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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


 

FORM 10-Q

 


(Mark One)

 

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

For the quarterly period ended September 30, 2015

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from       to         

 

Commission file number: 001-14733

 


 

LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)
     

Oregon

 

93-0572810

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

     
150 N. Bartlett Street, Medford, Oregon   97501
(Address of principal executive offices)   (Zip Code)
 

Registrant's telephone number, including area code: 541-776-6401

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company)     Smaller reporting company [ ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

 

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

 

Class A common stock without par value

 

23,694,039

Class B common stock without par value

 

2,562,231

(Class)

 

(Outstanding at October 30, 2015)

 



 

 
 

 

 

LITHIA MOTORS, INC.

FORM 10-Q

INDEX 

 

PART I - FINANCIAL INFORMATION

Page

     

Item 1.

Financial Statements

2
     
 

Consolidated Balance Sheets (Unaudited) – September 30, 2015 and December 31, 2014

 2

     
 

Consolidated Statements of Operations (Unaudited) – Three and Nine Months Ended September 30, 2015 and 2014

 3

     
 

Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended September 30, 2015 and 2014

 4

     
 

Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2015 and 2014

 5

     
 

Condensed Notes to Consolidated Financial Statements (Unaudited)

6

     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23
     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

48
     

Item 4.

Controls and Procedures

49
     

PART II - OTHER INFORMATION

 
     

Item 1A.

Risk Factors

49
     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

50
     

Item 6.

Exhibits

50
     

Signatures

  51

 

 
1

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

(Unaudited)

 

   

September 30,

   

December 31,

 
   

2015

   

2014

 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 32,707     $ 29,898  

Accounts receivable, net of allowance for doubtful accounts of $1,474 and $2,191

    285,730       295,379  

Inventories, net

    1,386,960       1,249,659  

Other current assets

    32,640       32,010  

Assets held for sale

    -       8,563  

Total Current Assets

    1,738,037       1,615,509  
                 

Property and equipment, net of accumulated depreciation of $135,365 and $117,679

    854,077       816,745  

Goodwill

    210,627       199,375  

Franchise value

    155,187       150,892  

Other non-current assets

    101,901       98,411  

Total Assets

  $ 3,059,829     $ 2,880,932  
                 

Liabilities and Stockholders' Equity

               

Current Liabilities:

               

Floor plan notes payable

  $ 46,651     $ 41,047  

Floor plan notes payable: non-trade

    1,168,223       1,137,632  

Current maturities of long-term debt

    38,745       31,912  

Trade payables

    77,723       70,853  

Accrued liabilities

    167,135       153,661  

Deferred income taxes

    3,792       2,603  

Liabilities related to assets held for sale

    -       4,892  

Total Current Liabilities

    1,502,269       1,442,600  
                 

Long-term debt, less current maturities

    591,231       609,066  

Deferred revenue

    63,238       54,403  

Deferred income taxes

    29,013       42,795  

Other long-term liabilities

    86,365       58,963  

Total Liabilities

    2,272,116       2,207,827  
                 

Stockholders' Equity:

               

Preferred stock - no par value; authorized 15,000 shares; none outstanding

    -       -  

Class A common stock - no par value; authorized 100,000 shares; issued and outstanding 23,742 and 23,671

    263,531       276,058  

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

    35,917       29,775  

Accumulated other comprehensive loss

    (461 )     (926 )

Retained earnings

    488,407       367,879  

Total Stockholders' Equity

    787,713       673,105  

Total Liabilities and Stockholders' Equity

  $ 3,059,829     $ 2,880,932  

 

See accompanying condensed notes to consolidated financial statements.

 

 
2

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Revenues:

                               

New vehicle

  $ 1,227,080     $ 732,121     $ 3,384,408     $ 2,006,127  

Used vehicle retail

    505,885       340,522       1,457,617       952,890  

Used vehicle wholesale

    69,472       48,853       198,476       135,832  

Finance and insurance

    76,633       46,855       213,700       130,324  

Service, body and parts

    189,796       120,772       545,966       339,726  

Fleet and other

    15,979       7,988       70,803       32,120  

Total revenues

    2,084,845       1,297,111       5,870,970       3,597,019  

Cost of sales:

                               

New vehicle

    1,149,923       684,473       3,176,135       1,873,461  

Used vehicle retail

    443,598       296,624       1,273,195       824,129  

Used vehicle wholesale

    68,892       48,349       194,329       132,493  

Service, body and parts

    95,846       62,351       276,828       174,291  

Fleet and other

    15,399       7,474       68,272       30,444  

Total cost of sales

    1,773,658       1,099,271       4,988,759       3,034,818  

Gross profit

    311,187       197,840       882,211       562,201  

Asset impairments

    4,131       -       14,391       -  

Selling, general and administrative

    223,728       131,627       610,956       378,919  

Depreciation and amortization

    10,531       6,067       30,544       17,399  

Operating income

    72,797       60,146       226,320       165,883  

Floor plan interest expense

    (4,951 )     (3,127 )     (14,255 )     (9,326 )

