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 June 30, 2006

OR

o  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)

 

 

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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer o   Accelerated filer x   Non-accelerated filer o

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

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

 

LITHIA MOTORS, INC.

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Balance Sheets (Unaudited) — June 30, 2006 and December 31, 2005
		Consolidated Statements of Operations (Unaudited) — Three and Six Months Ended June 30, 2006 and 2005
		Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended June 30, 2006 and 2005
		Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
PART II - OTHER INFORMATION
Item 1.		Legal Proceedings
Item 4.		Submission of Matters to a Vote of Security Holders
Item 6.		Exhibits
Signatures

 

1

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

		June 30,			December 31,
		2006			2005
		(Unaudited)
Assets
Current Assets:
Cash and cash equivalents		$	23,435		$	48,566
Contracts in transit		52,599			52,453
Trade receivables, net of allowance for doubtful accounts of $407 and $406		61,313			53,990
Inventories, net		881,990			606,047
Vehicles leased to others, current portion		7,028			6,296
Prepaid expenses and other		6,029			8,800
Deferred income taxes		—			685
Assets held for sale		—			27,411
Total Current Assets		1,032,394			804,248
Land and buildings, net of accumulated depreciation of $13,562 and $11,358		282,032			255,372
Equipment and other, net of accumulated depreciation of $35,815 and $31,622		84,008			77,805
Goodwill		276,731			260,899
Other intangible assets, net of accumulated amortization of $107 and $89		57,210			50,247
Other non-current assets		7,614			4,143
Total Assets		$	1,739,989		$	1,452,714
Liabilities and Stockholders’ Equity
Current Liabilities:
Floorplan notes payable		$	695,937		$	476,322
Floorplan notes payable: non-trade		67,144			54,130
Current maturities of long-term debt		7,587			6,868
Trade payables		33,898			30,917
Accrued liabilities		65,431			57,775
Deferred income taxes		481			—
Liabilities held for sale		—			22,388
Total Current Liabilities		870,478			648,400
Used vehicle flooring facility		18,000			—
Real estate debt, less current maturities		168,508			154,046
Other long-term debt, less current maturities		142,609			136,505
Other long-term liabilities		11,272			10,440
Deferred income taxes		46,471			43,690
Total Liabilities		1,257,338			993,081
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 15,855 and 15,629		227,797			224,775
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		4,226			2,559
Unearned compensation		—			(1,132		)
Accumulated other comprehensive income		4,223			3,316
Retained earnings		245,937			229,647
Total Stockholders’ Equity		482,651			459,633
Total Liabilities and Stockholders’ Equity		$	1,739,989		$	1,452,714

 

The accompanying notes are an integral part of these condensed consolidated balance sheets.

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LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except  per share amounts)

(Unaudited)

		Three months ended June 30,						Six months ended June 30,
		2006			2005			2006			2005
Revenues:
New vehicle sales		$	496,121		$	438,375		$	923,871		$	797,994
Used vehicle sales		230,909			200,769			439,987			398,091
Finance and insurance		32,776			27,204			60,330			51,820
Service, body and parts		85,736			75,417			168,209			149,682
Fleet and other		939			9,064			2,269			12,168
Total revenues		846,481			750,829			1,594,666			1,409,755
Cost of sales		702,256			623,584			1,319,660			1,165,278
Gross profit		144,225			127,245			275,006			244,477
Selling, general and administrative		107,536			93,323			208,253			182,455
Depreciation - buildings		1,114			886			2,204			1,714
Depreciation and amortization - other		3,098			2,520			6,054			5,080
Income from operations		32,477			30,516			58,495			55,228
Other income (expense):
Floorplan interest expense		(8,931		)	(6,000		)	(15,546		)	(11,102		)
Other interest expense		(3,641		)	(3,036		)	(6,972		)	(5,841		)
Other income, net		315			247			742			532
		(12,257		)	(8,789		)	(21,776		)	(16,411		)
Income from continuing operations before income taxes		20,220			21,727			36,719			38,817
Income taxes		(8,503		)	(8,622		)	(14,373		)	(15,236		)
Income before discontinued operations		11,717			13,105			22,346			23,581
Loss from discontinued operations, net of income tax benefit of $153, $285, $882 and $592		(50		)	(430		)	(1,371		)	(916		)
Net income		$	11,667		$	12,675		$	20,975		$	22,665
Basic income per share from continuing operations		$	0.60		$	0.68		$	1.15		$	1.24
Basic loss per share from discontinued operations		—			(0.02		)	(0.07		)	(0.05		)
Basic net income per share		$	0.60		$	0.66		$	1.08		$	1.19
Shares used in basic per share calculations		19,501			19,142			19,464			19,085
Diluted income per share from continuing operations		$	0.55		$	0.62		$	1.05		$	1.13
Diluted loss per share from discontinued operations		—			(0.02		)	(0.06		)	(0.04		)
Diluted net income per share		$	0.55		$	0.60		$	0.99		$	1.09
Shares used in diluted per share calculations		22,150			21,749			22,109			21,710

