LITHIA MOTORS INC - FORM 10-Q

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - LITHIA MOTORS INC	ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - LITHIA MOTORS INC	ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - LITHIA MOTORS INC	ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - LITHIA MOTORS INC	ex31-1.htm
EX-10.3 - EXHIBIT 10.3 - LITHIA MOTORS INC	ex10-3.htm
EX-10.2 - EXHIBIT 10.2 - LITHIA MOTORS INC	ex10-2.htm
EX-10.1 - EXHIBIT 10.1 - LITHIA MOTORS INC	ex10-1.htm

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 March 31, 2017

[ ]	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		(I.R.S. Employer Identification No.)
or organization)


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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and "emerging growth 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 [ ] Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

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		23,776,338
Class B common stock without par value		1,262,231
(Class)		Outstanding at April 28, 2017

LITHIA MOTORS, INC.

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION		Page

Item 1.	Financial Statements	2

	Consolidated Balance Sheets (Unaudited) - March 31, 2017 and December 31, 2016	2

	Consolidated Statements of Operations (Unaudited) – Three Months Ended March 31, 2017 and 2016	3

	Consolidated Statements of Comprehensive Income (Unaudited) – Three Months Ended March 31, 2017 and 2016	4

	Consolidated Statements of Cash Flows (Unaudited) – Three Months Ended March 31, 2017 and 2016	5

	Condensed Notes to Consolidated Financial Statements (Unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34

Item 4.	Controls and Procedures	34

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	34

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 6.	Exhibits	35

Signatures		36

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

(Unaudited)

	March 31, 2017		December 31, 2016
Assets
Current Assets:
Cash and cash equivalents	$	31,440	$	50,282
Accounts receivable, net of allowance for doubtful accounts of $4,953 and $5,281		341,591		417,714
Inventories, net		1,812,217		1,772,587
Other current assets		48,248		46,611
Total Current Assets		2,233,496		2,287,194

Property and equipment, net of accumulated depreciation of $175,231 and $167,300		1,010,496		1,006,130
Goodwill		259,399		259,399
Franchise value		184,268		184,268
Other non-current assets		114,305		107,159
Total Assets	$	3,801,964	$	3,844,150

Liabilities and Stockholders' Equity
Current Liabilities:
Floor plan notes payable	$	97,031	$	94,602
Floor plan notes payable: non-trade		1,503,257		1,506,895
Current maturities of long-term debt		17,917		20,965
Trade payables		80,022		88,423
Accrued liabilities		241,639		211,109
Total Current Liabilities		1,939,866		1,921,994

Long-term debt, less current maturities		666,135		769,916
Deferred revenue		86,840		81,929
Deferred income taxes		58,658		59,075
Other long-term liabilities		100,299		100,460
Total Liabilities		2,851,798		2,933,374

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 23,891 and 23,382		163,872		165,512
Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 1,262 and 1,762		157		219
Additional paid-in capital		37,714		41,225
Retained earnings		748,423		703,820
Total Stockholders' Equity		950,166		910,776
Total Liabilities and Stockholders' Equity	$	3,801,964	$	3,844,150

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 March 31,
	2017			2016
Revenues:
New vehicle	$	1,210,304		$	1,096,055
Used vehicle retail		602,223			532,726
Used vehicle wholesale		71,503			65,146
Finance and insurance		86,777			77,638
Service, body and parts		232,574			196,675
Fleet and other		32,720			14,621
Total revenues		2,236,101			1,982,861
Cost of sales:
New vehicle		1,140,186			1,029,289
Used vehicle retail		533,440			468,449
Used vehicle wholesale		69,986			63,316
Service, body and parts		119,380			100,556
Fleet and other		31,457			14,069
Total cost of sales		1,894,449			1,675,679
Gross profit		341,652			307,182
Asset impairments		—			3,498
Selling, general and administrative		242,772			219,106
Depreciation and amortization		12,739			11,663
Operating income		86,141			72,915
Floor plan interest expense		(8,052	)		(5,909	)
Other interest expense, net		(6,671	)		(5,459	)
Other income (expense), net		9,845			(1,526	)
Income before income taxes		81,263			60,021
Income tax provision		(30,536	)		(19,751	)
Net income	$	50,727		$	40,270

Basic net income per share	$	2.01		$	1.56
Shares used in basic per share calculations		25,180			25,816

Diluted net income per share	$	2.01		$	1.55
Shares used in diluted per share calculations		25,250			25,973

Cash dividends declared per Class A and Class B share	$	0.25		$	0.20

See accompanying condensed notes to consolidated financial statements.

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

	Three Months Ended March 31,
	2017		2016
Net income	$	50,727	$	40,270
Other comprehensive income, net of tax:
Gain on cash flow hedges, net of tax expense of $0 and $103, respectively		—		163
Comprehensive income	$	50,727	$	40,433

See accompanying condensed notes to consolidated financial statements.

LITHIA MOTORS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Three Months Ended March 31,
	2017			2016
Cash flows from operating activities:
Net income	$	50,727		$	40,270
Adjustments to reconcile net income to net cash provided by operating activities:
Asset impairments		—			3,498
Depreciation and amortization		12,739			11,663
Stock-based compensation		2,619			3,149
(Gain) loss on disposal of other assets		279			(3,391	)
Gain on disposal of franchise		—			(1,087	)
Deferred income taxes		(417	)		10,261
(Increase) decrease (net of acquisitions and dispositions):
Trade receivables, net		76,123			25,564
Inventories		(42,298	)		(73,744	)
Other assets		(3,776	)		(4,661	)
Increase (decrease) (net of acquisitions and dispositions):
Floor plan notes payable		2,429			7,753
Trade payables		(7,617	)		920
Accrued liabilities		31,116			13,425
Other long-term liabilities and deferred revenue		4,750			5,396
Net cash provided by operating activities		126,674			39,016

Cash flows from investing activities:
Capital expenditures		(16,039	)		(15,900	)
Proceeds from sales of assets		399			92
Cash paid for other investments		(6,863	)		(11,449	)
Cash paid for acquisitions, net of cash acquired		—			(13,799	)
Proceeds from sales of stores		—			11,822
Net cash used in investing activities		(22,503	)		(29,234	)

Cash flows from financing activities:
(Repayments) borrowings on floor plan notes payable, net: non-trade		(2,110	)		38,626
Borrowings on lines of credit		231,000			213,123
Repayments on lines of credit		(351,433	)		(229,311	)
Principal payments on long-term debt, scheduled		(4,648	)		(4,023	)
Principal payments on long-term debt and capital leases, other		(9,743	)		(2,303	)
Proceeds from issuance of long-term debt		27,878			12,080
Proceeds from issuance of common stock		1,523			1,464
Repurchase of common stock		(9,188	)		(57,736	)
Dividends paid		(6,292	)		(5,151	)
Net cash used in financing activities		(123,013	)		(33,231	)
Decrease in cash and cash equivalents		(18,842	)		(23,449	)
Cash and cash equivalents at beginning of period		50,282			45,008
Cash and cash equivalents at end of period	$	31,440		$	21,559

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	17,261		$	12,990
Cash paid during the period for income taxes, net		8			497

Supplemental schedule of non-cash activities:
Floor plan debt paid in connection with store disposals		—			5,284

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 March 31, 2017 and for the three months ended March 31, 2017 and 2016. 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 2016 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2016 is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2016 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 condensed Consolidated Financial Statements to maintain consistency and comparability between periods presented. This reclassification was related to our adoption of ASU 2016-09, "Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting." Specifically, we reclassified the presentation of excess tax benefits on our Consolidated Statements of Cash Flows and recorded reclassifications between additional paid-in capital and retained earnings. See also Note 11.

Note 2. Accounts Receivable

Accounts receivable consisted of the following (in thousands):

	March 31, 2017			December 31, 2016
Contracts in transit	$	168,642		$	233,506
Trade receivables		47,883			47,450
Vehicle receivables		39,630			43,937
Manufacturer receivables		68,883			76,948
Auto loan receivables		70,383			69,859
Other receivables		1,568			1,600
		396,989			473,300
Less: Allowance		(4,953	)		(5,281	)
Less: Long-term portion of accounts receivable, net		(50,445	)		(50,305	)
Total accounts receivable, net	$	341,591		$	417,714

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 approximately ten days after selling a vehicle.

•

Trade receivables are comprised of amounts due from customers for open charge accounts, 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 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):

	March 31, 2017		December 31, 2016
New vehicles	$	1,364,188	$	1,338,110
Used vehicles		381,190		368,067
Parts and accessories		66,839		66,410
Total inventories	$	1,812,217	$	1,772,587

Inventories are valued at the lower of net realizable value or cost, using a pooled approach for vehicles and the specific identification method for parts. Certain acquired inventories are valued using the last-in first-out (LIFO) method.

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, 2015¹	$	97,903		$	84,384	$	30,933	$	213,220
Additions through acquisitions²		18,154			21,795		7,448		47,397
Reductions through divestitures		(1,218	)		—		—		(1,218	)
Balance as of December 31, 2016¹	$	114,839		$	106,179	$	38,381	$	259,399
Additions through acquisitions		—			—		—		—
Reductions through divestitures		—			—		—		—
Balance as of March 31, 2017¹	$	114,839		$	106,179	$	38,381	$	259,399

¹ Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.

