191,228				170,519
Inventories, net			981,223				859,019
Deferred income taxes			222				1,548
Other current assets			12,028				15,251
Assets held for sale			-				11,526
Total Current Assets			1,212,904				1,081,549
Property and equipment, net of accumulated depreciation of $113,594 and $106,871			528,254				481,212
Goodwill			65,004				49,511
Franchise value			77,728				71,199
Deferred income taxes			14,624				10,256
Other non-current assets			41,613				31,394
Total Assets		$	1,940,127			$	1,725,121
Liabilities and Stockholders' Equity
Current Liabilities:
Floor plan notes payable		$	20,598			$	18,789
Floor plan notes payable: non-trade			806,684				695,066
Current maturities of long-term debt			7,578				7,083
Trade payables			56,384				51,159
Accrued liabilities			112,742				94,143
Liabilities related to assets held for sale			-				6,271
Total Current Liabilities			1,003,986				872,511
Long-term debt, less current maturities			260,835				245,471
Deferred revenue			48,918				44,005
Other long-term liabilities			34,537				28,412
Total Liabilities			1,348,276				1,190,399
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 23,544 and 23,329			266,172				268,255
Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 2,562 and 2,562			319				319
Additional paid-in capital			26,045				22,598
Accumulated other comprehensive loss			(1,259	)			(1,538	)
Retained earnings			300,574				245,088
Total Stockholders' Equity			591,851				534,722
Total Liabilities and Stockholders' Equity		$	1,940,127			$	1,725,121

 

See accompanying condensed notes to consolidated financial statements.

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Revenues:
New vehicle		$	694,484			$	569,487			$	1,274,006			$	1,062,928
Used vehicle retail			310,475				258,465				612,368				497,693
Used vehicle wholesale			44,286				37,691				86,979				77,197
Finance and insurance			43,838				34,218				83,469				65,881
Service, body and parts			114,337				94,462				218,954				184,902
Fleet and other			14,382				14,182				24,132				22,984
Total revenues			1,221,802				1,008,505				2,299,908				1,911,585
Cost of sales:
New vehicle			648,490				530,699				1,188,988				989,493
Used vehicle retail			266,408				219,572				527,505				423,827
Used vehicle wholesale			42,782				36,996				84,144				75,528
Service, body and parts			58,155				47,769				111,940				94,430
Fleet and other			13,667				13,636				22,970				22,036
Total cost of sales			1,029,502				848,672				1,935,547				1,605,314
Gross profit			192,300				159,833				364,361				306,271
Selling, general and administrative			125,463				109,283				247,292				210,414
Depreciation and amortization			5,825				4,899				11,332				9,620
Operating income			61,012				45,651				105,737				86,237
Floor plan interest expense			(3,215	)			(3,036	)			(6,199	)			(6,485	)
Other interest expense			(1,869	)			(1,941	)			(3,843	)			(4,302	)
Other income, net			1,146				584				2,083				1,385
Income from continuing operations before income taxes			57,074				41,258				97,778				76,835
Income tax provision			(21,904	)			(15,977	)			(37,914	)			(29,672	)
Income from continuing operations, net of income tax			35,170				25,281				59,864				47,163
Income from discontinued operations, net of income tax			3,139				274				3,179				447
Net income		$	38,309			$	25,555			$	63,043			$	47,610
Basic income per share from continuing operations		$	1.35			$	0.98			$	2.30			$	1.83
Basic income per share from discontinued operations			0.12				0.01				0.12				0.02
Basic net income per share		$	1.47			$	0.99			$	2.42			$	1.85
Shares used in basic per share calculations			26,119				25,782				26,047				25,730
Diluted income per share from continuing operations		$	1.34			$	0.97			$	2.27			$	1.81
Diluted income per share from discontinued operations			0.11				0.01				0.12				0.01
Diluted net income per share		$	1.45			$	0.98			$	2.39			$	1.82
Shares used in diluted per share calculations			26,331				26,134				26,326				26,120

 

See accompanying condensed notes to consolidated financial statements.

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited) 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Net income		$	38,309			$	25,555			$	63,043			$	47,610
Other comprehensive income, net of tax:
Gain on cash flow hedges, net of tax expense of $81, $209, $174, and $524 respectively			130				338				279				844
Comprehensive income		$	38,439			$	25,893			$	63,322			$	48,454

 

See accompanying condensed notes to consolidated financial statements.

