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EX-32.2 - EXHIBIT 32.2 - LITHIA MOTORS INClad2018q3-10q_ex322cfocert.htm
EX-32.1 - EXHIBIT 32.1 - LITHIA MOTORS INClad2018q3-10q_ex321ceocert.htm
EX-31.2 - EXHIBIT 31.2 - LITHIA MOTORS INClad2018q3-10q_ex312cfocert.htm
EX-31.1 - EXHIBIT 31.1 - LITHIA MOTORS INClad2018q3-10q_ex311ceocert.htm
EX-10.1 - EXHIBIT 10.1 - LITHIA MOTORS INClad2018q3-ex101_creditamend.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 September 30, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from       to         
 
Commission file number: 001-14733
 
LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
Oregon
 
93-0572810
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
150 N. Bartlett Street, Medford, Oregon
 
97501
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code: 541-776-6401
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
 
22,488,323
Class B common stock without par value
 
1,000,000
(Class)
 
Outstanding at October 26, 2018




LITHIA MOTORS, INC.
FORM 10-Q
INDEX 
 
PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
 
 
 
 
Consolidated Balance Sheets (Unaudited) - September 30, 2018 and December 31, 2017
 
 
 
 
Consolidated Statements of Operations (Unaudited) – Three and Nine Months Ended September 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 

1



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)
(Unaudited)
 
 
 
September 30, 2018
 
December 31, 2017
Assets
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
31,432

 
$
57,253

Accounts receivable, net of allowance for doubtful accounts of $6,426 and $7,386
 
470,689

 
521,938

Inventories, net
 
2,275,965

 
2,132,744

Other current assets
 
47,648

 
70,847

Total Current Assets
 
2,825,734

 
2,782,782

 
 
 
 
 
Property and equipment, net of accumulated depreciation of $228,992 and $197,802
 
1,248,692

 
1,185,169

Goodwill
 
356,968

 
256,320

Franchise value
 
256,004

 
186,977

Other non-current assets
 
487,171

 
271,818

Total Assets
 
$
5,174,569

 
$
4,683,066

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Current Liabilities:
 
 
 
 
Floor plan notes payable
 
$
135,626

 
$
116,774

Floor plan notes payable: non-trade
 
1,820,241

 
1,802,252

Current maturities of long-term debt
 
33,856

 
18,876

Trade payables
 
113,662

 
111,362

Accrued liabilities
 
259,825

 
251,717

Total Current Liabilities
 
2,363,210

 
2,300,981

 
 
 
 
 
Long-term debt, less current maturities
 
1,287,052

 
1,028,476

Deferred revenue
 
117,850

 
103,111

Deferred income taxes
 
77,684

 
56,277

Other long-term liabilities
 
123,631

 
111,003

Total Liabilities
 
3,969,427

 
3,599,848

 
 
 
 
 
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 22,912 and 23,968
 
50,104

 
149,123

Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 1,000 and 1,000
 
124

 
124

Additional paid-in capital
 
45,897

 
11,309

Retained earnings
 
1,109,017

 
922,662

Total Stockholders' Equity
 
1,205,142

 
1,083,218

Total Liabilities and Stockholders' Equity
 
$
5,174,569

 
$
4,683,066

 
See accompanying condensed notes to consolidated financial statements.

2



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
New vehicle
 
$
1,732,950

 
$
1,553,511

 
$
4,914,478

 
$
4,147,870

Used vehicle retail
 
805,928

 
679,180

 
2,325,600

 
1,915,038

Used vehicle wholesale
 
91,956

 
65,739

 
253,246

 
206,754

Finance and insurance
 
121,062

 
101,044

 
342,059

 
282,672

Service, body and parts
 
311,327

 
265,683

 
908,431

 
744,262

Fleet and other
 
28,729

 
15,185

 
104,354

 
86,883

Total revenues
 
3,091,952

 
2,680,342

 
8,848,168

 
7,383,479

Cost of sales:
 
 
 
 
 
 
 
 
New vehicle
 
1,632,068

 
1,465,466

 
4,625,155

 
3,909,168

Used vehicle retail
 
719,575

 
600,522

 
2,078,535

 
1,693,091

Used vehicle wholesale
 
90,553

 
64,565

 
248,991

 
202,351

Service, body and parts
 
156,871

 
133,191

 
461,860

 
376,096

Fleet and other
 
26,646

 
13,577

 
98,550

 
82,829

Total cost of sales
 
2,625,713

 
2,277,321

 
7,513,091

 
6,263,535

Gross profit
 
466,239

 
403,021

 
1,335,077

 
1,119,944

Selling, general and administrative
 
309,024

 
282,241

 
939,868

 
782,303

Depreciation and amortization
 
19,649

 
14,828

 
55,324

 
41,598

Operating income
 
137,566

 
105,952

 
339,885

 
296,043

Floor plan interest expense
 
(15,958
)
 
(10,629
)
 
(45,126
)
 
(28,013
)
Other interest expense, net
 
(15,010
)
 
(9,905
)
 
(40,645
)
 
(23,745
)
Other income, net
 
2,389

 
1,125

 
5,422

 
11,357

Income before income taxes
 
108,987

 
86,543

 
259,536

 
255,642

Income tax provision
 
(15,880
)
 
(34,657
)
 
(53,708
)
 
(99,829
)
Net income
 
$
93,107

 
$
51,886

 
$
205,828

 
$
155,813

 
 
 
 
 
 
 
 
 
Basic net income per share
 
$
3.85

 
$
2.07

 
$
8.34

 
$
6.21

Shares used in basic per share calculations
 
24,164

 
25,008

 
24,670

 
25,090

 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
3.84

 
$
2.07

 
$
8.31

 
$
6.19

Shares used in diluted per share calculations
 
24,258

 
25,076

 
24,767

 
25,158

 
 
 
 
 
 
 
 
 
Cash dividends paid per Class A and Class B share
 
$
0.29

 
$
0.27

 
$
0.85

 
$
0.79

 
See accompanying condensed notes to consolidated financial statements.