²Our purchase price allocation is preliminary for the acquisitions related to the Carbone Auto Group. The initial purchase price allocation is subject to change upon final valuation analysis. The primary balances still subject to analysis are certain intangible assets.

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

	Franchise Value
Balance as of December 31, 2015	$	157,699
Additions through acquisitions¹		27,087
Reductions through divestitures		(518	)
Balance as of December 31, 2016	$	184,268
Additions through acquisitions		—
Reductions through divestiture		—
Balance as of March 31, 2017	$	184,268

¹Our purchase price allocation is preliminary for the acquisitions related to the Carbone Auto Group. The initial purchase price allocation is subject to change upon final valuation analysis. The primary balances still subject to analysis are certain intangible assets.

Note 5. Stockholders’ Equity

Repurchases of Class A Common Stock

Repurchases of our Class A Common Stock occurred under a repurchase authorization granted by our Board of Directors and related to shares withheld as part of the vesting of restricted stock units ("RSUs"). In February 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. Share repurchases under this authorization were as follows:

Repurchases Occurring in

the Three Months Ended

March 31, 2017

Cumulative Repurchases as

of March 31, 2017

Shares

Average Price

Shares

Average Price

2016 Share Repurchase Authorization

62,000

96.94

775,725

81.12

As of March 31, 2017, we had $187.1 million available for repurchases pursuant to our 2016 share repurchase authorization.

In addition, during the first three months of 2017, we repurchased 31,986 shares at an average price of $99.34 per share, for a total of $3.2 million, related to tax withholdings associated with the vesting of 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.

Note 6. Fair Value Measurements

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 March 31, 2017, this debt had maturity dates between May 1, 2018 and December 31, 2050. There were no changes to our valuation techniques during the three-month period ended March 31, 2017.

A summary of the aggregate carrying values and fair values of our long-term fixed interest rate debt is as follows (in thousands):

	March 31, 2017		December 31, 2016
Carrying value	$	296,539	$	286,660
Fair value		299,623		293,522

Note 7. 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 common shares underlying equity awards that are unvested or subject to forfeiture. 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 RSUs 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.

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

Three Months Ended March 31,	2017					2016
(in thousands, except per share data)	Class A		Class B			Class A		Class B
Net income applicable to common stockholders - basic	$	47,826	$	2,901		$	36,692	$	3,578
Reallocation of net income as a result of conversion of dilutive stock options		1		(1	)		3		(3	)
Reallocation of net income due to conversion of Class B to Class A common shares outstanding		359		—			455		—
Conversion of Class B common shares into Class A common shares		2,534		—			3,102		—
Effect of dilutive stock options on net income		7		(7	)		18		(18	)
Net income applicable to common stockholders - diluted	$	50,727	$	2,893		$	40,270	$	3,557

Weighted average common shares outstanding – basic		23,740		1,440			23,522		2,294
Conversion of Class B common shares into Class A common shares		1,440		—			2,294		—
Effect of dilutive stock options on weighted average common shares		70		—			157		—
Weighted average common shares outstanding – diluted		25,250		1,440			25,973		2,294

Net income per common share - basic	$	2.01	$	2.01		$	1.56	$	1.56
Net income per common share - diluted	$	2.01	$	2.01		$	1.55	$	1.55

Three Months Ended March 31,

2017

2016

Diluted EPS

Class A

Class B

Class A

Class B

Antidilutive Securities

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

—

Note 8. 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 total equity contribution of $49.8 million. This investment generated 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 exercised management control over the limited liability company, due to the economic interest we held in the entity, we determined our ownership portion of the entity was appropriately accounted for using the equity method. We exited this equity-method investment in December 2016.

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

The following amounts related to this equity-method investment were recorded in our Consolidated Statements of Operations (in thousands):

	Three Months Ended March 31,
	2017		2016
Asset impairments to write investment down to fair value	$	—	$	3,498
Our portion of the partnership’s operating losses		—		2,066
Non-cash interest expense related to the amortization of the discounted fair value of future equity contributions		—		92
Tax benefits and credits generated		—		5,945

Note 9. Segments

While we have determined that each individual store is a reporting unit, we have aggregated our reporting units into three reportable segments based on their economic similarities: Domestic, Import and Luxury.

Our Domestic segment is comprised of retail automotive franchises that sell new vehicles manufactured by Chrysler, General Motors and Ford. Our Import segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by Honda, Toyota, Subaru, Nissan and Volkswagen. Our Luxury segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by BMW, Mercedes-Benz and Lexus. The franchises in each segment also sell used vehicles, parts and automotive services, and automotive finance and insurance products.

Corporate and other revenue and income includes the results of operations of our stand-alone body shop offset by unallocated corporate overhead expenses, such as corporate personnel costs, and certain unallocated reserve and elimination adjustments. Additionally, certain internal corporate expense allocations increase segment income for Corporate and other while decreasing segment income for the other reportable segments. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters that perform certain dealership functions.

We define our chief operating decision maker (“CODM”) to be certain members of our executive management group. Historical and forecasted operational performance is evaluated on a store-by-store basis and on a consolidated basis by the CODM. We derive the operating results of the segments directly from our internal management reporting system. The accounting policies used to derive segment results are substantially the same as those used to determine our consolidated results, except for the internal allocation within Corporate and other discussed above. Our CODM measures the performance of each operating segment based on several metrics, including earnings from operations, and uses these results, in part, to evaluate the performance of, and to allocate resources to, each of the operating segments.

Certain financial information on a segment basis is as follows (in thousands):

	Three Months Ended March 31,
	2017			2016
Revenues:
Domestic	$	899,759		$	771,902
Import		971,472			862,743
Luxury		363,803			346,813
		2,235,034			1,981,458
Corporate and other		1,067			1,403
	$	2,236,101		$	1,982,861
*Segment income:**
Domestic	$	25,442		$	23,132
Import		22,172			24,263
Luxury		4,713			4,583
		52,327			51,978
Corporate and other		38,501			26,691
Depreciation and amortization		(12,739	)		(11,663	)
Other interest expense		(6,671	)		(5,459	)
Other income (expense), net		9,845			(1,526	)
Income before income taxes	$	81,263		$	60,021

*Segment income for each of the segments is defined as income before income taxes, depreciation and amortization, other interest expense and other expense, net.

	Three Months Ended March 31,
	2017			2016
Floor plan interest expense:
Domestic	$	7,954		$	6,496
Import		5,873			4,234
Luxury		3,076			2,657
		16,903			13,387
Corporate and other		(8,851	)		(7,478	)
	$	8,052		$	5,909

	March 31, 2017		December 31, 2016
Total assets:
Domestic	$	1,206,623	$	1,225,387
Import		979,834		959,355
Luxury		480,275		511,779
Corporate and other		1,135,232		1,147,629
	$	3,801,964	$	3,844,150

Note 10. 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.

In Re Lithia Motors Derivative Litigation

On April 26, 2017, the Circuit Court of the State of Oregon for Marion County entered an order approving a settlement agreement between the plaintiffs and each of the defendants in In re Lithia Motors Derivative Litigation, Case No. 15CV33696. The claims in this case related to the adoption of a transition agreement between Lithia and Sidney B. DeBoer, as disclosed in a Current Report on Form 8-K filed September 16, 2015.

As part of the settlement, no changes were made to the transition agreement with Mr. DeBoer, no damages were paid by any defendant, and no fault was ascribed to any of Lithia’s directors. The parties agreed to payment of approximately $1 million in plaintiff’s attorney fees and changes to Lithia’s corporate governance procedures, which will remain in place for at least five years, as follows:

•	Lithia will publicly disclose the most recent five years’ compensation of named executive officers;

•	Lithia will identify in its annual proxy statement and on its website the committees of the board of directors and the members of the committees;

•	Lithia will disclose the results of its annual say-on-pay vote by voting share class;

•	The audit and compensation committees of the board will each have one independent director who is not a member of both committees, subject to a cure period;

•	After 2017, a director may not serve more than four consecutive years as the chair of a board committee;

•	After the annual shareholder meeting in 2019, a director who served more than 15 years on the board would no longer be considered independent;

•	A director who is over 79 years old may not serve as an independent director;

•

A bar on non-member participation in executive sessions of the compensation committee, except for committee advisers and independent directors, and best efforts to limit the involvement of non-independent board members from compensation committee meetings where that individual’s compensation is discussed;

•	By 2020, the board will have five independent directors, subject to a cure period;

•	The compensation committee will retain a compensation consultant each year;

•	Lithia will submit any life-time compensation agreements for named executive officers that include payments over $1 million per year to shareholders for approval; and

•	Related party transactions over $1 million must be reviewed by the audit committee of the board.

The original derivative claim (Stein v. DeBoer et al.) was filed on December 14, 2015 and consolidated with a subsequent claim (Jessos v. DeBoer, et al.) that was filed on February 12, 2016. The plaintiffs alleged that Lithia's directors breached their fiduciary duties of loyalty and due care, and wasted corporate assets, when they approved the agreement with Mr. DeBoer. The plaintiffs also alleged a claim against Sidney B. DeBoer, asserting that he has been unjustly enriched by the agreement. The plaintiffs sought relief in the amount of damages allegedly sustained by Lithia as a result of the alleged breaches of fiduciary duty and alleged corporate waste, disgorgement and imposition of a constructive trust on all property and profits Sidney B. DeBoer received as a result of the alleged wrongful conduct, and an award of the costs and disbursements of the lawsuit, including reasonable attorney fees, costs, and expenses.