 

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

3

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LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

		Six months ended June 30,
		2006			2005
Cash flows from operating activities:
Net income		$	20,975		$	22,665
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation and amortization		8,258			6,794
Depreciation and amortization of discontinued operations		—			155
Stock-based compensation		1,692			278
Loss on sale of assets		85			224
Gain on sale of franchise		—			(44		)
Deferred income taxes		3,771			1,527
Excess tax benefits from share-based payment arrangements		(366		)	—
(Increase) decrease, net of effect of acquisitions:
Trade and installment contract receivables, net		(7,188		)	(10,191		)
Contracts in transit		(146		)	(11,745		)
Inventories		(250,019		)	(103,862		)
Vehicles leased to others		(1,341		)	(498		)
Prepaid expenses and other		527			1,996
Other non-current assets		323			745
Increase (decrease), net of effect of acquisitions:
Floorplan notes payable		197,517			85,638
Trade payables		2,943			3,267
Accrued liabilities		7,348			5,593
Other long-term liabilities and deferred revenue		782			49
Net cash provided by (used in) operating activities		(14,839		)	2,591
Cash flows from investing activities:
Capital expenditures:
Non-financeable		(8,962		)	(12,769		)
Financeable		(23,175		)	(13,797		)
Proceeds from sale of assets		302			258
Cash paid for acquisitions, net of cash acquired		(28,015		)	(26,007		)
Proceeds from sale of dealerships		3,926			6,577
Net cash used in investing activities		(55,924		)	(45,738		)
Cash flows from financing activities:
Floorplan notes payable: non-trade		13,014			3,629
Net borrowings (repayments) on lines of credit		18,000			29,314
Principal payments on long-term debt and capital leases		(4,548		)	(3,757		)
Proceeds from issuance of long-term debt		19,723			13,334
Repurchase of common stock		—			(9		)
Proceeds from issuance of common stock		3,768			4,322
Excess tax benefits from share-based payment arrangements		366			—
Dividends paid		(4,691		)	(3,064		)
Net cash provided by financing activities		45,632			43,769
Increase (decrease) in cash and cash equivalents		(25,131		)	622
Cash and cash equivalents:
Beginning of period		48,566			28,869
End of period		$	23,435		$	29,491
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	22,081		$	17,253
Cash paid during the period for income taxes		7,029			6,207
Supplemental schedule of non-cash investing and financing activities:
Debt issued in connection with acquisitions		$	6,111		$	—
Flooring debt assumed in connection with acquisitions		25,857			23,352
Flooring debt paid by purchaser in connection with dealership disposals		4,713			—

 

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

4

LITHIA MOTORS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The financial information included herein as of June 30, 2006 and for the three and six-month periods ended June 30, 2006 and 2005 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2005 is derived from our 2005 Annual Report on Form 10-K. The interim condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in our 2005 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note 2. Inventories

Inventories are valued at the lower of market value or cost, using the specific identification method for vehicles and 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):

 

Note 3. Earnings Per Share

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

Three Months Ended June 30,		2006								2005
		Income from Continuing Operations			Shares		Per Share Amount			Income from Continuing Operations			Shares		Per Share Amount
Basic EPS
Income from continuing operations available to common stockholders		$	11,717		19,501		$	0.60		$	13,105		19,142		$	0.68
Effect of Dilutive Securities
2 7/8% convertible senior subordinated notes		438			2,255		(0.04		)	459			2,255		(0.05		)
Stock options and unvested restricted stock		—			394		(0.01		)	—			352		(0.01		)
Diluted EPS
Income from continuing operations available to common stockholders		$	12,155		22,150		$	0.55		$	13,564		21,749		$	0.62
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive					—								392

 

5

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Six Months Ended June 30,		2006								2005
		Income from Continuing Operations			Shares		Per Share Amount			Income from Continuing Operations			Shares		Per Share Amount
Basic EPS
Income from continuing operations available to common stockholders		$	22,346		19,464		$	1.15		$	23,581		19,085		$	1.24
Effect of Dilutive Securities
2 7/8% convertible senior subordinated notes		931			2,255		(0.08		)	927			2,255		(0.08		)
Stock options and unvested restricted stock		—			390		(0.02		)	—			370		(0.03		)
Diluted EPS
Income from continuing operations available to common stockholders		$	23,277		22,109		$	1.05		$	24,508		21,710		$	1.13
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive					—								392

 

Note 4.  Comprehensive Income

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

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net income		$	11,667		$	12,675		$	20,975		$	22,665
Cash flow hedges:
Net derivative gains (losses), net of tax effect of $(398), $869, $(944) and $(201), respectively		646			(1,363		)	1,560			334
Reversal of net derivative (gains) losses previously recorded due to their recognition in our statements of operations as a component of interest expense, net of tax effect of $234, $(148), $401 and $(367), respectively		(381		)	220			(653		)	567
Total comprehensive income		$	11,932		$	11,532		$	21,882		$	23,566

 

Note 5.  Acquisitions

The following acquisitions were made in the first six months of 2006:

·                  In April 2006, we acquired the Fresno Dodge store in Fresno, California. The store has anticipated annualized revenues of $50 million. The store was renamed Lithia Dodge of Fresno.

