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LITHIA MOTORS INC - Quarter Report: 2017 September (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
 

(Mark One)
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from       to         
 
Commission file number: 001-14733
 
LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
Oregon
 
93-0572810
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
150 N. Bartlett Street, Medford, Oregon
 
97501
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code: 541-776-6401
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [ ] Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class A common stock without par value
 
23,958,168
Class B common stock without par value
 
1,000,000
(Class)
 
Outstanding at November 7, 2017




LITHIA MOTORS, INC.
FORM 10-Q
INDEX 
 
PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
 
 
 
 
Consolidated Balance Sheets (Unaudited) - September 30, 2017 and December 31, 2016
 
 
 
 
Consolidated Statements of Operations (Unaudited) – Three and Nine Months Ended September 30, 2017 and 2016
 
 
 
 
Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended September 30, 2017 and 2016
 
 
 
 
Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2017 and 2016
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
 
 
 
 

1



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)
(Unaudited)
 
 
 
September 30, 2017
 
December 31, 2016
Assets
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
38,577

 
$
50,282

Accounts receivable, net of allowance for doubtful accounts of $6,145 and $5,281
 
446,613

 
417,714

Inventories, net
 
1,966,456

 
1,772,587

Other current assets
 
59,622

 
46,611

Total Current Assets
 
2,511,268

 
2,287,194

 
 
 
 
 
Property and equipment, net of accumulated depreciation of $190,962 and $167,300
 
1,087,920

 
1,006,130

Goodwill
 
257,185

 
259,399

Franchise value
 
186,977

 
184,268

Other non-current assets
 
328,243

 
107,159

Total Assets
 
$
4,371,593

 
$
3,844,150

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Current Liabilities:
 
 
 
 
Floor plan notes payable
 
$
114,833

 
$
94,602

Floor plan notes payable: non-trade
 
1,598,111

 
1,506,895

Current maturities of long-term debt
 
17,619

 
20,965

Trade payables
 
103,105

 
88,423

Accrued liabilities
 
241,094

 
211,109

Total Current Liabilities
 
2,074,762

 
1,921,994

 
 
 
 
 
Long-term debt, less current maturities
 
991,333

 
769,916

Deferred revenue
 
98,265

 
81,929

Deferred income taxes
 
66,474

 
59,075

Other long-term liabilities
 
109,383

 
100,460

Total Liabilities
 
3,340,217

 
2,933,374

 
 
 
 
 
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 23,966 and 23,382
 
148,880

 
165,512

Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 1,000 and 1,762
 
124

 
219

Additional paid-in capital
 
42,373

 
41,225

Retained earnings
 
839,999

 
703,820

Total Stockholders' Equity
 
1,031,376

 
910,776

Total Liabilities and Stockholders' Equity
 
$
4,371,593

 
$
3,844,150

 
See accompanying condensed notes to consolidated financial statements.

2



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
 
New vehicle
 
$
1,553,511

 
$
1,297,511

 
$
4,147,870

 
$
3,602,603

Used vehicle retail
 
679,180

 
580,885

 
1,915,038

 
1,667,258

Used vehicle wholesale
 
65,739

 
75,271

 
206,754

 
207,131

Finance and insurance
 
101,044

 
87,709

 
282,672

 
246,390

Service, body and parts
 
265,683

 
217,148

 
744,262

 
616,088

Fleet and other
 
15,185

 
11,443

 
86,883

 
46,697

Total revenues
 
2,680,342

 
2,269,967

 
7,383,479

 
6,386,167

Cost of sales:
 
 
 
 
 
 
 
 
New vehicle
 
1,465,466

 
1,221,668

 
3,909,168

 
3,387,132

Used vehicle retail
 
600,522

 
512,076

 
1,693,091

 
1,466,947

Used vehicle wholesale
 
64,565

 
74,353

 
202,351

 
202,897

Service, body and parts
 
133,191

 
112,806

 
376,096

 
317,028

Fleet and other
 
13,577

 
11,803

 
82,829

 
45,684

Total cost of sales
 
2,277,321

 
1,932,706

 
6,263,535

 
5,419,688

Gross profit
 
403,021

 
337,261

 
1,119,944

 
966,479

Asset impairments
 

 
3,498

 

 
10,494

Selling, general and administrative
 
282,241

 
228,134

 
782,303

 
662,766

Depreciation and amortization
 
14,828

 
12,206

 
41,598

 
36,372

Operating income
 
105,952

 
93,423

 
296,043

 
256,847

Floor plan interest expense
 
(10,629
)
 
(6,186
)
 
(28,013
)
 
(18,304
)
Other interest expense, net
 
(9,905
)
 
(5,647
)
 
(23,745
)
 
(16,608
)
Other income (expense), net
 
1,125

 
(1,513
)
 
11,357

 
(4,534
)
Income before income taxes
 
86,543

 
80,077

 
255,642

 
217,401

Income tax provision
 
(34,657
)
 
(26,036
)
 
(99,829
)
 
(71,662
)
Net income
 
$
51,886

 
$
54,041

 
$
155,813

 
$
145,739

 
 
 
 
 
 
 
 
 
Basic net income per share
 
$
2.07

 
$
2.15

 
$
6.21

 
$
5.72

Shares used in basic per share calculations
 
25,008

 
25,194

 
25,090

 
25,490

 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
2.07

 
$
2.14

 
$
6.19

 
$
5.69

Shares used in diluted per share calculations
 
25,076

 
25,290

 
25,158

 
25,598

 
 
 
 
 
 
 
 
 
Cash dividends declared per Class A and Class B share
 
$
0.27

 
$
0.25

 
$
0.79

 
$
0.70

 
See accompanying condensed notes to consolidated financial statements.

3



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Net income
 
$
51,886

 
$
54,041

 
$
155,813

 
$
145,739

Other comprehensive income, net of tax:
 
 
 
 
 

 

Gain on cash flow hedges, net of tax expense of $0, $0, $0, and $175, respectively
 

 

 

 
277

Comprehensive income
 
$
51,886

 
$
54,041

 
$
155,813

 
$
146,016

 
See accompanying condensed notes to consolidated financial statements.


4



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
155,813

 
$
145,739

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Asset impairments
 

 
10,494

Depreciation and amortization
 
41,598

 
36,372

Stock-based compensation
 
8,396

 
8,665

Gain on disposal of other assets
 
(382
)
 
(4,299
)
Gain on disposal of franchise
 

 
(1,102
)
Deferred income taxes
 
7,398

 
9,782

(Increase) decrease (net of acquisitions and dispositions):
 
 
 
 
Trade receivables, net
 
(13,345
)
 
(5,911
)
Inventories
 
(16,098
)
 
(85,564
)
Other assets
 
15,207

 
4,688

Increase (net of acquisitions and dispositions):
 
 
 
 
Floor plan notes payable
 
12,126

 
18,122

Trade payables
 
12,397

 
6,153

Accrued liabilities
 
25,907

 
32,874

Other long-term liabilities and deferred revenue
 
11,519

 
18,227

Net cash provided by operating activities
 
260,536

 
194,240

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(72,174
)
 
(81,363
)
Proceeds from sales of assets
 
12,327

 
1,756

Cash paid for other investments
 
(7,929
)
 
(22,279
)
Cash paid for acquisitions, net of cash acquired
 
(400,558
)
 
(199,435
)
Proceeds from sales of stores
 
3,417

 
11,837

Net cash used in investing activities
 
(464,917
)
 
(289,484
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Borrowings on floor plan notes payable, net: non-trade
 
34,056

 
93,817

Borrowings on lines of credit
 
1,306,000

 
841,623

Repayments on lines of credit
 
(1,432,853
)
 
(744,494
)
Principal payments on long-term debt and capital leases, scheduled
 
(13,697
)
 
(12,278
)
Principal payments on long-term debt and capital leases, other
 
(46,471
)
 
(5,903
)
Proceeds from issuance of long-term debt
 
395,905

 
22,816

Payments of debt issuance costs
 
(4,517
)
 

Proceeds from issuance of common stock
 
5,577

 
5,191

Repurchase of common stock
 
(31,521
)
 
(108,597
)
Dividends paid
 
(19,803
)
 
(17,823
)
Net cash provided by financing activities
 
192,676

 
74,352

Decrease in cash and cash equivalents
 
(11,705
)
 
(20,892
)
Cash and cash equivalents at beginning of period
 
50,282

 
45,008

Cash and cash equivalents at end of period
 
$
38,577

 
$
24,116

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for interest
 
$
51,160

 
$
36,641

Cash paid during the period for income taxes, net
 
89,206

 
29,478

Floor plan debt paid in connection with store disposals
 

 
5,284

 
 
 
 
 
Supplemental schedule of non-cash activities:
 
 
 
 
Debt issued in connection with acquisitions
 
$
1,748

 
$

Non-cash assets transferred in connection with acquisitions
 

 
2,637

Debt assumed in connection with acquisitions
 
86,902

 
19,657

Issuance of Class A common stock in connection with acquisitions
 
2,137

 


 See accompanying condensed notes to consolidated financial statements.