California Wage and Hour Litigations

In June 2012, Mr. Robles and Mr. Laredo brought claims against DCH Tustin Acura (Robles v. Tustin Motors, Inc., Case No. 30-2012-00579414, filed in the Superior Court of California, Orange County) alleging that the employer underpaid technicians citing California Wage Order provisions that require an employer to pay at least two times the minimum wage for each hour worked if the employee is required to bring his or her own tools. The plaintiffs amended the complaint in late 2013 to include allegations that the employer failed to pay technicians for non-productive time and time spent performing tasks not compensated by the flat-rate compensation system; off-the-clock time worked; and wages due at termination. The amended complaint also alleged that the employer failed to provide technicians accurate and complete wage statements; and statutory meal and rest periods. The plaintiffs are seeking relief on behalf of all employees at all DCH Auto Group dealerships in California in addition to attorney fees and costs. These plaintiffs (and several other former technicians in separate but partially overlapping actions) also seek relief under California’s Private Attorney General Action (PAGA) provisions, which allow private plaintiffs to recover civil penalties on behalf of the State of California. DCH successfully compelled arbitration based on arbitration agreements between these claimants and the employer, although certain representative claims were excluded and stayed pending arbitration.

During the pendency of Robles, related cases were filed that made substantially similar technician claims including Holzer (see below). DCH and the Robles claimants settled their individual claims in mediation in 2015. In April 2016, DCH and all technician plaintiffs in Robles and the related cases agreed in principle to settle the representative claims, although this settlement has not yet been approved by the California courts as expressly contemplated by the parties and required by applicable law as a condition of the agreed release of claims. DCH Auto Group (USA) Limited must indemnify Lithia Motors, Inc. for losses related to this claim pursuant to the stock purchase agreement between Lithia Motors, Inc. and DCH Auto Group (USA) Limited dated June 14, 2014. We believe the exposure related to this lawsuit, when considered in relation to the terms of the stock purchase agreement, is immaterial to our financial statements.

In August 2014, Ms. Holzer filed a complaint in the Central District of California (Holzer v. DCH Auto Group (USA) Inc., Case No. BC558869) alleging that her employer, an affiliate of DCH Auto Group (USA) Inc., failed to provide vehicle finance and sales persons, service advisors, and other clerical and hourly workers accurate and complete wage statements; and statutory meal and rest periods. The complaint also alleges that the employer failed to pay these employees for off-the-clock time worked; and wages due at termination. The plaintiffs also seek attorney fees and costs. DCH has sought to compel arbitration based on plaintiffs’ arbitration agreements. The plaintiffs (and several other employees in separate actions) are seeking relief under California’s PAGA provisions.

During the pendency of Holzer, related cases were filed that made substantially similar non-technician claims. DCH and all non-technician claimants settled their individual claims in mediation in 2017. In January 2017, DCH and all non-technician plaintiffs agreed in principle to settle the representative claims, although this settlement has not yet been approved by the California courts as expressly contemplated by the parties and required by applicable law as a condition of the agreed release of claims. DCH Auto Group (USA) Limited must indemnify Lithia Motors, Inc. for losses related to this claim pursuant to the stock purchase agreement between Lithia Motors, Inc. and DCH Auto Group (USA) Limited dated June 14, 2014. We believe the exposure related to this lawsuit, when considered in relation to the terms of the stock purchase agreement, is immaterial to our financial statements.

Note 11. Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued accounting standards update ("ASU") 2014-09, "Revenue from Contracts with Customers," which amends the accounting guidance related to revenues. This amendment will replace most of the existing revenue recognition guidance when it becomes effective. The new standard, as amended in July 2015, is effective for fiscal years beginning after December 15, 2017 and entities are allowed to adopt the standard as early as annual periods beginning after December 15, 2016, and interim periods therein. The standard permits the use of either the retrospective or cumulative effect transition method. We have evaluated the effect this amendment will have on our most significant types of transactions and expect the timing of our revenue recognition to generally remain the same. We plan to apply a cumulative effect transition method when we adopt this standard.

In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. We are evaluating the effect this pronouncement will have on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies the accounting for several aspects of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. In January 2017, we adopted this new guidance. As a result, we recorded the following:

•

Reclassified $0.2 million as a decrease to additional paid-in capital and an increase to retained earnings related to our policy election to record forfeitures as they occur.

•

All prior periods presented in our Consolidated Statements of Cash Flow have been adjusted for the presentation of excess tax benefits on the cash flow statement. This reclassification resulted in a $4.4 million reclassification between financing and operating cash flows.

•

We had $0.3 million of tax-effected state net operating loss carryforwards related to excess tax benefits for which a deferred tax asset has not been recognized. At adoption, this amount was recorded with the offset to retained earnings. Additionally, we do not believe that it is more-likely-than-not that the asset will be utilized and, as a result, a valuation allowance in the same amount was recorded, that offset the impact to retained earnings.

In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provides guidance for eight cash flow classification issues to reduce diversity in practice. The clarification includes guidance on items such as debt prepayment or debt extinguishment cost, contingent consideration payment made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies and distributions received from equity method investees. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted. We are evaluating the effect this pronouncement will have on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment." ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the updated standard, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU 2017-04 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our financial position, results of operations or cash flows.

Note 12. Subsequent Events

Common Stock Dividend

On April 17, 2017, our Board of Directors approved a dividend of $0.27 per share on our Class A and Class B common stock related to our first quarter 2017 financial results. The dividend will total approximately $6.7 million and will be paid on May 26, 2017 to shareholders of record on May 12, 2017.

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

Forward-Looking Statements and Risk Factors

Certain statements under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “project”, “outlook,” “target”, “may,” “will,” “would,” “should,” “seek,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “likely,” “goal,” “strategy,” “future,” “maintain,” and “continue” or the negative of these terms or other comparable terms. Examples of forward-looking statements in this Form 10-Q include, among others, statements we make regarding:

•

Future market conditions, including anticipated national new car sales levels;

•

Expected operating results, such as improved store performance; continued improvement of SG&A as a percentage of gross profit and all projections;

•

Anticipated continued success of acquisitions;

•

Anticipated ability to capture additional market share;

•

Anticipated ability to find accretive acquisitions;

•

Anticipated additions of dealership locations to our portfolio in the future;

•

Anticipated availability of liquidity from our unfinanced operating real estate; and

•

Anticipated levels of capital expenditures in the future.

The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results to materially differ from the results expressed or implied by these statements. Certain important factors that could cause actual results to differ from our expectations are discussed in Part II - Other Information, Item 1A in this Form 10-Q and in the Risk Factors section of our 2016 Annual Report on Form 10-K, as supplemented and amended from time to time in Quarterly Reports on Form 10-Q and our other filings with the Securities and Exchange Commission.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events that depend on circumstances that may or may not occur in the future. You should not place undue reliance on these forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. We assume no obligation to update or revise any forward-looking statement.

Overview

We are a leading operator of automotive franchises and strive to be the preferred auto retailer in each of the markets we serve. As of April 28, 2017, we offered 30 brands of new vehicles and all brands of used vehicles in 152 stores in the United States and online at Lithia.com, DCHauto.com and CarboneCars.com. We sell new and used vehicles 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 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 manage market risk and to maintain profitability.

The strategy for our continued growth focuses on capturing unrealized opportunities in our existing stores and acquiring dominant franchises that are under performing. Our world class performance management system allows us to identify and evaluate opportunities. We have developed a centralized support structure to reduce store-level administrative functions and allow store personnel to focus on providing a positive customer experience. These factors, combined with our people-driven culture and entrepreneurial leadership, create growth for our investors, employees and communities.

Results of Operations

For the three months ended March 31, 2017 and 2016, we reported net income of $50.7 million, or $2.01 per diluted share, and $40.3 million, or $1.55 per diluted share, respectively.

Key Revenue and Gross Profit Metrics

Key performance metrics for revenue and gross profit were as follows (dollars in thousands):

Three Months Ended March 31, 2017	Revenues		Percent of Total Revenues			Gross Profit		Gross Profit Margin			Percent of Total Gross Profit
New vehicle	$	1,210,304		54.1	%	$	70,118		5.8	%		20.5	%
Used vehicle retail		602,223		26.9			68,783		11.4			20.1
Used vehicle wholesale		71,503		3.2			1,517		2.1			0.4
Finance and insurance⁽¹⁾		86,777		3.9			86,777		100.0			25.4
Service, body and parts		232,574		10.4			113,194		48.7			33.1
Fleet and other		32,720		1.5			1,263		3.9			0.5
	$	2,236,101		100.0	%	$	341,652		15.3	%		100.0	%

Three Months Ended March 31, 2016	Revenues		Percent of Total Revenues			Gross Profit		Gross Profit Margin			Percent of Total Gross Profit
New vehicle	$	1,096,055		55.3	%	$	66,766		6.1	%		21.7	%
Used vehicle retail		532,726		26.9			64,277		12.1			20.9
Used vehicle wholesale		65,146		3.3			1,830		2.8			0.6
Finance and insurance⁽¹⁾		77,638		3.9			77,638		100.0			25.3
Service, body and parts		196,675		9.9			96,119		48.9			31.3
Fleet and other		14,621		0.7			552		3.8			0.2
	$	1,982,861		100.0	%	$	307,182		15.5	%		100.0	%

(1)	Commissions reported net of anticipated cancellations.