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

		Six Months Ended June 30,
		2014				2013
Cash flows from operating activities:
Net income		$	63,043			$	47,610
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization			11,332				9,620
Stock-based compensation			3,259				2,603
Loss on disposal of other assets			62				33
Gain on sale of franchise			(5,744	)			-
Deferred income taxes			2,840				825
Excess tax benefit from share-based payment arrangements			(6,058	)			(5,408	)
(Increase) decrease (net of acquisitions and dispositions):
Trade receivables, net			(20,709	)			(10,684	)
Inventories			(77,300	)			(48,899	)
Other current assets			1,360				5,980
Other non-current assets			(7,311	)			(3,394	)
Increase (decrease) (net of acquisitions and dispositions):
Floor plan notes payable, net			368				3,384
Trade payables			1,411				2,078
Accrued liabilities			17,594				8,812
Other long-term liabilities and deferred revenue			11,659				11,889
Net cash provided by (used in) operating activities			(4,194	)			24,449
Cash flows from investing activities:
Principal payments received on notes receivable			-				61
Capital expenditures			(35,230	)			(22,107	)
Proceeds from sales of assets			103				420
Payments for life insurance policies			(3,454	)			(2,566	)
Cash paid for acquisitions			(79,482	)			(31,786	)
Cash from dispositions			10,617				-
Net cash used in investing activities			(107,446	)			(55,978	)
Cash flows from financing activities:
Borrowings on floor plan notes payable: non-trade, net			112,910				5,989
Borrowings on lines of credit			578,000				358,000
Repayments on lines of credit			(567,000	)			(327,318	)
Principal payments on long-term debt, scheduled			(3,693	)			(3,667	)
Principal payments on long-term debt and capital leases, other			-				(25,770	)
Proceeds from issuance of long-term debt			5,392				4,721
Proceeds from issuance of common stock			2,253				2,843
Repurchase of common stock			(10,206	)			(7,903	)
Excess tax benefit from share-based payment arrangements			6,058				5,408
Dividends paid			(7,557	)			(3,356	)
Net cash provided by financing activities			116,157				8,947
Decrease in cash and cash equivalents			4,517				(22,582	)
Cash and cash equivalents at beginning of period			23,686				42,839
Cash and cash equivalents at end of period		$	28,203			$	20,257
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	10,218			$	10,989
Cash paid during the period for income taxes, net			23,444				16,111
Supplemental schedule of non-cash activities:
Debt issued in connection with acquisitions			3,161				-
Floorplan debt paid in connection with dealership disposals			3,311				-

 

See accompanying condensed notes to consolidated financial statements.

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Interim Financial Statements

 

Basis of Presentation

These condensed Consolidated Financial Statements contain unaudited information as of June 30, 2014 and for the three- and six-month periods ended June 30, 2014 and 2013. 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 2013 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2013 is derived from our 2013 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 2013 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, 2014				December 31, 2013
Contracts in transit		$	99,390			$	85,272
Trade receivables			24,960				23,154
Vehicle receivables			25,728				23,606
Manufacturer receivables			33,852				31,662
Auto loan receivables			17,828			$	11,438
Other receivables			5,573				5,622
			207,331				180,754
Less: Allowance			(805	)			(546	)
Less: Long-term portion of accounts receivable, net			(15,298	)			(9,689	)
Total accounts receivable, net		$	191,228			$	170,519

 

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 third parties 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 interest income is 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 was included as a component of other non-current assets in the Consolidated Balance Sheets.

 

Note 3. Inventories

The components of inventory consisted of the following (in thousands):

 

		June 30, 2014				December 31, 2013
New vehicles		$	741,220			$	657,043
Used vehicles			203,645				167,814
Parts and accessories			36,358				34,162
Total inventories		$	981,223			$	859,019

 

Note 4. Goodwill

The changes in the carrying amounts of goodwill are as follows (in thousands):

 

		Goodwill
Balance as of December, 31, 2012, gross		$	331,313
Accumulated impairment loss			(299,266	)
Balance as of December 31, 2012, net			32,047
Additions through acquisitions			17,464
Balance as of December 31, 2013, net			49,511
Additions through acquisition			15,493
Balance as of June 30, 2014, net		$	65,004

 

Note 5. Commitments and Contingencies

 

Litigation

We are party to numerous legal proceedings arising in the normal course of our business. Although we do not anticipate that the resolution of legal proceedings arising in the normal course of business or the proceedings described below will have a material adverse effect on our business, results of operations, financial condition, or cash flows, we cannot predict this with certainty.