5



LITHIA MOTORS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1. Interim Financial Statements
 
Basis of Presentation
These condensed Consolidated Financial Statements contain unaudited information as of September 30, 2017 and for the three and nine-months ended September 30, 2017 and 2016. The unaudited interim financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by accounting principles generally accepted in the United States of America for annual financial statements are not included herein. In management’s opinion, these unaudited financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the information when read in conjunction with our 2016 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2016 is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2016 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.
 
Reclassifications
Certain reclassifications of amounts previously reported have been made to the accompanying condensed Consolidated Financial Statements to maintain consistency and comparability between periods presented. These reclassifications were related to our adoption of ASU 2016-09, "Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting." Specifically, we reclassified the presentation of excess tax benefits on our Consolidated Statements of Cash Flows between financing and operating cash flows and recorded reclassifications between additional paid-in capital and retained earnings. See also Note 13.

Note 2. Accounts Receivable

Accounts receivable consisted of the following (in thousands):
 
 
September 30, 2017
 
December 31, 2016
Contracts in transit
 
$
225,564

 
$
233,506

Trade receivables
 
45,243

 
45,193

Vehicle receivables
 
53,166

 
43,937

Manufacturer receivables
 
85,307

 
76,948

Auto loan receivables
 
75,651

 
69,859

Other receivables
 
16,892

 
3,857

 
 
501,823


473,300

Less: Allowance
 
(6,145
)
 
(5,281
)
Less: Long-term portion of accounts receivable, net
 
(49,065
)
 
(50,305
)
Total accounts receivable, net
 
$
446,613


$
417,714


Accounts receivable classifications include the following:

Contracts in transit are receivables from various lenders for the financing of vehicles that we have arranged on behalf of the customer and are typically received approximately ten days after selling a vehicle.
Trade receivables are comprised of amounts due from customers for open charge accounts, lenders for the commissions earned on financing and others for commissions earned on service contracts and insurance products.
Vehicle receivables represent receivables for the portion of the vehicle sales price paid directly by the customer.
Manufacturer receivables represent amounts due from manufacturers, including holdbacks, rebates, incentives and warranty claims.
Auto loan receivables include amounts due from customers related to retail sales of vehicles and certain finance and insurance products.

Interest income on auto loan receivables is recognized based on the contractual terms of each loan and is accrued until repayment, charge-off, or repossession. Direct costs associated with loan originations are capitalized and expensed as an offset to interest

6



income when recognized on the loans. All other receivables are recorded at invoice and do not bear interest until they are 60 days past due.

The allowance for doubtful accounts is estimated based on our historical write-off experience and is reviewed monthly. Consideration is given to recent delinquency trends and recovery rates. Account balances are charged against the allowance after all appropriate means of collection have been exhausted and the potential for recovery is considered remote. The annual activity for charges and subsequent recoveries is immaterial.

The long-term portion of accounts receivable was included as a component of other non-current assets in the Consolidated Balance Sheets.

Note 3. Inventories

The components of inventories, net, consisted of the following (in thousands):
 
 
September 30, 2017
 
December 31, 2016
New vehicles
 
$
1,412,668

 
$
1,338,110

Used vehicles
 
474,948

 
368,067

Parts and accessories
 
78,840

 
66,410

Total inventories
 
$
1,966,456

 
$
1,772,587

 
Note 4. Goodwill and Franchise Value

The changes in the carrying amounts of goodwill are as follows (in thousands):
 
 
Domestic
 
Import
 
Luxury
 
Consolidated
Balance as of December 31, 2015 ¹
 
$
97,903

 
$
84,384

 
$
30,933

 
$
213,220

Additions through acquisitions2
 
18,154

 
21,795

 
7,448

 
47,397

Reductions through divestitures
 
(1,218
)
 

 

 
(1,218
)
Balance as of December 31, 2016 1
 
114,839

 
106,179

 
38,381

 
259,399

Adjustments to purchase price allocations2,3
 
(817
)
 
(1,006
)
 
(391
)
 
(2,214
)
Balance as of September 30, 2017 ¹
 
$
114,022

 
$
105,173

 
$
37,990

 
$
257,185


1 Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.
2 Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017. As a result, we reclassified $2.2 million of value from goodwill to franchise value.
3 Our purchase price allocation is preliminary for the acquisitions of the Baierl Auto Group and the Downtown LA Auto Group and the associated goodwill has not been allocated to each of our segments. See also Note 12.

The changes in the carrying amounts of franchise value are as follows (in thousands):
 
Franchise Value
Balance as of December 31, 2015
$
157,699

Additions through acquisitions
27,087

Reductions through divestitures
(518
)
Balance as of December 31, 2016
184,268

Additions through acquisitions 1
495

Adjustments to purchase price allocations 2
2,214

Balance as of September 30, 2017
$
186,977


1 Our purchase price allocation is preliminary for the acquisitions of the Baierl Auto Group and the Downtown LA Auto Group and have not been included in the above franchise value additions. See also Note 12.
2Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017, resulting in a reclassification in the current year of $2.2 million from goodwill to franchise value.


7



Note 5. Long-term Debt

Long-term debt consisted of the following:
(Dollars in thousands)
 
September 30, 2017
 
December 31, 2016
Real estate mortgages
 
$
476,559

 
$
428,367

5.25% Senior Notes due 2025
 
300,000

 

Used vehicle inventory financing facility and revolving lines of credit
 
226,654

 
353,507

Capital leases and other debt
 
12,699

 
11,191

Total long-term debt outstanding
 
1,015,912

 
793,065

Less: unamortized debt issuance costs
 
(6,960
)
 
(2,184
)
Less: current maturities (net of current debt issuance costs)
 
(17,619
)
 
(20,965
)
Long-term debt
 
$
991,333

 
$
769,916


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

We paid approximately $5.0 million in underwriting and other fees in connection with this issuance, which will be amortized as interest expense over the term of the Notes. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our existing and future restricted subsidiaries that is a borrower under, or that guarantees obligations under, our credit facility or other indebtedness. The terms of the Notes, in certain circumstances, may restrict our ability to, among other things, incur additional indebtedness, pay dividends, repurchase our common stock, or merge, consolidate or sell all or substantially all our assets.

Credit Facility
On August 1, 2017, we amended our existing credit facility to increase the total financing commitment to $2.4 billion. This syndicated credit facility is comprised of 18 financial institutions, including seven manufacturer-affiliated finance companies. Our credit facility provides for up to $1.9 billion in new vehicle inventory floor plan financing, up to $250 million in used vehicle inventory floor plan financing and a maximum of $250 million in revolving financing for general corporate purposes, including acquisitions and working capital. This credit facility may be expanded to $2.75 billion total availability, subject to lender approval.

Note 6. Stockholders’ Equity

Repurchases of Class A Common Stock
Repurchases of our Class A Common Stock occurred under a repurchase authorization granted by our Board of Directors and related to shares withheld as part of the vesting of restricted stock units ("RSUs"). In February 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. Share repurchases under this authorization were as follows:
 
 
Repurchases Occurring in the Nine Months Ended September 30, 2017
 
Cumulative Repurchases as of September 30, 2017
 
 
Shares
 
Average Price
 
Shares
 
Average Price
2016 Share Repurchase Authorization
 
310,000

 
$
91.33

 
1,023,725

 
$
83.25


As of September 30, 2017, we had $164.8 million available for repurchases pursuant to our 2016 share repurchase authorization.


8



In addition, during the first nine months of 2017, we repurchased 32,300 shares at an average price of $99.33 per share, for a total of $3.2 million, related to tax withholdings associated with the vesting of RSUs. The repurchase of shares related to tax withholdings associated with stock awards does not reduce the number of shares available for repurchase as approved by our Board of Directors.

Note 7. Fair Value Measurements

Fair Value Disclosures for Financial Assets and Liabilities
We determined the carrying value of cash equivalents, accounts receivable, trade payables, accrued liabilities and short-term borrowings approximate their fair values because of the nature of their terms and current market rates of these instruments. We believe the carrying value of our variable rate debt approximates fair value.
 
We have fixed rate debt primarily consisting of amounts outstanding under our senior notes and real estate mortgages. We calculated the estimated fair value of the senior notes using quoted prices for the identical liability (Level 1) and calculated the estimated fair value of the fixed rate real estate mortgages using a discounted cash flow methodology with estimated current interest rates based on a similar risk profile and duration (Level 2). The fixed cash flows are discounted and summed to compute the fair value of the debt. As of September 30, 2017, our real estate mortgages and other debt, which includes capital leases, had maturity dates between January 12, 2019 and December 31, 2050.

There were no changes to our valuation techniques during the nine-month period ended September 30, 2017.