3



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
205,828

 
$
155,813

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
55,324

 
41,598

Stock-based compensation
 
9,776

 
8,396

Gain on disposal of other assets
 
(91
)
 
(382
)
Gain on disposal of franchise
 
(15,396
)
 

Deferred income taxes
 
19,446

 
7,398

(Increase) decrease (net of acquisitions and dispositions):
 
 
 
 
Accounts receivable, net
 
63,419

 
(13,345
)
Inventories
 
(14,466
)
 
(16,098
)
Other assets
 
12,007

 
15,207

Increase (net of acquisitions and dispositions):
 
 
 
 
Floor plan notes payable
 
8,073

 
12,126

Trade payables
 
3,645

 
12,397

Accrued liabilities
 
8,637

 
25,907

Other long-term liabilities and deferred revenue
 
23,084

 
11,519

Net cash provided by operating activities
 
379,286

 
260,536

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(113,386
)
 
(72,174
)
Proceeds from sales of assets
 
2,044

 
12,327

Cash paid for other investments
 
(62,126
)
 
(7,929
)
Cash paid for acquisitions, net of cash acquired
 
(374,026
)
 
(400,558
)
Proceeds from sales of stores
 
32,893

 
3,417

Net cash used in investing activities
 
(514,601
)
 
(464,917
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Borrowings on floor plan notes payable, net: non-trade
 
61,705

 
34,056

Borrowings on lines of credit
 
1,964,490

 
1,306,000

Repayments on lines of credit
 
(1,860,222
)
 
(1,432,853
)
Principal payments on long-term debt and capital leases, scheduled
 
(16,944
)
 
(13,697
)
Principal payments on long-term debt and capital leases, other
 
(5,305
)
 
(46,471
)
Proceeds from issuance of long-term debt
 
62,140

 
395,905

Payments of debt issuance costs
 
(477
)
 
(4,517
)
Proceeds from issuance of common stock
 
7,416

 
5,577

Repurchase of common stock
 
(81,622
)
 
(31,521
)
Dividends paid
 
(20,915
)
 
(19,803
)
Payments of contingent consideration related to acquisitions
 
(772
)
 

Net cash provided by financing activities
 
109,494

 
192,676

Decrease in cash and cash equivalents
 
(25,821
)
 
(11,705
)
Cash and cash equivalents at beginning of period
 
57,253

 
50,282

Cash and cash equivalents at end of period
 
$
31,432

 
$
38,577

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for interest
 
$
88,938

 
$
51,160

Cash paid during the period for income taxes, net
 
2,907

 
89,206

Floor plan debt paid in connection with store disposals
 
33,139

 

 
 
 
 
 
Supplemental schedule of non-cash activities:
 
 
 
 
Debt issued in connection with acquisitions
 
$
125,055

 
$
1,748

Debt assumed in connection with acquisitions
 
10,769

 
86,902

Issuance of Class A common stock in connection with acquisitions
 

 
2,137


 See accompanying condensed notes to consolidated financial statements.

4



LITHIA MOTORS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1. Interim Financial Statements
 
Basis of Presentation
These condensed Consolidated Financial Statements contain unaudited information as of September 30, 2018, and for the three and nine-months ended September 30, 2018 and 2017. 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 2017 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2017, is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 23, 2018. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2017 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.
 
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. We adopted this standard utilizing a cumulative effect transition method effective January 2018. Except for the changes below, we have consistently applied the accounting policies to all periods presented in these consolidated financial statements. See Notes 2 and 14.

Reclassifications
Certain immaterial reclassifications of amounts previously reported have been made to the accompanying condensed Consolidated Financial Statements to maintain consistency and comparability between periods presented.

Note 2. Revenue Recognition

The following describes our major product lines, which represent the disaggregation of our revenues to transactions that are similar in nature, amount, timing, uncertainties and economic factors.

New Retail Vehicle and Used Retail Vehicle Sales
Revenue from the retail sale of a vehicle is recognized at a point in time, as all performance obligations are satisfied when a contract is signed by the customer, financing has been arranged or collectibility is probable and the control of the vehicle is transferred to the customer. The transaction price for a retail vehicle sale is specified in the contract with the customer and includes all cash and non-cash consideration. In a retail vehicle sale, customers often trade in their current vehicle. The trade-in is measured at its stand-alone selling price in the contract, utilizing various third-party pricing sources. There are no other non-cash forms of consideration related to retail sales. All vehicle rebates are applied to the vehicle purchase price at the time of the sale and are therefore incorporated into the price of the contract at the time of the exchange. We do not allow the return of new or used vehicles, except where mandated by state law.