Other interest expense

    (4,900 )     (2,051 )     (14,700 )     (5,894 )

Other (expense) income, net

    (307 )     1,027       (1,031 )     3,110  

Income from continuing operations before income taxes

    62,639       55,995       196,334       153,773  

Income tax provision

    (19,248 )     (21,458 )     (61,067 )     (59,372 )

Income from continuing operations, net of income tax

    43,391       34,537       135,267       94,401  

Income from discontinued operations, net of income tax

    -       -       -       3,179  

Net income

  $ 43,391     $ 34,537     $ 135,267     $ 97,580  
                                 

Basic income per share from continuing operations

  $ 1.65     $ 1.32     $ 5.14     $ 3.62  

Basic income per share from discontinued operations

    -       -       -       0.12  

Basic net income per share

  $ 1.65     $ 1.32     $ 5.14     $ 3.74  
                                 

Shares used in basic per share calculations

    26,289       26,118       26,304       26,071  
                                 

Diluted income per share from continuing operations

  $ 1.64     $ 1.31     $ 5.10     $ 3.58  

Diluted income per share from discontinued operations

    -       -       -       0.13  

Diluted net income per share

  $ 1.64     $ 1.31     $ 5.10     $ 3.71  
                                 

Shares used in diluted per share calculations

    26,480       26,359       26,500       26,337  

 

See accompanying condensed notes to consolidated financial statements.

 

 
3

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Net income

  $ 43,391     $ 34,537     $ 135,267     $ 97,580  

Other comprehensive income, net of tax:

                               

Gain on cash flow hedges, net of tax expense of $103, $114, $283, and $288 respectively

    161       184       465       463  

Comprehensive income

  $ 43,552     $ 34,721     $ 135,732     $ 98,043  

 

See accompanying condensed notes to consolidated financial statements.

 

 
4

 

 

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

   

Nine Months Ended September 30,

 
   

2015

   

2014

 

Cash flows from operating activities:

               

Net income

  $ 135,267     $ 97,580  

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

               

Asset impairments

    14,391       -  

Depreciation and amortization

    30,544       17,399  

Stock-based compensation

    8,579       5,054  

Loss on disposal of other assets

    27       307  

Gain on disposal of franchise

    (5,919 )     (5,744 )

Deferred income taxes

    (7,955 )     4,725  

Excess tax benefit from share-based payment arrangements

    (4,923 )     (6,160 )

(Increase) decrease (net of acquisitions and dispositions):

               

Trade receivables, net

    9,685       (11,336 )

Inventories

    (132,407 )     (44,349 )

Other assets

    (5,339 )     (13,700 )

Increase (decrease) (net of acquisitions and dispositions):

               

Floor plan notes payable

    5,604       1,132  

Trade payables

    7,768       4,246  

Accrued liabilities

    16,949       21,913  

Other long-term liabilities and deferred revenue

    34,651       16,635  

Net cash provided by operating activities

    106,922       87,702  
                 

Cash flows from investing activities:

               

Principal payments received on notes receivable

    -       2,882  

Capital expenditures

    (62,159 )     (54,149 )

Proceeds from sales of assets

    229       3,243  

Cash paid for other investments

    (20,693 )     (3,385 )

Cash paid for acquisitions, net of cash acquired

    (34,920 )     (81,558 )

Proceeds from sales of stores

    12,966       10,617  

Net cash used in investing activities

    (104,577 )     (122,350 )
                 

Cash flows from financing activities:

               

Borrowings on floor plan notes payable, net: non-trade

    36,204       30,375  

Borrowings on lines of credit

    878,340       836,156  

Repayments on lines of credit

    (939,817 )     (891,000 )

Principal payments on long-term debt, scheduled

    (11,048 )     (5,528 )

Principal payments on long-term debt and capital leases, other

    (9,189 )     -  

Proceeds from issuance of long-term debt

    75,675       76,530  

Proceeds from issuance of common stock

    4,313       3,411  

Repurchase of common stock

    (24,198 )     (11,745 )

Excess tax benefit from share-based payment arrangements

    4,923       6,160  

Dividends paid

    (14,739 )     (11,731 )

Net cash provided by financing activities

    464       32,628  
                 

Increase (decrease) in cash and cash equivalents

    2,809       (2,020 )
                 

Cash and cash equivalents at beginning of period

    29,898       23,686  

Cash and cash equivalents at end of period

  $ 32,707     $ 21,666  
                 
                 

Supplemental disclosure of cash flow information:

               

Cash paid during the period for interest

  $ 31,140     $ 15,556  

Cash paid during the period for income taxes, net

    50,917       44,918  
                 

Supplemental schedule of non-cash activities:

               

Debt issued in connection with acquisitions

  $ 2,160     $ 3,161  

Floor plan debt paid in connection with store disposals

    4,400       3,311  

 

See accompanying condensed notes to consolidated financial statements.