·                  In May 2006, we acquired the Latham Motors store in Twin Falls, Idaho. The store has anticipated annualized revenues of $25 million. The store was renamed Lithia Chrysler Jeep Dodge of Twin Falls.

·                  In June 2006, we acquired the TradeMark Chrysler Jeep Dodge store in Bryan — College Station, Texas. The store has anticipated annualized revenues of $60 million. The store was renamed Lithia Chrysler Jeep Dodge of Bryan College Station.

·                  In June 2006, we acquired the Eversole Motors store in La Crosse, Wisconsin. The store has anticipated annualized revenues of $25 million. The store was renamed Lithia Chrysler Jeep Dodge of La Crosse.

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The above acquisitions were all accounted for under the purchase method of accounting. Pro forma results of operations, assuming all of the above acquisitions and the previously disclosed 2005 acquisitions occurred as of January 1, 2005, were as follows (in thousands, except per share amounts).

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Total revenues		$	867,904		$	825,632		$	1,651,456		$	1,562,101
Net income		11,935			13,279			21,312			23,683
Basic earnings per share		0.61			0.69			1.09			1.24
Diluted earnings per share		0.56			0.63			1.01			1.13

 

There are no future contingent payouts related to any of the 2006 acquisitions and no portion of the purchase price was paid with our equity securities. During the first two quarters of 2006, we acquired the four stores discussed above for $28.0 million in cash, which included $15.0 million of goodwill and $7.0 million of other intangible assets.

Within one year from the purchase date, we may update the value allocated to purchased assets and the resulting goodwill balances based on pending information received regarding the valuation of such assets.  All of the goodwill from the above acquisitions is expected to be deductible for tax purposes.

Note 6.  Dividend Payments

Cash dividends at the rate of $0.12 per common share, which totaled approximately $2.3 million and $2.4 million were paid on March 6, 2006 and May 5, 2006, respectively.

Note 7.  Stock-Based Compensation

Adoption of SFAS No. 123R

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” which establishes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS No. 123R, stock-based compensation cost for equity classified awards is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity award). Prior to January 1, 2006, we accounted for share-based compensation to employees in accordance with Accounting Principles Board Option No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and related interpretations. We also followed the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.”

We have elected to adopt the modified prospective transition method as provided by SFAS No. 123R and, accordingly, financial statement amounts for the prior periods presented in this Form 10-Q have not been restated to reflect the fair value method of expensing stock-based compensation.  Under this method, the provisions of SFAS No. 123R apply to all awards granted or modified after the date of adoption, as well as to the unrecognized expense of awards not yet vested at the date of adoption. Such expense will be recognized as compensation expense in the periods after the date of adoption using the Black-Scholes valuation method over the remainder of the requisite service period. Our unearned compensation balance of $1.1 million as of December 31, 2005, which was accounted for under APB 25, was reclassified into our Class A common stock upon the adoptions of SFAS No. 123R. The cumulative effect of the change in accounting principle from APB 25 to SFAS No. 123R was not material.

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Disclosure of net income and earnings per share as if the method prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation,” had been applied in measuring compensation expense in prior periods was as follows (in thousands, except per share amounts):

		Three Months Ended June 30, 2005			Six Months Ended June 30, 2005
Net income, as reported		$	12,675		$	22,665
Add – Stock-based employee compensation expense included in reported net income, net of related tax effects		123			169
Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(781		)	(1,503		)
Net income, pro forma		$	12,017		$	21,331
Basic net income per share:
As reported		$	0.66		$	1.19
Pro forma		$	0.63		$	1.12
Diluted net income per share:
As reported		$	0.60		$	1.09
Pro forma		$	0.57		$	1.02

 

2003 Stock Incentive Plan

Our 2003 Stock Incentive Plan (the “2003 Plan”) allows for the granting of up to a total of 2.2 million nonqualified stock options and shares of restricted stock to our officers, key employees and consultants. We also have options outstanding and exercisable pursuant to their original terms pursuant to prior plans. Options canceled under prior plans do not return to the pool of options to be granted again in the future. All of our option plans are administered by the Compensation Committee of the Board and permit accelerated vesting of outstanding options upon the occurrence of certain changes in control. Options become exercisable over a period of up to five years from the date of grant with expiration dates up to ten years from the date of grant and at exercise prices as determined by the Board.  Beginning in 2004, the expiration date of options granted was reduced to six years. At June 30, 2006, 2,423,872 shares of Class A common stock were reserved for issuance under the plans, of which 1,171,444 were available for future grant.