Service, Body and Parts Sales
Revenue from service, body and parts sales is recognized upon the transfer of control of the parts or service to the customer. We allow for customer returns on sales of our parts inventory up to 30 days after the sale. Most parts returns generally occur within one to two weeks from the time of sale and are not significant.

We are the obligor on our lifetime oil contracts. Revenue is allocated to these performance obligations and is recognized over time as services are provided to the customer. The amount of revenue recognized is calculated, net of cancellations, using an input method, which most closely depicts performance of the contracts. Our contract liability balances were $144.9 million and $126.1 million as of September 30, 2018, and December 31, 2017, respectively; and we recognized $5.2 million and $16.9 million of revenue in the three and nine months ended September 30, 2018, related to our opening contract liability balance.

Finance and Insurance Sales
Revenue from finance and insurance sales is recognized, net of estimated charge-backs, at the time of the sale of the related vehicle. As a part of the vehicle sale, we seek to arrange financing for customers and sell a variety of add-ons, such as extended warranty service contracts. These products are inherently attached to the governing vehicle and performance of the obligation cannot be performed without the underlying sale of the vehicle. We act as an agent in the sale of these contracts as the pricing is set by the

5



third-party provider, and our commission is preset. A portion of the transaction price related to sales of finance and insurance contracts is considered variable consideration and is estimated and recognized upon the sale of the contract under the new standard. We recognized a $9.2 million asset associated with future estimated variable consideration on January 1, 2018, related to contracts sold on or before December 31, 2017. Our contract asset balance was $9.2 million as of September 30, 2018, and is included in trade receivables and other non-current assets.

Note 3. Accounts Receivable and Contract Assets

Accounts receivable consisted of the following (in thousands):
 
 
September 30, 2018
 
December 31, 2017
Contracts in transit
 
$
240,998

 
$
286,578

Trade receivables
 
52,336

 
45,895

Vehicle receivables
 
56,473

 
60,022

Manufacturer receivables
 
94,399

 
96,141

Auto loan receivables
 
64,090

 
75,052

Other receivables
 
5,386

 
14,634

 
 
513,682


578,322

Less: Allowance for doubtful accounts
 
(6,426
)
 
(7,386
)
Less: Long-term portion of accounts receivable, net
 
(36,567
)
 
(48,998
)
Total accounts receivable, net
 
$
470,689


$
521,938


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 4. Inventories

The components of inventories, net, consisted of the following (in thousands):
 
 
September 30, 2018
 
December 31, 2017
New vehicles
 
$
1,627,700

 
$
1,553,751

Used vehicles
 
562,497

 
500,011

Parts and accessories
 
85,768

 
78,982

Total inventories
 
$
2,275,965

 
$
2,132,744


6



Note 5. 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, 2016 ¹
 
$
114,839

 
$
106,179

 
$
38,381

 
$
259,399

Adjustments to purchase price allocations 2
 
(817
)
 
(1,006
)
 
(391
)
 
(2,214
)
Reductions through divestitures
 

 
(865
)
 

 
(865
)
Balance as of December 31, 2017 ¹
 
114,022

 
104,308

 
37,990

 
256,320

Adjustments to purchase price allocations 3
 
29,933

 
51,790

 
21,074

 
102,797

Reductions through divestitures
 
(951
)
 
(1,198
)
 

 
(2,149
)
Balance as of September 30, 2018 1, 4
 
$
143,004

 
$
154,900

 
$
59,064

 
$
356,968

1 Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.
2 Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017. As a result, we reclassified $2.2 million of value from goodwill to franchise value.
3 Our purchase price allocation for the acquisition of the Baierl Auto Group was finalized in the second quarter of 2018. Also, our purchase price allocation for the acquisitions of the Downtown LA Auto Group, Crater Lake Ford Lincoln, and Crater Lake Mazda were finalized in the third quarter of 2018. As a result, we added $102.8 million of goodwill in 2018.
4 Our purchase price allocation is preliminary for the acquisitions of Albany CJD Fiat, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford and the associated goodwill has not been allocated to each of our segments. See also Note 12.

The changes in the carrying amounts of franchise value are as follows (in thousands):
 
Franchise Value
Balance as of December 31, 2016
$
184,268

Additions through acquisitions
495

Adjustments to purchase price allocations 1
2,214

Balance as of December 31, 2017
186,977

Adjustments to purchase price allocations 2
70,828

Reductions through divestitures
(1,801
)
Balance as of September 30, 2018 3
$
256,004

1 Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017, resulting in a reclassification of $2.2 million from goodwill to franchise value.
2 Our purchase price allocation for the acquisition of the Baierl Auto Group was finalized in the second quarter of 2018. Also, our purchase price allocation for the acquisitions of the Downtown LA Auto Group, Crater Lake Ford Lincoln, and Crater Lake Mazda were finalized in the third quarter of 2018. As a result, we added $70.8 million of franchise value in 2018.
3Our purchase price allocation is preliminary for the acquisitions of Albany CJD Fiat, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford and have not been included in the above franchise value additions. See also Note 12.