Same Store Operating Data

We believe that same store comparisons are an important indicator of our financial performance. Same store measures demonstrate our ability to grow revenues in our existing locations. As a result, same store measures have been integrated into the discussion below.

Same store measures reflect results for stores that were operating in each comparison period and only include the months when operations occurred in both periods. For example, a store acquired in February 2016 would be included in same store operating data beginning in March 2017, after its first full complete comparable month of operation. The first quarter operating results for the same store comparisons would include results for that store in only the period of March for both comparable periods.

New Vehicle Revenue and Gross Profit

	Three Months Ended March 31,						Increase				% Increase
(Dollars in thousands, except per unit amounts)	2017			2016			(Decrease)				(Decrease)
Reported
Revenue	$	1,210,304		$	1,096,055		$	114,249				10.4	%
Gross profit	$	70,118		$	66,766		$	3,352				5.0
Gross margin		5.8	%		6.1	%		(30	) bp	⁽¹⁾

Retail units sold		35,616			32,749			2,867				8.8
Average selling price per retail unit	$	33,982		$	33,468		$	514				1.5
Average gross profit per retail unit	$	1,969		$	2,039		$	(70	)			(3.4	)

Same store
Revenue	$	1,096,703		$	1,094,134		$	2,569				0.2
Gross profit	$	63,811		$	66,753		$	(2,942	)			(4.4	)
Gross margin		5.8	%		6.1	%		(30	) bp

Retail units sold		32,215			32,687			(472	)			(1.4	)
Average selling price per retail unit	$	34,043		$	33,473		$	570				1.7
Average gross profit per retail unit	$	1,981		$	2,042		$	(61	)			(3.0	)

⁽¹⁾	A basis point is equal to 1/100^th of one percent

New vehicle sales increased 10.4% in the three-month period ended March 31, 2017 compared to the same period of 2016, primarily driven by an increase in volume related to acquisitions.

Same store new vehicle unit sales decreased 1.4%, in the three-month period ended March 31, 2017 compared to the same period of 2016. This volume decrease was offset by a 1.7% increase in average price per unit. Our stores, on a same store basis, performed relatively on par with national new vehicle sales levels, which decreased 1.2% in the three-month period ended March 31, 2017 compared to the same period of 2016.

Same store unit sales increased (decreased) as follows:

	Three months ended March 31, 2017 compared to the same period of 2016			National growth in the three months ended March 31, 2017 compared to the same period of 2016 ¹
Domestic brand same store unit sales change		0.1	%		(3.4	)%
Import brand same store unit sales change		1.2			(0.6	)
Luxury brand same store unit sales change		(17.3	)		8.9
Overall		(1.4	)		(1.2	)

¹ National auto unit sales and seasonally adjusted annual rate ("SAAR") data obtained from Stephens Auto Unit Sales and SAAR report as of March 2017.

National new vehicle sales market growth is moderating for all brands. Our domestic brand unit volume change outperformed the national average for the three-month period ended March 31, 2017. Our Chrysler and General Motors stores, which comprised 27.2% of our total new vehicle unit sales in the first quarter of 2017, had same store unit sales increases of 1.1% for the three-month period ended March 31, 2017 compared to the same period of 2016. The national average increased for General Motors 0.6% and decreased 8.7% for Chrysler for the three-month period ended March 31, 2017 compared to the same period of 2016.

Our import brand unit volume outperformed the national average for the three-month period ended March 31, 2017. Our Honda stores, which comprised 22.8% of our total new vehicle unit sales in the first quarter of 2017, had same store unit increases of 3.4% for the three-month period ended March 31, 2017 compared to the same period of 2016. The national average unit volume increased 2.1% for Honda in the three-month period ended March 31, 2017 compared to the same period of 2016.

The period-over-period volume decline for our luxury brand unit volume exceeded the national average in the three-month period ended March 31, 2017 compared to the same period of 2016. The decline was primarily associated with our BMW and Mercedes stores, which comprised 3.9% and 1.0%, respectively, of our total new vehicle unit sales in the first quarter of 2017. These stores had same store unit sales declines of 18.5% and 20.2%, respectively, for the three-month period ended March 31, 2017 compared to the same period of 2016. The national average unit volume for BMW and Mercedes increased 2.0% and 2.2%, respectively, for the three-month period ended March 31, 2017 compared to the same period in 2016. Our luxury brands were down more than the national average due to declines in our local markets, which are concentrated in areas such as Portland, Seattle and New Jersey. Registrations were down in our markets, which contributed to the decrease. Additionally, our Mercedes stores lost market share, while our BMW stores were able to retain market share.

New vehicle gross profit increased 5.0% in the three-month period ended March 31, 2017 compared to the same period of 2016. On a same store basis, new vehicle gross profit decreased 4.4% in the three-month period ended March 31, 2017 compared to the same period of 2016. The same store average gross profit per unit for new vehicles decreased $61 in the three-month period ended March 31, 2017 compared to the same period of 2016. Our import brands primarily drove this decrease in gross profit per unit as these stores focused on gaining incremental sales volume.

Used Vehicle Retail Revenue and Gross Profit

	Three Months Ended March 31,						Increase			% Increase
(Dollars in thousands, except per unit amounts)	2017			2016			(Decrease)			(Decrease)
Reported
Retail revenue	$	602,223		$	532,726		$	69,497			13.0	%
Retail gross profit	$	68,783		$	64,277		$	4,506			7.0
Retail gross margin		11.4	%		12.1	%		(70	) bp

Retail units sold		30,783			27,431			3,352			12.2
Average selling price per retail unit	$	19,563		$	19,421		$	142			0.7
Average gross profit per retail unit	$	2,234		$	2,343		$	(109	)		(4.7	)

Same store
Retail revenue	$	561,800		$	530,623		$	31,177			5.9
Retail gross profit	$	64,917		$	64,096		$	821			1.3
Retail gross margin		11.6	%		12.1	%		(50	) bp

Retail units sold		28,501			27,320			1,181			4.3
Average selling price per retail unit	$	19,712		$	19,423		$	289			1.5
Average gross profit per retail unit	$	2,278		$	2,346		$	(68	)		(2.9	)

Used vehicle retail sales are a strategic focus for organic growth. We offer three categories of used vehicles: manufacturer certified pre-owned ("CPO") vehicles; core vehicles, or late-model vehicles with lower mileage; and value autos, or vehicles with over 80,000 miles. Our volume-based strategy for new vehicle sales increases the organic opportunity to convert vehicles acquired via trade to retail used vehicle sales.

Same store sales increased in all three categories of used vehicles as follows:

	Three months ended March 31, 2017 compared to the same period of 2016
Certified pre-owned vehicles		1.0	%
Core vehicles		7.1
Value autos		12.7
Overall		5.9

The increase in same store sales was a result of both increased unit sales and an increase in average selling prices. We continue to see a mix shift towards certified pre-owned and core vehicle sales. This shift is mainly due to a greater supply of late-model, off-lease vehicles driven by growth in new vehicle leasing and overall higher new vehicle sales levels over the past six years. Because the average new lease is approximately 30 months, the supply of late model used vehicles has increased.

On an annualized average, as of March 31, 2017 and 2016, each of our stores sold 66 and 64 retail used vehicle units, respectively, per month. We continue to target increasing sales to 75 units per store per month, or approximately a 12% increase in units sold.

Used retail vehicle gross profit increased 7.0% in the three-month period ended March 31, 2017 compared to the same period of 2016. On a same store basis, gross profit increased 1.3% in the three-month period ended March 31, 2017 compared to the same period of 2016, driven by volume growth, partially offset by a decrease in the average gross profit per unit sold.

Similar to new vehicle sales, we focus on gross profit dollars earned per unit, not on gross margin, in evaluating our sales performance. Gross profit per unit decreased in all three categories of used vehicles in the three-month period ended March 31, 2017 compared to the same period of 2016 as our stores focused on gaining incremental sales volume. This volume-based strategy creates the ability to generate incremental future business through used vehicle trade-in opportunities, finance and insurance sales and service work.

Used Vehicle Wholesale Revenue and Gross Profit

	Three Months Ended March 31,						Increase			% Increase
(Dollars in thousands, except per unit amounts)	2017			2016			(Decrease)			(Decrease)
Reported
Wholesale revenue	$	71,503		$	65,146		$	6,357			9.8	%
Wholesale gross profit	$	1,517		$	1,830		$	(313	)		(17.1	)
Wholesale gross margin		2.1	%		2.8	%		(70	) bp

Wholesale units sold		10,840			9,513			1,327			13.9
Average selling price per wholesale unit	$	6,596		$	6,848		$	(252	)		(3.7	)
Average gross profit per retail unit	$	140		$	192		$	(52	)		(27.1	)

Same store
Wholesale revenue	$	63,132		$	65,013		$	(1,881	)		(2.9	)
Wholesale gross profit	$	1,426		$	1,852		$	(426	)		(23.0	)
Wholesale gross margin		2.3	%		2.8	%		(50	) bp

Wholesale units sold		9,594			9,488			106			1.1
Average selling price per wholesale unit	$	6,580		$	6,852		$	(272	)		(4.0	)
Average gross profit per wholesale unit	$	149		$	195		$	(46	)		(23.6	)

Wholesale transactions are vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to age or other factors. Wholesale vehicles are typically sold at or near cost and do not comprise a meaningful component of our gross profit.