 

 

Alaska Consumer Protection Act Claims

In December 2006, a class action suit was filed against us (Jackie Neese, et al vs. Lithia Chrysler Jeep of Anchorage, Inc., et al, Case No. 3AN-06-13341 CI), and in April 2007, a second class action suit (Jackie Neese, et al vs. Lithia Chrysler Jeep of Anchorage, Inc, et al, Case No. 3AN-06-4815 CI) was filed against us, in the Superior Court for the State of Alaska, Third Judicial District at Anchorage. These suits were subsequently consolidated. In the consolidated suit, plaintiffs alleged that we, through our Alaska dealerships, engaged in three practices that purportedly violate Alaska consumer protection laws: (i) charging customers dealer fees and costs (including document preparation fees) not disclosed in the advertised price, (ii) failing to disclose the acquisition, mechanical and accident history of used vehicles or whether the vehicles were originally manufactured for sale in a foreign country, and (iii) engaging in deception, misrepresentation and fraud by providing to customers financing from third parties without disclosing that we receive a fee or discount for placing that loan. The suit sought statutory damages of $500 for each violation or three times plaintiff’s actual damages, whichever was greater, and attorney fees and costs.

 

In June 2013, the parties agreed to mediate the claims. The mediation resulted in a settlement agreement that received the final approval of the Court on December 11, 2013.  Under the settlement agreement, we agreed to reimburse plaintiffs’ legal fees and to pay (i) $450 in the form of cash and vouchers to valid claimants and (ii) $3,000 for each claim representative. The majority of cash and vouchers have been mailed.

 

We have recorded expenses of $6.7 million to settle all claims against us and to pay plaintiffs’ legal fees. Of this amount, $0.7 million in expense was recorded in the six months ended June 30, 2014, as a component of selling, general and administrative expense in our Consolidated Statements of Operations. As of June 30, 2014, the liability for unused vouchers, assuming an expected redemption rate, was $1.3 million and is recorded as a component of accrued liabilities on the Consolidated Balance Sheet. We believe that these estimates are reasonable; however, actual cost could differ materially.

 

Note 6. Stockholders’ Equity

 

Reclassification From Accumulated Other Comprehensive Loss

The reclassification from accumulated other comprehensive loss was as follows (in thousands):

 

		Three Months Ended June 30, 2014				Six Months Ended June 30, 2014			Affected Line Item in the Consolidated Statements of Operations
Loss on cash flow hedges		$	(118	)		$	(252	)	Floor plan interest expense
Taxes			45				96		Income tax provision
Loss on cash flow hedges, net		$	(73	)		$	(156	)

 

See Note 9 for more details regarding our derivative contracts.

 

Share Repurchases

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. In the six months ended June 30, 2014, we repurchased 45,000 shares at an average price of $71.73 per share, for a total of $3.2 million. Through June 30, 2014, we have repurchased 1,318,047 shares and 1,681,953 shares remained available for repurchase. This authority to repurchase shares does not have an expiration date and we may continue to repurchase shares from time to time as conditions warrant.

 

In addition, we repurchased 106,772 shares during the first six months of 2014 at an average price of $65.36, for a total of $7.0 million, related to tax withholdings associated with the vesting of restricted stock units. 

 

 

Dividends

Dividends paid on our Class A and Class B common stock in the six months ended June 30, 2014 were as follows:

 

Quarter paid:		Dividend amount per share				Total amount of dividend (in thousands)
First quarter		$	0.13			$	3,378
Second quarter			0.16				4,179

 

See Note 14 for a discussion of a dividend related to our second quarter 2014 financial results.

 

Note 7. 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 between one and seven years based 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.

 

In 2014, we made discretionary contributions of $2.1 million to the LTIP. Participants will receive a guaranteed return of 5.25% in 2014. We recognized compensation expense related to the LTIP as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Compensation expense		$	377			$	352			$	1,077			$	686

 

As of June 30, 2014 and December 31, 2013, the balance due to participants was $9.4 million and $7.1 million, respectively, and was included as a component of other long-term liabilities in the Consolidated Balance Sheets.

 

Note 8. 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 and 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 our own, as well as the counterparty’s, risk of non-performance under the contract.

 

There were no changes to our valuation techniques during the six-month period ended June 30, 2014.

