Lithia Motors - 10-Q quarterly report FY

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission file number: 001-14733

LITHIA MOTORS, INC.

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

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

Yes  X        No

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

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

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LITHIA MOTORS, INC.
FORM 10-Q
INDEX

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

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

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

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

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

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

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

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

Note 1. Basis of Presentation

The financial information included herein as of September 30, 2003 and for the three and nine-month periods ended September 30, 2003 and 2002 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2002 is derived from our 2002 Annual Report on Form 10-K. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2002 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note 2. Inventories

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

Note 3. Supplemental Cash Flow Information

Supplemental disclosure of cash flow information is as follows (in thousands):

Note 4. Earnings Per Share

Following is a reconciliation of basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts).

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Potentially dilutive securities that are not included in the diluted EPS calculations because they would be antidilutive are as follows (in thousands):

Note 5. Comprehensive Income

Comprehensive income includes the fair value of cash flow hedging instruments that are reflected in shareholders’ equity instead of net income. The following table sets forth the calculation of comprehensive income for the periods indicated (in thousands):

Note 6. Acquisitions

The following acquisitions were made in the first nine months of 2003:

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See Note 15 Subsequent Events for acquisitions that occurred in October 2003.

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

There are no future contingent payouts related to any of the above acquisitions and no portion of the purchase price was paid with our equity securities. The purchase price for the above acquisitions was allocated as follows (in thousands):

Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances for new information received regarding the valuation of such assets. We anticipate that approximately 100% of the goodwill acquired in the above acquisitions will be deductible for tax purposes over the period of 15 years.

Note 7. DaimlerChrysler Agreement

In February 2003 we entered into a working capital and used vehicle flooring credit facility with DaimlerChrysler Services North America LLC totaling up to $200 million, which expires in February 2006, with interest due monthly.

The credit line with DaimlerChrysler Services is cross-collateralized and secured by cash and cash equivalents, new and used vehicle and parts inventories, accounts receivable, intangible assets and equipment. We pledged to DaimlerChrysler Services the stock of all of our subsidiaries except entities operating BMW, Honda, Nissan or Toyota stores.

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The financial covenants in the agreement with DaimlerChrysler Services require us to maintain compliance with, among other things, (i) a specified current ratio; (ii) a specified fixed charge coverage ratio; (iii) a specified interest coverage ratio; (iv) a specified adjusted leverage ratio; and (v) certain working capital levels. We were in compliance with these covenants at September 30, 2003.

Our previous facility with Ford Motor Credit Company was terminated and paid off on February 25, 2003.

Note 8. U.S. Bank Agreement Amendment

In April 2003, our U.S. Bank N.A. agreement was amended to provide for a $35.0 million revolving line of credit for leased vehicles and equipment purchases, which expires January 31, 2005. At September 30, 2003, we had $35.0 million outstanding on this line of credit. Previously, the amount available under this line of credit was $27.5 million and it expired January 31, 2004.

Note 9. 2003 Stock Incentive Plan

At our annual shareholders meeting in May 2003, our shareholders approved an amendment to and restatement of our 2001 Stock Option Plan in the form of the 2003 Stock Incentive Plan in order to bring the plan in compliance with new requirements related to the Sarbanes-Oxley Act of 2002. There were no additions made to the number of shares of our common stock reserved for issuance under the restated plan.

Note 10. Amendment to 1998 Employee Stock Purchase Plan

At our annual shareholders meeting in May 2003, our shareholders approved an amendment to our 1998 Employee Stock Purchase Plan to increase the number of shares reserved for issuance thereunder from 1,000,000 to 1,500,000.

Note 11. Dividend Payment

In July 2003, our Board of Directors approved a dividend of $0.07 per share for the second quarter of 2003. The dividend totaled $1.3 million and was paid on August 22, 2003 to shareholders of record on August 8, 2003. See Note 15 Subsequent Events for information regarding the declaration of a dividend in October 2003.

