Form 10-Q
Table of Contents

 

 

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, 2010

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.)

360 E. Jackson Street, Medford, Oregon   97501
(Address of principal executive offices)   (Zip Code)

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 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  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

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

 

Class A common stock without par value    22,214,702
Class B common stock without par value    3,762,231
(Class)    (Outstanding at April 30, 2010)

 

 

 


Table of Contents

LITHIA MOTORS, INC.

FORM 10-Q

INDEX

 

         Page
PART I—FINANCIAL INFORMATION   
Item 1.  

Financial Statements

  
 

Consolidated Balance Sheets (Unaudited)—March 31, 2010 and December 31, 2009

   2
 

Consolidated Statements of Operations (Unaudited)—Three Months Ended March 31, 2010 and 2009

   3
 

Consolidated Statements of Cash Flows (Unaudited)—Three Months Ended March 31, 2010 and 2009

   4
 

Condensed Notes to Consolidated Financial Statements (Unaudited)

   5
Item 2.  

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

   18
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

   29
Item 4.  

Controls and Procedures

   29
PART II—OTHER INFORMATION   
Item 1.  

Legal Proceedings

   29
Item 1A.  

Risk Factors

   29
Item 6.  

Exhibits

   30
Signatures    31

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

     March 31,
2010
    December 31,
2009
 

Assets

    

Current Assets:

    

Cash and cash equivalents

   $ 11,421      $ 12,776   

Contracts in transit

     26,046        21,940   

Trade receivables, net of allowance for doubtful accounts of $235 and $218

     34,635        30,157   

Inventories, net

     360,025        328,726   

Vehicles leased to others, current portion

     7,638        7,384   

Prepaid expenses and other

     2,667        5,387   

Assets held for sale

     2,202        11,693   
                

Total Current Assets

     444,634        418,063   

Land and buildings, net of accumulated depreciation of $27,334 and $25,495

     323,194        326,625   

Equipment and other, net of accumulated depreciation of $60,729 and $57,979

     56,975        59,429   

Other intangible assets, net of accumulated amortization of $100 and $93

     42,639        42,496   

Other non-current assets

     8,584        7,752   

Deferred income taxes

     45,474        40,735   
                

Total Assets

   $ 921,500      $ 895,100   
                

Liabilities and Stockholders' Equity

    

Current Liabilities:

    

Floorplan notes payable

   $ 71,839      $ 68,907   

Floorplan notes payable: non-trade

     165,084        141,581   

Current maturities of line of credit

     —          24,000   

Current maturities of other long-term debt

     23,837        14,303   

Trade payables

     26,345        18,782   

Accrued liabilities

     55,032        47,518   

Deferred income taxes

     546        1,036   

Liabilities related to assets held for sale

     2,140        5,050   
                

Total Current Liabilities

     344,823        321,177   

Real estate debt, less current maturities

     231,285        230,265   

Other long-term debt, less current maturities

     2,763        2,800   

Deferred revenue

     19,067        17,981   

Other long-term liabilities

     15,084        15,839   
                

Total Liabilities

     613,022        588,062   

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 22,111 and 22,036

     282,077        280,880   

Class B common stock—no par value; authorized 25,000 shares; issued and outstanding 3,762 and 3,762

     468        468   

Additional paid-in capital

     9,955        10,501   

Accumulated other comprehensive loss

     (4,328     (3,850

Retained earnings

     20,306        19,039   
                

Total Stockholders' Equity

     308,478        307,038   
                

Total Liabilities and Stockholders' Equity

   $ 921,500      $ 895,100   
                

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

 

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LITHIA MOTORS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

     Three months ended March 31,  
     2010     2009  

Revenues:

    

New vehicle sales

   $ 217,447      $ 194,318   

Used vehicle sales

     160,688        126,230   

Finance and insurance

     14,740        13,646   

Service, body and parts

     69,696        73,878   

Fleet and other

     806        573   
                

Total revenues

     463,377        408,645   

Cost of sales:

    

New vehicle sales

     198,913        177,470   

Used vehicle sales

     141,615        112,190   

Service, body and parts

     35,784        38,809   

Fleet and other

     451        214   
                

Total cost of sales

     376,763        328,683   
                

Gross profit

     86,614        79,962   

Asset impairment charges

     1,491        1,653   

Selling, general and administrative

     71,881        69,832   

Depreciation—buildings

     1,581        1,228   

Depreciation and amortization—other

     3,170        2,886   
                

Operating income

     8,491        4,363   

Other income (expense):

    

Floorplan interest expense

     (2,783     (2,929

Other interest expense

     (3,588     (3,987

Other income, net

     66        1,165   
                

Total other expense

     (6,305     (5,751
                

Income (loss) from continuing operations before income taxes

     2,186        (1,388

Income tax (expense) benefit

     (844     615   
                

Income (loss) from continuing operations, net of tax

     1,342        (773

Income (loss) from discontinued operations, net of tax

     (75     2,102   
                

Net income

   $ 1,267      $ 1,329   
                

Basic income (loss) per share from continuing operations

   $ 0.05      $ (0.04

Basic income (loss) per share from discontinued operations

     (0.00     0.10   
                

Basic net income per share

   $ 0.05      $ 0.06   
                

Shares used in basic per share calculations

     25,895        20,750   
                

Diluted income (loss) per share from continuing operations

   $ 0.05      $ (0.04

Diluted income (loss) per share from discontinued operations

     (0.00     0.10   
                

Diluted net income per share

   $ 0.05      $ 0.06   
                

Shares used in diluted per share calculations

     26,019        20,750   
                

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)

 

      Three months ended March 31,  
     2010     2009  

Cash flows from operating activities:

    

Net income

   $ 1,267      $ 1,329   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Asset impairments

     1,491        1,653   

Depreciation and amortization

     4,751        4,114   

Depreciation and amortization within discontinued operations

     2        214   

Amortization of debt discount

     —          48   

Stock-based compensation

     441        564   

Gain on early extinguishment of debt

     —          (1,086

(Gain) loss on disposal of other assets

     (300     (747

(Gain) loss from disposal activities within discontinued operations

     17        (5,853

Deferred income taxes

     (5,264     1,225   

Excess tax deficits from share-based payment arrangements

     329        77   

(Increase) decrease, net of effect of divestitures:

    

Trade receivables, net

     (4,478     5,374   

Contracts in transit

     (4,106     4,210   

Inventories

     (24,330     33,017   

Vehicles leased to others

     (569     448   

Prepaid expenses and other

     2,332        17,916   

Other non-current assets

     (832     434   

Increase (decrease), net of effect of divestitures:

    

Floorplan notes payable

     4,163        (60,504

Trade payables

     7,563        607   

Accrued liabilities

     7,234        788   

Other long-term liabilities and deferred revenue

     (160     11,898   
                

Net cash provided by (used in) operating activities

     (10,449     15,726   

Cash flows from investing activities:

    

Capital expenditures:

    

Non-financeable

     (583     (1,914

Financeable

     (206     (7,131

Proceeds from sale of other assets

     2,144        5,551   

Proceeds from sale of stores

     421        11,642   
                

Net cash provided by investing activities

     1,776        8,148   

Cash flows from financing activities:

    

Borrowings (repayments) under floorplan notes payable: non-trade

     20,615        (16,111

Borrowings on lines of credit

     —          15,000   

Repayments on lines of credit

     (24,000     (26,000

Principal payments on long-term debt, scheduled

     (2,038     (2,794

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

     (13,361     (19,476

Proceeds from issuance of long-term debt

     25,893        23,216   

Proceeds from issuance of common stock

     554        599   

Repurchase of common stock

     (16     (1

Excess tax deficits from share-based payment arrangements

     (329     (77
                

Net cash provided by (used in) financing activities

     7,318        (25,644
                

Decrease in cash and cash equivalents

     (1,355     (1,770

Cash and cash equivalents:

    

Beginning of period

     12,776        10,874   
                

End of period

   $ 11,421      $ 9,104   
                

Supplemental disclosure of cash flow information:

    

Cash paid during the period for interest

   $ (6,392   $ (8,789

Cash refunded during the period for income taxes, net

     1,180        17,891   

Supplemental schedule of non-cash investing and financing activities:

    

Floorplan debt paid in connection with store disposals

   $ —        $ 13,061   

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

 

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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, 2010 and for the three-month periods ended March 31, 2010 and 2009. 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 include all adjustments necessary for a fair presentation of the information when read in conjunction with our 2009 audited consolidated financial statements and the related notes thereto. The financial information as of December 31, 2009 is derived from our 2009 Annual Report on Form 10-K. The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2009 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.

Concentrations of Risk and Uncertainties Regarding Manufacturers

We purchase substantially all of our new vehicles and inventory from various manufacturers at the prevailing prices charged by auto makers to all franchised dealers. Our overall sales could be impacted by the auto manufacturers’ inability or unwillingness to supply the dealerships with an adequate supply of popular models.