 

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, 2014		Level 1				Level 2				Level 3
Measured on a recurring basis:
Derivative contract, net		$	-			$	(2,375	)		$	-

 

Fair Value at December 31, 2013		Level 1				Level 2				Level 3
Measured on a recurring basis:
Derivative contract, net		$	-			$	(2,900	)		$	-

 

See Note 9 for more details regarding our derivative contracts.

 

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, 2014, this debt had maturity dates between November 2016 and May 2031. A summary of the aggregate carrying values and fair values of our long-term fixed-interest rate debt is as follows (in thousands):

 

		June 30, 2014				December 31, 2013
Carrying value		$	138,283			$	132,616
Fair value			135,762				126,786

 

Note 9. 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, 2014, 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, 2014, the one-month LIBOR rate was 0.15% 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. The estimated amount that we expect to reclassify from accumulated other comprehensive loss to net income within the next twelve months is $1.2 million at June 30, 2014.

 

 

At June 30, 2014 and December 31, 2013, the fair value of our derivative instrument was included in our Consolidated Balance Sheets as follows (in thousands):

 

Balance Sheet Information		Fair Value of Liability Derivatives
Derivatives Designated as Hedging Instruments		Location in Balance Sheet		June 30, 2014
Interest Rate Swap Contract		Accrued liabilities		$	1,228
		Other long-term liabilities			1,147
				$	2,375

 

Balance Sheet Information		Fair Value of Liability Derivatives
Derivatives Designated as Hedging Instruments		Location in Balance Sheet		December 31, 2013
Interest Rate Swap Contract		Accrued liabilities		$	1,215
		Other long-term liabilities			1,685
				$	2,900

 

The effect of derivative instruments on our Consolidated Statements of Operations for the three- and six-month periods ended June 30, 2014 and 2013 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 Accumulated OCI into Income (Effective Portion)		Amount of Loss Reclassified from Accumulated OCI into Income (Effective Portion)			Location of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Three Months Ended June 30, 2014
Interest Rate Swap Contract		$	93		Floor plan interest expense		$	(118	)	Floor plan interest expense		$	(188	)
Three Months Ended June 30, 2013
Interest Rate Swap Contracts		$	381		Floor plan interest expense		$	(166	)	Floor plan  interest expense		$	(296	)

   

 

Derivatives in Cash Flow Hedging Relationships		Amount of Gain Recognized in Accumulated OCI (Effective Portion)			Location of Loss Reclassified from Accumulated OCI into Income (Effective Portion)		Amount of Loss Reclassified from Accumulated OCI into Income (Effective Portion)			Location of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Six Months Ended June 30, 2014
Interest Rate Swap Contract		$	201		Floor plan  interest expense		$	(252	)	Floor plan  interest expense		$	(359	)
Six Months Ended June 30, 2013
Interest Rate Swap Contracts		$	896		Floor plan  interest expense		$	(472	)	Floor plan interest expense		$	(890	)

 

 

See also Note 8.

 

Note 10. Acquisitions

In the first six months of 2014, we completed the following acquisitions, which contributed revenues of $53.3 million for the six months ended June 30, 2014:

●

On January 31, 2014, we acquired Island Honda in Kahului, Hawaii.

●

On February 3, 2014, we acquired Stockton Volkswagen in Stockton, California.

●

On March 5, 2014, we acquired Honolulu Buick GMC Cadillac and Honolulu Volkswagen in Honolulu, Hawaii.

●

On April 1, 2014, we acquired Corpus Christi Ford in Corpus Christi, Texas.

●

On June 11, 2014, we acquired Portland GMC Buick and Portland Cadillac in Portland, Oregon.

 

All acquisitions were accounted for as business combinations under the acquisition method of accounting. The results of operations of the acquired stores are included in our Consolidated Financial Statements from the date of acquisition.

 

No portion of the purchase price was paid with our equity securities. The following table summarizes the consideration paid for the acquisitions and the amount of identified assets acquired and liabilities assumed as of the acquisition date (in thousands):

		Consideration
Cash paid, net of cash acquired		$	79,482
Debt issued			3,161
		$	82,643

 

		Assets Acquired and Liabilities Assumed
Inventories		$	42,997
Franchise value			6,529
Property, plant and equipment			17,302
Other assets			430
Other liabilities			(108	)
			67,150
Goodwill			15,493
		$	82,643

 

 

In the first quarter of 2014, we assumed a contract associated with an acquisition and determined the remaining term would not provide economic benefit. As a result, we recorded costs of $1.4 million associated with the contract. For the three and six month periods ended June 30, 2014, we recorded acquisition expense of $0.2 million. This amount is included as a component of selling, general and administrative expense in our Consolidated Statements of Operations. We did not have any material acquisition-related expenses in 2013.