A summary of the aggregate carrying values, excluding unamortized debt issuance cost, and fair values of our long-term fixed interest rate debt is as follows (in thousands):
 
 
September 30, 2017
 
December 31, 2016
Carrying value
 
 
 
 
5.25% Senior Notes due 2025
 
$
300,000

 
$

Real Estate Mortgages and Other Debt
 
382,562

 
286,660

 
 
$
682,562


$
286,660

Fair value
 
 
 
 
5.25% Senior Notes due 2025
 
$
309,750

 
$

Real Estate Mortgages and Other Debt
 
403,009

 
293,522

 
 
$
712,759

 
$
293,522


Note 8. Net Income Per Share of Class A and Class B Common Stock

We compute net income per share of Class A and Class B common stock using the two-class method. Under this method, basic net income per share is computed using the weighted average number of common shares outstanding during the period excluding common shares underlying equity awards that are unvested or subject to forfeiture. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the common shares issuable upon the net exercise of stock options and unvested RSUs and is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares.
 
Except with respect to voting and transfer rights, the rights of the holders of our Class A and Class B common stock are identical. Under our Articles of Incorporation, the Class A and Class B common stock share equally in any dividends, liquidation proceeds or other distribution with respect to our common stock and the Articles of Incorporation can only be amended by a vote of the shareholders. Additionally, Oregon law provides that amendments to our Articles of Incorporation that would adversely alter the rights, powers or preferences of a given class of stock, must be approved by the class of stock adversely affected by the proposed amendment. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. Because the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis.


9



Following is a reconciliation of net income and weighted average shares used for our basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts):
Three Months Ended September 30,
 
2017
 
2016
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
49,687

 
$
2,199

 
$
50,262

 
$
3,779

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

 
(1
)
 
1

 
(1
)
Reallocation of net income due to conversion of Class B to Class A common shares outstanding
 
285

 

 
439

 

Conversion of Class B common shares into Class A common shares
 
1,908

 

 
3,326

 

Effect of dilutive stock options on net income
 
5

 
(5
)
 
13

 
(13
)
Net income applicable to common stockholders - diluted
 
$
51,886

 
$
2,193

 
$
54,041

 
$
3,765

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,948

 
1,060

 
23,432

 
1,762

Conversion of Class B common shares into Class A common shares
 
1,060

 

 
1,762

 

Effect of dilutive stock options on weighted average common shares
 
68

 

 
96

 

Weighted average common shares outstanding – diluted
 
25,076

 
1,060

 
25,290

 
1,762

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
2.07

 
$
2.07

 
$
2.15

 
$
2.15

Net income per common share - diluted
 
$
2.07

 
$
2.07

 
$
2.14

 
$
2.14

  
Three Months Ended September 30,
 
2017
 
2016
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
9

 

 

 



10



Nine Months Ended September 30,
 
2017
 
2016
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
147,876

 
$
7,937

 
$
134,533

 
$
11,206

Reallocation of distributed net income as a result of conversion of dilutive stock options
 
3

 
(3
)
 
5

 
(5
)
Reallocation of distributed net income due to conversion of Class B to Class A common shares outstanding
 
1,006

 

 
1,365

 

Conversion of Class B common shares into Class A common shares
 
6,909

 

 
9,794

 

Effect of dilutive stock options on net income
 
19

 
(19
)
 
42

 
(42
)
Net income applicable to common stockholders - diluted
 
$
155,813

 
$
7,915

 
$
145,739

 
$
11,159

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,812

 
1,278

 
23,530

 
1,960

Conversion of Class B common shares into Class A common shares
 
1,278

 

 
1,960

 

Effect of dilutive stock options on weighted average common shares
 
68

 

 
108

 

Weighted average common shares outstanding – diluted
 
25,158

 
1,278

 
25,598

 
1,960

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
6.21

 
$
6.21

 
$
5.72

 
$
5.72

Net income per common share - diluted
 
$
6.19

 
$
6.19

 
$
5.69

 
$
5.69

Nine Months Ended September 30,
 
2017
 
2016
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
10

 

 

 


Note 9. Equity-Method Investment

In October 2014, we acquired a 99.9% membership interest in a limited liability company managed by U.S. Bancorp Community Development Corporation with a total equity contribution of $49.8 million. This investment generated new markets tax credits under the New Markets Tax Credit Program (“NMTC Program”). The NMTC Program was established by Congress in 2000 to spur new or increased investments into operating businesses and real estate projects located in low-income communities.

While U.S. Bancorp Community Development Corporation exercised management control over the limited liability company, due to the economic interest we held in the entity, we determined our ownership portion of the entity was appropriately accounted for using the equity method. We exited this equity-method investment in December 2016.
 
We estimated the value of our equity-method investment, which was recorded at fair value on a non-recurring basis, based on a market valuation approach. We used prices and other relevant information generated primarily by recent market transactions involving similar or comparable assets. Because these valuations contained unobservable inputs, we classified the measurement of fair value of our equity-method investment as Level 3.

The following amounts related to this equity-method investment were recorded in our Consolidated Statements of Operations (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Asset impairments to write investment down to fair value
 
$

 
$
3,498

 
$

 
$
10,494

Our portion of the partnership’s operating losses
 

 
2,066

 

 
6,197

Non-cash interest expense related to the amortization of the discounted fair value of future equity contributions
 

 
31

 

 
185

Tax benefits and credits generated
 

 
7,592

 

 
20,374


11




Note 10. Segments

While we have determined that each individual store is a reporting unit, we have aggregated our reporting units into three reportable segments based on their economic similarities: Domestic, Import and Luxury.

Our Domestic segment is comprised of retail automotive franchises that sell new vehicles manufactured by Chrysler, General Motors and Ford. Our Import segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by Honda, Toyota, Subaru, Nissan and Volkswagen. Our Luxury segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by BMW, Mercedes-Benz and Lexus. The franchises in each segment also sell used vehicles, parts and automotive services, as well as, automotive finance and insurance products.

Corporate and other revenue and income includes the results of operations of our stand-alone body shop offset by unallocated corporate overhead expenses, such as corporate personnel costs, and certain unallocated reserve and elimination adjustments. Additionally, certain internal corporate expense allocations increase segment income for Corporate and other while decreasing segment income for the other reportable segments. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters that perform certain dealership functions.

We define our chief operating decision maker (“CODM”) to be certain members of our executive management group. Historical and forecasted operational performance is evaluated on a store-by-store basis and on a consolidated basis by the CODM. We derive the operating results of the segments directly from our internal management reporting system. The accounting policies used to derive segment results are substantially the same as those used to determine our consolidated results, except for the internal allocation within Corporate and other discussed above. Our CODM measures the performance of each operating segment based on several metrics, including earnings from operations, and uses these results, in part, to evaluate the performance of, and to allocate resources to, each of the operating segments.

12



Certain financial information on a segment basis is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
 
Domestic
 
$
1,008,310

 
$
893,156

 
$
2,863,018

 
$
2,495,468

Import
 
1,209,955

 
983,947

 
3,276,667

 
2,777,007

Luxury
 
463,518

 
392,537

 
1,246,484

 
1,111,215

 
 
2,681,783


2,269,640


7,386,169

 
6,383,690

Corporate and other
 
(1,441
)
 
327

 
(2,690
)
 
2,477

 
 
$
2,680,342


$
2,269,967


$
7,383,479

 
$
6,386,167

Segment income1:
 
 
 
 
 
 
 
 
Domestic
 
$
31,141

 
$
32,292

 
$
84,440

 
$
84,420

Import
 
36,954

 
32,934

 
91,365

 
86,878

Luxury
 
7,515

 
7,423

 
22,542

 
21,736

 
 
75,610


72,649


198,347

 
193,034

Corporate and other
 
34,541

 
26,794

 
111,281

 
81,881

Depreciation and amortization
 
(14,828
)
 
(12,206
)
 
(41,598
)
 
(36,372
)
Other interest expense
 
(9,905
)
 
(5,647
)
 
(23,745
)
 
(16,608
)
Other income (expense), net
 
1,125

 
(1,513
)
 
11,357

 
(4,534
)
Income before income taxes
 
$
86,543


$
80,077


$
255,642

 
$
217,401

 
1Segment income for each of the segments is defined as income before income taxes, depreciation and amortization, other interest expense and other income (expense), net.
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Floor plan interest expense:
 
 
 
 
 
 
 
 
Domestic
 
$
9,900

 
$
6,303

 
$
26,570

 
$
19,031

Import
 
8,007

 
4,613

 
20,608

 
13,241

Luxury
 
4,494

 
2,720

 
11,018

 
8,027

 
 
22,401

 
13,636

 
58,196

 
40,299

Corporate and other
 
(11,772
)
 
(7,450
)
 
(30,183
)
 
(21,995
)
 
 
$
10,629

 
$
6,186

 
$
28,013

 
$
18,304

 
 
 
September 30, 2017
 
December 31, 2016
Total assets:
 
 
 
 
Domestic
 
$
1,256,960

 
$
1,225,387

Import
 
1,067,466

 
959,355

Luxury
 
590,515

 
511,779

Corporate and other
 
1,456,652

 
1,147,629

 
 
$
4,371,593

 
$
3,844,150


13



Note 11. Contingencies

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

California Wage and Hour Litigations
In August 2014, Ms. Holzer filed a complaint in the Central District of California (Holzer v. DCH Auto Group (USA) Inc., Case No. BC558869) alleging that her employer, an affiliate of DCH Auto Group (USA) Inc., failed to provide vehicle finance and sales persons, service advisors, and other clerical and hourly workers accurate and complete wage statements; and statutory meal and rest periods. The complaint also alleges that the employer failed to pay these employees for off-the-clock time worked; and wages due at termination. The plaintiffs also seek attorney fees and costs. DCH has sought to compel arbitration based on plaintiffs’ arbitration agreements. The plaintiffs (and several other employees in separate actions) are seeking relief under California’s PAGA provisions.