 

 
5

 

 

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 September 30, 2015 and for the three- and nine-month periods ended September 30, 2015 and 2014. The unaudited interim financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by accounting principles generally accepted in the United States of America for annual financial statements are not included herein. In management’s opinion, these unaudited financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the information when read in conjunction with our 2014 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2014 is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2015. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2014 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

 

Reclassifications

Certain prior period amounts have been reclassified to conform to the current presentation of our financial information. This reclassification was limited to our definition of segment income, which is currently income from continuing operations before taxes less depreciation and amortization, other interest expense and other (expense) income, net. Specifically, we defined intercompany charges and no longer include depreciation and amortization, other interest expense and other (expense) income, net as a component of segment income. These reclassifications had no effect on previously reported net income.

 

Note 2. Accounts Receivable

Accounts receivable consisted of the following (in thousands):

 

   

September 30,
2015

   

December 31,

2014

 

Contracts in transit

  $ 147,729     $ 162,785  

Trade receivables

    33,567       37,194  

Vehicle receivables

    33,429       34,876  

Manufacturer receivables

    61,144       56,008  

Auto loan receivables

    34,943       25,424  

Other receivables

    4,494       4,554  
      315,306       320,841  

Less: Allowances

    (2,701 )     (3,130 )

Less: Long-term portion of accounts receivable, net

    (26,875 )     (22,332 )

Total accounts receivable, net

  $ 285,730     $ 295,379  

 

 
6

 

 

Accounts receivable classifications include the following:

 

 

Contracts in transit are receivables from various lenders for the financing of vehicles that we have arranged on behalf of the customer and are typically received within five to ten days of selling a vehicle.

 

Trade receivables are comprised of amounts due from customers, lenders for the commissions earned on financing and others for commissions earned on service contracts and insurance products.

 

Vehicle receivables represent receivables for the portion of the vehicle sales price paid directly by the customer.

 

Manufacturer receivables represent amounts due from manufacturers, including holdbacks, rebates, incentives and warranty claims.

 

Auto loan receivables include amounts due from customers related to retail sales of vehicles and certain finance and insurance products.

 

Interest income on auto loan receivables is recognized based on the contractual terms of each loan and is accrued until repayment, charge-off or repossession. Direct costs associated with loan originations are capitalized and expensed as an offset to interest income when recognized on the loans. All other receivables are recorded at invoice and do not bear interest until they are 60 days past due.

 

The allowance for doubtful accounts is estimated based on our historical write-off experience and is reviewed monthly. Consideration is given to recent delinquency trends and recovery rates. Account balances are charged against the allowance after all appropriate means of collection have been exhausted and the potential for recovery is considered remote. The annual activity for charges and subsequent recoveries is immaterial.

 

The long-term portion of accounts receivable, net, was included as a component of other non-current assets in the Consolidated Balance Sheets.

 

Note 3. Inventories

The components of inventories, net, consisted of the following (in thousands):

 

   

September 30,

2015

   

December 31,

2014

 

New vehicles

  $ 1,036,022     $ 958,876  

Used vehicles

    298,954       240,908  

Parts and accessories

    51,984       49,875  

Total inventories

  $ 1,386,960     $ 1,249,659  

 

Note 4. Goodwill and Franchise Value

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

 

   

Domestic

   

Import

   

Luxury

   

Consolidated

 

Balance as of December 31, 2013(1)

  $ 22,548     $ 16,797     $ 10,166     $ 49,511  

Additions through acquisitions

    68,463       62,804       18,597       149,864  

Balance as of December 31, 2014(1)

    91,011       79,601       28,763       199,375  

Additions through acquisitions

    5,825       3,870       1,803       11,498  

Reduction related to divestiture

    -       (246 )     -       (246 )

Balance as of September 30, 2015(1)

  $ 96,836     $ 83,225     $ 30,566     $ 210,627  

 

(1)

Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.