We enter into agreements (“Franchise Agreements”) with the manufacturers. Each Franchise Agreement generally limits the location of the dealership and provides the auto manufacturer approval rights over changes in dealership management and ownership. The auto manufacturers are also entitled to terminate the Franchise Agreements if the dealerships are in material breach of the terms. Our ability to expand operations depends, in part, on obtaining consents of the manufacturers for the acquisition of additional dealerships.

We are subject to a concentration of risk in the event of financial distress, including potential reorganization or bankruptcy, of a major vehicle manufacturer. We purchase substantially all of our new vehicles from various manufacturers or distributors at the prevailing prices available to all franchised dealers. Our sales volume could be materially adversely impacted by the manufacturers’ or distributors’ inability to supply the stores with an adequate supply of vehicles and related financing. Our Chrysler, General Motors (“GM”) and Ford (collectively, the “Domestic Manufacturers”) stores represented approximately 28%, 18% and 6% of our new vehicle sales for the first three months of 2010, respectively, and approximately 31%, 17% and 5% for all of 2009, respectively.

We receive incentives and rebates from our manufacturers, including cash allowances, financing programs, discounts, holdbacks and other incentives. These incentives are recorded as receivables on our balance sheet until payment is received. Our financial condition could be materially adversely impacted by the manufacturers’ or distributors’ inability to continue to offer these incentives and rebates at substantially similar terms, or to pay our outstanding receivables. Total receivables from Domestic Manufacturers were $9.0 million and $7.2 million as of March 31, 2010 and December 31, 2009, respectively.

We currently have relationships with a number of manufacturers or their affiliated finance companies, including GMAC LLC, Daimler Financial, Toyota Financial Services, Ford Motor Credit Company, VW Credit, Inc., American Honda Finance Corporation, Nissan Motor Acceptance Corporation and BMW Financial Services NA, LLC. These companies provide new vehicle floorplan financing for their respective brands. GMAC LLC serves as the primary lenders for all other brands. At March 31, 2010,

 

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GMAC was the floorplan provider on approximately 68.9% of the floorplan notes payable outstanding. Certain of these companies have incurred significant losses and are operating under financial constraints. Other companies may incur losses in the future or undergo funding limitations. As a result, credit that has typically been extended to us by the companies may be modified with terms unacceptable to us or revoked entirely. If these events were to occur, we may not be able to pay our floorplan debts or borrow sufficient funds to refinance the vehicles. Even if new financing were available, it may not be on terms acceptable to us.

Most manufacturers have experienced significant declines in sales due to the current economic recession. Many have disclosed substantial operating losses over the recent past. Two of these manufacturers, Chrysler and GM, filed a petition for Chapter 11 bankruptcy protection in the second quarter of 2009. Both succeeded in receiving approval for the transfer and sale of key operating assets into new companies with reduced debt, improved operating efficiencies, new ownership and resized operations.

In connection with its reorganization, the Chrysler entity emerging from bankruptcy protection (“New Chrysler”) assumed most Dealer Sales and Service (franchise) Agreements but elected to reject certain franchise agreements to reduce its dealer count. Two of our Chrysler stores (Omaha, NE Chrysler Jeep Dodge and Colorado Springs, CO Chrysler Jeep) were not assumed and those dealerships have ceased operations. Five of our existing Dodge dealerships were awarded additional franchises to sell either the Chrysler or Jeep brands, or both.

GM undertook a similar process in its reorganization, and selected certain dealerships within its network for termination. The terminated dealerships were offered agreements winding down their operations with a final termination no later than October 2010. The GM closure list was not made public, and each terminated dealership signed a non-disclosure agreement with respect to its closure. We received franchise agreement modification documents that terminate all operations at three locations, terminate Cadillac franchises at two Chevrolet/Cadillac stores, and terminate heavy truck franchises at two Chevrolet franchises. We have also received notification that our one Saturn franchise would not be continued by GM, and we terminated the franchise in December 2009.

Federal legislation was passed in December 2009 which provides terminated Chrysler dealers and GM dealers who have closed or have signed wind-down letters, the opportunity to pursue reinstatements through an arbitration proceeding. The legislation provides that the arbitrator, under the auspices of the American Arbitration Association, shall balance the economic interest of the covered dealership, the economic interest of the manufacturer and the economic interest of the public at large and shall decide, based upon that balancing, whether or not the covered dealership should be reinstated in the dealer network.

We filed notice of arbitration with respect to our previous Colorado Springs, CO Chrysler Jeep store; however, we withdrew the notice in the first quarter of 2010. We also filed notice of arbitration with respect to three GM stores. We continue to negotiate with GM for the full reinstatement of these stores.

As a result of this legislation, it is possible that we could lose the recently awarded additional brands at the five Chrysler stores or have competing points reinstated in these markets. Further, such reinstatements could add additional costs and burdens on the reorganized manufacturers, reducing their competitiveness. We are unable to predict the ultimate financial impact on our business, if any.

As evidenced by the recent bankruptcy proceedings of both Chrysler and GM, state dealer laws do not afford continued protection from manufacturer terminations or non-renewal of franchise agreements under federal bankruptcy laws. While we do not believe additional bankruptcy filings are probable, no assurances can be given that a manufacturer will not seek protection under bankruptcy laws, or that, in this event, they will not seek to terminate franchise rights held by us.

 

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While New Chrysler and GM have both emerged from bankruptcy protection and completed their reorganizations, and much of the near-term risk to the viability of the suppliers has been mitigated, the future remains uncertain. The success of the reorganizations and Chrysler’s integration with Fiat S.p.A., are unknown. The future financial condition of GM and New Chrysler, and their ability to provide products that result in sales and profits consistent with historical results is at risk. Resizing operations could negatively impact the volume of vehicles produced and made available to dealers. Shortages in inventory for any manufacturer as a result of production delays, recalls or other factors could also have a negative impact on our sales volumes and financial results. As such, no assurances can be given that our financial condition, results of operations and cash flows will not be adversely impacted in the future.

Note 2. Inventories

Inventories are valued at the lower of market value or cost, using a pooled approach for vehicles and the specific identification method for parts. The cost of new and used vehicle inventories includes the cost of any equipment added, reconditioning and transportation. Inventories consisted of the following (in thousands):

 

      March 31,
2010
   December 31,
2009

New and program vehicles

   $ 264,259    $ 238,814

Used vehicles

     75,157      70,819

Parts and accessories

     20,609      19,093
             
   $ 360,025    $ 328,726
             

Note 3. Credit Facility Amendment

In January 2010, we executed the eighth amendment to our Credit Facility, which increased the amount allowable for letters of credit to $2.0 million. In February 2010, we executed the ninth amendment to our Credit Facility, which altered the definition of vehicle equity in the agreement to allow more vehicles to be included in the borrowing base calculation.

We had $0 and $24.0 million outstanding on our Credit Facility as of March 31, 2010 and December 31, 2009, respectively. The Credit Facility matures in October 2010.

Note 4. Contingencies

Litigation

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

Phillips/Allen/Aripe Cases

On November 25, 2003, Aimee Phillips filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 03-3109-HO) against Lithia Motors, Inc. and two of its wholly-owned subsidiaries alleging violations of state and federal RICO laws, the Oregon Unfair Trade Practices Act (“UTPA”) and common law fraud. Ms. Phillips seeks damages, attorney’s fees and injunctive relief. Ms. Phillips’ complaint stems from her purchase of a Toyota Tacoma pick-up truck on July 6, 2002. On May 14, 2004, we filed an answer to Ms. Phillips’ Complaint. This case was consolidated with the Allen case described below and has a similar current procedural status.

On April 28, 2004, Robert Allen and 29 other plaintiffs (“Allen Plaintiffs”) filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 04-3032-HO) against Lithia Motors, Inc. and three of its wholly-owned subsidiaries alleging violations of state and federal RICO laws, the Oregon UTPA and common law fraud. The Allen Plaintiffs seek damages, attorney’s fees and injunctive relief. The Allen Plaintiffs’ Complaint stems from vehicle purchases made at Lithia stores between July 2000 and April 2001. On August 27, 2004, we filed a Motion to Dismiss the Complaint. On May 26, 2005, the

 

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Court entered an Order granting Defendants’ Motion to Dismiss plaintiffs’ state and federal RICO claims with prejudice. The Court declined to exercise supplemental jurisdiction over plaintiffs’ UTPA and fraud claims. Plaintiffs filed a Motion to Reconsider the dismissal Order. On August 23, 2005, the Court granted Plaintiffs’ Motion for Reconsideration and permitted the filing of a Second Amended Complaint (“SAC”). On September 21, 2005, the Allen Plaintiffs, along with Ms. Phillips, filed the SAC. In this complaint, the Allen plaintiffs seek actual damages that total less than $500,000, trebled, approximately $3.0 million in mental distress claims, trebled, punitive damages of $15.0 million, attorney’s fees and injunctive relief. The SAC added as defendants certain officers and employees of Lithia. In addition, the SAC added a claim for relief based on the Truth in Lending Act (“TILA”). On November 14, 2005 we filed a second Motion to Dismiss the Complaint and a Motion to Compel Arbitration. In two subsequent rulings, the Court has dismissed all claims except those under Oregon’s Unfair Trade Practices Act and a single fraud claim for a named individual. We believe the actions of the court have significantly narrowed the claims and potential damages sought by the plaintiffs. Discovery is completed and a resolution of the case is expected by the end of 2010.