During the pendency of Holzer, related cases were filed that made substantially similar non-technician claims. DCH and all non-technician claimants settled their individual claims in mediation in 2017. In January 2017, DCH and all non-technician plaintiffs agreed in principle to settle the representative claims, although this settlement has not yet been approved by the California courts as expressly contemplated by the parties and required by applicable law as a condition of the agreed release of claims. DCH Auto Group (USA) Limited must indemnify Lithia Motors, Inc. for losses related to this claim pursuant to the stock purchase agreement between Lithia Motors, Inc. and DCH Auto Group (USA) Limited dated June 14, 2014. We believe the exposure related to this lawsuit, when considered in relation to the terms of the stock purchase agreement, is immaterial to our financial statements.

Note 12. Acquisitions

In the first nine months of 2017, we completed the following acquisitions:
On May 1, 2017, Baierl Auto Group, an eight store platform based in Pennsylvania.
On August 7, 2017, Downtown LA ("DTLA") Auto Group, a seven store platform based in California.

Revenue and net income contributed by the 2017 acquisitions subsequent to the date of acquisition were as follows (in thousands):
Revenue
$
281,416

Net income
$
4,378


In 2016, we completed the following acquisitions:
On January 26, 2016, Singh Subaru in Riverside, California.
On February 1, 2016, Ira Toyota in Milford, Massachusetts.
On June 23, 2016, Helena Auto Center, LLC in Helena, Montana.
On August 1, 2016, Kemp Ford in Thousand Oaks, California.
On September 12, 2016, Carbone Auto Group, a nine store platform based in New York and Vermont.
On September 28, 2016, Greiner Ford Lincoln in Casper, Wyoming.
On October 5, 2016, Woodland Hills Audi in Woodland Hills, California.
On November 16, 2016, Honolulu Ford in Honolulu, Hawaii.

All acquisitions were accounted for as business combinations under the acquisition method of accounting. The results of operations of the acquired stores are included in our Consolidated Financial Statements from the date of acquisition.
 
The following tables summarize the consideration paid for the 2017 acquisitions and the amount of identified assets acquired and liabilities assumed as of the acquisition date (in thousands):
 
 
Consideration
Cash paid, net of cash acquired
 
$
400,558

Equity securities issued 1
 
2,137

Debt issued
 
1,748

 
 
$
404,443



14



1 In partial consideration for the purchase of Baierl Auto Group, we issued 4,489 shares of our Class A common stock on May 1, 2017 and will issue an additional 17,957 shares over the next four years for a total of 22,446 shares. As of May 1, 2017, these shares were deemed outstanding for purposes of calculating basic and diluted EPS and had a market value of $2.1 million, based on the closing price of our Class A common stock on May 1, 2017 of $95.22 per share. See also Note 8.

The purchase price allocations for the Baierl Auto Group and DTLA Auto Group acquisitions are preliminary and we have not obtained and evaluated all of the detailed information necessary to finalize the opening balance sheet amounts in all respects. We recorded the purchase price allocations based upon information that is currently available. Unallocated items are recorded as a component of other non-current assets in the Consolidated Balance Sheets.
 
 
Assets Acquired and Liabilities Assumed
Trade receivables, net
 
$
15,554

Inventories
 
190,079

Franchise value
 

Property and equipment
 
57,217

Other assets
 
249,725

Floor plan notes payable
 
(75,065
)
Debt and capital lease obligations
 
(11,837
)
Other liabilities
 
(21,230
)
 
 
$
404,443


In the three and nine-month periods ended September 30, 2017, we recorded $3.5 million and $5.7 million, respectively, in acquisition related expenses as a component of selling, general and administrative expense. These expenses include costs related to current year acquisitions, as well as reserve adjustments associated with contingent consideration recorded in association with previous acquisitions. We did not have any material acquisition expenses for the same periods in 2016.
 
The following unaudited proforma summary presents consolidated information as if all acquisitions in the three and nine-month periods ended September 30, 2017 and 2016 had occurred on January 1, 2016 (in thousands, except per share amounts):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenue
 
$
2,773,082

 
$
2,792,994

 
$
8,032,963

 
$
7,941,561

Net income
 
53,488

 
59,925

 
164,938

 
163,473

Basic net income per share
 
2.14

 
2.38

 
6.57

 
6.41

Diluted net income per share
 
2.13

 
2.37

 
6.56

 
6.39

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

Note 13. Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued accounting standards update ("ASU") 2014-09, "Revenue from Contracts with Customers," which amends the accounting guidance related to revenues. This amendment will replace most of the existing revenue recognition guidance when it becomes effective. The new standard, as amended in July 2015, is effective for fiscal years beginning after December 15, 2017 and entities are allowed to adopt the standard as early as annual periods beginning after December 15, 2016, and interim periods therein. The standard permits the use of either the retrospective or cumulative effect transition method. We have evaluated the effect this amendment will have on our most significant types of transactions and expect the timing of most of our revenue recognition to generally remain the same. A portion of the transaction price related to sales of finance and insurance contracts will likely be considered variable consideration and subject to accelerated recognition under the new standard. The new standard requires an entity to estimate variable consideration and apply the constraint in determining the transaction price. We are still evaluating how much variable consideration should be constrained and at what

15



point the constraint is resolved, which will also determine the amount of any potential cumulative effect adjustment. As a result, we have not yet quantified the impact to our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. We are evaluating the effect this pronouncement will have on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies the accounting for several aspects of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. In January 2017, we adopted this new guidance. As a result, we recorded the following:
Reclassified $0.2 million as a decrease to additional paid-in capital and an increase to retained earnings related to our policy election to record forfeitures as they occur.
All prior periods presented in our Consolidated Statements of Cash Flows have been adjusted for the presentation of excess tax benefits on the cash flow statement. This resulted in a $4.4 million reclassification between financing and operating cash flows.
We had $0.3 million of tax-affected state net operating loss carryforwards related to excess tax benefits for which a deferred tax asset had not been recognized. At adoption, this amount was recorded with the offset to retained earnings. Additionally, we do not believe that it is more-likely-than-not that the asset will be utilized and, as a result, a valuation allowance in the same amount was recorded that offset the impact to retained earnings. 

In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provides guidance for eight cash flow classification issues to reduce diversity in practice. The clarification includes guidance on items such as debt prepayment or debt extinguishment cost, contingent consideration payment made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies and distributions received from equity method investees. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted. We are evaluating the effect this pronouncement will have on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment." ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the updated standard, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU 2017-04 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our financial position, results of operations or cash flows.

In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting." ASU 2017-09 reduces both diversity in practice and cost and complexity when changing the terms or conditions of a share-based payment award. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. ASU 2017-09 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued. The amendments in this update should be applied prospectively to an award modified on or after the adoption date. We do not expect the adoption of ASU 2017-09 to have a material effect on our financial position, results of operations or cash flows.


16



Note 14. Subsequent Events
 
Disposal of Stores
On October 16, 2017, we disposed of Spokane Mercedes in Spokane, Washington. The disposal generated cash of approximately $13.2 million.

Common Stock Dividend
On October 23, 2017, our Board of Directors approved a dividend of $0.27 per share on our Class A and Class B common stock related to our third quarter 2017 financial results. The dividend will total approximately $6.7 million and will be paid on November 24, 2017 to shareholders of record on November 10, 2017.

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements and Risk Factors
Certain statements under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “project”, “outlook,” “target”, “may,” “will,” “would,” “should,” “seek,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “likely,” “goal,” “strategy,” “future,” “maintain,” and “continue” or the negative of these terms or other comparable terms. Examples of forward-looking statements in this Form 10-Q include, among others, statements we make regarding:
Future market conditions, including anticipated national new car sales levels;
Expected operating results, such as improved store performance; continued improvement of SG&A as a percentage of gross profit and all projections;
Anticipated continued success of acquisitions;
Anticipated ability to capture additional market share;
Anticipated ability to find accretive acquisitions;
Anticipated additions of dealership locations to our portfolio in the future;
Anticipated availability of liquidity from our unfinanced operating real estate; and
Anticipated levels of capital expenditures in the future.
 
The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results to materially differ from the results expressed or implied by these statements. Certain important factors that could cause actual results to differ from our expectations are discussed in Part II - Other Information, Item 1A in this Form 10-Q and in the Risk Factors section of our 2016 Annual Report on Form 10-K, as supplemented and amended from time to time in Quarterly Reports on Form 10-Q and our other filings with the Securities and Exchange Commission.
 