 

We account for franchise value as an indefinite-lived intangible asset. We expect the full amount of the goodwill recognized to be deductible for tax purposes.

 

The following unaudited pro forma summary presents consolidated information as if all acquisitions in the three- and six-month periods ended June 30, 2013 and 2014 had occurred on January 1, 2013 (in thousands, except for per share amounts):

 

Three Months Ended June 30,		2014				2013
Revenue		$	1,232,950			$	1,113,612
Income from continuing operations, net of tax			35,504				26,447
Basic income per share from continuing operations, net of tax			1.36				1.03
Diluted income per share from continuing operations, net of tax			1.35				1.01

 

Six Months Ended June 30,		2014				2013
Revenue		$	2,353,299			$	2,115,438
Income from continuing operations, net of tax			60,732				49,405
Basic income per share from continuing operations, net of tax			2.33				1.92
Diluted income per share from continuing operations, net of tax			2.31				1.89

 

These amounts have been calculated by applying our accounting policies and estimates. The results of the acquired stores have been adjusted to reflect the following: depreciation on a straight-line basis over the expected lives for property, plant and equipment; accounting for inventory on a specific identification method; and recognition of interest expense for real estate financing related to stores where we purchased the facility. No nonrecurring pro forma adjustments directly attributable to the acquisitions are included in the reported pro forma revenues and earnings.

 

Note 11. Discontinued Operations

We classify a store as discontinued operations if the location has been sold, we have ceased operations at that location or the store meets the criteria required by U.S. generally accepted accounting standards:

●

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.

 

We reclassify the store’s operations to discontinued operations in our Consolidated Statements of Operations, on a comparable basis for all periods presented, provided we do not expect to have any significant continuing involvement in the store’s operations after its disposal.

 

 

On May 1, 2014, we completed the sale of our one store which had been classified as held for sale since October 2012. As of June 30, 2014, we have no stores or properties classified as held for sale.

 

Actual floor plan interest expense for the store classified as discontinued operations is directly related to the store’s new vehicles. Interest expense related to our used vehicle inventory financing and revolving line of credit is allocated based on the working capital level of the store. For the six months ended June 30, 2014 and 2013, interest expense included as a component of discontinued operations was immaterial.

 

Certain financial information related to discontinued operations was as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Revenue		$	3,920			$	10,078			$	12,569			$	18,878
Pre-tax income (loss) from discontinued operations		$	(532	)		$	409			$	(467	)		$	693
Net gain on disposal activities			5,744				-				5,744				-
			5,212				409				5,277				693
Income tax expense			(2,073	)			(135	)			(2,098	)			(246	)
Income from discontinued operations, net of income tax expense		$	3,139			$	274			$	3,179			$	447
Goodwill and other intangible assets disposed of			221				-				221				-
Cash generated from disposal activities			10,617				-				10,617				-
Floor plan debt paid in connection with disposal activities			3,311				-				3,311				-

 

Note 12. 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. Our Restated Articles of Incorporation require that the Class A and Class B common stock 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, which would have the effect of adversely altering 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 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 for the three-month periods ended June 30, 2014 and 2013 (in thousands, except per share amounts):

 

Three Months Ended June 30,		2014								2013
Basic EPS from Continuing Operations		Class A				Class B				Class A				Class B
Numerator:
Income from continuing operations applicable to common stockholders		$	31,720			$	3,450			$	22,734			$	2,547
Distributed income applicable to common stockholders			(3,769	)			(410	)			(3,018	)			(338	)
Basic undistributed income from continuing operations applicable to common stockholders		$	27,951			$	3,040			$	19,716			$	2,209
Denominator:
Weighted average number of shares outstanding used to calculate basic income per share			23,557				2,562				23,185				2,597
Basic income per share from continuing operations applicable to common stockholders		$	1.35			$	1.35			$	0.98			$	0.98
Basic distributed income per share from continuing operations applicable to common stockholders			(0.16	)			(0.16	)			(0.13	)			(0.13	)
Basic undistributed income per share from continuing operations applicable to common stockholders		$	1.19			$	1.19			$	0.85			$	0.85

  

 

 