 

 

 
7

 

 

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

 

   

Franchise Value

 

Balance as of December 31, 2013

  $ 71,199  

Additions through acquisitions

    80,233  

Transfers to assets held for sale

    (540 )

Balance as of December 31, 2014

    150,892  

Additions through acquisitions

    4,331  

Reduction related to divestiture

    (36 )

Balance as of September 30, 2015

  $ 155,187  

 

Note 5. Stockholders’ Equity

 

Reclassification From Accumulated Other Comprehensive Loss

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

 

   

Three Months Ended
September 30,

   

Affected Line Item in the

Consolidated Statements

   

2015

   

2014

    of Operations

Loss on cash flow hedges

  $ (104 )   $ (119 )  

Floor plan interest expense

Taxes

    40       46    

Income tax provision

Loss on cash flow hedges, net

  $ (64 )   $ (73 )    

 

   

Nine Months Ended
September 30,

   

Affected Line Item in the

Consolidated Statements

   

2015

   

2014

    of Operations

Loss on cash flow hedges

  $ (336 )   $ (370 )  

Floor plan interest expense

Taxes

    131       141    

Income tax provision

Loss on cash flow hedges, net

  $ (205 )   $ (229 )    

 

See Note 8 for more details regarding our derivative contracts.

 

Repurchases of Class A Common Stock

In August 2011, our Board of Directors authorized the repurchase of up to 2,000,000 shares of our Class A common stock and, on July 20, 2012, our Board of Directors authorized the repurchase of 1,000,000 additional shares of our Class A common stock. Through September 30, 2015, we have repurchased 1,664,613 shares under this program at an average price of $38.51 per share. Of this amount, 164,837 shares were repurchased during the first nine months of 2015 at an average price of $105.15 per share for a total of $17.3 million. As of September 30, 2015, 1,335,387 shares remained available for repurchase pursuant to this program. The authority to repurchase does not have an expiration date.

 

In addition, during the first nine months of 2015, we repurchased 77,596 shares at an average price of $88.48 per share, for a total of $6.9 million, related to tax withholdings associated with the vesting of restricted stock units (“RSUs”). The repurchase of shares related to tax withholdings associated with stock awards does not reduce the number of shares available for repurchase as approved by our Board of Directors.

 

 
8

 

 

Dividends

Dividends paid on our Class A and Class B common stock were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Dividend amount per share

  $ 0.20     $ 0.16     $ 0.56     $ 0.45  

Total amount of dividend (in thousands)

    5,257       4,174       14,739       11,731  

 

See Note 16 for a discussion of a dividend related to our third quarter 2015 financial results.

 

Note 6. Deferred Compensation and Long-Term Incentive Plan

We offer a deferred compensation and long-term incentive plan (the “LTIP”) to provide certain employees the ability to accumulate assets for retirement on a tax-deferred basis. We may make discretionary contributions to the LTIP. Discretionary contributions vest over one to seven years depending on the employee’s age and position. Additionally, a participant may defer a portion of his or her compensation and receive the deferred amount upon certain events, including termination or retirement. The following is a summary related to our LTIP (dollars in thousands):

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Compensation expense

  $ 450     $ 381     $ 1,369     $ 1,458  

Discretionary contribution

    -       350       2,249       2,450  

Guaranteed annual return

    5.25 %     5.25 %     5.25 %     5.25 %

 

As of September 30, 2015 and December 31, 2014, the balance due to participants was $17.7 million and $14.2 million, respectively, and was included as a component of accrued liabilities and other long-term liabilities in the Consolidated Balance Sheets.

 

Note 7. Fair Value Measurements

Factors used in determining the fair value of our financial assets and liabilities are summarized into three broad categories:

 

 

Level 1 – quoted prices in active markets for identical securities;

 

Level 2 – other significant observable inputs, including quoted prices for similar securities, interest rates, prepayment spreads, credit risk; and

 

Level 3 – significant unobservable inputs, including our own assumptions in determining fair value.

 

The inputs or methodology used for valuing financial assets and liabilities are not necessarily an indication of the risk associated with investing in them.

 

We use the income approach to determine the fair value of our interest rate swap using observable Level 2 market expectations at each measurement date and an income approach to convert estimated future cash flows to a single present value amount (discounted) assuming that participants are motivated, but not compelled, to transact. Level 2 inputs for the swap valuation are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates and credit risk at commonly quoted intervals). Mid-market pricing is used as a practical expedient for fair value measurements. Key inputs, including the cash rates for very short term borrowings, futures rates for up to two years and LIBOR swap rates beyond the derivative maturity, are used to predict future reset rates to discount those future cash flows to present value at the measurement date.

 

 
9

 

 

Inputs are collected from Bloomberg on the last market day of the period and used to determine the rate applied to discount the future cash flows. The valuation of the interest rate swap also takes into consideration estimates of our own, as well as the counterparty’s, risk of non-performance under the contract. See Note 8 for more details regarding our derivative contracts.

 

We estimate the value of our equity-method investment which is recorded at fair value on a non-recurring basis based on a market valuation approach. We use prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets. Because these valuations contain unobservable inputs, we classified the measurement of fair value of our equity-method investment as Level 3.