By their nature, forward-looking statements involve risks and uncertainties because they relate to events that depend on circumstances that may or may not occur in the future. You should not place undue reliance on these forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. We assume no obligation to update or revise any forward-looking statement.
 
Overview
We are one of the largest automotive retailers in the highly fragmented American auto retail industry. As of November 7, 2017, we offered 30 brands of new vehicles and all major brands of used vehicles in 166 stores in the United States and online at over 200 websites. We sell new and used vehicles and replacement parts, provide vehicle maintenance, warranty, paint and repair services, arrange related financing, and sell service contracts, vehicle protection products and credit insurance.
 
In 2016, we were the fifth largest public automotive retailer in the U.S., as measured by revenue. Our stores are located in 18 states with concentrations west of the Mississippi and in the Northeast and offer 30 brands of new vehicles and all major brands of used vehicles. Our operations consist of domestic, import and luxury stores in markets ranging from mid-sized regional cities to metropolitan urban areas.

Results of Operations
For the three months ended September 30, 2017 and 2016, we reported net income of $51.9 million, or $2.07 per diluted share, and $54.0 million, or $2.14 per diluted share, respectively. For the nine months ended September 30, 2017 and 2016, we reported net income of $155.8 million, or $6.19 per diluted share, and $145.7 million, or $5.69 per diluted share, respectively.


17



Key Revenue and Gross Profit Metrics
Key performance metrics for revenue and gross profit were as follows (dollars in thousands):
Three Months Ended
September 30, 2017
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
1,553,511

 
58.0
%
 
$
88,045

 
5.7
%
 
21.8
%
Used vehicle retail
 
679,180

 
25.3

 
78,658

 
11.6

 
19.5

Used vehicle wholesale
 
65,739

 
2.5

 
1,174

 
1.8

 
0.3

Finance and insurance 1
 
101,044

 
3.8

 
101,044

 
100.0

 
25.1

Service, body and parts
 
265,683

 
9.9

 
132,492

 
49.9

 
32.9

Fleet and other
 
15,185

 
0.5

 
1,608

 
10.6

 
0.4

 
 
$
2,680,342

 
100.0
%
 
$
403,021

 
15.0
%
 
100.0
%
 
Three Months Ended
September 30, 2016
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
1,297,511

 
57.2
%
 
$
75,843

 
5.8
 %
 
22.5
 %
Used vehicle retail
 
580,885

 
25.6

 
68,809

 
11.8

 
20.4

Used vehicle wholesale
 
75,271

 
3.3

 
918

 
1.2

 
0.3

Finance and insurance 1
 
87,709

 
3.9

 
87,709

 
100.0

 
26.0

Service, body and parts
 
217,148

 
9.6

 
104,342

 
48.1

 
30.9

Fleet and other
 
11,443

 
0.4

 
(360
)
 
(3.1
)
 
(0.1
)
 
 
$
2,269,967

 
100.0
%
 
$
337,261

 
14.9
 %
 
100.0
 %

1 Commissions reported net of anticipated cancellations.
Nine Months Ended
September 30, 2017
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
4,147,870

 
56.2
%
 
$
238,702

 
5.8
%
 
21.3
%
Used vehicle retail
 
1,915,038

 
25.9

 
221,947

 
11.6

 
19.8

Used vehicle wholesale
 
206,754

 
2.8

 
4,403

 
2.1

 
0.4

Finance and insurance 1
 
282,672

 
3.8

 
282,672

 
100.0

 
25.2

Service, body and parts
 
744,262

 
10.1

 
368,166

 
49.5

 
32.9

Fleet and other
 
86,883

 
1.2

 
4,054

 
4.7

 
0.4

 
 
$
7,383,479

 
100.0
%
 
$
1,119,944

 
15.2
%
 
100.0
%
 
Nine Months Ended
September 30, 2016
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
3,602,603

 
56.4
%
 
$
215,471

 
6.0
%
 
22.3
%
Used vehicle retail
 
1,667,258

 
26.1

 
200,311

 
12.0

 
20.7

Used vehicle wholesale
 
207,131

 
3.2

 
4,234

 
2.0

 
0.4

Finance and insurance 1
 
246,390

 
3.9

 
246,390

 
100.0

 
25.5

Service, body and parts
 
616,088

 
9.6

 
299,060

 
48.5

 
30.9

Fleet and other
 
46,697

 
0.8

 
1,013

 
2.2

 
0.2

 
 
$
6,386,167

 
100.0
%
 
$
966,479

 
15.1
%
 
100.0
%

1 Commissions reported net of anticipated cancellations.


18



Same Store Operating Data
We believe that same store comparisons are an important indicator of our financial performance. Same store measures demonstrate our ability to grow revenues in our existing locations. As a result, same store measures have been integrated into the discussion below.
 
Same store measures reflect results for stores that were operating in each comparison period and only include the months when operations occurred in both periods. For example, a store acquired in August 2016 would be included in same store operating data beginning in September 2017, after its first full complete comparable month of operation. The third quarter operating results for the same store comparisons would include results for that store in only the period of September for both comparable periods.

New Vehicle Revenue and Gross Profit
 
 
Three Months Ended September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
1,553,511

 
$
1,297,511

 
$
256,000

 
19.7
 %
Gross profit
 
$
88,045

 
$
75,843

 
$
12,202

 
16.1

Gross margin
 
5.7
%
 
5.8
%
 
(10
)bp
1 
 
 
 
 
 
 
 
 
 
 
Retail units sold
 
45,452

 
38,417

 
7,035

 
18.3

Average selling price per retail unit
 
$
34,179

 
$
33,774

 
$
405

 
1.2

Average gross profit per retail unit
 
$
1,937

 
$
1,974

 
$
(37
)
 
(1.9
)
 
 
 
 
 
 
 
 


Same store
 
 

 
 

 
 

 
 

Revenue
 
$
1,288,680

 
$
1,280,030

 
$
8,650

 
0.7

Gross profit
 
$
72,246

 
$
74,903

 
$
(2,657
)
 
(3.5
)
Gross margin
 
5.6
%
 
5.9
%
 
(30
)bp
 


 
 
 
 
 
 
 
 


Retail units sold
 
37,762

 
37,870

 
(108
)
 
(0.3
)
Average selling price per retail unit
 
$
34,126

 
$
33,801

 
$
325

 
1.0

Average gross profit per retail unit
 
$
1,913

 
$
1,978

 
$
(65
)
 
(3.3
)
 

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

19



 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
4,147,870

 
$
3,602,603

 
$
545,267

 
15.1
 %
Gross profit
 
$
238,702

 
$
215,471

 
$
23,231

 
10.8

Gross margin
 
5.8
%
 
6.0
%
 
(20
)bp
1 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
121,944

 
107,225

 
14,719

 
13.7

Average selling price per retail unit
 
$
34,015

 
$
33,599

 
$
416

 
1.2

Average gross profit per retail unit
 
$
1,957

 
$
2,010

 
$
(53
)
 
(2.6
)
 
 
 
 
 
 
 
 


Same store
 
 
 
 
 
 

 
 

Revenue
 
$
3,602,946

 
$
3,582,725

 
$
20,221

 
0.6

Gross profit
 
$
207,549

 
$
214,415

 
$
(6,866
)
 
(3.2
)
Gross margin
 
5.8
%
 
6.0
%
 
(20
)bp
 


 
 
 
 
 
 
 
 


Retail units sold
 
105,870

 
106,599

 
(729
)
 
(0.7
)
Average selling price per retail unit
 
$
34,032

 
$
33,609

 
$
423

 
1.3

Average gross profit per retail unit
 
$
1,960

 
$
2,011

 
$
(51
)
 
(2.5
)
 
1 A basis point is equal to 1/100th of one percent

New vehicle sales increased 19.7% and 15.1% in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016, primarily driven by an increase in volume related to acquisitions.

Same store new vehicle unit sales decreased 0.3% and 0.7%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. These volume decreases were offset by a 1.0% and 1.3% increase, respectively, in average price per unit for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. On a same store basis, our stores performed better than national new vehicle sales levels, which decreased 1.2% and 1.9% , respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.
 
Same store unit sales increased (decreased) as follows:

 
Three months ended September 30, 2017 compared to the same period of 2016
 
National growth in the three months ended September 30, 2017 compared to the same period of 2016 ¹
 
Nine months ended September 30, 2017 compared to the same period of 2016
 
National growth in the nine months ended September 30, 2017 compared to the same period of 2016 ¹
Domestic brand same store unit sales change
 
(5.8
)%
 
(2.9
)%
 
(3.1
)%
 
(3.6
)%
Import brand same store unit sales change
 
4.5

 
0.6

 
2.7

 
(0.6
)
Luxury brand same store unit sales change
 
(7.8
)
 
(2.7
)
 
(9.7
)
 
0.3

Overall
 
(0.3
)
 
(1.2
)
 
(0.7
)
 
(1.9
)

1 National auto unit sales and seasonally adjusted annual rate ("SAAR") data obtained from Stephens Auto Unit Sales and SAAR report as of September 2017.