7



Note 6. Credit Facilities and Long-term Debt

Below is a summary of our outstanding balances on credit facilities and long-term debt (in thousands):
(Dollars in thousands)
 
September 30, 2018
 
December 31, 2017
Floor plan notes payable: non-trade
 
$
1,820,241

 
$
1,802,252

Floor plan notes payable
 
135,626

 
116,774

Total floor plan debt
 
$
1,955,867

 
$
1,919,026

 
 
 
 
 
Used vehicle inventory financing facility
 
$
316,000

 
$
177,222

Revolving lines of credit
 
60,058

 
94,568

Real estate mortgages
 
623,885

 
469,969

5.25% Senior Notes due 2025
 
300,000

 
300,000

Other debt
 
27,403

 
12,512

Total long-term debt outstanding
 
1,327,346

 
1,054,271

Less: unamortized debt issuance costs
 
(6,438
)
 
(6,919
)
Less: current maturities (net of current debt issuance costs)
 
(33,856
)
 
(18,876
)
Long-term debt
 
$
1,287,052

 
$
1,028,476


Credit Facility
Effective June 25, 2018, we amended our syndicated credit facility, now comprised of 20 financial institutions, including seven manufacturer-affiliated finance companies. Prior to this amendment, the credit facility, with an aggregate total financing commitment of $2.4 billion, would have matured in August 2022. With this amendment, the aggregate total financing commitment has been increased to $2.6 billion and the term of the credit facility has been extended to July 2023, among other changes.

The total commitment is allocated as $318 million to used vehicle inventory floor plan financing, $266 million to revolving loans for acquisitions and other general corporate purposes, and the remaining $2.0 billion for new vehicle inventory floor plan financing. We have the option to reallocate the commitments, provided that the used vehicle inventory floor plan financing commitment does not exceed 16.5% of aggregate commitments, the revolving loan commitment does not exceed 18.75% of aggregate commitments, and the sum of these commitments plus the new vehicle inventory floor plan financing commitment does not exceed the aggregate total financing commitment of $2.6 billion. Additionally, we may request an increase in the aggregate new vehicle floor plan commitment of up to $400 million provided that the aggregate commitment does not exceed $3.0 billion. 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 receivable (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 floor plan loans are secured only by collateral owned by borrowers of new vehicle floor plan loans under the credit facility.

The interest rate on the credit facility, as amended, 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 2.25% depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment was 3.51% at September 30, 2018. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 3.76% at September 30, 2018.

5.25% Senior Notes Due 2025
On July 24, 2017, we issued $300 million in aggregate principal amount of 5.25% Senior Notes due 2025 ("the Notes") to eligible purchasers in a private placement under Rule 144A and Regulation S of the Securities Act of 1933. Interest accrues on the Notes from July 24, 2017, and is payable semiannually on February 1 and August 1. The first interest payment was paid on February 1, 2018. We may redeem the Notes in whole or in part at any time prior to August 1, 2020, at a price equal to 100% of the principal amount plus a make-whole premium set forth in the Indenture and accrued and unpaid interest. After August 1, 2020, we may redeem some or all of the Notes subject to the redemption prices set forth in the Indenture. If we experience specific kinds of changes of control, as described in the Indenture, we must offer to repurchase the Notes at 101% of their principal amount plus accrued and unpaid interest to the date of purchase.

8



Note 7. 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 Nine Months Ended September 30, 2018
 
Cumulative Repurchases as of September 30, 2018
 
 
Shares
 
Average Price
 
Shares
 
Average Price
2016 Share Repurchase Authorization
 
1,199,257

 
$
93.11

 
2,241,982

 
$
88.81


As of September 30, 2018, we had $50.9 million available for repurchases pursuant to our 2016 share repurchase authorization.

In addition, during the first nine months of 2018, we repurchased 29,875 shares at an average price of $112.19 per share, for a total of $3.4 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 8. 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 primarily consisting of amounts outstanding under our senior notes and real estate mortgages. We calculated the estimated fair value of the senior notes using quoted prices for the identical liability (Level 1) and calculated the estimated fair value of the fixed rate real estate mortgages using a discounted cash flow methodology with estimated current interest rates based on a similar risk profile and duration (Level 2). The fixed cash flows are discounted and summed to compute the fair value of the debt. As of September 30, 2018, our real estate mortgages and other debt, which includes capital leases, had maturity dates between January 12, 2019, and December 31, 2050.

There were no changes to our valuation techniques during the nine-month period ended September 30, 2018.

A summary of the aggregate carrying values, excluding unamortized debt issuance cost, and fair values of our long-term fixed interest rate debt is as follows (in thousands):
 
 
September 30, 2018
 
December 31, 2017
Carrying value
 
 
 
 
5.25% Senior Notes due 2025
 
$
300,000

 
$
300,000

Real Estate Mortgages and Other Debt
 
462,334

 
376,880

 
 
$
762,334


$
676,880

Fair value
 
 
 
 
5.25% Senior Notes due 2025
 
$
288,000

 
$
312,750

Real Estate Mortgages and Other Debt
 
466,871

 
385,337

 
 
$
754,871

 
$
698,087


Note 9. Investments

On September 12, 2018, we invested $54 million in Shift Technologies, Inc., a San Francisco-based digital retailer, in exchange for Series D convertible preferred stock. We have determined that our investment in Shift does not meet the criteria for a variable interest entity, and we do not have control or significant influence over Shift. As a result, we currently recorded a cost method investment within Other Assets on our Consolidated Balance Sheet as of September 30, 2018.

9



As of September 30, 2018, there were no identified events or changes in circumstances that would have a significant effect on the value of the investment and we believe the current value represents fair value. We did not record any impairment charges associated with this investment in the three and nine-month periods ended September 30, 2018.