 

We estimate the value of long-lived assets that are recorded at fair value based on a market valuation approach. We use prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets, as well as our historical experience in divestitures, acquisitions and real estate transactions. Additionally, we may use a cost valuation approach to value long-lived assets when a market valuation approach is unavailable. Under this approach, we determine the cost to replace the service capacity of an asset, adjusted for physical and economic obsolescence. When available, we use valuation inputs from independent valuation experts, such as real estate appraisers and brokers, to corroborate our estimates of fair value. Real estate appraisers’ and brokers’ valuations are typically developed using one or more valuation techniques including market, income and replacement cost approaches. Because these valuations contain unobservable inputs, we classified the measurement of fair value of long-lived assets as Level 3.

 

There were no changes to our valuation techniques during the nine-month period ended September 30, 2015.

 

Assets and Liabilities Measured at Fair Value

Following are the disclosures related to our assets and (liabilities) that are measured at fair value (in thousands):

 

Fair Value at September 30, 2015

 

Level 1

   

Level 2

   

Level 3

 

Measured on a recurring basis:

                       

Derivative contracts, net

  $ -     $ (877 )   $ -  
                         

Measured on a non-recurring basis:

                       

Equity-method investment

  $ -     $ -     $ 28,147  

Long-lived assets held and used:

                       

Certain buildings and improvements

    -       -       3,367  

 

Fair Value at December 31, 2014

 

Level 1

   

Level 2

   

Level 3

 

Measured on a recurring basis:

                       

Derivative contracts, net

  $ -     $ (1,750 )   $ -  
                         

Measured on a non-recurring basis:

                       

Equity-method investment

  $ -     $ -     $ 33,282  

 

See Note 8 for more details regarding our derivative contracts.

 

Based on operating losses recognized by the equity-method investment, we determined that an impairment of our investment had occurred. Accordingly, we performed a fair value calculation for this investment and determined that a $4.1 million and an $12.4 million impairment, respectively, was required to be recorded as asset impairments in our Consolidated Statements of Operations for the three and nine months ended September 30, 2015. See Note 12.

 

 
10

 

 

Long-lived assets classified as held and used are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. An estimate of future undiscounted net cash flows associated with the long-lived assets is used to determine if the carrying value of the assets is recoverable. An impairment charge is recorded if the carrying value of the asset is determined to not be recoverable and exceeds its fair value. Due to changes in the expected future use for certain properties, during the second quarter of 2015, we evaluated the future undiscounted net cash flows for each property. We determined the carrying value was not recoverable and exceeded the estimated fair value. As a result of this evaluation, we recorded $2.0 million of impairment charges associated with these properties in the second quarter of 2015.

 

Fair Value Disclosures for Financial Assets and Liabilities

We determined the carrying value of cash equivalents, accounts receivable, trade payables, accrued liabilities and short-term borrowings approximate their fair values because of the nature of their terms and current market rates of these instruments. We believe the carrying value of our variable rate debt approximates fair value.

 

We have fixed rate debt and calculate the estimated fair value of our fixed rate debt using a discounted cash flow methodology. Using estimated current interest rates based on a similar risk profile and duration (Level 2), the fixed cash flows are discounted and summed to compute the fair value of the debt. As of September 30, 2015, this debt had maturity dates between November 2016 and October 2034. A summary of the aggregate carrying values and fair values of our long-term fixed interest rate debt is as follows (in thousands):

 

   

September 30,

2015

   

December 31,

2014

 

Carrying value

  $ 248,557     $ 257,780  

Fair value

    256,881       270,781  

 

Note 8. Derivative Financial Instrument

From time to time, we enter into interest rate swaps to fix a portion of our interest expense. We do not enter into derivative instruments for any purpose other than to manage interest rate exposure to fluctuations in the one-month LIBOR benchmark. That is, we do not engage in interest rate speculation using derivative instruments.

 

As of September 30, 2015, we had a $25 million interest rate swap outstanding with U.S. Bank Dealer Commercial Services. This interest rate swap matures on June 15, 2016 and has a fixed rate of 5.587% per annum. The variable rate on the interest rate swap is the one-month LIBOR rate. At September 30, 2015, the one-month LIBOR rate was 0.20% per annum, as reported in the Wall Street Journal.

 

Typically, we designate all interest rate swaps as cash flow hedges and, accordingly, we record the change in fair value for the effective portion of these interest rate swaps in comprehensive income rather than net income until the underlying hedged transaction affects net income. If a swap is no longer designated as a cash flow hedge and the forecasted transaction remains probable or reasonably possible of occurring, the gain or loss recorded in accumulated other comprehensive loss is recognized in income as the forecasted transaction occurs. If the forecasted transaction is probable of not occurring, the gain or loss recorded in accumulated other comprehensive loss is recognized in income immediately. See Note 7.

 

The estimated amount that we expect to reclassify from accumulated other comprehensive loss to net income within the next twelve months is $0.8 million at September 30, 2015.