National new vehicle sales market growth continues to moderate for all brands. Our domestic brand unit volume change outperformed the national average for the nine-month period ended September 30, 2017 compared to the same period of 2016 despite a decline in the third quarter of 2017 that exceeded the national domestic brand decline for the same period. Our performance, compared to the national trend for domestic brands, was mainly driven by Chrysler, which had same store unit sales decreases of 9.0% and 3.4%, respectively, offset by Ford, which had a same store unit sales increases of 6.5% and 1.5%, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. This performance compares to

20



national market decreases of 10.3% and 8.0%, respectively, for Chrysler and 0.9% and 2.9%, respectively, for Ford for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.

Our import brand unit volume outperformed the national average for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Our Toyota stores, which comprised 21.2% of our total new vehicle unit sales in the third quarter of 2017, grew 11.3% and 4.0% for the three and nine-month periods ended September 30, 2017 compared to the same periods in 2016. This compares to national market increases of 8.3% and 0.5%, respectively, for the three and nine-months ended September 30, 2017 compared to the same periods of 2016. Our Honda stores, which comprised 20.4% of our total new vehicle unit sales in the third quarter of 2017, had same store unit increases of 2.1% and 1.1%, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. The national average unit volume increases were 0.8% and 0.3%, respectively, for Honda in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.

The period-over-period volume decreases for our luxury brand unit volume exceeded the national average in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. The decreases were primarily associated with our BMW and Mercedes stores, which comprised 3.3% and 1.2%, respectively, of our total new vehicle unit sales in the third quarter of 2017. Our BMW stores had same store unit sales decreases of 24.6% and 18.6%, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. This compares to national average decreases for BMW of 7.5% and 5.2% for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Our Mercedes stores had same store unit sales decreases of 7.1% and 12.1%, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. This compares to national average decreases for Mercedes of 7.1% and 3.0% for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Our luxury brands were down more than the national average due to decreases in our local markets. We are concentrated in areas such as Seattle and New Jersey, where new vehicle registrations were down. Additionally, our BMW stores lost market share.

We seek to grow our new vehicle sales organically by gaining share in the markets we serve. To increase awareness and customer traffic, we use a combination of traditional, digital and social media advertisements to reach customers. We have established a company-wide target of achieving 25% higher sales than the national OEM average. As of September 30, 2017, our sales were 9% higher than the national OEM average.

New vehicle gross profit increased 16.1% and 10.8%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. On a same store basis, new vehicle gross profit decreased 3.5% and 3.2% in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. The same store average gross profit per unit for new vehicles decreased $65 and $51 in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.

Under our business strategy, we believe that our new vehicle sales create incremental profit opportunities through certain manufacturer incentive programs, arranging of third party financing, vehicle service and insurance contracts, future resale of used vehicles acquired through trade-in and parts and service work.


21



Used Vehicle Retail Revenue and Gross Profit
 
 
Three Months Ended September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Retail revenue
 
$
679,180

 
$
580,885

 
$
98,295

 
16.9
 %
Retail gross profit
 
$
78,658

 
$
68,809

 
$
9,849

 
14.3

Retail gross margin
 
11.6
%
 
11.8
%
 
(20
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
34,717

 
29,636

 
5,081

 
17.1

Average selling price per retail unit
 
$
19,563

 
$
19,601

 
$
(38
)
 
(0.2
)
Average gross profit per retail unit
 
$
2,266

 
$
2,322

 
$
(56
)
 
(2.4
)
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 

 
 

Retail revenue
 
$
593,285

 
$
572,862

 
$
20,423

 
3.6

Retail gross profit
 
$
71,248

 
$
68,215

 
$
3,033

 
4.4

Retail gross margin
 
12.0
%
 
11.9
%
 
10
bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
30,115

 
29,171

 
944

 
3.2

Average selling price per retail unit
 
$
19,701

 
$
19,638

 
$
63

 
0.3

Average gross profit per retail unit
 
$
2,366

 
$
2,338

 
$
28

 
1.2

 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Retail revenue
 
$
1,915,038

 
$
1,667,258

 
$
247,780

 
14.9
 %
Retail gross profit
 
$
221,947

 
$
200,311

 
$
21,636

 
10.8

Retail gross margin
 
11.6
%
 
12.0
%
 
(40
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
97,671

 
84,783

 
12,888

 
15.2

Average selling price per retail unit
 
$
19,607

 
$
19,665

 
$
(58
)
 
(0.3
)
Average gross profit per retail unit
 
$
2,272

 
$
2,363

 
$
(91
)
 
(3.9
)
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 

 
 

Retail revenue
 
$
1,730,495

 
$
1,656,119

 
$
74,376

 
4.5

Retail gross profit
 
$
205,438

 
$
199,432

 
$
6,006

 
3.0

Retail gross margin
 
11.9
%
 
12.0
%
 
(10
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
87,553

 
84,148

 
3,405

 
4.0

Average selling price per retail unit
 
$
19,765

 
$
19,681

 
$
84

 
0.4

Average gross profit per retail unit
 
$
2,346

 
$
2,370

 
$
(24
)
 
(1.0
)

Used vehicle retail sales are a strategic focus for organic growth. We offer three categories of used vehicles: manufacturer certified pre-owned ("CPO") vehicles; core vehicles, or late-model vehicles with lower mileage; and value autos, or vehicles with over 80,000 miles. We have established a company-wide target of achieving a per store average of 85 used retail units per month. Strategies to achieve this target include reducing wholesale sales and selling the full spectrum of used units, from late model CPO models to vehicles over ten years old.


22



Same store sales of used vehicles increased (decreased) as follows:
 
 
Three months ended September 30, 2017 compared to the same period of 2016
 
Nine months ended September 30, 2017 compared to the same period of 2016
Certified pre-owned vehicles
 
(5.3
)%
 
(1.2
)%
Core vehicles
 
7.6

 
6.4

Value autos
 
9.3

 
10.8

Overall
 
3.6

 
4.5

 
The increases in same store used vehicle sales were primarily driven by increased unit sales in our core and value auto categories. For value autos, average selling prices increased 4.8% and 5.7%, respectively, for the three and nine-months ended September 30, 2017 compared to the same periods of 2016. For core autos, average selling prices increased 1.1% and 0.2%, respectively, for the three and nine-months ended September 30, 2017 compared to the same periods of 2016. These increases offset the decreases in growth of our CPO vehicles, which had difficult comparisons as this category had double digit growth in 2016. On an annualized average, as of September 30, 2017 and 2016, each of our stores sold 67 and 65 retail used vehicle units, respectively, per month.
 
Used retail vehicle gross profit increased 14.3% and 10.8%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. On a same store basis, gross profit increased 4.4% and 3.0%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016, primarily driven by volume growth, partially offset in the nine-month period by a decrease in the average gross profit per unit sold. The same store gross profit per unit increased $28 and decreased $24, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.

Our used vehicle operations provide an opportunity to generate sales to customers unable or unwilling to purchase a new vehicle, sell brands other than the store’s new vehicle franchise(s) and increase sales from finance and insurance and parts and service.

Used Vehicle Wholesale Revenue and Gross Profit
 
 
Three Months Ended September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Wholesale revenue
 
$
65,739

 
$
75,271

 
$
(9,532
)
 
(12.7
)%
Wholesale gross profit
 
$
1,174

 
$
918

 
$
256

 
27.9

Wholesale gross margin
 
1.8
%
 
1.2
%
 
60
bp
 
 

 
 
 
 
 
 
 
 
 
Wholesale units sold
 
11,122

 
10,853

 
269

 
2.5

Average selling price per wholesale unit
 
$
5,911

 
$
6,936

 
$
(1,025
)
 
(14.8
)
Average gross profit per retail unit
 
$
106

 
$
85

 
$
21

 
24.7


 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Wholesale revenue
 
$
206,754

 
$
207,131

 
$
(377
)
 
(0.2
)%
Wholesale gross profit
 
$
4,403

 
$
4,234

 
$
169

 
4.0

Wholesale gross margin
 
2.1
%
 
2.0
%
 
10
bp
 
 

 
 
 
 
 
 
 
 
 
Wholesale units sold
 
32,868

 
30,140

 
2,728

 
9.1

Average selling price per wholesale unit
 
$
6,290

 
$
6,872

 
$
(582
)
 
(8.5
)
Average gross profit per retail unit
 
$
134

 
$
140

 
$
(6
)
 
(4.3
)


23



Wholesale transactions are vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to age or other factors. Wholesale vehicles are typically sold at or near cost and do not comprise a meaningful component of our gross profit.

Finance and Insurance
 
 
Three Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
101,044

 
$
87,709

 
$
13,335

 
15.2
 %
Average finance and insurance per retail unit
 
$
1,260

 
$
1,289

 
$
(29
)
 
(2.2
)%
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Revenue
 
$
87,371

 
$
86,951

 
$
420

 
0.5
 %
Average finance and insurance per retail unit
 
$
1,287

 
$
1,297

 
$
(10
)
 
(0.8
)%

 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands, except per unit amounts)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
282,672

 
$
246,390

 
$
36,282

 
14.7
%
Average finance and insurance per retail unit
 
$
1,287

 
$
1,283

 
$
4

 
0.3
%
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Revenue
 
$
257,155

 
$
245,397

 
$
11,758

 
4.8
%
Average finance and insurance per retail unit
 
$
1,329

 
$
1,287

 
$
42

 
3.3
%

We believe that arranging timely vehicle financing is an important part of our ability to sell vehicles and we attempt to arrange financing for every vehicle we sell. We also offer related products such as extended warranties, insurance contracts and vehicle and theft protection.