On September 23, 2005, Maria Anabel Aripe and 19 other plaintiffs (“Aripe Plaintiffs”) filed a lawsuit in the U.S. District Court for the District of Oregon (Case No. 05-3083-HO) against Lithia Motors, Inc., 12 of its wholly-owned subsidiaries and certain officers and employees of Lithia, alleging violations of state and federal RICO laws, the Oregon UTPA, common law fraud and TILA. The Aripe Plaintiffs seek actual damages of less than $600,000, trebled, approximately $3.7 million in mental distress claims, trebled, punitive damages of $12.6 million, attorney’s fees and injunctive relief. The Aripe Plaintiffs’ Complaint stems from vehicle purchases made at Lithia stores between May 2001 and August 2005 and is substantially similar to the allegations made in the Allen case. On July 27, 2009, we filed a Motion to Dismiss all claims with the Arbitrators hearing the dispute. On September 30, 2009, the Chief Arbitrator issued an Order acknowledging the voluntary withdrawal of the federal RICO claims by the Plaintiff and dismissed the claim for emotional distress damages. Further motions are pending, but the most significant monetary exposures have been removed from the case.

Alaska Service and Parts Advisors and Managers Overtime Suit

On March 22, 2006, seven former employees in Alaska brought suit against Lithia (Dunham, et al. v. Lithia Support Services, et al., 3AN-06-6338 Civil, Superior Court for the State of Alaska) seeking overtime wages, additional liquidated damages and attorney’s fees. The complaint was later amended to include a total of 11 named plaintiffs. The court ordered the dispute to arbitration. In February 2008, the arbitrator granted the plaintiffs’ request to establish a class of plaintiffs consisting of all present and former service and parts department employees totaling approximately 150 individuals who were paid on a commission basis. We have filed a motion requesting reconsideration of this class certification, but the arbitrator died before issuing his opinion. The reconsideration sought a ruling whether these employees or some of these employees are exempt from the applicable state law that provides for the payment of overtime under certain circumstances. The replacement arbitrator has now been appointed and recently ruled to remove all service and parts managers from the case. A class action opt-out notice was mailed to the service and parts employees in October 2009. No arbitration date has been set.

We intend to vigorously defend all matters noted above, and to assert available defenses. We cannot make an estimate of the likelihood of negative judgment in any of these cases at this time. The ultimate resolution of the above noted cases is not expected to result in any significant settlement amounts. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our results of operations, financial condition or cash flows.

 

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Note 5. Comprehensive Income

Comprehensive income for the three-month periods ended March 31, 2010 and 2009 included the change in the fair value of cash flow hedging instruments that are reflected in stockholders’ equity, net of tax, instead of net income . The following table sets forth the calculation of comprehensive income (in thousands):

 

      Three Months Ended March 31,
     2010     2009

Net income

   $ 1,267      $ 1,329

Cash flow hedges:

    

Derivative gain (loss), net of tax effect of $294 and $(483), respectively

     (478     831
              

Comprehensive income

   $ 789      $ 2,160
              

Note 6. 2003 Stock Incentive Plan

At our 2010 Annual Meeting of Shareholders in April 2010, our shareholders amended and restated the 2003 Stock Incentive Plan (the “2003 Plan”), increasing the number of shares issuable by 600,000 shares to 2,800,000 shares.

Note 7. Reclassifications

The results of operations of stores classified as discontinued operations have been presented on a comparable basis for all periods presented in the accompanying consolidated statements of operations. See also Note 13.

Note 8. Earnings (Loss) Per Share

We compute net income per share of Class A and Class B common stock using the two-class method. Under this method, basic net income per share is computed using the weighted average number of common shares outstanding during the period excluding unvested common shares subject to repurchase or cancellation. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options, warrants, conversion of any convertible senior subordinated notes and unvested common shares subject to repurchase or cancellation. The dilutive effect of outstanding stock options and warrants 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 rights, the rights of the holders of our Class A and Class B common stock are identical. Our Articles of Incorporation require that the Class A and Class B common stock must share equally in any dividends, liquidation proceeds or other distribution with respect to our common stock and the Articles of Incorporation can only be amended by a vote of the shareholders. Additionally, Oregon law provides that amendments to our Articles of Incorporation, which would have the effect of adversely altering the rights, powers or preferences of a given class of stock, must be approved by the class of stock adversely affected by the proposed amendment. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. Further, as we assume the conversion of Class B common stock in the computation of the diluted net income per share of Class A common stock, the undistributed earnings are equal to net income for that computation.

 

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Following is a reconciliation of the income (loss) from continuing operations and weighted average shares used for our basic earnings per share (“EPS”) and diluted EPS for the three months ended March 31, 2010 and 2009 (in thousands, except per share amounts):

 

Three Months Ended March 31,

   2010     2009  

Basic EPS

   Class A    Class B     Class A     Class B  

Numerator:

         

Income (loss) from continuing operations applicable to common stockholders

   $ 1,147    $ 195      $ (633   $ (140

Distributed income applicable to common stockholders

     —        —          —          —     
                               

Basic undistributed (loss) income from continuing operations applicable to common stockholders

   $ 1,147    $ 195      $ (633   $ (140
                               

Denominator:

         

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

     22,133      3,762        16,988        3,762   
                               

Basic distributed income per share applicable to common stockholders

   $ —      $ —        $ —        $ —     

Basic undistributed income (loss) per share applicable to common stockholders

     0.05      0.05        (0.04     (0.04
                               

Basic income (loss) per share applicable to common stockholders

   $ 0.05      0.05      $ (0.04   $ (0.04
                               

Three Months Ended March 31,

   2010     2009  

Diluted EPS

   Class A    Class B     Class A     Class B  

Numerator:

         

Distributed income applicable to common stockholders

   $ —      $ —        $ —        $ —     

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

     —        —          —          —     

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

     —        —          —          —     
                               

Diluted distributed income applicable to common stockholders

   $ —      $ —        $ —        $ —     
                               

Undistributed income (loss) from continuing operations applicable to common stockholders

   $ 1,147    $ 195      $ (633   $ (140

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

     1      (1     —          —     

Reallocation of undistributed income (loss) due to conversion of Class B to Class A

     194      —          (140     —     
                               

Diluted undistributed income (loss) from continuing operations applicable to common stockholders

   $ 1,342    $ 194      $ (773   $ (140
                               

 

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Denominator:

          

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

     22,133      3,762      16,988        3,762   

Weighted average number of shares from stock options

     124      —        —          —     

Conversion of Class B to Class A common shares outstanding

     3,762      —        3,762        —     
                              

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

     26,019      3,762      20,750        3,762   
                              

Diluted distributed income per share applicable to common stockholders

   $ —      $ —      $ —        $ —     

Diluted undistributed income (loss) per share applicable to common stockholders

     0.05      0.05      (0.04     (0.04
                              

Diluted income (loss) per share available to common stockholders

   $ 0.05    $ 0.05    $ (0.04   $ (0.04
                              

Three Months Ended March 31,

   2010    2009  

Diluted EPS

   Class A    Class B    Class A     Class B  

Antidilutive Securities

          

2 7/8% convertible senior subordinated notes

     —        —        1,177        —     

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

     734      —        1,858        —     

Note 9. Asset Impairment Charges

Long-lived assets classified as held and used and definite-lived intangible assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. If estimated future undiscounted net cash flows are not sufficient to recover the carrying value of the assets, an impairment charge is recorded for the amount by which the carrying value of the asset exceeds its fair value.

In the first quarter of 2010, due to changes in specific facts and circumstances on three properties held for future development, we tested certain long-lived assets for recoverability. As a result of the test, we recorded an impairment of $1.5 million as a component of asset impairment charges on our Consolidated Statements of Operations mainly related to a property for which a preliminary agreement to sell was entered into in March 2010. See also Note 12.

Note 10. Stock-Based Compensation

In the first quarter of 2010, we issued restricted stock units covering 309,000 shares of our Class A common stock to certain employees. The restricted stock units are not participating and fully vest on the fourth anniversary of the grant date. Total estimated compensation expense to be recognized over the vesting period related to these stock-based awards, calculated using a fair value methodology, is $1.5 million, of which approximately $0.3 million will be recognized in 2010.

Note 11. Derivative Instruments

We enter into interest rate swaps to manage the variability of our interest rate exposure, thus fixing a portion of our interest expense in a rising or falling rate environment. We do not enter into derivative instruments for any purpose other than to manage interest rate exposure of the 1-month LIBOR benchmark. That is, we do not engage in interest rate speculation using derivative instruments.