Finance and Insurance

	Three Months Ended March 31,
(Dollars in thousands, except per unit amounts)	2017		2016		Increase		% Increase
Reported
Revenue	$	86,777	$	77,638	$	9,139		11.8	%
Average finance and insurance per retail unit	$	1,307	$	1,290	$	17		1.3	%

Same store
Revenue	$	82,131	$	77,458	$	4,673		6.0	%
Average finance and insurance per retail unit	$	1,353	$	1,291	$	62		4.8	%

The increase in same store finance and insurance revenue in the three-month period ended March 31, 2017 was primarily due to higher unit volume and an increase in the average finance and insurance amount per retail unit. On a same store basis, our finance and insurance revenues per retail unit increased $62 in the three-month period ended March 31, 2017 compared to the same period of 2016, mainly driven by improved penetration rates for service contracts.

Trends in penetration rates for total new and used retail vehicles sold are detailed below:

	Three Months Ended March 31,
	2017			2016
Finance and insurance		77	%		78	%
Service contracts		47			43
Lifetime lube, oil and filter contracts		27			26

Service, Body and Parts Revenue and Gross Profit

	Three Months Ended March 31,						Increase
(Dollars in thousands)	2017			2016			(Decrease)		% Increase
Reported
Customer pay	$	122,620		$	106,891		$	15,729		14.7	%
Warranty		54,499			45,617			8,882		19.5
Wholesale parts		36,702			29,755			6,947		23.3
Body shop		18,753			14,412			4,341		30.1
Total service, body and parts	$	232,574		$	196,675		$	35,899		18.3	%

Service, body and parts gross profit	$	113,194		$	96,119		$	17,075		17.8	%
Service, body and parts gross margin		48.7	%		48.9	%	(20) bp

Same store
Customer pay	$	113,925		$	106,396		$	7,529		7.1	%
Warranty		49,607			45,445			4,162		9.2
Wholesale parts		31,347			29,705			1,642		5.5
Body shop		15,962			14,342			1,620		11.3
Total service, body and parts	$	210,841		$	195,888		$	14,953		7.6	%

Service, body and parts gross profit	$	103,150		$	95,723		$	7,427		7.8	%
Service, body and parts gross margin		48.9	%		48.9	%	0 bp

Our service, body and parts sales grew in all areas in the three-month period ended March 31, 2017 compared to the same period of 2016. There are more late-model units in operation as new vehicle sales volumes have been increasing since 2010. We believe this increase in units in operation will continue to benefit our service, body and parts sales in the coming years as more late-model vehicles age and require repairs and maintenance.

We focus on retaining customers by offering competitively-priced routine maintenance and through our marketing efforts. We increased our same store customer pay business 7.1% in the three-month period ended March 31, 2017 compared to the same period of 2016.

Same store warranty sales increased 9.2% in the three-month period ended March 31, 2017 compared to the same period of 2016. We continue to experience the impact of the significant recalls across multiple manufacturers. Combined with a growing number of units in operation, our warranty sales have steadily increased.

The increase in same-store warranty work by segment was as follows:

	Three months ended March 31, 2017 compared to the same period of 2016
Domestic		2.9	%
Import		11.5
Luxury		13.9

Same store wholesale parts increased 5.5% in the three-month period ended March 31, 2017 compared to the same period of 2016. We target independent repair shops, competing new vehicle dealers and wholesale accounts to expand parts sales to other repair shops.

Same store body shop increased 11.3% in the three-month period ended March 31, 2017 compared to the same period of 2016. Our stores have increased production through calculated adjustments to optimize personnel and equipment. Additionally, several of our body shops were in locations which experienced increased snowfall compared to the 2016 winter season and had increased volume.

Same store service, body and parts gross profit increased 7.8% in the three-month period ended March 31, 2017 compared to the same period of 2016, which is in line with our revenue growth. Our gross margins were flat as an increase in customer pay gross margin was offset by slight decreases in other areas.

Segments

Certain financial information by segment is as follows:

	Three Months Ended March 31,				Increase			% Increase
(Dollars in thousands)	2017		2016		(Decrease)			(Decrease)
Revenues:
Domestic	$	899,759	$	771,902	$	127,857			16.6	%
Import		971,472		862,743		108,729			12.6
Luxury		363,803		346,813		16,990			4.9
		2,235,034		1,981,458		253,576			12.8
Corporate and other		1,067		1,403		(336	)		(23.9	)
	$	2,236,101	$	1,982,861	$	253,240			12.8	%

	Three Months Ended March 31,						Increase			% Increase
(Dollars in thousands)	2017			2016			(Decrease)			(Decrease)
*Segment income:**
Domestic	$	25,442		$	23,132		$	2,310			10.0	%
Import		22,172			24,263			(2,091	)		(8.6	)
Luxury		4,713			4,583			130			2.8
		52,327			51,978			349			0.7
Corporate and other		38,501			26,691			11,810			44.2
Depreciation and amortization		(12,739	)		(11,663	)		1,076			9.2
Other interest expense		(6,671	)		(5,459	)		1,212			22.2
Other income (expense), net		9,845			(1,526	)		NM			NM
Income before income taxes	$	81,263		$	60,021		$	21,242			35.4	%

NM – not meaningful

*Segment income for each reportable segment is defined as income before income taxes, depreciation and amortization, other interest expense and other expense, net.

	Three Months Ended March 31,						Increase			% Increase
	2017			2016			(Decrease)			(Decrease)
Retail new vehicle unit sales:
Domestic		12,240			10,729			1,511			14.1	%
Import		19,835			18,034			1,801			10.0
Luxury		3,616			4,063			(447	)		(11.0	)
		35,691			32,826			2,865			8.7
Allocated to management		(75	)		(77	)		(2	)		NM
		35,616			32,749			2,867			8.8	%

NM – Not meaningful

Domestic

A summary of financial information for our Domestic segment follows:

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016		Increase		% Increase
Revenue	$	899,759	$	771,902	$	127,857		16.6	%
Segment income	$	25,442	$	23,132	$	2,310		10.0
Retail new vehicle unit sales		12,240		10,729		1,511		14.1

Our Domestic segment revenue increased 16.6% in the three-month period ended March 31, 2017 compared to the same period of 2016. In the second half of 2016, we acquired seven additional domestic brand stores, which contributed to increases in new vehicle, used vehicle retail, finance and insurance and service body and parts sales.

Our Domestic segment income increased 10.0% in the three-month period ended March 31, 2017 compared to the same period of 2016. This increase lagged our revenue growth. SG&A expenses increased 18.1% mainly related to personnel cost and increased headcount. Increased floor plan interest of 22.4% related to higher inventory levels and rising interest rates further impacted our Domestic segment income.

Import

A summary of financial information for our Import segment follows:

	Three Months Ended March 31,				Increase			% Increase
(Dollars in thousands)	2017		2016		(Decrease)			(Decrease)
Revenue	$	971,472	$	862,743	$	108,729			12.6	%
Segment income	$	22,172	$	24,263	$	(2,091	)		(8.6	)
Retail new vehicle unit sales		19,835		18,034		1,801			10.0

Our Import segment revenue increased 12.6% in the three-month period ended March 31, 2017 compared to the same period of 2016 due to increases in all major business lines. In 2016, we added seven import brand stores.

Segment income for our Import segment decreased 8.6% in the three-month period ended March 31, 2017 compared to the same period of 2016. Gross profit growth of 8.6% lagged revenue growth. Additionally, floor plan interest for the Import segment increased 38.7% due to higher inventory levels and rising interest rates. The outpaced growth in costs compared to gross profits resulted in lower segment income.

Luxury

A summary of financial information for our Luxury segment follows:

	Three Months Ended March 31,				Increase			% Increase
(Dollars in thousands)	2017		2016		(Decrease)			(Decrease)
Revenue	$	363,803	$	346,813	$	16,990			4.9	%
Segment income	$	4,713	$	4,583	$	130			2.8
Retail new vehicle unit sales		3,616		4,063		(447	)		(11.0	)

Our Luxury segment revenue increased 4.9% in the three-month period ended March 31, 2017 compared to the same period of 2016 due to increases in used vehicle retail, finance and insurance and service body and parts sales.

Our Luxury segment income increased 2.8% for the three months ended March 31, 2017 compared to the same period of 2016. Overall gross profits increased 8.2%, driven by increased used vehicle unit sales and strong service, body and parts growth. These improvements were offset by a decline in new vehicle unit sales. An increase in floor plan interest expense of 15.7% compared to the prior year period was due to higher inventory levels and rising interest rates. These increased expenses negatively affected Luxury segment income.

Corporate and Other

Revenues attributable to Corporate and other include the results of operations of our stand-alone body shop offset by certain unallocated reserve and elimination adjustments related to vehicle sales.