Same store finance and insurance revenues were flat for the three-month period ended September 30, 2017 and increased 4.8% for the nine-month period ended September 30, 2017 as compared to the same periods of 2016. The slowing in the third quarter of 2017 was primarily due to a decline in penetration rates and a decrease in the average finance and insurance amount per retail unit. On a same store basis, our finance and insurance revenues per retail unit decreased $10 and increased $42, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016, mainly due to increases in unit volume offset by flat or slightly declining penetration rates.

Trends in penetration rates for total new and used retail vehicles sold are detailed below:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Finance and insurance
 
75
%
 
76
%
 
76
%
 
77
%
Service contracts
 
45

 
44

 
45

 
44

Lifetime lube, oil and filter contracts
 
26

 
27

 
26

 
27


We seek to increase our penetration of vehicle financing on the number of vehicles that we sell and to offer a comprehensive suite of products. We target an average F&I per retail unit of $1,450. We believe improved performance from sales training and revised compensation plans will be critical factors in achieving this target.


24



Service, Body and Parts Revenue and Gross Profit
 
 
Three Months Ended September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Customer pay
 
$
143,842

 
$
118,915

 
$
24,927

 
21.0
%
Warranty
 
63,350

 
53,203

 
10,147

 
19.1

Wholesale parts
 
39,463

 
30,543

 
8,920

 
29.2

Body shop
 
19,028

 
14,487

 
4,541

 
31.3

Total service, body and parts
 
$
265,683

 
$
217,148

 
$
48,535

 
22.4
%
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
132,492

 
$
104,342

 
$
28,150

 
27.0
%
Service, body and parts gross margin
 
49.9
%
 
48.1
%
 
180 bp

 
 
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Customer pay
 
$
123,001

 
$
117,904

 
$
5,097

 
4.3
%
Warranty
 
52,836

 
52,801

 
35

 
0.1

Wholesale parts
 
30,836

 
29,844

 
992

 
3.3

Body shop
 
14,683

 
13,842

 
841

 
6.1

Total service, body and parts
 
$
221,356

 
$
214,391

 
$
6,965

 
3.2
%
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
109,591

 
$
103,025

 
$
6,566

 
6.4
%
Service, body and parts gross margin
 
49.5
%
 
48.1
%
 
140 bp

 
 


 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Reported
 
 
 
 
 
 
 
 
Customer pay
 
$
402,313

 
$
339,640

 
$
62,673

 
18.5
%
Warranty
 
174,552

 
145,747

 
28,805

 
19.8

Wholesale parts
 
111,796

 
88,710

 
23,086

 
26.0

Body shop
 
55,601

 
41,991

 
13,610

 
32.4

Total service, body and parts
 
$
744,262

 
$
616,088

 
$
128,174

 
20.8
%
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
368,166

 
$
299,060

 
$
69,106

 
23.1
%
Service, body and parts gross margin
 
49.5
%
 
48.5
%
 
100
 bp
 
 

 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Customer pay
 
$
358,724

 
$
338,078

 
$
20,646

 
6.1
%
Warranty
 
152,738

 
145,140

 
7,598

 
5.2

Wholesale parts
 
92,124

 
87,958

 
4,166

 
4.7

Body shop
 
44,723

 
40,966

 
3,757

 
9.2

Total service, body and parts
 
$
648,309

 
$
612,142

 
$
36,167

 
5.9
%
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
320,345

 
$
297,185

 
$
23,160

 
7.8
%
Service, body and parts gross margin
 
49.4
%
 
48.5
%
 
90
 bp
 
 


We provide service, body and parts for the new vehicle brands sold by our stores, as well as service and repairs for most other makes and models. Our parts and service operations are an integral part of our customer retention and the largest contributor to our overall profitability. Earnings from service, body and parts have historically been more resilient during economic downturns, when owners have tended to repair their existing vehicles rather than buy new vehicles.

25




Our service, body and parts sales grew in all areas in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. There are more late-model units in operation as new vehicle sales volumes have been increasing since 2010. We believe this increase in units in operation will continue to benefit our service, body and parts sales in the coming years as more late-model vehicles age and require repairs and maintenance.
 
We focus on retaining customers by offering competitively-priced routine maintenance and through our marketing efforts. We increased our same store customer pay business 4.3% and 6.1%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016.
 
Same store warranty sales increased 0.1% and 5.2%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Warranty sales growth slowed in the third quarter of 2017, as compared to the growth experience in the nine-month period ended September 30, 2017. This is due to slowing warranty work related to recalls, particularly Honda and Toyota, which had decreases in warranty sales of 39.2% and 14.9%, respectively, in the three month period ended September 30, 2017 and decreases of 14.9% and 11.3%, respectively, in the nine-month period ended September 30, 2017 as compared to the same periods of 2016. Our domestic and luxury stores offset this trend, resulting in the slight increase for the quarter.
 
The increases in same-store warranty work by segment were as follows:
 
 
Three months ended September 30, 2017 compared to the same period of 2016
 
Nine months ended September 30, 2017 compared to the same period of 2016
Domestic
 
10.0
 %
 
6.5
 %
Import
 
(11.5
)
 
(0.3
)
Luxury
 
9.8

 
13.8

 
Same store wholesale parts increased 3.3% and 4.7% in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. We target independent repair shops, competing new vehicle dealers and wholesale accounts to expand parts sales to other repair shops.
 
Same store body shop increased 6.1% and 9.2%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Our stores have increased production through calculated adjustments to optimize personnel and equipment.

Same store service, body and parts gross profit increased 6.4% and 7.8%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016, which is in line with our revenue growth. Our gross margins increased as our mix shifted toward customer pay, which has a higher margin than other service.

Segments
Certain financial information by segment is as follows:
 
 
Three Months Ended September 30,
 
Increase (Decrease)
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenues:
 
 
 
 
 
 
 
 
Domestic
 
$
1,008,310

 
$
893,156

 
$
115,154

 
12.9
%
Import
 
1,209,955

 
983,947

 
226,008

 
23.0

Luxury
 
463,518

 
392,537

 
70,981

 
18.1

 
 
2,681,783

 
2,269,640

 
412,143

 
18.2

Corporate and other
 
(1,441
)
 
327

 
(1,768
)
 
NM

 
 
$
2,680,342

 
$
2,269,967

 
$
410,375

 
18.1
%
NM - not meaningful

26



 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenues:
 
 
 
 
 
 
 
 
Domestic
 
$
2,863,018

 
$
2,495,468

 
$
367,550

 
14.7
%
Import
 
3,276,667

 
2,777,007

 
499,660

 
18.0

Luxury
 
1,246,484

 
1,111,215

 
135,269

 
12.2

 
 
7,386,169

 
6,383,690

 
1,002,479

 
15.7

Corporate and other
 
(2,690
)
 
2,477

 
(5,167
)
 
NM

 
 
$
7,383,479

 
$
6,386,167

 
$
997,312

 
15.6
%
NM - not meaningful
 
 
Three Months Ended September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
 
Segment income1:
 
 
 
 
 
 
 
 
Domestic
 
$
31,141

 
$
32,292

 
$
(1,151
)
 
(3.6
)%
Import
 
36,954

 
32,934

 
4,020

 
12.2

Luxury
 
7,515

 
7,423

 
92

 
1.2

 
 
75,610

 
72,649

 
2,961

 
4.1

Corporate and other
 
34,541

 
26,794

 
7,747

 
28.9

Depreciation and amortization
 
(14,828
)
 
(12,206
)
 
2,622

 
21.5

Other interest expense
 
(9,905
)
 
(5,647
)
 
4,258

 
75.4

Other income (expense), net
 
1,125

 
(1,513
)
 
2,638

 
NM

Income before income taxes
 
$
86,543

 
$
80,077

 
$
6,466

 
8.1
 %
 
NM – not meaningful
 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Segment income1:
 
 
 
 
 
 
 
 
Domestic
 
$
84,440

 
$
84,420

 
$
20

 
%
Import
 
91,365

 
86,878

 
4,487

 
5.2

Luxury
 
22,542

 
21,736

 
806

 
3.7

 
 
198,347

 
193,034

 
5,313

 
2.8

Corporate and other
 
111,281

 
81,881

 
29,400

 
35.9

Depreciation and amortization
 
(41,598
)
 
(36,372
)
 
5,226

 
14.4

Other interest expense
 
(23,745
)
 
(16,608
)
 
7,137

 
43.0

Other income (expense), net
 
11,357

 
(4,534
)
 
15,891

 
NM

Income before income taxes
 
$
255,642

 
$
217,401

 
$
38,241

 
17.6
%
 NM – Not meaningful

1Segment income for each reportable segment is defined as income before income taxes, depreciation and amortization, other interest expense and other expense, net.