Note 10. Net Income Per Share of Class A and Class B Common Stock

We compute net income per share of Class A and Class B common stock using the two-class method. Under this method, basic net income per share is computed using the weighted average number of common shares outstanding during the period excluding 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 September 30,
 
2018
 
2017
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
89,254

 
$
3,853

 
$
49,687

 
$
2,199

Reallocation of net income as a result of conversion of dilutive stock options
 
1

 
(1
)
 
1

 
(1
)
Reallocation of net income due to conversion of Class B to Class A common shares outstanding
 
288

 

 
285

 

Conversion of Class B common shares into Class A common shares
 
3,551

 

 
1,908

 

Effect of dilutive stock options on net income
 
13

 
(13
)
 
5

 
(5
)
Net income applicable to common stockholders - diluted
 
$
93,107

 
$
3,839

 
$
51,886

 
$
2,193

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,164

 
1,000

 
23,948

 
1,060

Conversion of Class B common shares into Class A common shares
 
1,000

 

 
1,060

 

Effect of dilutive stock options on weighted average common shares
 
94

 

 
68

 

Weighted average common shares outstanding – diluted
 
24,258

 
1,000

 
25,076

 
1,060

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
3.85

 
$
3.85

 
$
2.07

 
$
2.07

Net income per common share - diluted
 
$
3.84

 
$
3.84

 
$
2.07

 
$
2.07

  
Three Months Ended September 30,
 
2018
 
2017
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
33

 

 
9

 



10



Nine Months Ended September 30,
 
2018
 
2017
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
197,485

 
$
8,343

 
$
147,876

 
$
7,937

Reallocation of distributed net income as a result of conversion of dilutive stock options
 
4

 
(4
)
 
3

 
(3
)
Reallocation of distributed net income due to conversion of Class B to Class A common shares outstanding
 
844

 

 
1,006

 

Conversion of Class B common shares into Class A common shares
 
7,466

 

 
6,909

 

Effect of dilutive stock options on net income
 
29

 
(29
)
 
19

 
(19
)
Net income applicable to common stockholders - diluted
 
$
205,828

 
$
8,310

 
$
155,813

 
$
7,915

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,670

 
1,000

 
23,812

 
1,278

Conversion of Class B common shares into Class A common shares
 
1,000

 

 
1,278

 

Effect of employee stock purchases and restricted stock units on weighted average common shares
 
97

 

 
68

 

Weighted average common shares outstanding – diluted
 
24,767

 
1,000

 
25,158

 
1,278

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
8.34

 
$
8.34

 
$
6.21

 
$
6.21

Net income per common share - diluted
 
$
8.31

 
$
8.31

 
$
6.19

 
$
6.19

Nine Months Ended September 30,
 
2018
 
2017
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
30

 

 
10

 


Note 11. 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 and Lexus. The franchises in each segment also sell used vehicles, parts and automotive services, as well as automotive finance and insurance products.

Corporate and other revenue and income includes the results of operations of our stand-alone body shops 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 who 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 are 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.


11



Certain financial information on a segment basis is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 

 
 

 
 

 
 

Domestic
 
 
 
 
 
 
 
 
New vehicle
 
$
600,054

 
$
567,423

 
$
1,711,179

 
$
1,581,329

Used vehicle retail
 
288,238

 
260,622

 
836,473

 
756,834

Used vehicle wholesale
 
36,983

 
27,986

 
104,502

 
90,972

Finance and insurance
 
42,541

 
38,408

 
125,626

 
111,970

Service, body and parts
 
114,756

 
103,070

 
335,370

 
292,987

Fleet and other
 
15,282

 
10,801

 
50,389

 
28,926

 
 
1,097,854

 
1,008,310

 
3,163,539

 
2,863,018

Import
 
 
 
 
 
 
 
 
New vehicle
 
787,803

 
737,931

 
2,227,393

 
1,933,217

Used vehicle retail
 
334,614

 
289,723

 
977,931

 
806,510

Used vehicle wholesale
 
35,162

 
24,337

 
94,340

 
78,456

Finance and insurance
 
60,494

 
51,564

 
167,057

 
137,419

Service, body and parts
 
114,776

 
104,106

 
340,816

 
289,733

Fleet and other
 
3,512

 
2,294

 
21,987

 
31,332

 
 
1,336,361

 
1,209,955

 
3,829,524

 
3,276,667

Luxury
 
 
 
 
 
 
 
 
New vehicle
 
347,568

 
252,861

 
988,002

 
649,566

Used vehicle retail
 
182,479

 
128,355

 
510,323

 
350,992

Used vehicle wholesale
 
19,896

 
13,418

 
54,359

 
37,114

Finance and insurance
 
16,421

 
10,816

 
44,606

 
28,335

Service, body and parts
 
76,906

 
56,240

 
218,582

 
154,598

Fleet and other
 
9,617

 
1,828

 
31,039

 
25,879

 
 
652,887

 
463,518

 
1,846,911

 
1,246,484

 
 
3,087,102


2,681,783


8,839,974

 
7,386,169

Corporate and other
 
4,850

 
(1,441
)
 
8,194

 
(2,690
)
 
 
$
3,091,952


$
2,680,342


$
8,848,168

 
$
7,383,479

Segment income1:
 
 

 
 

 
 

 
 

Domestic
 
$
25,304

 
$
31,141

 
$
79,466

 
$
84,440

Import
 
37,369

 
36,954

 
90,634

 
91,365

Luxury
 
11,685

 
7,515

 
30,510

 
22,542

 
 
74,358


75,610


200,610

 
198,347

Corporate and other
 
66,899

 
34,541

 
149,473

 
111,281

Depreciation and amortization
 
(19,649
)
 
(14,828
)
 
(55,324
)
 
(41,598
)
Other interest expense
 
(15,010
)
 
(9,905
)
 
(40,645
)
 
(23,745
)
Other income, net
 
2,389

 
1,125

 
5,422

 
11,357

Income before income taxes
 
$
108,987


$
86,543


$
259,536

 
$
255,642

1Segment income for each of the segments is defined as income before income taxes, depreciation and amortization, other interest expense and other income, net.