Three Months Ended June 30,		2014								2013
Diluted EPS from Continuing Operations		Class A				Class B				Class A				Class B
Numerator:
Distributed income applicable to common stockholders		$	3,769			$	410			$	3,018			$	338
Reallocation of distributed income as a result of conversion of dilutive stock options			3				(3	)			5				(5	)
Reallocation of distributed income due to conversion of Class B to Class A common shares outstanding			407				-				333				-
Diluted distributed income applicable to common stockholders		$	4,179			$	407			$	3,356			$	333
Undistributed income from continuing operations applicable to common stockholders		$	27,951			$	3,040			$	19,716			$	2,209
Reallocation of undistributed income as a result of conversion of dilutive stock options			25				(25	)			30				(30	)
Reallocation of undistributed income due to conversion of Class B to Class A			3,015				-				2,179				-
Diluted undistributed income from continuing operations applicable to common stockholders		$	30,991			$	3,015			$	21,925			$	2,179
Denominator:
Weighted average number of shares outstanding used to calculate basic income per share from continuing operations			23,557				2,562				23,185				2,597
Weighted average number of shares from stock options			212				-				352				-
Conversion of Class B to Class A common shares outstanding			2,562				-				2,597				-
Weighted average number of shares outstanding used to calculate diluted income per share from continuing operations			26,331				2,562				26,134				2,597
Diluted income per share from continuing operations applicable to common stockholders		$	1.34			$	1.34			$	0.97			$	0.97
Diluted distributed income per share from continuing operations applicable to common stockholders			(0.16	)			(0.16	)			(0.13	)			(0.13	)
Diluted undistributed income per share from continuing operations applicable to common stockholders		$	1.18			$	1.18			$	0.84			$	0.84

 

 

 

Three Months Ended June 30,		2014								2013
Diluted EPS		Class A				Class B				Class A				Class B
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive			12				-				18				-

 

Six Months Ended June 30,		2014								2013
Basic EPS from Continuing Operations		Class A				Class B				Class A				Class B
Numerator:
Income from continuing operations applicable to common stockholders		$	53,976			$	5,888			$	42,254			$	4,909
Distributed income applicable to common stockholders			(6,814	)			(743	)			(3,007	)			(349	)
Basic undistributed income from continuing operations applicable to common stockholders		$	47,162			$	5,145			$	39,247			$	4,560
Denominator:
Weighted average number of shares outstanding used to calculate basic income per share			23,485				2,562				23,052				2,678
Basic income per share from continuing operations applicable to common stockholders		$	2.30			$	2.30			$	1.83			$	1.83
Basic distributed income per share from continuing operations applicable to common stockholders			(0.29	)			(0.29	)			(0.13	)			(0.13	)
Basic undistributed income per share from continuing operations applicable to common stockholders		$	2.01			$	2.01			$	1.70			$	1.70

  

 

Six Months Ended June 30,		2014								2013
Diluted EPS from Continuing Operations		Class A				Class B				Class A				Class B
Numerator:
Distributed income applicable to common stockholders		$	6,814			$	743			$	3,007			$	349
Reallocation of distributed income as a result of conversion of dilutive stock options			8				(8	)			5				(5	)
Reallocation of distributed income due to conversion of Class B to Class A common shares outstanding			735				-				344				-
Diluted distributed income applicable to common stockholders		$	7,557			$	735			$	3,356			$	344
Undistributed income from continuing operations applicable to common stockholders		$	47,162			$	5,145			$	39,247			$	4,560
Reallocation of undistributed income as a result of conversion of dilutive stock options			55				(55	)			69				(69	)
Reallocation of undistributed income due to conversion of Class B to Class A			5,090				-				4,491				-
Diluted undistributed income from continuing operations applicable to common stockholders		$	52,307			$	5,090			$	43,807			$	4,491
Denominator:
Weighted average number of shares outstanding used to calculate basic income per share from continuing operations			23,485				2,562				23,052				2,678
Weighted average number of shares from stock options			279				-				390				-
Conversion of Class B to Class A common shares outstanding			2,562				-				2,678				-
Weighted average number of shares outstanding used to calculate diluted income per share from continuing operations			26,326				2,562				26,120				2,678
Diluted income per share from continuing operations applicable to common stockholders		$	2.27			$	2.27			$	1.81			$	1.81
Diluted distributed income per share from continuing operations applicable to common stockholders			(0.29	)			(0.29	)			(0.13	)			(0.13	)
Diluted undistributed income per share from continuing operations applicable to common stockholders		$	1.98			$	1.98			$	1.68			$	1.68