 

 
11

 

 

The fair value of our derivative instruments 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

 

September 30,

2015

 

Interest Rate Swap Contract

 

Accrued liabilities

  $ 877  
   

Other long-term liabilities

    -  
        $ 877  

 

Balance Sheet Information

 

Fair Value of Liability Derivatives

 

Derivatives Designated as

Hedging Instruments

 

Location in Balance Sheet

 

December 31,

2014

 

Interest Rate Swap Contract

 

Accrued liabilities

  $ 1,194  
   

Other long-term liabilities

    556  
        $ 1,750  

 

The effect of derivative instruments on our Consolidated Statements of Operations was as follows (in thousands):

Derivatives in Cash Flow Hedging Relationships

 

Amount of Gain Recognized in Accumulated OCI (Effective Portion)

 

Location of Loss Reclassified from 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 September 30, 2015

       

Floor plan

       

Floor plan

       

Interest Rate Swap Contract

  $ 160  

interest expense

  $ (104 )

interest expense

  $ (195 )
                             

Three Months Ended September 30, 2014

       

Floor plan

       

Floor plan

       

Interest Rate Swap Contract

  $ 179  

interest expense

  $ (119 )

interest expense

  $ (184 )

 

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)

 
                             

Nine Months Ended September 30, 2015

       

Floor plan

       

Floor plan

       

Interest Rate Swap Contract

  $ 412  

interest expense

  $ (336 )

interest expense

  $ (563 )
                             

Nine Months Ended September 30, 2014

       

Floor plan

       

Floor plan

       

Interest Rate Swap Contract

  $ 381  

interest expense

  $ (370 )

interest expense

  $ (543 )

 

See also Note 7.

 

 
12

 

 

Note 9. Acquisitions

In the first nine months of 2015, we completed the following acquisitions, which contributed revenues of $10.5 million for the nine months ended September 30, 2015:

 

On May 14, 2015, we acquired a smart franchise from Smart Center of Omaha.

 

On July 31, 2015, we acquired Bitterroot Ford in Missoula, Montana.

 

On August 20, 2015, we acquired Acura of Honolulu in Honolulu, Hawaii.

 

On September 28, 2015, we acquired Bennett Motors in Great Falls, Montana.

 

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

  $ 34,920  

Debt issued

    2,160  
    $ 37,080  

 

   

Assets Acquired and Liabilities Assumed

 

Inventories

  $ 12,551  

Franchise value

    4,331  

Property, plant and equipment

    10,990  

Other assets

    178  

Other liabilities

    (2,468 )
      25,582  

Goodwill

    11,498  
    $ 37,080  

 

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 nine-month periods ended September 30, 2015 and 2014 had occurred on January 1, 2014 (in thousands, except for per share amounts):

 

Three Months Ended September 30,

 

2015

   

2014

 

Revenue

  $ 2,102,459     $ 1,424,809  

Income from continuing operations, net of tax

    43,293       35,672  

Basic income per share from continuing operations, net of tax

    1.65       1.37  

Diluted income per share from continuing operations, net of tax

    1.63       1.35  

 

Nine Months Ended September 30,

 

2015

   

2014

 

Revenue

  $ 5,936,256     $ 3,991,066  

Income from continuing operations, net of tax

    134,738       97,903  

Basic income per share from continuing operations, net of tax

    5.12       3.76  

Diluted income per share from continuing operations, net of tax

    5.08       3.72  

 

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.

 

 
13

 

 

Note 10. Assets Held for Sale and Discontinued Operations

 

Assets Held for Sale

We classify an asset group as held for sale if we have ceased operations at that location or the store meets the criteria required by U.S. generally accepted accounting standards as follows:

 

 

our management team, possessing the necessary authority, commits to a plan to sell the store;

 

the store is available for immediate sale in its present condition;

 

an active program to locate buyers and other actions that are required to sell the store are initiated;

 

a market for the store exists and we believe its sale is likely within one year;

 

active marketing of the store commences at a price that is reasonable in relation to the estimated fair market value; and

 

our management team believes it is unlikely changes will be made to the plan or the plan to dispose of the store will be withdrawn.

 

As of December 31, 2014, we had two Import stores classified as held for sale. During the first nine months of 2015, we completed the sale of both of these Import stores, and recognized a gain of $5.9 million as a component of selling, general and administrative in our Consolidated Statements of Operations for the nine months ended September 30, 2015.