	Three Months Ended March 31,				Increase			% Increase
(Dollars in thousands)	2017		2016		(Decrease)			(Decrease)
Revenue	$	1,067	$	1,403	$	(336	)		(23.9	)%
Segment income	$	38,501	$	26,691	$	11,810			44.2

The decrease in Corporate and other revenue in the first three months of 2017 compared to the same period of 2016 was primarily related to changes to certain reserves that are not specifically identified with our domestic, import or luxury segment revenue, such as our reserve for revenue reversals associated with unwound vehicle sales and elimination of revenues associated with internal corporate vehicle purchases and leases with our stores.

Segment income attributable to Corporate and other includes amounts associated with the operating income from our stand-alone body shop and certain internal corporate expense allocations that reduce reportable segment income but increase Corporate and other income. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters who perform certain dealership functions.

Corporate and other segment income increased $11.8 million for the three-month period ended March 31, 2017 compared to the same period of 2016. The 2016 results included a $3.5 million impairment charge related to an equity investment and the 2017 results include $9.1 million related to revenue from legal settlement with two OEMs.

Asset Impairments

Asset impairments consist of the following:

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016
Equity-method investment	$	—	$	3,498

The asset impairment recorded in 2016 was associated with our equity-method investment in a limited liability company that participated in the NMTC Program. We evaluated this equity-method investment at the end of each reporting period and identified indications of loss resulting from other than temporary declines in value. We exited this equity-method investment in December 2016. See Note 8 of the Condensed Notes to the Consolidated Financial Statements for additional information.

Selling, General and Administrative Expense (“SG&A”)

SG&A includes salaries and related personnel expenses, advertising (net of manufacturer cooperative advertising credits), rent, facility costs, and other general corporate expenses.

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016		Increase		% Increase
Personnel	$	163,672	$	148,724	$	14,948		10.1	%
Advertising		19,956		19,336		620		3.2
Rent		7,221		6,402		819		12.8
Facility costs		15,127		8,059		7,068		87.7
Other		36,796		36,585		211		0.6
Total SG&A	$	242,772	$	219,106	$	23,666		10.8	%

	Three Months Ended March 31,						Increase
As a % of gross profit	2017			2016			(Decrease)
Personnel		47.9	%		48.4	%		(50	) bp
Advertising		5.8			6.3			(50	)
Rent		2.1			2.1			—
Facility costs		4.4			2.6			180
Other		10.9			11.9			(100	)
Total SG&A		71.1	%		71.3	%		(20	)

SG&A expense increased 10.8% in the three-month period ended March 31, 2017 compared to the same period of 2016. This increase was primarily driven by facility costs, which outpaced the growth in sales volume and increased $7.1 million compared to the same period of 2016 mainly related to increased facility cost associated with dealership acquisitions. Additionally, we recorded a $3.4 million gain for property-related insurance proceeds and a $1.1 million gain on the sale of stores in 2016.

SG&A expense adjusted for non-core charges was as follows (in thousands):

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016		Increase		% Increase
Personnel	$	163,672	$	148,789	$	14,883		10.0	%
Advertising		19,956		19,336		620		3.2
Rent		7,221		6,402		819		12.8
Adjusted facility costs		15,127		9,146		5,981		65.4
Adjusted other		36,796		34,614		2,182		6.3
Adjusted total SG&A	$	242,772	$	218,287	$	24,485		11.2	%

	Three Months Ended March 31,						Increase
As a % of gross profit	2017			2016			(Decrease)
Personnel		47.9	%		48.4	%		(50	) bp
Advertising		5.8	%		6.3	%		(50	)
Rent		2.1	%		2.1	%		—
Adjusted facility costs		4.4	%		3.0	%		140
Adjusted other		10.9	%		11.3	%		(40	)
Adjusted total SG&A		71.1	%		71.1	%		—	bp

Adjusted SG&A excludes a $1.1 million gain associated with the disposal of stores offset by a $1.9 million legal reserve adjustment for the three-month period ended March 31, 2016. We did not have any adjustments in 2017. See “Non-GAAP Reconciliations” for more details.

Depreciation and Amortization

Depreciation and amortization is comprised of depreciation expense related to buildings, significant remodels or improvements, furniture, tools, equipment and signage and amortization of certain intangible assets, including customer lists and non-compete agreements.

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016		Increase		% Increase
Depreciation and amortization	$	12,739	$	11,663	$	1,076		9.2	%

The increase in depreciation and amortization in the three-month period ended March 31, 2017 compared to the same period of 2016 was primarily due to capital expenditures that occurred since March 31, 2016. Our largest capital investments were related to expanding and improving facilities subsequent to the acquisition of stores, as well as, investments in improvements at our existing facilities. These investments increase the amount of depreciable assets and amortizable expenses. In the full year of 2016 and the first three months of 2017, we had capital expenditures of $100.8 million and $16.0 million, respectively.

Operating Margin

Operating income as a percentage of revenue, or operating margin, was as follows:

	Three Months Ended March 31,
	2017			2016
Operating margin		3.9	%		3.7	%
Operating margin adjusted for non-core charges⁽¹⁾		3.9	%		3.9	%

⁽¹⁾ See “Non-GAAP Reconciliations” for more details.

In the first quarter of 2017, our operating margin increased by 20 basis points compared to the same period of 2016. Adjusting for non-core charges, as detailed below in Non-GAAP Reconciliations, adjusted operating margin was consistent with the prior year period. We continue to focus on cost control, which allows us to leverage our cost structure in an environment of improving sales.

Floor Plan Interest Expense and Floor Plan Assistance

Floor plan interest expense increased $2.1 million in the three-month period ended March 31, 2017 compared to the same period of 2016, primarily as a result of increased average outstanding balances on our floor plan facilities due to increased inventory levels and increasing interest rates.

Floor plan assistance is provided by manufacturers to support store financing of new vehicle inventory. Under accounting standards, floor plan assistance is recorded as a component of new vehicle gross profit when the specific vehicle is sold. However, because manufacturers provide this assistance to offset inventory carrying costs, we believe a comparison of floor plan interest expense to floor plan assistance is a useful measure of the efficiency of our new vehicle sales relative to stocking levels.

The following tables detail the carrying costs for new vehicles and include new vehicle floor plan interest net of floor plan assistance earned.

	Three Months Ended March 31,									%
(Dollars in thousands)	2017			2016			Change			Change
Floor plan interest expense (new vehicles)	$	8,052		$	5,909		$	2,143			36.3	%
Floor plan assistance (included as an offset to cost of sales)		(11,788	)		(10,300	)		(1,488	)		14.4
Net new vehicle carrying costs	$	(3,736	)	$	(4,391	)	$	655			(14.9	)%

Other Interest Expense

Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle inventory financing facility and our revolving line of credit.

	Three Months Ended March 31,						Increase			% Increase
(Dollars in thousands)	2017			2016			(Decrease)			(Decrease)
Mortgage interest	$	4,391		$	3,547		$	844			23.8
Other interest		2,363			2,020			343			17.0
Capitalized interest		(83	)		(108	)		(25	)		(23.1	)
Total other interest expense	$	6,671		$	5,459			1,212			22.2	%

The increase of $1.2 million in other interest expense in the three-month period ended March 31, 2017 compared to the same period of 2016 was primarily due to higher volumes of borrowing on our credit facility and higher mortgage interest due to additional mortgage financings and increased interest rates.

Other Income (Expense), Net

Other income (expense), net was $9.8 million for the three-months ended March 31, 2017 compared to an expense of $1.5 million in the same period in 2016. This income in the three-months ended March 31, 2017 was primarily related to a legal settlement with two OEMs associated with diesel emissions litigation. Other income (expense), net in the same period in 2016, included the gains and losses related to equity-method investments.

Three Months Ended

March 31,

(Dollars in thousands)

2017

2016

Increase

% Increase

Other Income (Expense), net

9,845

(1,526

)

11,371

Income Tax Provision

Our effective income tax rate was as follows:

	Three Months Ended March 31,
	2017			2016
Effective income tax rate		37.6	%		32.9	%
Effective income tax rate excluding tax credits generated through our equity-method investment and other non-core items⁽¹⁾		37.6	%		39.2	%

⁽¹⁾ See “Non-GAAP Reconciliations” for more details.

Our effective income tax rate was 37.6% and 32.9%, respectively, for the three-month periods ended March 31, 2017 and 2016. Our 2016 tax rate was positively affected by new markets tax credits that were generated through our equity-method investment with U.S. Bancorp Community Development Corporation. Our effective tax rate for the three-month period ended March 31, 2017 was favorably impacted by excess tax benefits related our stock-based compensation. The adoption of this new guidance was applied prospectively beginning in 2017. See Note 11 of the Condensed Notes to the Consolidated Financial Statements for additional information.

Excluding the tax credits generated by our equity-method investment and adjusting for other non-core items, our effective tax rate would have been 37.6% and 39.2%, respectively, for the three-month periods ended March 31, 2017 and 2016.

Non-GAAP Reconciliations

We believe each of the non-GAAP financial measures below improves the transparency of our disclosures, provides a meaningful presentation of our results from the core business operations because they exclude adjustments for items not related to our ongoing core business operations and other non-cash adjustments, and improves the period-to-period comparability of our results from the core business operations. We use these measures in conjunction with GAAP financial measures to assess our business, including our compliance with covenants in our credit facility and in communications with our Board of Directors concerning financial performance. These measures should not be considered an alternative to GAAP measures.