Activity under the above plan was as follows:

 

 

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Certain information regarding options outstanding as of June 30, 2006 was as follows:

 

As of June 30, 2006, unrecognized stock-based compensation related to outstanding, but unvested stock option and stock awards was $5.9 million, which will be recognized over the weighted average remaining vesting period of 2.5 years.

1998 Employee Stock Purchase Plan

In 1998, the Board of Directors and the stockholders approved the implementation of an Employee Stock Purchase Plan (the “Purchase Plan”), and, as amended in May 2006, have reserved a total of 2.45 million shares of Class A common stock for issuance thereunder. The Purchase Plan expires December 31, 2012. The Purchase Plan is intended to qualify as an “Employee Stock Purchase Plan” under Section 423 of the Internal Revenue Code of 1986, as amended, and is administered by the Compensation Committee of the Board. Eligible employees are entitled to defer up to 10% of their base pay for the purchase of stock up to $25,000 of fair market value of our Class A common stock annually. Prior to April 1, 2005, the purchase price for shares purchased under the Purchase Plan was 85% of the lesser of the fair market value at the beginning or end of the purchase period.  Beginning April 1, 2005, the purchase price is equal to 85% of the fair market value at the end of the purchase period. During the first six months of 2006, a total of 101,119 shares were purchased under the Purchase Plan at a weighted average price of $28.16 per share, which represented a weighted average discount from the fair market value of $4.95 per share. As of June 30, 2006, 883,341 shares remained available for purchase under the Purchase Plan.

Stock-Based Compensation

We estimate the fair value of stock options using the Black-Scholes valuation model. This valuation model takes into account the exercise price of the award, as well as a variety of significant assumptions. We believe that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

Beginning April 1, 2005, compensation expense related to our Purchase Plan is calculated based on the 15% discount from the per share market price on the date of grant. Prior to April 1, 2005, it was calculated using the Black-Scholes valuation model. Compensation expense related to non-vested stock is based on the intrinsic value on the date of grant as if the stock is vested. Compensation expense related to nonqualified stock options was valued using the Black-Scholes valuation model with following assumptions:

 

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(1)          There are no values for the employee stock purchase plan for 2006 since there is no longer a look-back period and the related compensation cost is equal to the intrinsic value of the 15% discount on the day of purchase.

(2)          The risk-free interest rate for each grant is based on the U.S. Treasury yield curve in effect at the time of grant for a period equal to the expected term of the stock option.

(3)          The dividend yield is calculated as a ratio of annualized expected dividend per share to the market value of our common stock on the date of grant.

(4)          The expected term is calculated based on the observed and expected time to post-vesting exercise behavior of separate identifiable employee groups.

(5)          The expected volatility is estimated based on a weighted average of historical volatility of our common stock.

We amortize stock-based compensation on a straight-line basis over the vesting period of the individual award with estimated forfeitures considered. Shares to be issued upon the exercise of stock options will come from newly issued shares.

Certain information regarding our stock-based compensation was as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Weighted average grant-date per share fair value of share options granted		$	—		$	—		$	10.93		$	10.69
Per share intrinsic value of non-vested stock granted		32.50			26.85			31.73			27.54
Weighted average per share discount for compensation expense recognized under the Purchase Plan		4.52			4.31			4.84			4.84
Total intrinsic value of share options exercised		127,000			114,000			1.0 million			1.2 million
Fair value of non-vested shares that vested during the period		142,000			86,000			142,000			86,000
Stock-based compensation recognized in results of operations (all as a component of selling, general and administrative expense)		1.0 million			203,000			1.7 million			278,000
Tax benefit recognized in statement of operations		179,000			80,000			253,000			109,000
Cash received from options exercised and shares purchased under all share-based arrangements		1.7 million			1.7 million			3.8 million			4.3 million
Tax deduction realized related to stock options exercised		105,000			67,000			420,000			362,000

 

Prior to the adoption of SFAS No. 123R, excess tax benefits realized upon the exercise of stock options were classified as an operating cash flow.  SFAS No. 123R requires that these excess tax benefits be reclassified in the statements of cash flows as a cash flow from financing activities.  For the three and six-month periods ended June 30, 2006, the amount of excess tax benefits that were shown as a financing activity was $51,000 and $366,000, respectively.