Note 12. Stock-Based Compensation

We account for stock options using the intrinsic value method as prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Pursuant to Statement of Financial Accounting Standards (SFAS) No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure,” which we adopted in December 2002, we have computed, for pro forma disclosure purposes, the impact on net income and net income per share as if we had accounted for our stock-based compensation plans in accordance with the fair value method prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation” as follows (in thousands):

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

Note 13. Recent Accounting Pronouncements

In July 2002, the FASB approved SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS No. 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The adoption of SFAS No. 146 on January 1, 2003 did not have any effect on our financial position or results of operations.

The FASB’s Emerging Issues Task Force (EITF) finalized EITF 00-21 “Accounting for Multiple Element Arrangements” in November 2002. EITF 00-21 requires arrangements with multiple elements to be broken out as separate units of accounting based on their relative fair values. Revenue for a separate unit of accounting should be recognized only if the amount due can be reliably measured and the earnings process is substantially complete. Any units that can not be separated must be accounted for as a combined unit. Our accounting policy is consistent with EITF 00-21 and therefore, the adoption on January 1, 2003 did not have any effect on our financial position or results of operations.

In March 2003, the EITF issued EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” EITF 02-16 primarily applies to floorplan interest credits and advertising credits received by us from auto manufacturers and specifies the timing of and appropriate classification of such items in our statement of operations. We recognize floorplan interest credits and advertising credits that are tied to specific vehicles as a reduction to the carrying value of the specific inventory and ultimately as a reduction to cost of goods sold as related vehicles are sold and we recognize other advertising credits as a credit to advertising expense. The adoption of EITF 02-16 on January 1, 2003 resulted in the reclassification of certain expenses, but did not have any effect on our net income or financial position (see Note 14).

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In May 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 addresses certain accounting issues related to hedging activity and derivative instruments embedded in other contracts. In general, the amendments require contracts with comparable characteristics to be accounted for similarly. In addition, SFAS No. 149 provides guidance as to when a financing component of a derivative must be given special reporting treatment in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on our financial position or results of operations.

In May 2003, the FASB approved SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 establishes standards for how to classify and measure financial instruments with characteristics of both liabilities and equity. It requires financial instruments that fall within its scope to be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and, for pre-existing financial instruments, as of July 1, 2003. We do not have any financial instruments that fall under the guidance of SFAS No. 150 and, therefore, the adoption did not have any effect on our financial position or results of operations.

Note 14. Reclassifications

In the fourth quarter of 2002, we reclassified documentation fees from finance and insurance income to new and used vehicle revenue, as appropriate, in order to bring our reporting in line with industry practice. The resulting effect was a reduction of approximately $100 per vehicle of finance and insurance income and an increase in new and retail used vehicle gross margins of between 20 and 50 basis points. Accordingly, the finance and insurance sales per retail unit, revenue by product line and gross margin percentage disclosures have been recalculated for the first three quarters of 2002. Net income was not affected by this reclassification.

Pursuant to EITF 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” in the second quarter of 2003 we began classifying advertising credits that are tied to specific vehicles as a reduction to cost of goods sold as related vehicles are sold. Accordingly, $1.1 million of credits included in selling, general and administrative costs in the first quarter of 2003 were reclassified as a credit to cost of sales for that period. Net income was not affected by this reclassification.

Note 15. Subsequent Events

Quarterly Dividend

In October 2003, our Board of Directors approved a dividend on our Class A and Class B common stock of $0.07 per share for the third quarter of 2003. The dividend, which will total approximately $1.3 million, will be paid on November 21, 2003 to shareholders of record on November 7, 2003.

Acquisitions

The following acquisitions were made subsequent to September 30, 2003:

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

Forward Looking Statements and Risk Factors

Some of the statements in this Form 10-Q constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Exhibit 99.3 to our 2002 Annual Report on Form 10-K.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements.

General

We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of November 10, 2003, we offered 24 brands of new vehicles through 146 franchises in 78 stores in the western United States and over the Internet. As of November 10, 2003, we operate 16 stores in Oregon, 13 in California, 11 in Washington, 8 in Texas, 7 in Idaho, 7 in Colorado, 5 in Nevada, 4 in Alaska, 2 in South Dakota, 2 in Nebraska, 2 in Montana and 1 in Oklahoma. We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing and warranty insurance for our automotive customers. Approximately 79% of our stores are located in cities where they benefit from little or no competition from the same brand in that city.