 

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

At March 31, 2010 and December 31, 2009, the net fair value of all of our agreements totaled a loss of $7.7 million and $6.9 million, respectively, which was recorded on our balance sheet as a component of accrued liabilities and other long-term liabilities. The estimated amount expected to be reclassified into earnings within the next twelve months was $2.8 million at March 31, 2010.

As of March 31, 2010, we had outstanding the following interest rate swaps with U.S. Bank Dealer Commercial Services:

 

   

effective June 16, 2006 – a ten year, $25 million interest rate swap at a fixed rate of 5.587% per annum, variable rate adjusted on the 1st and 16th of each month;

 

   

effective January 26, 2008 – a five year, $25 million interest rate swap at a fixed rate of 4.495% per annum, variable rate adjusted on the 26th of each month;

 

   

effective May 1, 2008 – a five year, $25 million interest rate swap at a fixed rate of 3.495% per annum, variable rate adjusted on the 1 st and 16th of each month; and

 

   

effective May 1, 2008 – a five year, $25 million interest rate swap at a fixed rate of 3.495% per annum, variable rate adjusted on the 1 st and 16th of each month.

We receive interest on all of the interest rate swaps at the one-month LIBOR rate. The one-month LIBOR rate at March 31, 2010 was 0.2486% per annum as reported in the Wall Street Journal.

The fair value of our derivative instruments was included in our balance sheet as follows:

Balance Sheet Information

 

            (in thousands)            

   Fair Value of Asset Derivatives    Fair Value of Liability Derivatives
     

Location in

Balance Sheet

   March 31,
2010
   Location in
Balance Sheet
   March 31,
2010

    Derivatives Designated as

        Hedging Instruments    

                   

Interest Rate Swap

Contracts

   Prepaid expenses
and other
   $ —      Accrued
liabilities
   $ 2,020
   Other non-current
assets
     —      Other long-term
liabilities
     5,703
                   
      $ —         $ 7,723
                   

Balance Sheet Information

 

           

            (in thousands)            

   Fair Value of Asset Derivatives    Fair Value of Liability Derivatives
     

Location in

Balance Sheet

   December 31,
2009
   Location in
Balance Sheet
   December 31,
2009

    Derivatives Designated as

        Hedging Instruments    

                   

Interest Rate Swap

Contracts

   Prepaid expenses
and other
   $ —      Accrued
liabilities
   $ 1,668
   Other non-current
assets
     —      Other long-term
liabilities
     5,212
                   
      $ —         $ 6,880
                   

 

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The effect of derivative instruments on our Consolidated Statements of Operations for the three-month periods ended March 31, 2010 and 2009 was as follows (in thousands):

 

    Derivatives in Cash

          Flow Hedging

          Relationships

   Amount of
Gain/(Loss)
Recognized
in OCI
(Effective
Portion)
    Location of
Gain/(Loss)
Reclassified
from
Accumulated
OCI into
Income
(Effective
Portion)
   Amount of
Gain/(Loss)
Reclassified
from
Accumulated
OCI into Income
(Effective
Portion)
    Location of
Gain/(Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
   Amount of
Gain/(Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
 

    Three Months Ended

        March 31, 2010        

                            

Interest Rate Swap
Contracts

   $ (1,534   Floorplan

Interest
expense

   $ (762   Floorplan

Interest
expense

   $ (318

    Three Months Ended

        March 31, 2009        

                            

Interest Rate Swap
Contracts

   $ 374      Floorplan

Interest
expense

   $ (940   Floorplan

Interest
expense

   $ (61

    Derivatives Not Designated

        as Hedging Instruments

   Location of
Gain/(Loss)
Recognized in Income
on Derivative
   Amount of
Gain/(Loss)
Recognized in
Income on
Derivative
            

    Three Months Ended

        March 31, 2010        

                      

Interest Rate Swap Contracts

    

 

 

Floorplan

interest

expense

   $ —          

    Three Months Ended

        March 31, 2009        

                      

Interest Rate Swap Contracts

    

 

 

Floorplan

interest

expense

   $ (6)        

See also Notes 5 and 12.

Note 12. Fair Value Measurements

Effective January 1, 2010, we adopted the amended provisions of fair value measurements and disclosures. The amendment requires new disclosures about recurring and non-recurring fair value measurements, including transfers into and out of Level 1 and Level 2 fair value measurement categories. The amendment also clarifies existing fair value measurement disclosure guidance about the level of disaggregation, inputs and valuation techniques. In the initial adoption period, disclosures for previous comparative periods are not required.

Additionally, information about purchases, sales, issuances and settlements on a gross basis will be required for Level 3 fair value measurements in interim and year-end periods ending after December 15, 2010. Since this information pertains only to disclosures, we do not believe this requirement will have any impact on our financial position or results of operations.

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

 

   

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

 

   

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

 

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

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

We use the income approach to determine the fair value of our interest rate swaps using observable Level 2 market expectations at measurement date and an “income” approach to convert estimated future cash flows to a single present amount (discounted) assuming that participants are motivated, but not compelled to transact. Level 2 inputs for the swap valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates and credit risk at commonly quoted intervals). Mid-market pricing is used as a practical expedient for fair value measurements. Key inputs, including the cash rates for very short term, futures rates for up to two years and LIBOR swap rates beyond the derivative maturity are used to predict future reset rates to discount those future cash flows to present value at measurement date. Inputs are collected from Bloomberg on the last market day of the period. The same rates are used to determine the rate used to discount the future cash flows. The valuation of the interest rate swaps also takes into consideration our own, as well as the counterparty’s, risk of non-performance under the contract. See also Note 11.

We estimate the fair value of our assets held for sale and liabilities related to assets held for sale based on a “market” valuation approach, which uses prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets or liabilities, as well as our historical experience in divestitures, acquisitions and real estate transactions. When available, we use inputs from independent valuation experts, such as brokers and real estate appraisers, to corroborate our internal estimates. As these valuations contain unobservable inputs, we classified the assets held for sale and liabilities related to assets held for sale as Level 3.

In the first quarter of 2010, long-lived assets including real estate property and equipment previously classified as held for sale were reclassified to held and used at the lower of their depreciated carrying value, assuming depreciation had not ceased while classified in held for sale, or their current fair value. Additionally, other real estate property held for future development was determined to require evaluation for potential impairment during the first quarter of 2010. Based on this evaluation, certain long-lived assets were measured at their fair value. We estimate the fair value of long-lived assets based on a “market” valuation approach. We use prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets or liabilities, as well as our historical experience in divestitures, acquisitions and real estate transactions. Additionally, we may use a cost valuation approach to value long-lived assets when a market valuation approach is unavailable. Under this approach, we determine the cost to replace the service capacity of an asset adjusted for physical and economic obsolescence. When available, we use valuation inputs from independent valuation experts, such as real estate appraisers and brokers, to corroborate our estimates of fair value. Real estate appraisers’ and brokers’ valuations are typically developed using one or more valuation techniques including market, income and replacement cost approaches. As these valuations contain unobservable inputs, we classified the long-lived assets as Level 3.

There were no changes to our valuation techniques during the three month period ended March 31, 2010.

 

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The following table summarizes our non-financial assets and liabilities measured at fair value at March 31, 2010 and December 31, 2009 (in thousands):

 

     March 31, 2010
      Fair Value    Input Level

Assets held for sale

   $ 2,202    Level 3

Liabilities related to assets held for sale

     2,140    Level 3

Long-lived assets

     12,446    Level 3
     December 31, 2009
      Fair Value    Input Level

Assets held for sale

   $ 11,693    Level 3

Liabilities related to assets held for sale

     5,050    Level 3

Franchise value

     1,691    Level 3

Long-lived assets

     52,419    Level 3

The following tables summarize valuation adjustments recorded in our Consolidated Statement of Operations on non-financial assets measured and recorded at fair value on a non-recurring basis for the three-month periods ended March 31, 2010 and 2009 (in thousands):

 

            Three Months Ended            Fair Value Measurement Using             Gain/(Loss)  

                  March 31, 2010            

       Level 1            Level 2            Level 3       

Long-lived assets held and used

           

Building and improvements

   $ —      —      9,157    $ (1,018

Land

     —      —      3,289      (473
            Three Months Ended    Fair Value Measurement Using    Gain/(Loss)  

                  March 31, 2009            

   Level 1    Level 2    Level 3   

Long-lived assets held and used

   $ —      —      440    $ (303

Assets held for sale

   $ —      —      139,603    $ (1,485

Valuation adjustments recorded in the three months ended March 31, 2009, for assets held for sale of $1.4 million and $0.1 million were included as a component of asset impairment charges and income (loss) from discontinued operations, net of tax, respectively, in our Consolidated Statements of Operations. See also Note 13.