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The following reconciles what certain operating results would have been without the effects of applying SFAS No. 123R in the three and six-month periods ended June 30, 2006 (in thousands, except per share amounts):

		Three Months Ended June 30, 2006						Six Months Ended June 30, 2006
		As Reported			Pro Forma without effects of applying SFAS No. 123R			As Reported			Pro Forma without effects of applying SFAS No. 123R
Income from continuing operations before income taxes		$	20,220		$	21,109		$	36,719		$	38,171
Net income		11,667			12,434			20,975			22,292
Cash flow from operating activities		n/a			n/a			(14,839		)	(14,473		)
Cash flow from financing activities		n/a			n/a			45,632			45,266
Basic earnings per share		0.60			0.64			1.08			1.15
Diluted earnings per share		0.55			0.58			0.99			1.05

 

Note 8.  Discontinued Operations

We continually monitor the performance of each of our dealerships and make determinations to sell based primarily on return on capital criteria.  When a dealership meets the criteria of “held for sale,” as defined in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the results of operations are reclassified into discontinued operations. All dealerships included in discontinued operations have been, or will be, eliminated from our on-going operations upon completion of the sale. We anticipate the completion of the sale for each dealership to occur within 12 months from the date of determination.

During the first six months of 2006, we disposed of two of our dealerships that were held for sale at December 31, 2005 and, at June 30, 2006, no dealerships remained available for sale. Certain financial information related to discontinued operations was as follows (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Revenue		$	2,642		$	12,235		$	11,248		$	27,920
Pre-tax loss		(203		)	(715		)	(2,253		)	(1,544		)
Gain on disposal of discontinued operations, net of tax		—			—			—			36
Amount of goodwill and other intangible assets disposed of		1,606			4,406			3,552			4,406

 

The pre-tax loss in the six months ended June 30, 2006 included legal settlements related to dealerships in California that were sold in prior years.

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 used vehicle line of credit is allocated based on total used vehicle inventory of the store, and interest expense related to our equipment line of credit is allocated based on the amount of fixed assets.

Assets held for sale included the following (in thousands):

 

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Liabilities held for sale of $22.4 million at December 31, 2005 represented new vehicle flooring notes payable related to the dealerships held for sale.

 

Note 9. New Accounting Pronouncements

FASB Interpretation No. 48

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, which is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” Interpretation No. 48 applies to all tax positions accounted for under SFAS No. 109. The interpretation applies to situations where the uncertainty is to the timing of the deduction, the amount of the deduction, or the validity of the deduction. Interpretation No. 48 is effective as of the beginning of the first fiscal year beginning after December 15, 2006 (January 1, 2007 for calendar-year companies).  At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date.  Positions that meet this criterion should be measured using the largest benefit that is more than 50 percent likely to be realized. The necessary adjustment should be recorded directly to the beginning balance of retained earnings in the period of adoption and reported as a change in accounting principle.  Retrospective application is prohibited. The impact of adopting Interpretation No. 48 on the financial statements is not fully known or estimable, however, it is expected to have no effect on results of operations or cash flow.

EITF Issue No. 06-3

Emerging Issues Task Force (“EITF”) Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation),” requires us to disclose our accounting policy for any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction (i.e., sales, use, value added) on a gross (included in revenues and costs) or net (excluded from revenues) basis. EITF Issue 06-3 is effective for periods beginning after December 15, 2005, with earlier application permitted.  We account for such taxes on a net basis.

SFAS No. 156

In March 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140.” SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” with respect to accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for fiscal years that begin after September 15, 2006, with early adoption permitted as of the beginning of an entity’s fiscal year. We do not have any servicing assets or servicing liabilities and, accordingly, the adoption of SFAS No. 156 will not have any effect on our results of operations, financial condition or cash flows.

SFAS No. 155

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No 133 and 140.” SFAS No. 155 resolves implementation issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS No. 155 is effective for fiscal years that begin after September 15, 2006, with early adoption permitted as of the beginning of an entity’s fiscal year. We do not have any beneficial interests in securitized financial assets and, accordingly, the adoption of SFAS No. 155 will not have any effect on our results of operations, financial condition or cash flows.

EITF 04-13

In September 2005, the Emerging Issues Task Force (“EITF”) issued EITF 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty,” which clarifies accounting when two or more inventory purchase and sales transactions with the same counterparty should be viewed as a single exchange transaction, subject to Accounting Principles Board Issue No. 29, “Accounting for

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Non-Monetary Transactions.” EITF 04-13 is required for interim or annual reporting periods beginning after March 15, 2006. Accordingly, we adopted EITF 04-13 effective April 1, 2006. The adoption of EITF 04-3 did not have a significant impact on our results of operations, financial condition or cash flows.

Note 10. Reclassifications

Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation.

Note 11.  Subsequent Events

Acquisition

In August 2006, we acquired the Ukiah Dodge Chrysler Jeep store in Ukiah, California. The store has anticipated annualized revenues of $10 million. The store was renamed Lithia Chrysler Jeep Dodge of Ukiah.

Dividend

In July 2006, we announced a dividend on our Class A and Class B common stock of $0.14 per share for the second quarter of 2006. The dividend, which totaled approximately $2.8 million, was paid on August 4, 2006 to shareholders of record on July 21, 2006. The $0.14 dividend represents a 17% increase over the $0.12 dividend paid in each of the prior four quarters.