 

Six Months Ended June 30,		2014								2013
Diluted EPS		Class A				Class B				Class A				Class B
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive			14				-				19				-

  

 

Note 13. Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (FASB) issued an accounting standard update that amends the accounting guidance related to discontinued operations. This amendment defines discontinued operations as a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has or will have a major effect on an entity’s operations and financial results. This amendment also introduces new disclosures for disposals. The amendments in this accounting standard update are effective for fiscal years beginning after December 15, 2014 and applies to new disposals and new classifications of disposal groups as held for sale after the effective date. The accounting standard update is expected to result in fewer disposals being presented as discontinued operations and, because the guidance relates to presentation and disclosure requirements, will not affect our consolidated financial position, results of operations, or cash flows.

 

On May 28, 2014, the FASB issued an accounting standard update 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 is effective for fiscal years beginning after December 15, 2016. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect this amendment will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

Note 14. Subsequent Events

 

Acquisition

On July 28, 2014, we acquired the inventory, equipment and intangible assets of Bellingham Buick GMC in Bellingham, Washington. We paid $1.7 million in cash for this acquisition.

 

Common Stock Dividend

On July 21, 2014, our Board of Directors approved a dividend of $0.16 per share on our Class A and Class B common stock related to our second quarter 2014 financial results. The dividend will total approximately $4.2 million and will be paid on August 22, 2014 to shareholders of record on August 8, 2014.

 

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 terminology. 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 maintaining SG&A as a percentage of gross profit in the mid to upper 60% range and targeting incremental throughput of 50% on a same store basis.

●

The increase in our annual revenues and earnings per share that we estimate will result from the dealerships that we acquired and from the DCH Auto Group transaction.

 

 

●

Our belief that the DCH Auto Group transaction will close early in the fourth quarter.

●

Anticipated availability of liquidity from our unfinanced operating real estate.

●

Anticipated levels of capital expenditures in the future.

●

Our strategies for customer retention, growth, market position, financial results and risk management.

 

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. 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 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. While we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results of operations, financial condition and liquidity and development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements in this Form 10-Q. 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 August 8, 2014, we offer 29 brands of new vehicles and all brands of used vehicles in 101 stores in the United States and online at Lithia.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 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 our customers 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, we seek to gain economies of scale from our dealership network.

 

Results of Continuing Operations

For the three months ended June 30, 2014 and 2013, we reported income from continuing operations, net of tax, of $35.2 million, or $1.34 per diluted share, and $25.3 million, or $0.97 per diluted share, respectively.

 

For the six months ended June 30, 2014 and 2013, we reported income from continuing operations, net of tax, of $59.9 million, or $2.27 per diluted share, and $47.2 million, or $1.81 per diluted share, respectively. 

 

 

Discontinued Operations

The results of operations for stores sold, closed or held for sale are presented as discontinued operations for all periods in our Consolidated Statements of Operations if they qualify for reclassification under the applicable accounting guidance. As a result, our results from continuing operations are presented on a comparable basis for all periods.

 

We realized income from discontinued operations, net of tax, for the three months ended June 30, 2014 and 2013, of $3.1 million and $274,000, respectively. Income from discontinued operations, net of tax, for the six months ended June 30, 2014 and 2013 totaled $3.2 million and $447,000, respectively. See Note 11 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 for the three and six months ended June 30, 2014 and 2013 (dollars in thousands):

 

Three months ended June 30, 2014		Revenues				Percent of Total Revenues				Gross Profit				Gross Profit Margin				Percent of Total Gross Profit
New vehicle		$	694,484				56.8	%		$	45,994				6.6	%			23.9	%
Used vehicle retail			310,475				25.4				44,067				14.2				22.9
Used vehicle wholesale			44,286				3.6				1,504				3.4				0.8
Finance and insurance(1)			43,838				3.6				43,838				100.0				22.8
Service, body and parts			114,337				9.4				56,182				49.1				29.2
Fleet and other			14,382				1.2				715				5.0				0.4
		$	1,221,802				100.0	%		$	192,300				15.7	%			100.0	%

 

Three months ended June 30, 2013		Revenues				Percent of Total Revenues				Gross Profit				Gross Profit Margin				Percent of Total Gross Profit
New vehicle		$	569,487				56.5	%		$	38,788