We had $155.0 million and $162.4 million of long-term fixed interest rate debt outstanding as of March 31, 2010 and December 31, 2009, respectively. As of March 31, 2010, this debt had maturity dates between January 2011 and October 2029. We 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, the fixed cash flows are discounted and summed to compute the fair value of the debt. Based on this analysis, we have determined that the fair value of this long-term fixed interest rate debt was approximately $162.2 million and $166.8 million at March 31, 2010 and December 31, 2009, respectively. We believe the carrying value of our variable rate debt approximates fair value.

Note 13. Discontinued Operations

We perform an internal evaluation of our store performance, on a store-by-store basis, in the last month of each quarter. If a store does not meet certain return on investment criteria established by our management team, the location is included on a “watch list” and is considered for potential disposition. Factors we consider in reaching the conclusion to dispose of a store include: (i) actual operating results of the store over a predetermined period of time subsequent to placing the store on the “watch list,” including prospects for improved financial performance; (ii) extent of capital improvements and commitments thereto necessary to optimize operational efficiencies and marketability of the associated franchise; (iii) outlook as to the economic prospects for the local market and viability of the franchise within that market; and (iv) geographic location and franchise mix of our portfolio.

 

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Once we have reached a decision to dispose of a store, we evaluate the following criteria as required by U.S generally accepted accounting standards:

 

   

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

 

   

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

 

   

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

 

   

a market for the store exists and we believe its sale is likely. We also expect to record the transfer of the store as a completed sale within one year;

 

   

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

 

   

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

If we determine the above criteria have been met, we classify the store assets to be disposed of, and liabilities directly associated with those assets, as held for sale in our consolidated balance sheet.

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

At December 31, 2009, two operating stores were classified as held for sale. Both were under contract to sell, and, based on our evaluation, we believe the locations met the criteria to be classified as held for sale at that time. Based on subsequent negotiations with the buyer in the first quarter of 2010, management concluded that it was no longer probable that the sale of these stores would be effected, resulting in the determination that these two operating stores no longer met all of the criteria for classification as held for sale at March 31, 2010. Therefore, in the first quarter of 2010, assets and related liabilities associated with two stores were reclassified from assets held for sale to held and used. Their associated results of operations were retrospectively reclassified from discontinued operations to continuing operations for all periods presented.

As of March 31, 2010 and December 31, 2009, we had no stores and three properties and two stores and three properties, respectively, classified as held for sale. Assets held for sale included the following (in thousands):

 

      March 31,
2010
   December 31,
2009

Inventories

   $ —      $ 8,098

Property, plant and equipment

     2,202      3,572

Intangible assets

     —        23
             
   $ 2,202    $ 11,693
             

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

 

      March 31,
2010
   December 31,
2009

Floorplan notes payable

   $ —      $ 2,888

Real estate debt

     2,140      2,162
             
   $ 2,140    $ 5,050
             

 

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Assets and liabilities held for sale are valued at the lower of cost or fair value less costs to sell. Estimates of fair value are based on the proceeds we expect to realize on the sale of the disposal groups.

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

 

        Three Months Ended March 31,  
       2010     2009  

Revenue

     $ —        $ 44,641   
                  

Pre-tax loss from discontinued operations

     $ (105   $ (2,247

Gain (loss) on disposal activities

       (17     5,853   
                  
       (122     3,606   

Income tax (expense) benefit

       47        (1,504
                  

Gain (loss) from discontinued operations, net of tax

     $ (75   $ 2,102   
                  

Amount of goodwill and other intangible assets disposed of

     $ —        $ 1,037   
                  

Cash generated from disposal activities

     $ 421      $ 11,642   
                  

The gain (loss) on disposal activities included the following (in thousands):

 

     Three Months Ended March 31,  
    2010     2009  

Goodwill and other intangible assets

  $ —        $ 7,401   

Property, plant and equipment

    (11     (2,398

Inventory

    —          917   

Other

    (6     (67
               
  $ (17   $ 5,853   
               

Interest expense is allocated to stores classified as discontinued operations for actual flooring interest expense directly related to the new vehicles in the store. Interest expense related to our working capital, acquisition and used vehicle credit facility is allocated based on the amount of assets pledged towards the total borrowing base.

As additional market information becomes available and negotiations with prospective buyers continue, estimated fair market values may change for the assets and liabilities held for sale. These changes may require the recognition of additional losses in future periods.

Note 14. Self-insured Medical Plan Coverage

In the first quarter of 2010, we modified our employee medical insurance plan coverage. Effective with the plan year starting January 1, 2010, we changed employee coverage from a fully insured plan to a self-insured plan, except for a population of employees in select California dealerships that remains on a fully insured plan. We carry specific stop-loss coverage insurance in the event a large claim is made under the plan. We estimate the cost to provide medical benefits for existing claims, including claims incurred but not reported, based primarily on an analysis of our historical claims experience, the design of the plan and expectations of medical cost growth factors. We monitor actual claims activity and related costs on a regular basis and evaluate their impact on our assumptions. Any changes to assumptions, including actual claims experience and medical cost factors, may result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.

At March 31, 2010, the self-insured medical plan reserve, net of payments made in the period, totaled $1.7 million, and was included in accrued liabilities on our Consolidated Balance Sheets.

 

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Note 15. Subsequent Event

On April 29, 2010, we announced that our Board of Directors approved a dividend of $0.05 per share on our Class A and Class B common stock for the first quarter of 2010. The dividend will total approximately $1.3 million and will be paid on May 28, 2010 to shareholders of record on May 14, 2010.

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

Forward Looking Statements and Risk Factors

Some of the statements under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute forward-looking statements. Generally, 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 Part II—Other Information, Item 1A. in this Form 10-Q.

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

Overview

We are a leading operator of automotive franchises and retailer of new and used vehicles and services. As of April 30, 2010, we offered 26 brands of new vehicles and all brands of used vehicles in 84 stores in the United States and online at Lithia.com. We sell new and used cars and light trucks, replacement parts, provide vehicle maintenance, warranty, paint and repair services and arrange related financing, service contracts, protection products and credit insurance.

We have restructured our operations to align our costs with current industry vehicle sales levels. We believe that we are well positioned to benefit from an increase in new vehicle sales above current levels. We believe the actions we have taken over the past two years demonstrate the resiliency of our company. However, no assurances can be given that industry sales will not experience a further decline, or that our restructuring plan was sufficient to meet our operating objectives in a declining market.

We continue to believe that the fragmented nature of the automotive dealership sector provides us with the opportunity to achieve growth through consolidation. We have completed over 100 acquisitions since our initial public offering in 1996. Our acquisition strategy has been to acquire underperforming dealerships and, through the application of our centralized operating structure, improve store profitability. We believe the current economic environment provides us with attractive acquisition opportunities. Additionally, our management team possesses substantial experience, with our key management executives having an average of over 25 years experience in automotive retailing, and has demonstrated the ability to profitably operate stores and successfully integrate acquisitions.

 

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Results of Continuing Operations

The results of operations of stores classified as discontinued operations have been presented on a comparable basis for all periods presented in the accompanying consolidated statements of operations. The following tables set forth the changes in our operating results from continuing operations in the three-month period ended March 31, 2010 compared to the three-month period ended March 31, 2009:

 

(Dollars in thousands)

   Three Months Ended March 31,     Increase
(Decrease)
    %
Increase

(Decrease)
 
     2010     2009      

Revenues:

        

New vehicle

   $ 217,447      $ 194,318      $ 23,129      11.9

Used vehicle retail

     136,938        109,602        27,336      24.9   

Used vehicle wholesale

     23,750        16,628        7,122      42.8   

Finance and insurance

     14,740        13,646        1,094      8.0   

Service, body and parts

     69,696        73,878        (4,182   (5.7

Fleet and other

     806        573        233      40.7   
                              

Total revenues

     463,377        408,645        54,732      13.4   

Cost of sales:

        

New vehicle

     198,913        177,470        21,443      12.1   

Used vehicle retail

     118,236        95,915        22,321      23.3   

Used vehicle wholesale

     23,379        16,275        7,104      43.6   

Service, body and parts

     35,784        38,809        (3,025   (7.8

Fleet and other

     451        214        237      110.7   
                              

Total cost of sales

     376,763        328,683        48,080      14.6   
                              

Gross profit

     86,614        79,962        6,652      8.3   

Asset impairment charges

     1,491        1,653        (162   (9.8

Selling, general and administrative

     71,881        69,832        2,049      2.9   

Depreciation and amortization

     4,751        4,114        637      15.5   
                              

Operating income

     8,491        4,363        4,128      94.6   

Floorplan interest expense

     (2,783     (2,929     (146   (5.0

Other interest expense

     (3,588     (3,987     (399   (10.0

Other income, net

     66        1,165        (1,099   (94.3
                              

Income (loss) from continuing operations before taxes

     2,186        (1,388     3,574      (257.5

Income tax expense (benefit)

     844        (615     1,459      (237.2
                              

Income (loss) from continuing operations

   $ 1,342      $ (773   $ 2,115      (273.6
                              

Certain key performance metrics used to manage our business were as follows for the three month periods ended March 31, 2010 and 2009:

 

Three Months Ended March 31, 2010

   Percent of
Total Revenues
    Gross
Margin
    Percent of Total
Gross Profit
 

New vehicle

   46.9   8.5   21.4

Used vehicle, retail

   29.6      13.7      21.6   

Used vehicle, wholesale

   5.1      1.6      0.4   

Finance and insurance( 1)

   3.2      100.0      17.0   

Service, body and parts

   15.0      48.7      39.2   

Fleet and other

   0.2      44.0      0.4   

Three Months Ended March 31, 2009

   Percent of
Total Revenues
    Gross
Margin
    Percent of Total
Gross Profit
 

New vehicle

   47.6   8.7   21.1

Used vehicle, retail

   26.8      12.5      17.1   

Used vehicle, wholesale

   4.1      2.1      0.4   

Finance and insurance(1)

   3.3      100.0      17.1   

Service, body and parts

   18.1      47.5      43.9   

Fleet and other

   0.1      62.7      0.4   

 

  (1) Commissions reported net of anticipated cancellations.