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

Forward Looking Statements and Risk Factors

Some of the statements in this Form 10-Q constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Item 1A to our 2005 Form 10-K, which was filed with the Securities and Exchange Commission on March 8, 2006. These risk factors have not significantly changed since the filing of the 2005 Form 10-K.

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

Overview

We are a leading operator of automotive franchises and retailer of new and used vehicles and services.  As of August 7, 2006, we offered 25 brands of new vehicles in 97 stores in the Western United States and over the Internet. As of August 7, 2006, we operated 16 stores in Oregon, 14 in Texas, 13 in California, 12 in Washington, 8 in Idaho, 7 in Colorado, 7 in Alaska, 7 in Montana, 6 in Nevada, 3 in Nebraska, 2 in South Dakota, 1 in New Mexico and 1 in Wisconsin. We sell new and used cars and light trucks; sell replacement parts; provide vehicle maintenance, warranty, paint and repair services; and arrange related financing, service contracts, protection products and credit insurance for our automotive customers.

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We currently achieve gross profit margins above industry averages by selling a higher ratio of retail used vehicles to new vehicles and by arranging finance and extended warranty contracts for a greater percentage of our customers.

Our acquisition model is focused on acquiring average performing new vehicle franchised stores and then integrating and improving them. Our goal is to maximize the operations of all four departments of every store we acquire. We have had success with this strategy since our initial public offering in 1996. While our strategy has not changed since 1996, our ability to integrate and improve the stores that we acquire has increased dramatically. We have also developed a better process for identifying acquisition targets that fit our operating model. Our cash position, substantial lines of credit, plus an experienced and well-trained staff are all available to facilitate our continued growth as the opportunities develop.

In keeping with this model, we acquired four stores in the first six months of 2006 with total estimated annual revenues of approximately $160 million and have a number of acquisitions expected to close during the remainder of 2006.

Although manufacturer incentives have been lower in 2006 than in the comparable 2005 periods, we expect that manufacturers will continue to offer incentives on new vehicle sales during the remainder of 2006 through a combination of repricing strategies, rebates, lease programs, early lease cancellation programs and low interest rate loans to consumers. To complement the manufacturers’ incentive strategy, we employ a volume-based strategy for our new vehicle sales.

We are currently working on several initiatives that we expect will improve our operations in future periods. Such initiatives include the following:

·                  our Customer Centric Sales Process, which will help us leverage the benefits of our Lithia Store Management System (“LSMS”) that allows us to track advertising and increase the productivity of the sales staff by providing daily work plans and focused training. Under this program, our showrooms will have interactive personal computers, which will allow the salesperson to quickly and efficiently enter data and interact with the customer to speed up the sales process. We rolled out this program in all of our California stores during May and June 2006, with positive results;

·                  our Finance and Insurance (“F&I”) Certification Program for our F&I managers;

·                  improving the functionality of our centralized inventory control process;

·                  our Internet initiative, which involves developing a centralized department that will be staffed 24 hours a day, seven days a week with brand specialists capable of communicating with customers by phone or live chat;

·                  IT initiatives related to automating our offices, centralizing certain office functions and establishing independent used vehicle operations; and

·                  our Assured Used Vehicle buying program and our independent used vehicle strategy. We began our Assured Used Vehicle buying program in the Tri-Cities, Abilene and Reno markets during the second quarter of 2006, with positive results. We expect to have our first independent used vehicle outlet operating by late spring or early summer 2007.

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Results of Continuing Operations

Certain revenue, gross profit margin and gross profit information by product line was as follows:

Three Months Ended June 30, 2006		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		58.6	%	7.3	%	25.1	%
Used vehicle(1)		27.3		13.7		22.0
Finance and insurance(2)		3.9		100.0		22.7
Service, body and parts		10.1		50.3		29.9
Fleet and other.		0.1		45.4		0.3

 

Three Months Ended June 30, 2005		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		58.4	%	7.9	%	27.2	%
Used vehicle(1)		26.8		13.8		21.9
Finance and insurance(2)		3.6		100.0		21.4
Service, body and parts		10.0		49.3		29.2
Fleet and other.		1.2		4.7		0.3

 

Six Months Ended June 30, 2006		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		57.9	%	7.6	%	25.5	%
Used vehicle(1)		27.7		13.7		22.0
Finance and insurance(2)		3.8		100.0		21.9
Service, body and parts		10.5		49.6		30.3
Fleet and other.		0.1		37.4		0.3

 

Six Months Ended June 30, 2005		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		56.6	%	8.0	%	26.2	%
Used vehicle(1)		28.2		13.7		22.3
Finance and insurance(2)		3.7		100.0		21.2
Service, body and parts		10.6		49.0		30.0
Fleet and other.		0.9		6.5		0.3

 

(1)          Includes retail and wholesale used vehicles.