 

As of September 30, 2015, we no longer had any stores classified as held for sale. Assets held for sale included the following (in thousands):

 

   

September 30,

2015

   

December 31,

2014

 

Inventories

  $ -     $ 6,284  

Property, plant and equipment

    -       1,739  

Intangible assets

    -       540  
    $ -     $ 8,563  

 

Liabilities related to assets held for sale included the following (in thousands):

 

   

September 30,

2015

   

December 31,

2014

 

Floor plan notes payable

  $ -     $ 4,892  

 

Discontinued Operations and the Sales of Stores

In the third quarter of 2014, we early-adopted guidance that redefined discontinued operations. As a result, we determined that individual stores which met the criteria for held for sale after our adoption date would no longer qualify for classification as discontinued operations. We had previously reclassified a store’s operations to discontinued operations in our Consolidated Statements of Operations, on a comparable basis for all periods presented, provided we did not expect to have any significant continuing involvement in the store’s operations after its disposal.

 

 
14

 

 

Certain financial information related to discontinued operations and sales of stores was as follows (in thousands):

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Revenue

  $ -     $ -     $ -     $ 12,569  
                                 

Pre-tax loss from discontinued operations

  $ -     $ -     $ -     $ (467 )

Net gain on disposal activities

    -       -       -       5,744  
      -       -       -       5,277  

Income tax expense

    -       -       -       (2,098 )

Income from discontinued operations, net of income tax expense

  $ -     $ -     $ -     $ 3,179  
                                 

Goodwill and other intangible assets disposed of

  $ -     $ -     $ 282     $ 221  

Cash generated from disposal activities

    -       -       12,966       10,617  

Floor plan debt paid in connection with disposal activities

    -       -       4,400       3,311  

 

Note 11. 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 common shares issuable upon the net exercise of stock options and unvested restricted stock units and is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares.

 

Except with respect to voting and transfer rights, the rights of the holders of our Class A and Class B common stock are identical. Under our Articles of Incorporation, 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 that would adversely alter the rights, powers or preferences of a given class of stock, must be approved by the class of stock adversely affected by the proposed amendment. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. Because the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis.

 

 
15

 

 

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

 

Three Months Ended September 30,

 

2015

   

2014

 

Basic EPS from Continuing Operations

 

Class A

   

Class B

   

Class A

   

Class B

 

Numerator:

                               

Income from continuing operations applicable to common stockholders

  $ 39,162     $ 4,229     $ 31,149     $ 3,388  

Distributed income applicable to common stockholders

    (4,745 )     (512 )     (3,765 )     (409 )

Basic undistributed income from continuing operations applicable to common stockholders

  $ 34,417     $ 3,717     $ 27,384     $ 2,979  
                                 

Denominator:

                               

Weighted average number of shares outstanding used to calculate basic income per share

    23,727       2,562       23,556       2,562  
                                 

Basic income per share from continuing operations applicable to common stockholders

  $ 1.65     $ 1.65     $ 1.32     $ 1.32  

Basic distributed income per share from continuing operations applicable to common stockholders

    (0.20 )     (0.20 )     (0.16 )     (0.16 )

Basic undistributed income per share from continuing operations applicable to common stockholders

  $ 1.45     $ 1.45     $ 1.16     $ 1.16  

 

Three Months Ended September 30,

 

2015

   

2014

 

Diluted EPS from Continuing Operations

 

Class A

   

Class B

   

Class A

   

Class B

 

Numerator:

                               

Distributed income applicable to common stockholders

  $ 4,745     $ 512     $ 3,765     $ 409  

Reallocation of distributed income as a result of conversion of dilutive stock options

    3       (3 )     3       (3 )

Reallocation of distributed income due to conversion of Class B to Class A common shares outstanding

    509       -       406       -  

Diluted distributed income applicable to common stockholders

  $ 5,257     $ 509     $ 4,174     $ 406  

Undistributed income from continuing operations applicable to common stockholders

  $ 34,417     $ 3,717     $ 27,384     $ 2,979  

Reallocation of undistributed income as a result of conversion of dilutive stock options

    27       (27 )     28       (28 )

Reallocation of undistributed income due to conversion of Class B to Class A

    3,690       -       2,951       -  

Diluted undistributed income from continuing operations applicable to common stockholders

  $ 38,134     $ 3,690     $ 30,363     $ 2,951  

 

 
16

 

 

 

Denominator:

                       

Weighted average number of shares outstanding used to calculate basic income per share from continuing operations

  23,727     2,562     23,556     2,562  

Weighted average number of shares from stock options

  191     -     241     -  

Conversion of Class B to Class A common shares outstanding

  2,562     -     2,562     -  

Weighted average number of shares outstanding used to calculate diluted income per share from continuing operations

  26,480     2,562     26,359     2,562  
                         

Diluted income per share from continuing operations applicable to common stockholders

$ 1.64   $ 1.64   $ 1.31   $ 1.31  

Diluted distributed income per share from continuing operations applicable to common stockholders

  (0.20 )   (0.20 )   (0.16 )   (0.16 )