 

      Three Months Ended March 31,  
     2010     2009  

Total gross margin

   18.7   19.6

Selling, general and administrative expenses as a % of gross profit

   83.0      87.3   

Operating margin

   1.8      1.1   

Pre-tax margin

   0.5      (0.3

 

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Same-store sales percentage increases (decreases) were as follows:

 

      Three months ended
March 31, 2010 vs.
three months ended
March 31, 2009
 

New vehicle retail, excluding fleet

   11.5

Used vehicle retail

   22.4   

Used vehicle wholesale

   41.9   

Total vehicle sales, excluding fleet

   16.8   

Finance and insurance

   (0.4

Service, body and parts

   (6.0

Total sales, excluding fleet

   12.1   

Same-store sales are calculated for stores that were in operation as of March 31, 2010, and only including the months of operations for both comparable periods. For example, a store acquired in June 2008 would be included in same store operating data beginning in July 2009, after its first full complete comparable month of operation. Thus, operating results for same store comparisons would include only the periods of July through December of both comparable years.

Floorplan assistance is provided by manufacturers to specifically support store financing of new vehicle inventory. Under U.S. generally accepted accounting principles, floorplan assistance is recorded as a component of new vehicle gross profit when the specific vehicle is sold. However, as manufacturers provide this assistance to offset inventory carrying costs, we believe a comparison of floorplan interest expense to floorplan assistance can be used to evaluate the efficiency of our new vehicle sales relative to stocking levels. The following table details the carrying costs for new vehicles and includes new and program vehicle floorplan interest net of floorplan assistance earned (dollars in thousands):

 

      Three Months Ended March 31,     Increase
(Decrease)
    %
Increase

(Decrease)
 
     2010     2009      

Floorplan interest expense (new vehicles)

   $ 2,783      $ 2,929      $ (146   (5.0 )% 

Floorplan assistance (included in cost of sales)

     (2,153     (2,156     (3   (0.0
                              

Net new vehicle carrying costs

   $ 630      $ 773      $ (143   18.5
                              

Results of Operations

For the three months ended March 31, 2010, we realized a reported net income of $1.3 million, or $0.05 per diluted share. For the three months ended March 31, 2009, we realized a reported net income of $1.3 million, or $0.06 per diluted share.

Pro Forma Reconciliations

Due to the non-cash charges related to asset impairments, reserve adjustments, disposal gains and gains on extinguishment of debt, we are providing our results of operations excluding these items. We believe that each of the non-GAAP financial measures provided improves the transparency of our disclosure, by presenting our results that exclude the impact of certain items that affect their period-to-period comparability.

 

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The following table reconciles certain reported GAAP income (loss) amounts per the Statements of Operations to the comparable non-GAAP income (loss) amounts:

 

     Three Months Ended March 31,  
      Income (loss)
(In thousands)
    Diluted income (loss)
per share
 
      2010     2009     2010    2009  

Continuing Operations

         

As reported

   $ 1,342      $ (773   $ 0.05    $ (0.04

Asset impairments and disposal gains, net

     731        1,147        0.03      0.06   

Reserve adjustments

     160        —          0.01      —     

Gain on extinguishment of debt

     —          (607     —        (0.03
                               

Adjusted

   $ 2,233      $ (233   $ 0.09    $ (0.01
                               

Discontinued Operations

         

As reported

   $ (75   $ 2,102      $ —      $ 0.10   

Impairments and disposal (gain) loss, net

     10        (3,469     —        (0.17
                               

Adjusted

   $ (65   $ (1,367   $ —      $ (0.07
                               

Consolidated Operations

         

As reported

   $ 1,267      $ 1,329      $ 0.05    $ 0.06   
                               

Adjusted

   $ 2,168      $ (1,600   $ 0.09    $ (0.08
                               

New Vehicle Revenues

 

     Three Months Ended March 31,    Increase
(Decrease)
   %
Increase

(Decrease)
 
      2010    2009      

Revenue (In thousands)

   $ 217,447    $ 194,318    $ 23,129    11.9

Retail units sold

     6,946      6,460      486    7.5   

Average selling price per retail unit

   $ 31,305    $ 30,080    $ 1,225    4.1   

New vehicle sales have been at historic lows over the past two years, driven by weak consumer confidence and a lack of available credit. The first quarter of 2010 saw the first incremental improvement over the anemic sales levels experienced in recent years. We believe that the new vehicle market has stabilized and there are some indications that it may improve throughout 2010. Despite these positive trends, Chrysler experienced declining national market share, from approximately 11.2% in the first quarter of 2009 to 9.2% in the first quarter of 2010.

Used Vehicle Revenues

 

     Three Months Ended March 31,    Increase
(Decrease)
   %
Increase

(Decrease)
 
      2010    2009      

Retail revenue (In thousands)

   $ 136,938    $ 109,602    $ 27,336    24.9

Retail units sold

     8,281      7,156      1,125    15.7   

Average selling price per retail unit

   $ 16,536    $ 15,316    $ 1,220    8.0   

Wholesale revenue (In thousands)

   $ 23,750    $ 16,628    $ 7,122    42.8   

Wholesale units sold

     3,320      3,196      124    3.9   

Average selling price per wholesale unit

   $ 7,154    $ 5,203    $ 1,951    37.5   

Used vehicle retail unit sales have increased as consumers opt to purchase used vehicles instead of new vehicles, and as we increase the number of lower-price, higher-margin older used cars we sell. In the first quarter of 2010, we believe average selling price per retail unit increased primarily as a result of a stronger used vehicle market due to supply constraints, and due to a recent shift to selling higher-dollar, late model used vehicles to offset new vehicle inventory shortages experienced in late 2009. We have focused our store personnel on maximizing retail used vehicle sales and reducing the number of used vehicles we wholesale after acquiring via trade-in. As a result of the shift in mix to more used vehicles and fewer new vehicles sold, our used retail to new vehicle sales ratio has improved from 1.1:1 in the first quarter of 2009 to 1.2:1 in the first quarter of 2010.

 

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Finance and Insurance

 

     Three Months Ended March 31,    Increase
(Decrease)
    %
Increase

(Decrease)
 
      2010    2009     

Revenue (In thousands)

   $ 14,740    $ 13,646    $ 1,094      8.0

Revenue per retail unit

   $ 968    $ 1,002    $ (34   (3.4

The increase in finance and insurance sales were primarily due to more vehicles sold in the first quarter of 2010 compared to the first quarter of 2009. Penetration rates were relatively flat in the comparable periods. On a per unit basis, revenue declined primarily due to a change in mix toward lower priced contracts. Also, financing restrictions on the overall loan amount to vehicle invoice cost, which can impact the ability of customers to finance the ancillary products we offer, contributed to the decline in revenue per unit.

Additionally, during the first quarter of 2009, we discontinued the transfer of the obligation related to most of our lifetime lube, oil and filter insurance contracts to a third party. As a result, beginning March 1, 2009, we no longer recognize revenue related to earned commissions at the inception of the contract but, instead, defer the full sale price of the contract and recognize the revenue over the expected life of the contract as services are provided. This change improves our cash position as we retain 100% of the contract sales price, but defers the recognition of the revenues to later periods. Assuming we did not self-insure these contracts, our revenue per retail unit would have been higher by approximately $80 per vehicle and $30 per vehicle for the three months ended March 31, 2010 and 2009, respectively.

Penetration rates for certain products were as follows:

 

      Three Months Ended March 31,  
     2010     2009  

Finance and insurance

   70   71

Service contracts

   42      42   

Lifetime oil change and filter

   35      34   

Service, Body and Parts Revenue

 

     Three Months Ended March 31,    Increase
(Decrease)
    %
Increase

(Decrease)
 
      2010    2009     

Revenue (In thousands)

   $ 69,696    $ 73,878    $ (4,182   (5.7 )% 

The declines in new vehicle sales in 2008 and 2009 have reduced the number of units-in-operation, particularly for the domestic automotive manufacturers. This lack of late-model vehicles in operation has put downward pressure on warranty work and the opportunity to sell ancillary services during this captive customer visit. To a lesser extent, declining consumer confidence has caused customers to defer maintenance work and routine servicing for longer periods of time.