 

12



 
 
September 30, 2018
 
December 31, 2017
Total assets:
 
 
 
 
Domestic
 
$
1,451,031

 
$
1,338,232

Import
 
1,171,557

 
1,137,934

Luxury
 
767,952

 
641,118

Corporate and other
 
1,784,029

 
1,565,782

 
 
$
5,174,569

 
$
4,683,066


Note 12. Acquisitions

In the first nine months of 2018, we completed the following acquisitions:
On January 15, 2018, Ray Laks Honda in Orchard Park, New York and Ray Laks Acura in Buffalo, New York.
On February 26, 2018, Day Auto Group, a seven store platform based in Pennsylvania.
On March 1, 2018, Prestige Auto Group, a six store platform based in New Jersey and New York.
On April 2, 2018, Broadway Ford in Idaho Falls, Idaho.
On April 23, 2018, Buhler Ford in Eatontown, New Jersey.

Revenue and net loss contributed by the 2018 acquisitions subsequent to the date of acquisition were as follows (in thousands):
Revenue
$
634,482

Net loss
$
(1,949
)

In 2017, we completed the following acquisitions:
On May 1, 2017, we acquired Baierl Auto Group, an eight store platform based in Pennsylvania.
On August 7, 2017, we acquired Downtown LA Auto Group, a seven store platform based in California.
On November 11, 2017, we acquired Albany CJD Fiat in Albany, New York.
On November 15, 2017, we acquired Crater Lake Ford Lincoln and Crater Lake Mazda in Medford, Oregon.

All acquisitions were accounted for as business combinations under the acquisition method of accounting. The results of operations of the acquired stores are included in our Consolidated Financial Statements from the date of acquisition.
 
The following tables summarize the consideration paid for the 2018 acquisitions and the amount of identified assets acquired and liabilities assumed as of the acquisition date (in thousands):
 
 
Consideration
Cash paid, net of cash acquired
 
$
374,026

Debt issued
 
125,055

 
 
$
499,081


The purchase price allocations for Albany CJD Fiat, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford acquisitions are preliminary, and we have not obtained and evaluated all of the detailed information necessary to finalize the opening balance sheet amounts in all respects. We recorded the purchase price allocations based upon information that is currently available. Unallocated items are recorded as a component of other non-current assets in the Consolidated Balance Sheets.
 
 
Assets Acquired and Liabilities Assumed
Accounts receivable
 
$
732

Inventories, net
 
179,973

Property and equipment, net
 
9,868

Other non-current assets
 
321,629

Floor plan notes payable
 
(10,779
)
Other long-term liabilities
 
(2,342
)
 
 
$
499,081



13



In the three and nine-month periods ended September 30, 2018, we recorded $0.2 million and $4.3 million, respectively, in acquisition-related expenses as a component of selling, general and administrative expense. Comparatively, we recorded $3.5 million and $5.7 million, respectively, of acquisition-related expenses in the same periods in 2017.
 
The following unaudited proforma summary presents consolidated information as if all acquisitions in the three and nine-month periods ended September 30, 2018 and 2017, had occurred on January 1, 2017 (in thousands, except per share amounts):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenue
 
$
3,091,952

 
$
3,118,676

 
$
9,048,379

 
$
9,024,723

Net income
 
93,107

 
52,452

 
204,526

 
161,614

Basic net income per share
 
3.85

 
2.10

 
8.29

 
6.44

Diluted net income per share
 
3.84

 
2.09

 
8.26

 
6.42

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

Note 13. Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 increases transparency and comparability among organizations by recognizing right of use 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 will adopt this accounting standard update effective January 1, 2019. A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We expect to adopt this guidance using the effective date as our date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates prior to January 1, 2019. We expect to elect the 'package of practical expedients,' which permits us to not reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We currently expect to elect the short-term lease recognition exemption for all leases that qualify. We have both real estate leases and equipment leases that will be impacted by the new guidance. We continue to evaluate 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.


14



Note 14. Changes in Accounting Policies

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers," which amends the accounting guidance related to revenues. This amendment replaced most of the existing revenue recognition guidance. The new standard, as amended in July 2015, is effective for fiscal years beginning after December 15, 2017, and interim periods therein. The standard permits the use of either the retrospective or cumulative effect transition method. We adopted this standard utilizing a cumulative effect transition method effective January 2018. While the adoption of the new standard did not have a significant effect on earnings or on the timing of our most significant types of transactions, we made the following changes to our revenue policies:

A portion of the transaction price related to sales of finance and insurance contracts is considered variable consideration and subject to accelerated recognition under the new standard. Accordingly, we recognized a $9.2 million asset associated with future estimated variable consideration and a net of tax increase to retained earnings of $6.5 million. We do not believe there will be a significant impact to future revenue recognized.