During an economic downturn, customers tend to shift towards the purchase of more reasonably priced new vehicle models or used vehicles. Many customers decide to delay purchasing a new vehicle and instead repair existing vehicles. In addition, manufacturers typically offer increased dealer and customer incentives during an economic downturn in order to support new vehicle sales volume. These factors generally lead to less volatility in earnings for automobile retailers than for automobile manufacturers.

Historically, new vehicle sales have accounted for approximately 50% of our total revenues but less than 30% of total gross profit. The first nine months of 2003 have been characterized by a very strong incentive environment, which led to higher than normal new vehicle sales for the period.

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Our revenues and gross profit by product line were as follows:

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

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Results of Operations

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Revenues. Total revenues increased 5.9% in the third quarter of 2003 compared to the third quarter of 2002 as a result of acquisitions, which were partially offset by an overall same store retail sales decrease of 0.6% Total revenues increased 10.2% in the first nine months of 2003 compared to the first nine months of 2002 as a result of acquisitions and 1.6% growth in same store retail sales.

Same store retail sales increases (decreases) for the 2003 periods compared to the 2002 periods were as follows:

The automotive retailing industry reported declines in new vehicle sales of approximately 0.2% and 1.6%, respectively, for the same three and nine month periods of 2003 compared to 2002. The industry has reported an approximate 6.0% decrease in sales of Chrysler products, which is our largest brand, in the first nine months of 2003 compared to the first nine months of 2002. Our same-store Chrysler sales have increased approximately 6.3% in the same period. We have same-store sales increases in the nine month period ended September 30, 2003 compared to the same period of 2002 for all domestic brands, which is counter to national trends. We are able to generate positive sales trends that run contrary to industry and specific brand trends due to our operating model that is focused on increasing market share at the stores and the market dynamics of smaller, non-metropolitan, western markets where domestic trucks and SUVs are still the staple.

Slowing economies in our markets and higher than normal new vehicle inventories at the end of 2002, coupled with a strong new vehicle incentive environment, spurred our aggressive approach to new vehicle sales in the first three quarters of 2003. We have utilized an aggressive company-wide marketing campaign based on the “Driving America” theme that is aimed at increasing market share by competitively pricing new vehicles in order to secure a long-term customer base for future parts and service business and repeat and referral business. The increases in new vehicle sales also led to increases in same-store finance and insurance sales, as we have been able to maintain our high penetration rate for such sales.

The industry used vehicle business was weak in the first nine months of 2003 due to competition from highly incentivized new vehicles within the overall weaker total vehicle market. However, in the second and third quarters of 2003, Lithia’s used vehicle business demonstrated improvement over the first quarter of the year. We were able to substantially improve our used vehicle margins by 160 basis points and 80 basis points in the third quarter of 2003 compared to the first two quarters of 2003, respectively. The improvements in used vehicle margins in the 2003 periods more than offset the

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declines in same-store sales resulting in positive same-store gross profit growth for the three and nine month periods ended September 30, 2003.

The service and parts business has been negatively impacted in the past couple of years by substantial improvements in the quality of domestic vehicles, resulting in less warranty work, offset in part by increases in the customer-pay portion of the business. However, in the third quarter of 2003 we saw positive trends with the decline in domestic warranty repairs slowing in comparison to declines in previous quarters and customer-pay service and parts growth increasing 4.5% and 3.8%, respectively, on a same store basis in the three and nine month periods ended September 30, 2003 compared to the same periods of 2002.

Penetration rates for certain products were as follows:

During the first three quarters of 2003, manufacturers offered, and are continuing to offer, incentives, including low interest rates and rebates, in order to attract new vehicle buyers. The availability of cash rebates and zero percent and low interest rate financing have enhanced our ability to sell finance, warranty and insurance products and services.

Gross Profit. Gross profit increased due to increased total revenues. Certain incentives and rebates received from manufacturers, including floorplan interest credits and advertising credits that are tied to specific vehicles are recorded as a reduction to cost of goods sold at the time of vehicle sale. Gross profit margins achieved were as follows: