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, 2007
	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)

 

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, 2007 and December 31, 2006
	Consolidated Statements of Operations (Unaudited) - Three and Six Months Ended June 30, 2007 and 2006
	Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended June 30, 2007 and 2006
	Condensed Notes to 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 1A.	Risk Factors
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

CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

		June 30, 2007			December 31, 2006
Assets
Current Assets:
Cash and cash equivalents		$	32,903		$	26,600
Contracts in transit		60,281			56,211
Trade receivables, net of allowance for doubtful accounts of $423 and $390		70,997			62,317
Inventories, net		684,926			603,306
Vehicles leased to others, current portion		9,747			7,698
Prepaid expenses and other		6,262			6,825
Deferred income taxes		71			1,198
Assets held for sale		68,859			15,485
Total Current Assets		934,046			779,640
Land and buildings, net of accumulated depreciation of $17,667 and $15,953		333,540			327,890
Equipment and other, net of accumulated depreciation of $40,505 and $38,866		95,513			89,213
Goodwill		309,065			307,424
Other intangible assets, net of accumulated amortization of $36 and $21		69,966			69,054
Other non-current assets		4,972			6,136
Total Assets		$	1,747,102		$	1,579,357
Liabilities and Stockholders’ Equity
Current Liabilities:
Floorplan notes payable		$	403,121		$	422,411
Floorplan notes payable: non-trade		170,211			77,268
Current maturities of long-term debt		9,694			16,557
Trade payables		44,329			39,794
Accrued liabilities		67,037			62,299
Liabilities held for sale		48,513			11,610
Total Current Liabilities		742,905			629,939
Used vehicle credit facility		111,843			95,614
Real estate debt, less current maturities		161,629			155,890
Other long-term debt, less current maturities		152,324			140,879
Other long-term liabilities		12,384			13,509
Deferred income taxes		59,196			50,133
Total Liabilities		1,240,281			1,085,964
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 15,890 and 15,789		227,462			226,670
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		7,076			5,574
Accumulated other comprehensive income		905			—
Retained earnings		270,910			260,681
Total Stockholders’ Equity		506,821			493,393
Total Liabilities and Stockholders’ Equity		$	1,747,102		$	1,579,357

 

The accompanying notes are an 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 June 30,						Six months ended June 30,
		2007			2006			2007			2006
Revenues:
New vehicle sales		$	515,234		$	468,710		$	952,741		$	872,799
Used vehicle sales		238,936			219,149			451,970			415,269
Finance and insurance		33,143			31,487			62,787			57,905
Service, body and parts		96,490			81,062			190,107			158,685
Fleet and other		1,306			796			1,996			1,949
Total revenues		885,109			801,204			1,659,601			1,506,607
Cost of sales		736,797			664,909			1,375,311			1,247,132
Gross profit		148,312			136,295			284,290			259,475
Selling, general and administrative		112,135			100,482			219,679			194,391
Depreciation - buildings		1,341			1,042			2,649			2,059
Depreciation and amortization - other		3,756			2,965			7,211			5,789
Income from operations		31,080			31,806			54,751			57,236
Other income (expense):
Floorplan interest expense		(8,480		)	(7,800		)	(15,834		)	(12,861		)
Other interest expense		(5,039		)	(3,312		)	(9,667		)	(6,335		)
Other income, net		113			261			325			637
		(13,406		)	(10,851		)	(25,176		)	(18,559		)
Income from continuing operations before income taxes		17,674			20,955			29,575			38,677
Income taxes		(7,022		)	(8,834		)	(11,698		)	(15,737		)
Income from continuing operations		10,652			12,121			17,877			22,940
Discontinued operations:
Loss from operations, net of income taxes		(228		)	(230		)	(378		)	(1,681		)
Impairment loss, net of income taxes		(2,481		)	—			(2,481		)	—
		(2,709		)	(230		)	(2,859		)	(1,681		)
Net income		$	7,943		$	11,891		$	15,018		$	21,259
Basic income per share from continuing operations		$	0.55		$	0.62		$	0.92		$	1.18
Basic loss per share from discontinued operations		(0.14		)	(0.01		)	(0.15		)	(0.09		)
Basic net income per share		$	0.41		$	0.61		$	0.77		$	1.09
Shares used in basic per share calculations		19,486			19,501			19,488			19,464
Diluted income per share from continuing operations		$	0.50		$	0.57		$	0.85		$	1.08
Diluted loss per share from discontinued operations		(0.12		)	(0.01		)	(0.13		)	(0.08		)
Diluted net income per share		$	(0.38	)	$	0.56		$	0.72		$	1.00
Shares used in diluted per share calculations		22,109			22,150			22,116			22,109

 

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)

		Six months ended June 30,
		2007			2006
Cash flows from operating activities:
Net income		$	15,018		$	21,259
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		9,860			7,848
Depreciation and amortization of discontinued operations		249			410
Amortization of debt discount		107			—
Stock-based compensation		1,892			1,692
Loss on sale of assets		151			85
Impairment loss on discontinued operations		4,105			—
Deferred income taxes		10,551			3,771
Excess tax benefits from share-based payment arrangements		(214		)	(366		)
(Increase) decrease, net of effect of acquisitions:
Trade and installment contract receivables, net		(8,477		)	(7,188		)
Contracts in transit		(4,070		)	(146		)
Inventories		(101,482		)	(250,019		)
Vehicles leased to others		(2,820		)	(1,341		)
Prepaid expenses and other		2,318			2,821
Other non-current assets		1,976			(3,471		)
Increase (decrease), net of effect of acquisitions:
Floorplan notes payable		(9,275		)	197,517
Trade payables		4,535			2,943
Accrued liabilities		4,650			8,514
Other long-term liabilities and deferred revenue		(2,049		)	832
Net cash used in operating activities		(72,975		)	(14,839		)
Cash flows from investing activities:
Capital expenditures:
Non-financeable		(18,193		)	(8,962		)
Financeable		(32,412		)	(23,175		)
Proceeds from sale of assets		6,856			302
Cash paid for acquisitions, net of cash acquired		(13,318		)	(28,015		)
Proceeds from sale of dealerships		—			3,926
Net cash used in investing activities		(57,067		)	(55,924		)
Cash flows from financing activities:
Floorplan notes payable: non-trade		100,830			13,014
Net borrowings (repayments) on lines of credit		28,000			18,000
Principal payments on long-term debt and capital leases		(5,666		)	(4,548		)
Proceeds from issuance of long-term debt		18,372			19,723
Proceeds from issuance of common stock		3,445			3,768
Repurchases of common stock		(3,355		)	—
Excess tax benefits from share-based payment arrangements		214			366
Dividends paid		(5,495		)	(4,691		)
Net cash provided by financing activities		136,345			45,632
Increase (decrease) in cash and cash equivalents		6,303			(25,131		)
Cash and cash equivalents:
Beginning of period		26,600			48,566
End of period		$	32,903		$	23,435
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	28,351		$	22,081
Cash paid during the period for income taxes		278			7,029
Supplemental schedule of non-cash investing and financing activities:
Debt issued in connection with acquisitions		$	—		$	6,111
Flooring debt acquired in connection with acquisitions		13,376			25,857
Flooring debt paid by purchaser in connection with dealership disposals		—			4,713
Common stock received for the exercise price of stock options		87			—

 

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

4

LITHIA MOTORS, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

These condensed consolidated financial statements contain unaudited information as of June 30, 2007 and for the three and six-month periods ended June 30, 2007 and 2006. 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 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 audited consolidated financial statements and the related notes thereto. The financial information as of December 31, 2006 is derived from our 2006 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 2006 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):

		June 30, 2007			December 31, 2006
New and program vehicles		$	536,766		$	466,703
Used vehicles		117,005			103,857
Parts and accessories		31,155			32,746
		$	684,926		$	603,306

 

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):

		2007								2006
Three Months Ended June 30,		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		$	10,652		19,486		$	0.55		$	12,121		19,501		$	0.62
Effect of Dilutive Securities
2 7/8% convertible senior subordinated notes		479			2,283		(0.04		)	438			2,255		(0.04		)
Stock options and unvested restricted stock		—			340		(0.01		)	—			394		(0.01		)
Diluted EPS
Income from continuing operations available to common stockholders		$	11,131		22,109		$	0.50		$	12,559		22,150		$	0.57
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive					556								—

 

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		2007								2006
Six Months Ended June 30,		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		$	17,877		19,488		$	0.92		$	22,940		19,464		$	1.18
Effect of Dilutive Securities
2 7/8% convertible senior subordinated notes		927			2,280		(0.05		)	931			2,255		(0.08		)
Stock options and unvested restricted stock		—			348		(0.02		)	—			390		(0.02		)
Diluted EPS
Income from continuing operations available to common stockholders		$	18,804		22,116		$	0.85		$	23,871		22,109		$	1.08
Antidilutive Securities
Shares issuable pursuant to stock options not included since they were antidilutive					510								—

 

Note 4.  Comprehensive Income

Comprehensive income for the three and six-month periods ended June 30, 2007 included the change in the fair value of cash flow hedging instruments, since their designation date of December 31, 2006, that are reflected in stockholders’ equity, net of tax, instead of net income. Comprehensive income was the same as net income for the three and six-month periods ended June 30, 2006. The following table sets forth the calculation of comprehensive income for the three and six-month periods ended June 30, 2007 (in thousands):

		Three  Months  Ended  June 30,  2007			Six Months Ended  June 30, 2007
Net income		$	7,943		$	15,018
Cash flow hedges:
Derivative gain, net of tax effect of $(586) and $(559)		949			905
Total comprehensive income		$	8,892		$	15,923

 

Note 5.  Acquisitions

The following acquisitions were made in the first six months of 2007:

·                  In February 2007, we acquired Jordan Motors, Inc., which was comprised of four stores, in Ames, Johnston and Des Moines, Iowa. The stores had annualized combined revenues of approximately $100 million. The stores were renamed Honda of Ames, Lithia Nissan of Ames, Acura of Johnston, Lithia Infiniti of Des Moines, Lithia Volkswagen of Des Moines and Audi Des Moines. The three stores in Des Moines are considered one location; and

·                  In May 2007, we acquired the operations of a Jeep franchise in Pocatello, Idaho that was added to our existing Chrysler store.

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The above acquisitions were accounted for under the purchase method of accounting. Pro forma results of operations, assuming the above acquisitions and the previously disclosed 2006 acquisitions occurred as of January 1, 2006, were as follows (in thousands, except per share amounts):

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Total revenues		$	885,109		$	902,283		$	1,671,406		$	1,710,384
Net income		7,943			11,450			14,980			20,266
Basic earnings per share		0.41			0.59			0.77			1.04
Diluted earnings per share		0.38			0.54			0.72			0.96

 

There are no future contingent payouts related to the 2007 acquisitions and no portion of the purchase price was paid with our equity securities. During the first six months of 2007, we acquired the four stores and the Jeep franchise discussed above for $13.3 million in cash, which included $8.2 million of goodwill and $3.2 million of other, primarily indefinite lived, intangible assets. The purchase price for the balance of the assets acquired was funded by borrowings. In addition, we acquired new vehicle inventory and associated floorplan debt in the amount of $13.4 million in connection with the above acquisitions.

Within one year from the purchase date of each store, we may update the value allocated to its purchased assets and the resulting goodwill balances as a result of information received regarding the valuation of such assets and liabilities that was not available at the time of purchase. 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 $0.14 per common share, which totaled approximately $2.7 million, were paid on each of January 30, 2007 and April 30, 2007 to shareholders of record on January 16, 2007 and April 16, 2007, respectively.

Note 7.  Stock-Based Compensation

In the first quarter of 2007, we issued our annual non-qualified stock option grants to executive officers and restricted stock grants to other employees. The non-qualified stock option grants cover a total of 108,000 shares of our common stock and were granted at the fair market value on the date of grant at $28.34 per share. These options vest 100% on the fifth anniversary of the grant date and expire on the sixth anniversary. Restricted stock grants covering 60,821 shares of our common stock were also granted and have varying vesting provisions with full vesting occurring between four and five years. Total compensation related to these stock-based awards was $2.1 million as calculated pursuant to the fair value methods prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payments.” Of the $2.1 million, approximately $0.4 million will be recognized in 2007.

In the second quarter of 2007, we granted 5,600 shares of common stock to members of our Board of Directors and one consultant. The fair market value on the date of grant was $27.13 per share and the shares were 100% vested on the date of grant. Total compensation expense related to these shares in the second quarter of 2007 was $152,000.

Note 8.  Discontinued Operations

We continually monitor the performance of each of our stores and make determinations to sell a store based primarily on return on capital criteria.  When a store 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 stores 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 store to occur within 12 months from the date of determination.

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During the second quarter of 2007, we classified three stores and one body shop as discontinued operations. As of June 30, 2007 and December 31, 2006, we had five and two stores, respectively, held for sale and classified as discontinued operations. The body shop was closed and is not held for sale. Certain financial information related to discontinued operations was as follows (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Revenue		$	37,473		$	47,920		$	75,951		$	99,308
Pre-tax loss from discontinued operations		$	(378	)	$	(510	)	$	(625	)	$	(2,762	)
Impairment loss related to discontinued operations(1)		(4,105		)	—			(4,105		)	—
		(4,483		)	(510		)	(4,730		)	(2,762		)
Income tax benefit		1,774			280			1,871			1,081
Loss from discontinued operations, net of income taxes		$	(2,709	)	$	(230	)	$	(2,859	)	$	(1,681	)
Amount of goodwill and other intangible assets disposed of		$	—		$	1,606		$	—		$	3,552

 

(1) The impairment loss is related to goodwill and other intangible assets.

The pre-tax loss in the six-month period ended June 30, 2006 included legal settlements related to stores 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 working capital, acquisition and used vehicle credit facility is allocated based on the amount of assets pledged towards the total borrowing base.

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

		June 30, 2007			December 31, 2006
Inventories		$	38,112		$	11,594
Property, plant and equipment		23,140			2,949
Goodwill and other intangible assets		7,607			942
		$	68,859		$	15,485

 

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

		June 30, 2007			December 31, 2006
Floorplan notes payable		$	32,196		$	9,605
Real estate debt		16,317			2,005
		$	48,513		$	11,610

 

Note 9. Adoption of 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.  Interpretation No. 48 applies to all tax positions accounted for under Statement 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 us). 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, if material. However, because of the immaterial nature of the adjustment, we have not presented this item separately on the face of the balance sheet.

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At adoption, important information in regard to our reporting for Interpretation No. 48 was as follows:

Total amount of unrecognized tax benefits	$	—
Amount of unrecognized tax benefits that would impact the effective rate if recognized	$	—
Nature and potential magnitude of significant changes in unrecognized tax benefits that are reasonably possible within the 12 months following the adoption date pursuant to paragraph 21(d) of Interpretation No. 48	$	—
Accrued interest and penalties as of the date of adoption	$	—

 

Entity policy for classifying interest and penalties:	Tax expense
Description of open tax years:	Federal 2003 – 2006
	15 States 2002 - 2006

 

Note 10. Repurchases of Common Stock

In the first quarter of 2007, we repurchased 124,809 shares of our Class A common stock for $3.4 million, or an average price of $26.88 per share. Of these repurchases, 121,800 were pursuant to the program approved by our Board of Directors in June 2000, which authorized the repurchase of up to 1,000,000 shares of our Class A common stock. Through June 30, 2007, we have purchased a total of 378,631 shares under this program.

Note 11. Reclassifications

Reclassifications related to discontinued operations were made to the prior period financial statements to conform to the current period presentation in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

Note 12.  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 proceedings will have a material adverse effect on our business, results of operations, financial condition, or cash flows.

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 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

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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. Lithia’s motion to Compel Arbitration of Plaintiff’s remaining claims was denied. We filed a Motion to Reconsider and a Notice of Appeal relating to the denial of our motion to Compel Arbitration.

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. We expect certain of the rulings in the Allen case to apply equally to this case and proceedings in this matter are awaiting further rulings in the Allen case. Once resolved, we further expect to file motions directed at all claims.

On May 30, 2006 four of our wholly owned subsidiaries located in Alaska were served with a lawsuit alleging that the stores failed to comply with Alaska law relating to various disclosures required to be made during the sale of a used vehicle.  The complaint was filed by Jackie Lee Neese et al v. Lithia Chrysler Jeep of Anchorage, Inc. et al in the Superior Court for the State of Alaska at Anchorage, case number 3AN-06-04815CI. The complainants seek to represent other similarly situated customers. The court has not certified the suit as a class action.

We intend to vigorously defend all matters and management believes that the likelihood of a judgment for the amount of damages sought in any of the cases is remote.

Note 13.  Subsequent Events

Disposal

On August 3, 2007, we disposed of one of our stores that was held for sale at June 30, 2007.

Dividend

In July 2007, we announced a dividend on our Class A and Class B common stock of $0.14 per share for the second quarter of 2007. The dividend, which totaled approximately $2.8 million, was paid on July 30, 2007 to shareholders of record on July 16, 2007.

Debt Modification

On July 6, 2007, we entered into a modification of certain mortgage loans held by Toyota Mortgage Credit Corporation. Under the modification, the maturity dates on the loans were extended for a period of 24 months, with the interest rate on the loans re-pricing to a fixed or floating rate, at our choice, as of the original maturity date. As a result of this modification, we classified $31.0 million in debt obligations from current to long-term liabilities as of June 30, 2007.

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

Forward Looking Statements and Risk Factors

Some of the statements in this Form 10-Q constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” and “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Some of the important factors that could cause actual results to differ from our expectations are discussed in Item 1A to our 2006 Form 10-K, which was filed with the Securities and Exchange Commission on March 9, 2007. These risk factors have not significantly changed since the filing of the 2006 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, 2007, we offered 30 brands of new vehicles in 107 stores in the Western United States and over the Internet.  As of August 7, 2007 we operated 16 stores in Oregon, 15 in California, 14 in Texas, 11 in Washington, 8 in Iowa, 7 in Idaho, 7 in Colorado, 7 in Alaska, 7 in Montana, 6 in Nevada, 3 in Nebraska, 2 in South Dakota, 2 in North 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.

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 new vehicle stores where the store is the dominant or the only franchise of that brand in the market. Our goal is to improve 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. Since 1996, our ability to integrate the stores that we acquire continues to improve. 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 opportunities develop.

Our current brand mix is weighted towards domestic brands at approximately 60%. Our strategy is to target a more balanced mix between our domestic, import and luxury brands in the years ahead. Approximately 60% of our acquisition revenues in the last four quarters were from import and luxury brands, contributing to an improvement in our import/domestic mix, especially as we continue to dispose of our lowest performing domestic stores.

In keeping with this model, we acquired four stores and one franchise in the first seven months of 2007 with total estimated annual revenues of approximately $100 million.  At August 7, 2007, we had four stores held for sale and listed as discontinued operations with combined annual revenues of approximately $127 million.

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We expect that manufacturers will continue to offer incentives on new vehicle sales during 2007 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 have completed, or are currently working on, the following initiatives that we expect will improve our operations in future periods:

·                  Under the automated car deal process, our showrooms are equipped with interactive personal computers, which allows the salesperson to quickly and efficiently enter data and interact with the customer to speed up the sales process;

·                  Improved functionality of our centralized inventory control and procurement process;

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

·                  In August 2007, we opened our first independent used vehicle outlet, L2 Auto in Loveland, Colorado; and

·                  Our assured vehicle selling program has been fully installed in Alaska and will be rolled out to additional locations in future periods.

Results of Continuing Operations

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

Three Months Ended June 30, 2007		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		58.2	%	7.3	%	25.3	%
Used vehicle retail		22.3		15.0		19.9
Used vehicle wholesale		4.8		2.7		0.8
Finance and insurance(1)		3.7		100.0		22.3
Service, body and parts		10.9		48.2		31.4
Fleet and other		0.1		33.1		0.3

 

 

Three Months Ended June 30, 2006		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		58.5	%	7.3	%	25.3	%
Used vehicle retail		22.9		15.8		21.3
Used vehicle wholesale		4.5		2.8		0.7
Finance and insurance(1)		3.9		100.0		23.1
Service, body and parts		10.1		49.3		29.3
Fleet and other		0.1		52.4		0.3

 

Six Months Ended June 30, 2007		Percent of Total Revenues		Gross Margin		Percent of Total Gross Profit
New vehicle		57.4	%	7.5	%	25.1	%
Used vehicle retail		22.3		15.0		19.5
Used vehicle wholesale		4.9		3.4		1.0
Finance and insurance(1)		3.8		100.0		22.1
Service, body and parts		11.5		47.8		32.0
Fleet and other		0.1		37.5		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	%	25.7	%
Used vehicle retail		23.0		15.7		20.9
Used vehicle wholesale		4.7		4.0		1.1
Finance and insurance(1)		3.8		100.0		22.3
Service, body and parts		10.5		48.5		29.7
Fleet and other		0.1		42.7		0.3

 

(1)          Commissions reported net of anticipated cancellations.

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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,
		2007(1)		2006(1)		2007(1)		2006(1)
Revenues:
New vehicle		58.2	%	58.5	%	57.4	%	57.9	%
Used vehicle retail		22.3		22.9		22.3		23.0
Used vehicle wholesale		4.8		4.5		4.9		4.7
Finance and insurance		3.7		3.9		3.8		3.8
Service, body and parts		10.9		10.1		11.5		10.5
Fleet and other		0.1		0.1		0.1		0.1
Total revenues		100.0	%	100.0	%	100.0	%	100.0	%
Gross profit		16.8		17.0		17.1		17.2
Selling, general and administrative expenses		12.7		12.5		13.2		12.9
Depreciation and amortization		0.6		0.5		0.6		0.5
Income from operations		3.5		4.0		3.3		3.8
Floorplan interest expense		1.0		1.0		1.0		0.9
Other interest expense		0.6		0.4		0.6		0.4
Other income, net		0.0		0.0		0.0		0.0
Income from continuing operations before taxes		2.0		2.6		1.8		2.6
Income tax expense		0.8		1.1		0.7		1.0
Income from continuing operations		1.2	%	1.5	%	1.1	%	1.5	%

 

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

The following tables set forth the changes in our operating results from continuing operations in the three and six-month periods ended June 30, 2007 compared to the three and six-month periods ended June 30, 2006:

		Three Months Ended June 30,						Increase			% Increase
(Dollars in thousands)		2007			2006			(Decrease)			(Decrease)
Revenues:
New vehicle		$	515,234		$	468,710		$	46,524		9.9	%
Used vehicle retail		197,007			183,076			13,931			7.6
Used vehicle wholesale		41,929			36,073			5,856			16.2
Finance and insurance		33,143			31,487			1,656			5.3
Service, body and parts		96,490			81,062			15,428			19.0
Fleet and other		1,306			796			510			64.1
Total revenues		885,109			801,204			83,905			10.5
Cost of sales		736,797			664,909			71,888			10.8
Gross profit		148,312			136,295			12,017			8.8
Selling, general and administrative		112,135			100,482			11,653			11.6
Depreciation and amortization		5,097			4,007			1,090			27.2
Income from operations		31,080			31,806			(726		)	(2.3	)
Floorplan interest expense		(8,480		)	(7,800		)	680			8.7
Other interest expense		(5,039		)	(3,312		)	1,727			52.1
Other income, net		113			261			(148		)	(56.7	)
Income from continuing operations before taxes		17,674			20,955			(3,281		)	(15.7	)
Income tax expense		7,022			8,834			(1,812		)	(20.5	)
Income from continuing operations		$	10,652		$	12,121		$	(1,469	)	(12.1	)%

 

		Three Months Ended June 30,						Increase			% Increase
		2007			2006			(Decrease)			(Decrease)
New units sold		17,882			17,326			556			3.2	%
Average selling price per new vehicle		$	28,813		$	27,052		$	1,761		6.5
Used retail units sold		11,814			11,328			486			4.3
Average selling price per used retail vehicle		$	16,676		$	16,161		$	515		3.2
Used wholesale units sold		6,625			5,999			626			10.4
Average selling price per used wholesale vehicle		$	6,329		$	6,013		$	316		5.3
Finance and insurance sales per retail unit		$	1,116		$	1,099		$	17		1.5

 

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(Dollars in thousands)		Six Months Ended June 30,						Increase			% Increase
		2007			2006			(Decrease)			(Decrease)
Revenues:
New vehicle		$	952,741		$	872,799		$	79,942		9.2	%
Used vehicle retail		369,389			346,818			22,571			6.5
Used vehicle wholesale		82,581			68,451			14,130			20.6
Finance and insurance		62,787			57,905			4,882			8.4
Service, body and parts		190,107			158,685			31,422			19.8
Fleet and other		1,996			1,949			47			2.4
Total revenues		1,659,601			1,506,607			152,994			10.2
Cost of sales		1,375,311			1,247,132			128,179			10.3
Gross profit		284,290			259,475			24,815			9.6
Selling, general and administrative		219,679			194,391			25,288			13.0
Depreciation and amortization		9,860			7,848			2,012			25.6
Income from operations		54,751			57,236			(2,485		)	(4.3	)
Floorplan interest expense		(15,834		)	(12,861		)	2,973			23.1
Other interest expense		(9,667		)	(6,335		)	3,332			52.6
Other income, net		325			637			(312		)	(49.0	)
Income from continuing operations before taxes		29,575			38,677			(9,102		)	(23.5	)
Income tax expense		11,698			15,737			(4,039		)	(25.7	)
Income from continuing operations		$	17,877		$	22,940		$	(5,063	)	(22.1	)%

 

		Six Months Ended June 30,						Increase			% Increase
		2007			2006			(Decrease)			(Decrease)
New units sold		33,165			31,798			1,367			4.3	%
Average selling price per new vehicle		$	28,727		$	27,448		$	1,279		4.7
Used retail units sold		22,447			21,544			903			4.2
Average selling price per used retail vehicle		$	16,456		$	16,098		$	358		2.2
Used wholesale units sold		12,687			11,174			1,513			13.5
Average selling price per used wholesale vehicle		$	6,509		$	6,126		$	383		6.3
Finance and insurance sales per retail unit		$	1,129		$	1,086		$	43		4.0

 

Revenues

Total revenues increased 10.5% and 10.2%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006, as a result of acquisitions, partially offset by a 2.0% and a 1.8% decrease, respectively, in same-store sales, excluding fleet. The three and six-month periods ended June 30, 2007 faced difficult comparisons with the comparable periods of 2006 when total same store sales grew by 9.3% and 7.5%, respectively. The decreases in the 2007 periods were also impacted by a weak retail sales environment, especially with our domestic brands in the metro markets. We believe that sales have been affected by the slowdown in residential construction, high fuel prices and consumer concerns over personal debt.

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

		Three months ended June  30, 2007 vs. three months  ended June 30, 2006		Six months ended June  30, 2007 vs. six months  ended June 30, 2006
New vehicle retail, excluding fleet		(2.8	)%	(3.0	)%
Used vehicle retail		(4.3	)	(4.4	)
Used vehicle wholesale		4.1		9.6
Total vehicle sales, excluding fleet		(2.8	)	(2.7	)
Finance and insurance		(1.4	)	0.7
Service, body and parts		4.6		5.1
Total sales, excluding fleet		(2.0	)	(1.8	)

 

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Same store sales are calculated for stores that were in operation as of June 30, 2006, and only including the months of operations for both comparable periods. For example, a store acquired in April 2006 would be included in same store operating data beginning in May 2006, after its first full complete comparable month of operation. Thus, operating results for same store comparisons would include only the periods of May through June of both comparable years.

New vehicle same store sales declined 2.8% and 3.0%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006. The decreases were primarily due to a challenging sales environment in the first half of 2007 and declining sales of domestic manufacturers’ vehicles that represent a large percentage of our new vehicle sales. Prior year comparisons were high due to aggressive manufacturer incentive programs which have not been sustained in 2007. Same store unit sales were down 7.3% and 5.8%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006. The decreases in same-store unit sales were partially offset by a 4.9% and a 3.0% increase, respectively, in same-store average selling prices.

Used retail vehicle same store sales declined 4.3% and 4.4%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006. The decreases in same-store sales were primarily due to the challenging sales environment mentioned above. Same-store retail unit sales decreased 6.0% and 5.3%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006. These same-store decreases were partially offset by a 1.8% and a 0.9% increase in same-store average selling prices.

Used wholesale vehicle same-store sales increased 4.1% and 9.6%, respectively, in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006. Same store unit sales declined 1.6% in the three-month period and increased 2.8% in the six-month period.  The same-store average selling price increased 5.8% and 6.6%, respectively, in the same periods.

The combined used retail and wholesale same store sales decreased 2.9% and 2.1%, respectively, in the three and six-month periods compared to the same periods of 2006. This decrease is in line with new vehicle same-store sales declines due to the challenging sales environment discussed above.

Same-store finance and insurance sales were negatively affected in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006 by decreases in same-store vehicle unit sales, which lowered the overall opportunity for finance and insurance sales. This was offset by a 1.5% and a 4.0% increase, respectively, in the finance and insurance sales per unit in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006.

The increases in service, body and parts sales in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006 were primarily due to a 3.8% and a 5.2% increase, respectively, in the same-store customer-pay portion of the business, where all three business lines increased. The customer-pay portion of the business currently represents approximately 81% of total service, body and parts sales. In addition, we realized an 8.1% and a 4.7% increase, respectively, in same-store warranty sales.

Penetration rates for certain products were as follows:

		Three Months Ended June 30,				Six Months Ended June 30,
		2007		2006		2007		2006
Finance and insurance		75	%	78	%	75	%	79	%
Service contracts		43		42		43		42
Lifetime oil change and filter		37		39		38		39

 

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