The adoption of the new standard clarifies the determination and capitalization of direct costs incurred. As a result, we reassessed the method used to capitalize and amortize direct costs associated with the sale of lifetime lube, oil and filter contracts, which resulted in a $7.2 million reduction in prepaid commissions and a net of tax $5.1 million reduction to retained earnings.

These changes had an immaterial effect on our Consolidated Statements of Operations and the following impact on our Consolidated Balance Sheets (in thousands):
 
 
As Reported
 
 
 
Balances without the adoption of Topic 606
Impact on Consolidated Balance Sheets
 
September 30, 2018
 
Adjustments
 
Accounts receivable, net
 
$
470,689

 
$
(3,631
)
 
$
467,058

Other current assets
 
47,648

 
(1,732
)
 
45,916

Other non-current assets
 
487,171

 
4,835

 
492,006

Total Assets
 
5,174,569

 
(528
)
 
5,174,041

Accrued Liabilities
 
259,825

 
313

 
260,138

Deferred income taxes
 
77,684

 
(599
)
 
77,085

Total Liabilities
 
3,969,427

 
(286
)
 
3,969,141

Retained earnings
 
1,109,017

 
(242
)
 
1,108,775

Total Liabilities and Stockholders' Equity
 
5,174,569

 
(528
)
 
5,174,041


Note 15. Subsequent Events
 
Repurchase of Class A Common Stock
Since September 30, 2018, we repurchased 423,863 shares at a weighted average price of $76.85 per share and, as of October 26, 2018, under our existing share repurchase authorization, $18.3 million remained available for share repurchases. In addition, on October 22, 2018, the Board of Directors increased our repurchase authorization by an additional $250 million, bringing our total repurchase authorization to $268 million.

15



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 2017 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. Such factors include, but are not limited to:
Changing economic conditions, including changes in consumer demand, the availability of credit, fuel prices and interest rates;
Natural disasters, adverse weather conditions, acts of God or other incidents;
Increasing competition in our industry;
Adverse conditions affecting one or more key manufacturers whose brands we sell;
Availability of manufacturer incentives, warranty and other promotional programs;
Manufacturers relationships and our ability to renew or enter into new franchise agreements on acceptable terms;
Changes in laws and regulations;
Breaches in our data security systems or in systems used by our vendor partners; and
Our ability to acquire and successfully integrate additional stores
 
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
Lithia Motors, Inc. is one of the largest providers of personal transportation solutions in the United States and is among the fastest growing companies in the Fortune 500 (#294-2018). We provide an omni-channel retail experience, allowing customers to shop wherever, whenever and however they desire. We offer convenient personalized service combined with the large company advantages of a nationwide network, one of the largest owned online inventories and competitive pricing on vehicles and service. Our "Growth Powered by People" strategy drives us to innovate and continuously improve the customer experience.

To create a seamless omni-channel retail experience and adapt to an evolving retail space we are focused on driving revenue growth, optimizing our network, unlocking earnings potential and generating cash flow for future investment in continued growth and innovation.

We believe that the fragmented nature of the automotive dealership sector provides us with the opportunity to scale our nationwide footprint through acquisitions, drive revenue growth and seek innovative ways to expand our digital offerings. We strive for diversification in our products, services, brands and geographic locations to manage risk and increase profitability. Our nationwide network of service and delivery points includes 182 locations, representing 28 brands across 18 states.


16



We target acquiring domestic, import and luxury franchises in cities ranging from mid-sized regional markets to metropolitan markets. We evaluate all brands for expansion opportunities provided the market is large enough to support adequate new vehicle sales to justify the required capital investment. Our acquisition strategy seeks underperforming dealerships and platforms at prices that meet our internal investment targets and, through the application of our performance management and centralized operating structure, leverage costs and improve store profitability. Platform acquisitions may include one or more locations which do not meet our criteria. We regularly optimize and balance our network through strategic divestitures to ensure continued high performance. During the first nine months of 2018, we acquired 17 stores, opened one store and divested nine stores. Approximately half of the divested stores were from platform acquisitions. The divestiture of these underperforming stores increases availability of capital and personnel resources and reduces future capital expenditures for facility improvements. These divestitures generated approximately $33 million in proceeds and reduced forecasted capital expenditures by approximately $15 million to be redeployed for investment in innovation. We believe our disciplined approach and the current economic environment provides us with attractive acquisition opportunities and expanded coast to coast coverage.
 
We also remain focused on unlocking the estimated $250 million in additional earnings potential at existing locations. Operations are structured to promote an entrepreneurial environment at the local and regional levels. Each store's general manager and department managers, with assistance from regional and corporate management, are responsible for executing successful retail strategies in their markets. We strive for continuous improvement and for each store to achieve its potential profitability through increased sales and market share. Strong performance also creates synergistic benefits such as increased trade-ins resulting in additional used vehicle sales, additional finance and insurance sales and increased units in operation and customer retention which generate additional service revenues.