Warranty work accounted for approximately 19% of our same-store service, body and parts sales in the first quarter of 2010 compared to 20% in the first quarter of 2009, which resulted in a 13.7% decrease in same-store warranty sales in the 2010 period compared to the 2009 period. Domestic brand warranty work decreased by 23.9%, while import/luxury warranty work increased by 1.0% in the comparable periods. The customer pay service and parts business, which represented 81% of the total service, body and parts business in the first quarter of 2010, was down 4.0% on a same-store basis compared to the first quarter of 2009.

 

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Table of Contents

Gross Profit

Gross profit increased $6.7 million in the three month period ended March 31, 2010 compared to the same period of 2009 due to an increase in total revenues, offset by decreases in our overall gross profit margin. Our gross profit margin by business line was as follows:

 

      Three Months Ended March 31,     Basis
Point Change*
 
     2010     2009    

New vehicle

   8.5   8.7   (20 )bp 

Retail used vehicle

   13.7      12.5      120   

Wholesale used vehicle

   1.6      2.1      (50

Finance and insurance

   100.0      100.0      —     

Service, body and parts

   48.7      47.5      120   

Overall

   18.7      19.6      (90

 

  *

A basis point is equal to 1/100th of one percent.

During 2010, we continue to focus attention on maximizing retail profit opportunities on each transaction. We are also adjusting our used vehicle inventories to respond to shifts in consumer demand. We continue to increase sales to customers seeking lower priced vehicles, improving gross margins and resulting in fewer wholesale vehicle sales. These factors led to improved gross profit margins in our retail used vehicle business line. We had a greater proportion of higher-margin service work in the service, body and parts business, leading to an increase in margin compared to the prior year period. Overall, as retail vehicle sales increased, gross margin declined due to service, body and parts comprising a smaller percentage of total sales.

Asset Impairment Charges

We are required to test our indefinite-lived intangible assets for impairment at least annually or more frequently if conditions indicate that an impairment may have occurred. In addition, long-lived assets held and used by us and intangible assets with determinable lives are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable.

We continue to market a number of properties we currently hold for future development, including vacant stores and undeveloped land. We seek the highest and best use for these assets, either through their sale to a third-party or our acquisition of a business that could operate at the location. In the first quarter of 2010, due to changes in specific facts and circumstances on three properties held for future development, we tested certain long-lived assets for recoverability. As a result of the testing, we recorded an impairment of $1.5 million as a component of income from continuing operations mainly related to a property for which a preliminary agreement to sell was entered into in March 2010.

Impairment charges recorded in the first quarter of 2009 were associated with assets previously classified as held for sale. As a result of their reclassification in the fourth quarter of 2009 and first quarter of 2010, the associated impairment charges were reclassified from discontinued operations to continuing operations as a component of asset impairment charges.

Asset impairments recorded as a component of continuing operations consisted of the following (in thousands):

 

      Three Months Ended March 31,  
     2010    2009  

Intangible assets

   $ —      $ 250   

Long-lived assets

     1,491      1,657   

Costs to sell

     —        (254
               

Total asset impairments

   $ 1,491    $ 1,653   
               

 

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In addition, we recorded impairment charges on certain other assets of $0.4 million for the three months ended March 31, 2009, as a component of selling, general and administrative expense.

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A”) includes salaries and related personnel expenses, facility lease expense, advertising (net of manufacturer cooperative advertising credits), legal, accounting, professional services and general corporate expenses.

 

     Three Months Ended March 31,  
     2010     2009  

SG&A as a % of revenue

   15.5   17.1

SG&A as a % of gross profit

   83.0      87.3   

SG&A increased $2.0 million in the three-month period ended March 31, 2010 compared to same period of 2009. The decrease in SG&A as a percentage of revenue was primarily due to a higher revenue base.

The increases (decreases) in dollars spent were primarily due to the following:

 

     Three months ended March 31,
2010 vs. three months
ended March 31, 2009

Increase related to salaries, bonuses and benefits

   $ 1.2 million

Increase related to sale of assets

     0.8 million

Increase related to advertising expenses

     1.3 million

Decrease related to utilities expense

     (0.8) million

Decrease related to insurance expenses

     (0.8) million

Increase in other general expenses

     0.3 million
      
   $ 2.0 million
      

Depreciation and Amortization

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

Depreciation and amortization increased $0.6 million in the three-month period ended March 31, 2010 compared to the same period of 2009 due primarily to newly constructed facilities depreciating in the current period compared to the prior period.

Operating Income

Operating income in the three-month period ended March 31, 2010 was 1.8% of revenue compared to 1.1% in the comparable period of 2009. This increase was mainly due to increased vehicle sales in the current period, partially offset by lower gross margins. Our improved cost structure also contributed to this increase.

Floorplan Interest Expense

Floorplan interest expense decreased $0.1 million in the three-month period ended March 31, 2010 compared to the same period of 2009. A decrease of $0.6 million resulted from decreases in the average outstanding balances of our floorplan facilities. This decrease was offset by an increase of $0.4 million from changes in the average interest rates on our floorplan facilities. Changes from interest rate swaps resulted in increases of $0.1 million in the three-month period ended March 31, 2010.

 

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Table of Contents

Other Interest Expense

Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages and our working capital, acquisition and used vehicle lines of credit. It also included interest on our senior subordinated convertible notes in the first quarter of 2009.

Other interest expense decreased $0.4 million in the three-month period ended March 31, 2010 compared to the same period of 2009, due to the repurchase of our convertible notes in 2009 and the reduction of outstanding amounts on our Credit Facility, partially offset by an increase in outstanding amounts of real estate mortgages and a reduction in capitalized interest recorded on construction projects. In the first quarter of 2010, other interest expense mainly related to mortgages. Mortgage interest expense for the three months ended March 31, 2010 and 2009 was $3.4 million and $2.7 million, respectively. Mortgage interest expense for the three months ended December 31, 2009 was $3.3 million.

For the three-month period ended March 31, 2010 and 2009, capitalized interest was $0 and $0.3 million, respectively.

Income Tax Expense

Our effective income tax rate was 38.6% in the three-month period ended March 31, 2010 compared to an effective income tax rate of 44.3% in the comparable period of 2009. For the full year 2010, we anticipate our income tax rate to be approximately 38.6%.

Liquidity and Capital Resources

Principal Needs

Our principal needs for liquidity and capital resources are for capital expenditures, working capital, dividend payments and debt repayment. Historically, we have also used capital resources to fund our acquisitions.

We have relied primarily upon internally generated cash flows from operations, borrowings under our credit agreements, financing of real estate and the proceeds from public equity and private debt offerings to finance operations and expansion. In addition, during the first three months of 2010, we generated $15.1 million through the sale of assets and stores and the issuance of long-term debt, net of unscheduled long-term debt repayments.

We have a $50 million Credit Facility with U.S. Bank National Association, which expires October 28, 2010. We currently have no borrowings outstanding under this facility. We are pursuing an extension of the maturity date on the Credit Facility and believe we will be successful in this endeavor; however, we can provide no assurance that we will be able to extend or replace the Credit Facility on terms acceptable to us, or at all, prior to its maturity. At March 31, 2010, we had approximately $11.4 million in cash and cash equivalents and $32.2 million in unfinanced new vehicles that could be financed immediately for cash. These amounts of available liquidity, combined with projections for future cash flows, are expected to be sufficient to fund our future operations and capital needs in the event we are unable to extend the maturity date of our Credit Facility.

Summary of Outstanding Balances on Credit Facilities

Interest rates on all of our credit facilities, excluding the effects of our interest rate swaps, ranged from 1.8% to 5.0% at March 31, 2010. Amounts outstanding on the lines at March 31, 2010, together with amounts remaining available under such lines were as follows (in thousands):

 

     Outstanding at
March 31, 2010
   Remaining
Availability at

March 31, 2010
 

New and program vehicle lines

   $ 236,923    $ —   (1) 

Working capital, acquisition and used vehicle credit facility

     —        47,224 (2) (3) 
               
   $ 236,923    $ 47,224   
               

 

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(1) There are no formal limits on the new and program vehicle lines with certain lenders, and we had approximately $32.2 million in unfinanced new vehicles at March 31, 2010.
(2) Reduced by $1.4 million for outstanding letters of credit.
(3) The amount available on the line is limited based on a borrowing base calculation and fluctuates monthly.

Working Capital, Acquisition and Used Vehicle Credit Facility

We have a $50 million Credit Facility with U.S. Bank National Association, which expires October 28, 2010. We believe the Credit Facility continues to be an attractive source of financing given the current cost and availability of credit alternatives. The interest rate on the Credit Facility is the 1-month LIBOR plus 3.25%.