(2)          Reported net of anticipated cancellations.

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

		Three Months Ended June 30,				Six Months Ended June 30,
		2006(1)		2005(1)		2006(1)		2005(1)
Revenues:
New vehicle		58.6	%	58.4	%	57.9	%	56.6	%
Used vehicle		27.3		26.8		27.7		28.2
Finance and insurance		3.9		3.6		3.8		3.7
Service, body and parts		10.1		10.0		10.5		10.6
Fleet and other		0.1		1.2		0.1		0.9
Total revenues		100.0	%	100.0	%	100.0	%	100.0	%
Gross profit		17.0		16.9		17.2		17.3
Selling, general and administrative expenses		12.7		12.4		13.1		12.9
Depreciation and amortization		0.5		0.4		0.5		0.5
Income from operations		3.8		4.1		3.7		3.9
Floorplan interest expense		1.1		0.8		1.0		0.8
Other interest expense		0.4		0.4		0.4		0.4
Other income, net		0.0		0.0		0.0		0.0
Income from continuing operations before taxes		2.4		2.9		2.3		2.8
Income tax expense		1.0		1.1		0.9		1.1
Income from continuing operations		1.4	%	1.7	%	1.4	%	1.7	%

 

(1) The percentages may not add due to rounding.

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The following tables set forth the changes in our operating results from continuing operations in the three and six-month periods ended June 30, 2006 compared to the three and six-month periods ended June 30, 2005:

		Three Months Ended June 30,									%
(Dollars in thousands)		2006			2005			Increase			Increase
								(Decrease)			(Decrease)
Revenues:
New vehicle		$	496,121		$	438,375		$	57,746		13.2	%
Used vehicle		230,909			200,769			30,140			15.0
Finance and insurance		32,776			27,204			5,572			20.5
Service, body and parts		85,736			75,417			10,319			13.7
Fleet and other		939			9,064			(8,125		)	(89.6	)
Total revenues		846,481			750,829			95,652			12.7
Cost of sales		702,256			623,584			78,672			12.6
Gross profit		144,225			127,245			16,980			13.3
Selling, general and administrative		107,536			93,323			14,213			15.2
Depreciation and amortization		4,212			3,406			806			23.7
Income from operations		32,477			30,516			1,961			6.4
Floorplan interest expense		(8,931		)	(6,000		)	2,931			48.9
Other interest expense		(3,641		)	(3,036		)	605			19.9
Other income, net		315			247			68			27.5
Income from continuing operations before taxes		20,220			21,727			(1,507		)	(6.9	)
Income tax expense		8,503			8,622			(119		)	(1.4	)
Income from continuing operations		$	11,717		$	13,105		$	(1,388	)	(10.6	)%

 

		Three Months Ended June 30,						Increase			% Increase
		2006			2005			(Decrease)			(Decrease)
New units sold		18,276			15,601			2,675			17.1	%
Average selling price per new vehicle		$	27,146		$	28,099		$	(953	)	(3.4	)
Used units sold		18,178			16,304			1,874			11.5
Average selling price per used vehicle		$	12,703		$	12,314		$	389		3.2
Finance and insurance sales per retail unit		$	1,088		$	1,038		$	50		4.8

 

		Six Months Ended June 30,						Increase			% Increase
(Dollars in thousands)		2006			2005			(Decrease)			(Decrease)
Revenues:
New vehicle		$	923,871		$	797,994		$	125,877		15.8	%
Used vehicle		439,987			398,091			41,896			10.5
Finance and insurance		60,330			51,820			8,510			16.4
Service, body and parts		168,209			149,682			18,527			12.4
Fleet and other		2,269			12,168			(9,899		)	(81.4	)
Total revenues		1,594,666			1,409,755			184,911			13.1
Cost of sales		1,319,660			1,165,278			154,382			13.2
Gross profit		275,006			244,477			30,529			12.5
Selling, general and administrative		208,253			182,455			25,798			14.1
Depreciation and amortization		8,258			6,794			1,464			21.5
Income from operations		58,495			55,228			3,267			5.9
Floorplan interest expense		(15,546		)	(11,102		)	4,444			40.0
Other interest expense		(6,972		)	(5,841		)	1,131			19.4
Other income, net		742			532			210			39.5
Income from continuing operations before taxes		36,719			38,817			(2,098		)	(5.4	)
Income tax expense		14,373			15,236			(863		)	(5.7	)
Income from continuing operations		$	22,346		$	23,581		$	(1,235	)	(5.2	)%

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		Six Months Ended June 30,						Increase			% Increase
		2006			2005			(Decrease)			(Decrease)
New units sold		33,517			28,465			5,052			17.7	%
Average selling price per new vehicle		$	27,564		$	28,034		$	(470	)	(1.7	)
Used units sold		34,469			32,668			1,801			5.5
Average selling price per used vehicle		$	12,765		$	12,186		$	579		4.7
Finance and insurance sales per retail unit		$	1,075		$	1,039		$	36		3.5