The following tables reconcile certain reported non-GAAP measures to the most comparable GAAP measure from our Consolidated Statements of Operations:

	Three Months Ended March 31, 2017
(Dollars in Thousands, Except per Share Amounts)	As reported			OEM Settlements			Adjusted
Other income (expense)	$	9,845		$	(9,111	)	$	734

Income before income taxes	$	81,263		$	(9,111	)	$	72,152
Income tax provision		(30,536	)		3,423			(27,113	)
Net income	$	50,727		$	(5,688	)	$	45,039

Diluted net income (loss) per share	$	2.01		$	(0.23	)	$	1.78
Diluted share count		25,250

	Three Months Ended March 31, 2016
(Dollars in thousands, except per share amounts)	As reported			Disposal gain on sale of stores			Equity- method investment			Legal reserve			Adjusted
Asset impairment	$	3,498		$	—		$	(3,498	)	$	—		$	—
Selling, general and administrative		219,106			1,087			—			(1,906	)		218,287
Operating income		72,915			(1,087	)		3,498			1,906			77,232
Other income (expense)		(1,526	)		—			2,066			—			540

Income before income taxes	$	60,021		$	(1,087	)	$	5,564		$	1,906		$	66,404
Income tax provision		(19,751	)		426			(5,945	)		(747	)		(26,017	)
Net income	$	40,270		$	(661	)	$	(381	)	$	1,159		$	40,387

Diluted net income (loss) per share	$	1.55		$	(0.03	)	$	(0.01	)	$	0.04		$	1.55
Diluted share count		25,973

Liquidity and Capital Resources

We manage our liquidity and capital resources to fund our operating, investing and financing activities. We rely primarily on cash flows from operations and borrowings under our credit facilities as the main sources for liquidity. We use those funds to invest in capital expenditures, increase working capital and fulfill contractual obligations. Remaining funds are used for acquisitions, debt retirement, cash dividends, share repurchases and general business purposes.

Available Sources

Below is a summary of our immediately available funds:

	As of March 31,
(Dollars in thousands)	2017		2016		Increase		% Increase
Cash and cash equivalents	$	31,440	$	21,559	$	9,881		45.8	%
Available credit on the credit facilities		254,739		148,959		105,780		71.0
Total current available funds		286,179		170,518		115,661		67.8
Estimated funds from unfinanced real estate		163,745		150,129		13,616		9.1
Total estimated available funds	$	449,924	$	320,647	$	129,277		40.3	%

Cash flows generated by operating activities and borrowings under our credit facility are our most significant sources of liquidity. We also have the ability to raise funds through mortgaging real estate. As of March 31, 2017, our unencumbered owned operating real estate had a book value of $218 million. Assuming we can obtain financing on 75% of this value, we estimate we could have obtained additional funds of approximately $164 million at March 31, 2017; however, no assurances can be provided that the appraised value of these properties will match or exceed their book values or that this capital source will be available on terms acceptable to us.

In addition to the above sources of liquidity, potential sources include the placement of subordinated debentures or loans, the sale of equity securities and the sale of stores or other assets. We evaluate all of these options and may select one or more of them depending on overall capital needs and the availability and cost of capital, although no assurances can be provided that these capital sources will be available in sufficient amounts or with terms acceptable to us.

Information about our cash flows, by category, is presented in our Consolidated Statements of Cash Flows. The following table summarizes our cash flows:

	Three Months Ended March 31,						Increase (Decrease)
(Dollars in thousands)	2017			2016			in Cash Flow
Net cash provided by operating activities	$	126,674		$	39,016		$	87,658
Net cash used in investing activities		(22,503	)		(29,234	)		6,731
Net cash used in financing activities		(123,013	)		(33,231	)		(89,782	)

Operating Activities

Cash provided by operating activities for the three months ended March 31, 2017 increased $87.7 million compared to the same period of 2016, primarily related to changes in trade receivables, net, inventory and accrued liabilities.

Borrowings from and repayments to our syndicated lending group related to our new vehicle inventory floor plan financing are presented as financing activities. To better understand the impact of changes in inventory and the associated financing, we also consider our adjusted net cash provided by operating activities to include borrowings or repayments associated with our new vehicle floor plan credit facility.

Adjusted net cash provided by operating activities is presented below (in thousands):

	Three Months Ended March 31,						Increase (Decrease)
(Dollars in thousands)	2017			2016			in Cash Flow
Net cash provided by operating activities – as reported	$	126,674		$	39,016		$	87,658
Add: Net borrowings on floor plan notes payable, non-trade		(2,110	)		38,626			(40,736	)
Less: Borrowings on floor plan notes payable, non-trade associated with acquired new vehicle inventory		—			(4,854	)		4,854
Net cash provided by operating activities – adjusted	$	124,564		$	72,788		$	51,776

Inventories are the most significant component of our cash flow from operations. As of March 31, 2017, our new vehicle days supply was 76, or eight days higher than our days supply as of December 31, 2016. Our days supply of used vehicles was 50 days as of March 31, 2017, or six days lower than our days supply as of December 31, 2016. We calculate days supply of inventory based on current inventory levels, excluding in-transit vehicles, and a 30-day historical cost of sales level. We have continued to focus on managing our unit mix and maintaining an appropriate level of new and used vehicle inventory.

Investing Activities

Net cash used in investing activities totaled $22.5 million and $29.2 million, respectively, for the three-month periods ended March 31, 2017 and 2016. Cash flows from investing activities relate primarily to capital expenditures, acquisition and divestiture activity and sales of property and equipment.

Below are highlights of significant activity related to our cash flows from investing activities:

	Three Months Ended March 31,						Increase (Decrease)
(Dollars in thousands)	2017			2016			in Cash Flow
Capital expenditures	$	(16,039	)	$	(15,900	)	$	(139	)
Cash paid for acquisitions, net of cash acquired		—			(13,799	)		13,799
Cash paid for other investments		(6,863	)		(11,449	)		4,586
Proceeds from sales of stores		—			11,822			(11,822	)

Capital Expenditures

Below is a summary of our capital expenditure activities:

	Three Months Ended March 31,
(Dollars in thousands)	2017		2016
Post-acquisition capital improvements	$	3,795	$	6,801
Facilities for open points		76		—
Purchases of previously leased facilities		10		137
Existing facility improvements		4,550		2,468
Maintenance		7,608		6,494
Total capital expenditures	$	16,039	$	15,900

Many manufacturers provide assistance in the form of additional incentives or assistance if facilities meet specified standards and requirements. We expect that certain facility upgrades and remodels will generate additional manufacturer incentive payments. Also, tax laws allowing accelerated deductions for capital expenditures reduce the overall investment needed and encourage accelerated project timelines.

We expect to use a portion of our future capital expenditures to upgrade facilities that we recently acquired. This additional capital investment is contemplated in our initial evaluation of the investment return metrics applied to each acquisition and is usually associated with manufacturer standards and requirements.

If we undertake a significant capital commitment in the future, we expect to pay for the commitment out of existing cash balances, construction financing and borrowings on our credit facility. Upon completion of the projects, we believe we would have the ability to secure long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended, although no assurances can be provided that these financings will be available to us in sufficient amounts or on terms acceptable to us.

We expect to make expenditures of approximately $117 million in 2017 for capital improvements at recently acquired stores, purchases of land for expansion of existing stores, facility image improvements, purchases of store facilities, purchases of previously leased facilities and replacement of equipment.

Acquisitions

We focus on acquiring stores at attractive purchase prices that meet our return thresholds and strategic objectives. We look for acquisitions that diversify our brand and geographic mix as we continue to evaluate our portfolio to minimize exposure to any one manufacturer and achieve financial returns.

We are able to subsequently floor new vehicle inventory acquired as part of an acquisition; however, the cash generated by this transaction is recorded as borrowings on floor plan notes payable, non-trade. Adjusted net cash paid for acquisitions, as well as certain other acquisition-related information is presented below:

	Three Months Ended March 31,
	2017		2016
Number of stores acquired		—		2

(Dollars in thousands)
Cash paid for acquisitions, net of cash acquired	$	—	$	13,799
Less: Borrowings on floor plan notes payable: non-trade associated with acquired new vehicle inventory		—		(4,854	)
Cash paid for acquisitions, net of cash acquired – adjusted	$	—	$	8,945

We evaluate potential capital investments primarily based on targeted rates of return on assets and return on our net equity investment.

Financing Activities

Net cash used in financing activities, adjusted for borrowing on floor plan facilities: non-trade was as follows:

	Three Months Ended March 31,						Increase (Decrease)
(Dollars in thousands)	2017			2016			in Cash Flow
Cash used in financing activities, as reported	$	(123,013	)	$	(33,231	)	$	(89,782	)
Adjust: Repayments (borrowings) on floor plan notes payable: non-trade		2,110			(38,626	)		40,736
Cash used in financing activities – adjusted	$	(120,903	)	$	(71,857	)	$	(49,046	)

Below are highlights of significant activity related to our cash flows from financing activities, excluding net borrowings on floor plan notes payable: non-trade, which are discussed above:

	Three Months Ended March 31,						Increase (Decrease)
(Dollars in thousands)	2017			2016			in Cash Flow
Net repayments on lines of credit	$	(120,433	)	$	(16,188	)	$	(104,245	)
Principal payments on long-term debt and capital leases, unscheduled		(9,743	)		(2,303	)		(7,440	)
Proceeds from issuance of long-term debt		27,878			12,080			15,798
Repurchases of common stock		(9,188	)		(57,736	)		48,548
Dividends paid		(6,292	)		(5,151	)		(1,141	)

Borrowing and Repayment Activity

During the first three months of 2017, we raised net mortgage proceeds of $18.1 million, which was mainly used to pay down our outstanding balances on our long-term debt and our lines of credit and fund repurchases of common stock. Our debt to total capital ratio, excluding floor plan notes payable, was 41.9% at March 31, 2017 compared to 43.6% at March 31, 2016.