Diluted undistributed income per share from continuing operations applicable to common stockholders

$ 1.44   $ 1.44   $ 1.15   $ 1.15  

 

Three Months Ended September 30,

 

2015

   

2014

 

Diluted EPS

 

Class A

   

Class B

   

Class A

   

Class B

 

Antidilutive Securities

                               

Shares issuable pursuant to stock options not included since they were antidilutive

    18       -       13       -  

 

Nine Months Ended September 30,

 

2015

   

2014

 

Basic EPS from Continuing Operations

 

Class A

   

Class B

   

Class A

   

Class B

 

Numerator:

                               

Income from continuing operations applicable to common stockholders

  $ 122,092     $ 13,175     $ 85,124     $ 9,277  

Distributed income applicable to common stockholders

    (13,303 )     (1,436 )     (10,578 )     (1,153 )

Basic undistributed income from continuing operations applicable to common stockholders

  $ 108,789     $ 11,739     $ 74,546     $ 8,124  
                                 

Denominator:

                               

Weighted average number of shares outstanding used to calculate basic income per share

    23,742       2,562       23,509       2,562  
                                 

Basic income per share from continuing operations applicable to common stockholders

  $ 5.14     $ 5.14     $ 3.62     $ 3.62  

Basic distributed income per share from continuing operations applicable to common stockholders

    (0.56 )     (0.56 )     (0.45 )     (0.45 )

Basic undistributed income per share from continuing operations applicable to common stockholders

  $ 4.58     $ 4.58     $ 3.17     $ 3.17  

 

 
17

 

 

Nine Months Ended September 30,

 

2015

   

2014

 

Diluted EPS from Continuing Operations

 

Class A

   

Class B

   

Class A

   

Class B

 

Numerator:

                               

Distributed income applicable to common stockholders

  $ 13,303     $ 1,436     $ 10,578     $ 1,153  

Reallocation of distributed income as a result of conversion of dilutive stock options

    11       (11 )     12       (12 )

Reallocation of distributed income due to conversion of Class B to Class A common shares outstanding

    1,425       -       1,141       -  

Diluted distributed income applicable to common stockholders

  $ 14,739     $ 1,425     $ 11,731     $ 1,141  

Undistributed income from continuing operations applicable to common stockholders

  $ 108,789     $ 11,739     $ 74,546     $ 8,124  

Reallocation of undistributed income as a result of conversion of dilutive stock options

    86       (86 )     82       (82 )

Reallocation of undistributed income due to conversion of Class B to Class A

    11,653       -       8,042       -  

Diluted undistributed income from continuing operations applicable to common stockholders

  $ 120,528     $ 11,653     $ 82,670     $ 8,042  
                                 

Denominator:

                               

Weighted average number of shares outstanding used to calculate basic income per share from continuing operations

    23,742       2,562       23,509       2,562  

Weighted average number of shares from stock options

    196       -       266       -  

Conversion of Class B to Class A common shares outstanding

    2,562       -       2,562       -  

Weighted average number of shares outstanding used to calculate diluted income per share from continuing operations

    26,500       2,562       26,337       2,562  
                                 

Diluted income per share from continuing operations applicable to common stockholders

  $ 5.10     $ 5.10     $ 3.58     $ 3.58  

Diluted distributed income per share from continuing operations applicable to common stockholders

    (0.56 )     (0.56 )     (0.45 )     (0.45 )

Diluted undistributed income per share from continuing operations applicable to common stockholders

  $ 4.54     $ 4.54     $ 3.13     $ 3.13  

 

Nine Months Ended September 30,

 

2015

   

2014

 

Diluted EPS

 

Class A

   

Class B

   

Class A

   

Class B

 

Antidilutive Securities

                               

Shares issuable pursuant to stock options not included since they were antidilutive

    17       -       13       -  

 

 
18

 

 

Note 12. Equity-Method Investment

In October 2014, we acquired a 99.9% membership interest in a limited liability company managed by U.S. Bancorp Community Development Corporation with an initial equity contribution of $4.1 million. We made additional equity contributions to the entity of $5.7 million and $17.1 million, respectively, in the three and nine-month periods ended September 30, 2015. We are obligated to make $49.8 million of contributions to the entity over a two-year period ending October 2016, $21.2 million of which had been paid as of September 30, 2015.

 

This investment generates new markets tax credits under the New Markets Tax Credit Program (“NMTC Program”). The NMTC Program was established by Congress in 2000 to spur new or increased investments into operating businesses and real estate projects located in low-income communities.

 

While U.S. Bancorp Community Development Corporation exercises management control over the limited liability company, due to the economic interest we hold in the entity, we determined our ownership portion of the entity was appropriately accounted for using the equity method.

 

The following amounts related to this equity-method investment were recorded in our Consolidated Balance Sheets (in thousands):