Revenues

Total revenues increased 12.7% and 13.1%, respectively, in the three and six-month periods ended June 30, 2006 compared to the same periods of 2005, as a result of acquisitions, as well as a 7.6% and a 7.4% increase, respectively, in same-store sales, excluding fleet. We believe that our strong operating systems, integrated store network and regional market focus contributed to our same-store sales increases, especially in the new vehicle sales. During the first six months of 2006, we focused on new vehicle sales to gain market share and create long-term parts and services business, which resulted in a 6.6% and an 8.8% increase, respectively, in same-store new vehicle retail sales in the three and six-month periods ended June 30, 2006 compared to the same periods of 2005 and compared to an approximately 5.1% and 2.3% decrease, respectively, in the industry during the same periods. These industry figures include a large number of fleet sales, so industry retail figures were down substantially more. Improvements in same-store used vehicle sales resulted from strong inventories of good quality used vehicles, which resulted, in part, from trade-ins related to our increased new vehicle sales. The improvements in finance and insurance same store sales resulted primarily from the unit increases in sales of both new and used vehicles during the 2006 periods compared to the 2005 periods.

Same-store sales percentage increases were as follows:

		Three months ended June 30, 2006 vs. three months ended June 30, 2005		Six months ended June 30, 2006 vs. six months ended June 30, 2005
New vehicle retail, excluding fleet		6.6	%	8.8	%
Used vehicles, including wholesale		9.2		4.7
Finance and insurance		14.3		9.5
Service, body and parts		7.5		6.3
Total sales, excluding fleet		7.6		7.4

Same-store sales are calculated by dealership comparing only those dealerships with operations in both comparative periods.

Penetration rates for certain products were as follows:

		Three Months Ended June 30,				Six Months Ended June 30,
		2006		2005		2006		2005
Finance and insurance		78	%	77	%	79	%	78	%
Service contracts		42		42		42		43
Lifetime oil change and filter		39		39		39		39

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Gross Profit

Gross profit increased $17.0 million and $30.5 million, respectively, in the three and six-month periods ended June 30, 2006 compared to the same periods of 2005 due to increased total revenues. Our gross profit margins by business lines were as follows:

		Three Months Ended June 30,				Basis
		2006		2005		Point Change*
New vehicle		7.3	%	7.9	%	(60	)bp
Retail used vehicle		15.8		15.9		(10	)
Wholesale used vehicle		2.8		3.9		(110	)
Finance and insurance		100.0		100.0		—
Service, body and parts		50.3		49.3		100
Overall		17.0		16.9		10

 

		Six Months Ended June 30,				Basis
		2006		2005		Point Change*
New vehicle		7.6	%	8.0	%	(40	)bp
Retail used vehicle		15.6		15.7		(10	)
Wholesale used vehicle		3.9		4.1		(20	)
Finance and insurance		100.0		100.0		—
Service, body and parts		49.6		49.0		60
Overall		17.2		17.3		(10	)

 

* “bp” stands for basis points (one hundred basis points equals one percent).

The decreases in new vehicle gross profit margin were due to our focus on selling volume and gaining market share in the first half of 2006.

The decreases in wholesale used vehicle gross profit margin were due to wholesale market conditions and a focus on retailing more used vehicles and bringing in trade-ins nearer to market value. We dispose of these units by using centralized control, holding our own local used vehicle auctions and managing the disposal of units at larger third party auctions.

The increases in service, body and parts gross profit margin were due to our continued focus on service advisor training, which has led to gains in the sale of higher margin service items, as well as a number of pricing and cost saving initiatives.

The decline in the overall gross profit margin during the six-month period ended June 30, 2006 compared to the same period of 2005 was primarily due to our focus on increased new vehicle sales, which carry a lower margin than the other business lines.

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.

Selling, general and administrative expense increased $14.2 million and $25.8 million, respectively, in the three and six-month periods ended June 30, 2006 compared to same periods of 2005. The increases in dollars spent were primarily due to increased selling, or variable, expenses related to the increase in acquisition revenues and the number of locations. Also, SG&A in the three and six-month periods ended June 30, 2006 included $1.0 million and $1.7 million, respectively, of stock-based compensation compared to $0.2 million and $0.3 million, respectively, in the same periods of 2005, due to the adoption of SFAS No. 123R. In addition, the three and six-month periods ended June 30, 2006 included expenses for certain initiatives that we expect will lead to operating efficiencies in future periods as discussed in “Overview” above. After salaries and wages, the next four largest expense categories, sales compensation, payroll taxes, rent and advertising, all improved or were flat as a percentage of gross profit in the three and six-month periods ended June 30, 2006 compared to the same periods of 2005, despite the increases in the number of vehicles sold.

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