Driving revenue growth and achieving earnings potential generates the free cash flow that allows us to invest in innovation, diversification and digital initiatives, thereby providing more ways to meet our consumers' personal transportation needs. Through innovation and technology, we strive to provide a personalized customer experience wherever, whenever and however consumers desire. During the third quarter of 2018, we entered into a strategic partnership with Shift Technologies, Inc. ("Shift"), a San Francisco-based digital retailer. Shift provides an innovative platform to consumers for a digital vehicle purchase and selling experience, providing vehicle pickup and delivery at a customer’s location. We invested $54 million, leading the series D fundraising round and becoming the largest shareholder. In addition, in early October we collaborated with Shift and assisted in Shift securing a credit line for acquiring used vehicle inventory. This collaboration resulted in Lithia receiving additional equity ownership in Shift. The strategic partnership with Shift will allow both companies to share and scale technology, data, inventory and business relationships to capture more of the over 40 million used vehicles sold in the United States annually.


17



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

 
 
Three Months Ended September 30,
 
 
 
Nine Months Ended September 30,
 
 
 
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
New vehicle
 
$
1,732,950

 
$
1,553,511

 
11.6
%
 
$
4,914,478

 
$
4,147,870

 
18.5
%
Used vehicle retail
 
805,928

 
679,180

 
18.7

 
2,325,600

 
1,915,038

 
21.4

Finance and insurance
 
121,062

 
101,044

 
19.8

 
342,059

 
282,672

 
21.0

Service, body and parts
 
311,327

 
265,683

 
17.2

 
908,431

 
744,262

 
22.1

Total Revenues
 
3,091,952

 
2,680,342

 
15.4

 
8,848,168

 
7,383,479

 
19.8

 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
 
 
 
 
 
 
 
 
 
 
New vehicle
 
$
100,882

 
$
88,045

 
14.6
%
 
$
289,323

 
$
238,702

 
21.2
%
Used vehicle retail
 
86,353

 
78,658

 
9.8

 
247,065

 
221,947

 
11.3

Finance and insurance
 
121,062

 
101,044

 
19.8

 
342,059

 
282,672

 
21.0

Service, body and parts
 
154,456

 
132,492

 
16.6

 
446,571

 
368,166

 
21.3

Total Gross Profit
 
466,239

 
403,021

 
15.7

 
1,335,077

 
1,119,944

 
19.2

 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit margins
 
 
 
 
 
 
 
 
 
 
 
 
New vehicle
 
5.8
%
 
5.7
%
 
10 bp
 
5.9
%
 
5.8
%
 
10 bp
Used vehicle retail
 
10.7

 
11.6

 
-90 bp
 
10.6

 
11.6

 
-100 bp
Finance and insurance
 
100.0

 
100.0

 
0 bp
 
100.0

 
100.0

 
0 bp
Service, body and parts
 
49.6

 
49.9

 
-30 bp
 
49.2

 
49.5

 
-30 bp
Total Gross Profit Margin
 
15.1

 
15.0

 
10 bp
 
15.1

 
15.2

 
-10 bp
 
 
 
 
 
 
 
 
 
 
 
 
 
Retail units sold
 
 
 
 
 
 
 
 
 
 
 
 
New vehicles
 
48,790

 
45,452

 
7.3
%
 
139,314

 
121,944

 
14.2
%
Used vehicles
 
39,751

 
34,717

 
14.5

 
114,961

 
97,671

 
17.7

 
 
 
 
 
 
 
 
 
 
 
 
 
Average selling price per retail unit
 
 
 
 
 
 
 
 
 
 
 
 
New vehicles
 
$
35,519

 
$
34,179

 
3.9
%
 
$
35,276

 
$
34,015

 
3.7
%
Used vehicles
 
20,274

 
19,563

 
3.6

 
20,229

 
19,607

 
3.2

 
 
 
 
 
 
 
 
 
 
 
 
 
Average gross profit per retail unit
 
 
 
 
 
 
 
 
 
 
 
 
New vehicles
 
$
2,068

 
$
1,937

 
6.8
%
 
$
2,077

 
$
1,957

 
6.1
%
Used vehicles
 
2,172

 
2,266

 
(4.1
)
 
2,149

 
2,272

 
(5.4
)
Finance and insurance
 
1,367

 
1,260

 
8.5

 
1,345

 
1,287

 
4.5


18



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 August 2017 would be included in same store operating data beginning in September 2018, after its first full complete comparable month of operation. The third quarter operating results for the same store comparisons would include results for that store in only the period of September for both comparable periods.
 
 
Three Months Ended September 30,
 
 
 
Nine Months Ended September 30,
 
 
 
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
New vehicle
 
$
1,443,965

 
$
1,480,737

 
(2.5
)%
 
$
3,954,946

 
$
3,998,702

 
(1.1
)%
Used vehicle retail
 
688,965

 
655,814

 
5.1

 
1,960,126

 
1,855,211

 
5.7

Finance and insurance
 
105,462

 
97,033

 
8.7

 
287,202

 
273,143

 
5.1

Service, body and parts
 
260,683

 
254,084

 
2.6

 
740,725

 
719,898

 
2.9

Total Revenues
 
2,594,562

 
2,566,159

 
1.1

 
7,230,131

 
7,134,877

 
1.3

 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
 
 
 
 
 
 
 
 
 
 
New vehicle
 
$
82,596

 
$
83,478

 
(1.1
)%
 
$
226,531

 
$
228,625

 
(0.9
)%
Used vehicle retail
 
77,667

 
76,836

 
1.1

 
218,013

 
217,190

 
0.4

Finance and insurance
 
105,462

 
97,033

 
8.7

 
287,202

 
273,143

 
5.1

Service, body an