Loans are guaranteed by all of our subsidiaries and are secured by new vehicle inventory, used vehicle and parts inventory, equipment other than fixtures, deposit accounts, accounts receivable, investment property and other intangible personal property. Capital stock and other equity interests of our subsidiary stores and certain other subsidiaries are excluded. The lender’s security interest in new vehicle inventory is subordinated to the interests of floorplan financing lenders, including GMAC LLC, Daimler Financial, Toyota Financial Services, Ford Motor Credit Company, VW Credit, Inc., American Honda Finance Corporation, Nissan Motor Acceptance Corporation and BMW Financial Services NA, LLC.

The Credit Facility agreement provides for events of default that include nonpayment, breach of covenants, a change of control and certain cross-defaults with other indebtedness. In the event of a default, the agreement provides that the lenders may declare the entire principal balance immediately due, foreclose on collateral and increase the applicable interest rate to the revolving loan rate plus 3%, among other remedies.

Debt Covenants

We are subject to certain financial and restrictive covenants for all of our debt agreements. The covenants restrict us from incurring additional indebtedness, making investments, selling or acquiring assets and granting security interests in our assets.

The Credit Facility stipulates the following financial covenants:

 

   

a minimum tangible net worth requirement of $200 million;

 

   

a minimum vehicle equity requirement of $45 million;

 

   

a fixed charge coverage ratio of 1.15:1 through June 30, 2010 and 1.20:1 for periods thereafter; and

 

   

a liabilities to tangible net worth ratio not to exceed 4.00:1.

As of March 31, 2010, our tangible net worth was approximately $264.5 million, our vehicle equity was $141.0 million, our fixed charge coverage ratio was 1.25:1 and our liabilities to tangible net worth was 2.32:1. Accordingly, we were in compliance with the Credit Facility financial 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.

In the event that we are unable to meet the financial and restrictive covenants, we would enter into a discussion with the lenders to remediate the condition. If we were unable to remediate or cure the condition, a breach would give rise to certain remedies under the agreement, the most severe of which is the termination of the agreement and acceleration of the amounts owed, including the triggering of cross-default provisions to other debt agreements.

New Vehicle Flooring

GMAC LLC, Daimler Financial, Toyota Financial Services, Ford Motor Credit Company, VW Credit, Inc., American Honda Finance Corporation, Nissan Motor Acceptance Corporation and BMW Financial Services NA, LLC provide new vehicle floorplan financing for their respective brands. GMAC LLC serves as the primary lenders for all other brands. The new vehicle lines are secured by new vehicle inventory of the stores financed by that lender.

 

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Vehicles financed by lenders not directly associated with the manufacturer are classified as floorplan notes payable: non-trade and are included as a financing activity in our statements of cash flows. Vehicles financed by lenders directly associated with the manufacturer are classified as floorplan notes payable and are included as an operating activity.

To improve the visibility of cash flows related to vehicle financing, which is a core part of our business, the non-GAAP financial measures below demonstrate cash flows assuming all floorplan notes payable are included as an operating activity. We believe that this non-GAAP financial measure improves the transparency of our disclosure, by providing period-to-period comparability of our results from core business operations.

 

      Three Months Ended March 31,  
(In thousands)    2010     2009  

As Reported

    

Cash flow from (used in) operations

   $ (10,449   $ 15,726   

Change in flooring notes payable: non-trade

     20,615        (16,111
                

Adjusted

   $ 10,166      $ (385
                

As Reported

    

Cash flow from (used in) financing

   $ 7,318      $ (25,644

Change in flooring notes payable: non-trade

     (20,615     16,111   
                

Adjusted

   $ (13,297   $ (9,533
                

Inventories and Flooring Notes Payable

Our days supply of new vehicles at March 31, 2010 was two days below our historical March 31 balances and eight days below our December 31, 2009 levels. The decrease compared to December 31, 2009 was a result of increased sales, as well as a more disciplined approach to stocking inventories. Our new vehicle floorplan notes payable increased to $236.9 million at March 31, 2010 from $210.5 million at December 31, 2009. New vehicles are financed at approximately 100% of invoice cost.

Our days supply of used vehicles at March 31, 2010 was seven days below our historical March 31 balances and seven days below our December 31, 2009 balances. We continue to focus on stocking more higher-mileage, lower-cost vehicles to match consumer preference and to provide opportunities for incremental sales. Despite this focus, we seek to reduce the amount of used vehicle inventory on hand to improve turns and to prevent aging. We believe our current used vehicle inventory levels are appropriate given our projected sales volumes and the shift in consumer demand away from new vehicles.

Share Repurchases and Dividends

On April 29, 2010, our Board of Directors declared a dividend of $0.05 per share on our Class A and Class B common stock, related to the first quarter of 2010 which totaled approximately $1.3 million and will be paid on May 28, 2010. Management evaluates performance and makes a recommendation on dividend payments on a quarterly basis.

In June 2000, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our Class A common stock. Through March 31, 2010, we have purchased a total of 479,731 shares under this program, none of which were purchased during 2010. We may continue to repurchase shares from time to time in the future, if permitted by our credit facilities, and as conditions warrant.

 

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Table of Contents

Capital Commitments

We had no capital commitments at March 31, 2010. We have approximately $3.1 million in capital expenditures in consideration for various remodeling projects and equipment upgrades over the next one to three years. These projects are still in the planning state or are awaiting approval from manufacturers. We will continue to evaluate the advisability of the expenditures given the current economic environment and anticipate a prudent approach to future capital commitments.

In the event we undertake a significant capital commitment in the future, we expect to pay for the construction out of existing cash balances, construction financing and borrowings on our line of credit. Upon completion of the projects, we would anticipate securing 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 anticipate approximately $0.6 million in non-financeable capital expenditures in the next one to three years for various facilities and other construction projects currently under consideration. Non-financeable capital expenditures are defined as minor upgrades to existing facilities, minor leasehold improvements, the percentage of major construction typically not financed by commercial mortgage debt, and purchases of furniture and equipment. We will continue to evaluate the advisability of the expenditures given the current weak economic environment, and anticipate a prudent approach to future capital commitments.

Critical Accounting Policies and Use of Estimates

In the first quarter of 2010, we modified our employee medical insurance plan coverage. Effective with the plan year starting January 1, 2010, we changed employee coverage from a fully insured plan to a self-insured plan, except for a population of employees in select California dealerships that remains on a fully insured plan. We carry specific stop-loss coverage insurance in the event a large claim is made under the plan. We estimate the cost to provide medical benefits for existing claims, including claims incurred but not reported, based primarily on an analysis of our historical claims experience, the design of the plan and expectations of medical cost growth factors. We monitor actual claims activity and related costs on a regular basis and evaluate their impact on our assumptions. Actual claims experience may deviate from historical experience, which could cause our estimated liability to either be over or under accrued. Any changes to assumptions, including actual claims experience and medical cost factors, could result in the recognition of additional charges, which could have a material adverse impact on our financial position and results of operations.

At March 31, 2010 the self-insured medical plan reserve, net of payments made in the period, totaled $1.7 million, and was included in accrued liabilities on our Consolidated Balance Sheets. A 10% increase in claims experience would result in additional self-insured medical reserves of $0.2 million at March 31, 2010.

With the addition of the above, we reaffirm our critical accounting policies and use of estimates as described in our 2009 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 3, 2010.

 

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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 2009 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 3, 2010.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and 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

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

We intend to vigorously defend all outstanding matters, and to assert available defenses. We cannot make an estimate of the likelihood of negative judgment in any of the outstanding cases at this time. The ultimate resolution of the outstanding cases is not reasonably expected to have a material adverse impact on our results of operations, financial condition or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our results of operations, financial condition or cash flows. See Note 4 of Condensed Notes to Consolidated Financial Statements.

Item 1A. Risk Factors

Our Annual Report on Form 10-K for the year ended December 31, 2009 includes a detailed discussion of our risk factors. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K. Accordingly, the information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the Securities and Exchange Commission on March 3, 2010.

 

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Item 6. Exhibits

The following exhibits are filed herewith and this list is intended to constitute the exhibit index:

 

3.1    Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999 (filed as Exhibit 3.1 to Form 10-K filed March 30, 2000 and incorporated herein by reference).
3.2    Amended and Restated Bylaws of Lithia Motors, Inc. - Corrected (filed as Exhibit 3.2 to Form 10-K filed March 16, 2009 and incorporated herein by reference).
10.1    Lithia Motors, Inc. Amended and Restated 2003 Stock Incentive 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.

 

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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 30, 2010     LITHIA MOTORS, INC.  
  By  

/s/ Sidney B. DeBoer

 
    Sidney B. DeBoer  
    Chairman of the Board and  
    Chief Executive Officer  
    (Principal Executive Officer)  
  By  

/s/ Jeffrey B. DeBoer

 
    Jeffrey B. DeBoer  
    Senior Vice President and  
    Chief Financial Officer  
    (Principal Financial and Accounting Officer)  

 

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