Equity Transactions

On February 25, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. We repurchased a total of 93,986 shares of our Class A common stock at an average price of $97.76 per share in the first three months of 2017: 62,000 shares as part of the repurchase plan at an average price per share of $96.94 and 31,986 shares related to tax withholding on vesting RSUs. As of March 31, 2017, we had $187.1 million remaining available for repurchases and the authorization does not have an expiration date.

In the first three months of 2017, we declared and paid dividends on our Class A and Class B common stock as follows:

Dividend paid:

Dividend

amount

per share

Total amount

of dividend

(in thousands)

March 2017

0.25

6,292

We evaluate performance and make a recommendation to the Board of Directors on dividend payments on a quarterly basis.

Summary of Outstanding Balances on Credit Facilities and Long-Term Debt

Below is a summary of our outstanding balances on credit facilities and long-term debt:

	As of March 31, 2017
(Dollars in thousands)	Outstanding		Remaining Available
Floor plan note payable: non-trade	$	1,503,257	$	—	(1)
Floor plan notes payable		97,031		—
Used vehicle inventory financing facility		173,000		34,603	(2)
Revolving lines of credit		60,073		220,136	(2),(3)
Real estate mortgages		442,183		—
Other debt		8,796		—
Total debt	$	2,284,340	$	254,739

(1)

As of March 31, 2017, we had a $1.55 billion new vehicle floor plan commitment as part of our credit facility.

(2)

The amount available on the credit facility is limited based on a borrowing base calculation and fluctuates monthly.

(3)

Available credit is based on the borrowing base amount effective as of February 28, 2017. This amount is reduced by $8.3 million for outstanding letters of credit.

Credit Facility

On July 27, 2016, we amended our existing credit facility to increase the total financing commitment by $300 million to $2.05 billion and extend the maturity to July 2021. This syndicated credit facility is comprised of 18 financial institutions, including eight manufacturer-affiliated finance companies. Under our credit facility we are permitted to allocate the total financing commitment among floor plan financing for new vehicle inventory, floor plan financing for used vehicles (up to a maximum of $350 million) and revolving financing for general corporate purposes, including acquisitions and working capital (up to a maximum of $400 million). Our credit facility may be expanded to $2.4 billion total availability, subject to lender approval. All borrowings from, and repayments to, our lending group are presented in the Consolidated Statements of Cash Flows as financing activities.

Our obligations under our revolving syndicated credit facility are secured by a substantial amount of our assets, including our inventory (including new and used vehicles, parts and accessories), equipment, accounts (and other rights to payment) and our equity interests in certain of our subsidiaries. Under our revolving syndicated credit facility, our obligations relating to new vehicle floorplan loans are secured only by collateral owned by borrowers of new vehicle floorplan loans under the credit facility.

We have the ability to deposit up to $50 million in cash in Principal Reduction (PR) accounts associated with our new vehicle inventory floor plan commitment. The PR accounts are recognized as offsetting credits against outstanding amounts on our new vehicle floor plan commitment and would reduce interest expense associated with the outstanding principal balance. As of March 31, 2017, we had no balances in our PR accounts.

If the outstanding principal balance on our new vehicle inventory floor plan commitment, plus requests on any day, exceeds 95% of the loan commitment, a portion of the revolving line of credit must be reserved. The reserve amount is equal to the lesser of $15.0 million or the maximum revolving line of credit commitment less the outstanding balance on the line less outstanding letters of credit. The reserve amount will decrease the revolving line of credit availability and may be used to repay the new vehicle floor plan commitment balance.

The interest rate on the credit facility varies based on the type of debt, with the rate of one-month LIBOR plus 1.25% for new vehicle floor plan financing, one-month LIBOR plus 1.50% for used vehicle floor plan financing; and a variable interest rate on the revolving financing ranging from the one-month LIBOR plus 1.25% to 2.50%, depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment was 2.23% at March 31, 2017. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 2.48% and 2.73%, respectively, at March 31, 2017.

Under the terms of our credit facility we are subject to financial covenants and restrictive covenants that limit or restrict our incurring additional indebtedness, making investments, selling or acquiring assets and granting security interests in our assets.

Under our credit facility, we are required to maintain the ratios detailed in the following table:

Debt Covenant Ratio	Requirement	As of March 31, 2017
Current ratio	Not less than 1.10 to 1	1.26 to 1
Fixed charge coverage ratio	Not less than 1.20 to 1	3.16 to 1
Leverage ratio	Not more than 5.00 to 1	1.91 to 1
Funded debt restriction	Not to exceed $900 million	$487.1 million

As of March 31, 2017, we were in compliance with all covenants. We expect to remain in compliance with the financial and restrictive covenants in our credit facility and other debt agreements. However, no assurances can be provided that we will continue to remain in compliance with the financial and restrictive covenants.

If we do not meet the financial and restrictive covenants and are unable to remediate or cure the condition or obtain a waiver from our lenders, a breach would give rise to remedies under the agreement, the most severe of which are the termination of the agreement, acceleration of the amounts owed and the seizure and sale of our assets comprising the collateral for the loans. A breach would also trigger cross-defaults under other debt agreements.

Floor Plan Notes Payable

We have floor plan agreements with manufacturer-affiliated finance companies for new vehicles at certain stores and vehicles designated for use as service loaners. The variable interest rates on these floor plan notes payable commitments vary by manufacturer. At March 31, 2017, $97.0 million was outstanding on these arrangements. Borrowings from, and repayments to, manufacturer-affiliated finance companies are classified as operating activities in the Consolidated Statements of Cash Flows.

Real Estate Mortgages and Other Debt

We have mortgages associated with our owned real estate. Interest rates related to this debt ranged from 2.5% to 5.0% at March 31, 2017. The mortgages are payable in various installments through October 2034. As of March 31, 2017, we had fixed interest rates on 65% of our outstanding mortgage debt.

Our other debt includes capital leases and sellers’ notes. The interest rates associated with our other debt ranged from 4.0% to 9.7% at March 31, 2017. This debt, which totaled $8.8 million at March 31, 2017, is due in various installments through December 2050.

Recent Accounting Pronouncements

See Note 11 of the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Critical Accounting Policies and Use of Estimates

There have been no material changes in the critical accounting policies and use of estimates described in our 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017.

Seasonality and Quarterly Fluctuations

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

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our reported market risks or risk management policies since the filing of our 2016 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 28, 2017.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

See Note 10 of the Condensed Notes to the Consolidated Financial Statements for additional information.

Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in our 2016 Annual Report on Form 10-K. The information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed in that report, which was filed with the Securities and Exchange Commission on February 28, 2017.

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

We repurchased the following shares of our Class A common stock during the first quarter of 2017:

	Total number of shares purchased⁽²⁾		Average price paid per share		Total number of shares purchased as part of publicly announced plans⁽¹⁾		Maximum dollar value of shares that may yet be purchased under publicly announced plan (in thousands)⁽¹⁾
January		36,853	$	99.08		20,000	$	191,080
February		33,984		100.92		19,000		189,163
March		23,149		91.00		23,000		187,070
		93,986	$	97.76		62,000	$	187,070

(1)

Effective February 29, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. This authorization does not have an expiration date and it replaced the previous authorizations, which limited the number of shares we were authorized to repurchase.

(2)

Of the shares repurchased in the first quarter of 2017, 31,986 shares were related to the tax withholdings on vesting RSUs.

Item 6. Exhibits

The following exhibits are filed herewith and this list is intended to constitute the exhibit index. An asterisk (*) beside the exhibit number indicates the exhibits containing a management contract, compensatory plan or arrangement.

3.1	Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999 (incorporated by reference to exhibit 3.1 to our Form 10-K for the year ended December 31, 1999).
3.2	2013 Amended and Restated Bylaws of Lithia Motors, Inc. (incorporated by reference to exhibit 3.1 to Form 8-K dated August 20, 2013 and filed with the Securities and Exchange Commission on August 26, 2013).
10.1*	Form of Restricted Stock Unit Agreement (Time-Vesting) (for Non-Employee Directors)
10.2*	Lithia Motors, Inc. 2013 Amended and Restated Stock Incentive Plan, as amended
10.3*	Lithia Motors, Inc. Performance Bonus Plan (formerly known as the Lithia Motors, Inc. 2013 Discretionary Support Services Variable Performance Compensation Plan)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
32.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
101.INS	XBRL Instance Document.
101.SCH	XBRL Taxonomy Extension Schema Document.
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB	XBRL Taxonomy Extension Label Linkbase Document.
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: April 28, 2017	LITHIA MOTORS, INC.

	By: /s/ John F. North III
	John F. North III
	Senior Vice President and Chief Financial Officer
	(Duly Authorized Officer and Principal Financial and
	Accounting Officer)

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