27



 
 
Three Months Ended September 30,
 
Increase
 
% Increase
 
 
2017
 
2016
 
 
Retail new vehicle unit sales:
 
 
 
 
 
 
 
 
Domestic
 
13,911

 
12,735

 
1,176

 
9.2
%
Import
 
26,621

 
21,467

 
5,154

 
24.0

Luxury
 
5,029

 
4,287

 
742

 
17.3

 
 
45,561

 
38,489

 
7,072

 
18.4

Allocated to management
 
(109
)
 
(72
)
 
37

 
NM

 
 
45,452

 
38,417

 
7,035

 
18.3
%
NM – Not meaningful

 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
 
 
2017
 
2016
 
 
Retail new vehicle unit sales:
 
 
 
 
 
 
 
 
Domestic
 
39,407

 
35,176

 
4,231

 
12.0
%
Import
 
69,643

 
59,581

 
10,062

 
16.9

Luxury
 
13,168

 
12,667

 
501

 
4.0

 
 
122,218

 
107,424

 
14,794

 
13.8

Allocated to management
 
(274
)
 
(199
)
 
75

 
NM

 
 
121,944

 
107,225

 
14,719

 
13.7
%

Domestic
A summary of financial information for our Domestic segment follows:
 
 
Three Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
1,008,310

 
$
893,156

 
$
115,154

 
12.9
 %
Segment income
 
$
31,141

 
$
32,292

 
$
(1,151
)
 
(3.6
)
Retail new vehicle unit sales
 
13,911

 
12,735

 
1,176

 
9.2


 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
2,863,018

 
$
2,495,468

 
$
367,550

 
14.7
%
Segment income
 
$
84,440

 
$
84,420

 
$
20

 

Retail new vehicle unit sales
 
39,407

 
35,176

 
4,231

 
12.0


Our Domestic segment revenue increased 12.9% and 14.7%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Since September 2016, we acquired five additional domestic brand stores, which contributed to increases in new vehicle, used vehicle retail, finance and insurance and service body and parts sales.

Our Domestic segment income decreased 3.6% and was unchanged, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. In the three-months ended September 30, 2017, the decrease in segment income was due to gross profits growth of 14.4%, in line with revenues, offset by growth in SG&A of 17.7% due to expense growth exceeding the rate of gross profit growth in all categories. Our Domestic segment experienced higher SG&A expenses in all areas. Additionally, floor plan interest expense increased 57.1%, comprised of approximately 26% related to increased volume due to acquisitions, 9% related to increased volume at existing stores and 22% related to rising interest rates. For the nine months ended September 30, 2017, segment income was flat despite growth in both revenue and gross profit. Growth in SG&A expenses of 18.6% and floor plan interest expense of 39.6% were the main drivers, offsetting all revenue growth resulting in flat segment income over the same period of 2016.

28




Import
A summary of financial information for our Import segment follows:
 
 
Three Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
1,209,955

 
$
983,947

 
$
226,008

 
23.0
%
Segment income
 
$
36,954

 
$
32,934

 
$
4,020

 
12.2

Retail new vehicle unit sales
 
26,621

 
21,467

 
5,154

 
24.0


 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
3,276,667

 
$
2,777,007

 
$
499,660

 
18.0
%
Segment income
 
$
91,365

 
$
86,878

 
$
4,487

 
5.2

Retail new vehicle unit sales
 
69,643

 
59,581

 
10,062

 
16.9

 
Our Import segment revenue increased 23.0% and 18.0%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016 due to increases in all major business lines. Since September 2016, we added eight import brand stores.

Segment income for our Import segment increased 12.2% and 5.2%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. In the three months ended September 30, 2017, the 12.2% growth in segment income was due to gross profits growth of 22.3%, in line with revenues, offset by SG&A expense growth of 23.2% mainly related to rising facility cost. Floor plan interest expense increased 73.6% and was a significant contributor to the slower growth in segment income. Acquisitions, resulting in increased volumes, comprised 27.5% of this increase, increased inventory levels at existing stores increased floor plan interest expense 14.2% and rising interest rates increased the expense 31.9%. For the nine months ended September 30, 2017, segment income grew 5.2% and lagged our revenue growth. Gross profit growth was 16.3% and lagged behind revenue growth for the period. Additionally, growth in SG&A expenses was 17.7%, slightly higher than the growth in gross profit, and floor plan interest expense increased 55.6% due to increased inventory levels and rising interest rates. The net effect of these factors was slower segment income growth compared to revenue growth.

Luxury
A summary of financial information for our Luxury segment follows:
 
 
Three Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
463,518

 
$
392,537

 
$
70,981

 
18.1
%
Segment income
 
$
7,515

 
$
7,423

 
$
92

 
1.2

Retail new vehicle unit sales
 
5,029

 
4,287

 
742

 
17.3


 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue
 
$
1,246,484

 
$
1,111,215

 
$
135,269

 
12.2
%
Segment income
 
$
22,542

 
$
21,736

 
$
806

 
3.7

Retail new vehicle unit sales
 
13,168

 
12,667

 
501

 
4.0


Our Luxury segment revenue increased 18.1% and 12.2%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016 due to increases in used vehicle retail, finance and insurance and service body and parts sales. In the past twelve months, we added five luxury brand stores.
 

29



Our Luxury segment income increased 1.2% and 3.7%, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. In the three months ended September 30, 2017, the 1.2% growth in segment income was due to gross profit growth of 21.9%, offset by an SG&A expense increase of 22.7%, mainly related to advertising expense. Floor plan interest expense increase of 65.2%, which was comprised of 33.1% related to increased volume from acquisitions, 7.8% related to increased volume at existing stores and 24.3% related to rising interest rates. These factors resulted in slower Luxury segment income growth compared to revenue growth. For the nine months ended September 30, 2017, segment income grew 3.7% and lagged our revenue growth for that period. Gross profit growth was 13.5%, slightly better than revenue growth for the period. This was offset by growth in SG&A expense of 13.7% and floor plan interest expense growth of 37.3% due to rising interest rates and increasing inventories. These factors resulted in slower segment income growth than revenue growth.

Corporate and Other
Revenues attributable to Corporate and other include the results of operations of our stand-alone body shop, offset by certain unallocated reserve and elimination adjustments related to vehicle sales.
 
 
Three Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue, net
 
$
(1,441
)
 
$
327

 
$
(1,768
)
 
(540.7
)%
Segment income
 
$
34,541

 
$
26,794

 
$
7,747

 
28.9


 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
 
Revenue, net
 
$
(2,690
)
 
$
2,477

 
$
(5,167
)
 
(208.6
)%
Segment income
 
$
111,281

 
$
81,881

 
$
29,400

 
35.9

 
The decreases in Corporate and other revenue in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016 were primarily related to changes to certain reserves that are not specifically identified with our domestic, import or luxury segment revenue, such as our reserve for revenue reversals associated with unwound vehicle sales and elimination of revenues associated with internal corporate vehicle purchases and leases with our stores. Corporate and other revenues were impacted in 2017 from an increase in internal corporate vehicle purchases and leases with our stores resulting in negative revenues for the three and nine month-periods ended September 30, 2017.
 
Segment income attributable to Corporate and other includes amounts associated with the operating income from our stand-alone body shop, and certain internal corporate expense allocations that reduce reportable segment income but increase Corporate and other income. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters who perform certain dealership functions.

Corporate and other segment income increased $7.7 million and $29.4 million, respectively, for the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. These increases were due to the addition of 18 stores in the past twelve months, reduced by certain unusual expenses. The three and nine-month periods ended September 30, 2017 included acquisition expenses of $3.5 million and $5.7 million, respectively, and an insurance reserve charge of $1.7 million and $5.6 million, respectively, related storm damages. The 2016 results included impairment charges of $3.5 million and $10.5 million, respectively, for the three and nine-month periods ended September 30, 2016 related to an equity investment.

Asset Impairments
Asset impairments consist of the following:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Dollars in thousands)
 
2017
 
2016
 
2017
 
2016
Equity-method investment
 
$

 
$
3,498

 
$

 
$
10,494

 

30



The asset impairments recorded in 2016 were associated with our equity-method investment in a limited liability company. We evaluated this equity-method investment at the end of each reporting period and identified indications of loss resulting from other than temporary declines in value. We exited this equity-method investment in December 2016. See Note 9 of the Condensed Notes to the Consolidated Financial Statements for additional information.

Selling, General and Administrative Expense (“SG&A”)
SG&A includes salaries and related personnel expenses, advertising (net of manufacturer cooperative advertising credits), rent, facility costs, and other general corporate expenses.
 
 
Three Months Ended September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Personnel
 
$
182,443

 
$
151,801

 
$
30,642

 
20.2
%
Advertising
 
24,572

 
20,110

 
4,462

 
22.2

Rent
 
8,768

 
6,694

 
2,074

 
31.0

Facility costs
 
14,992

 
12,488

 
2,504

 
20.1

Other
 
51,466

 
37,041

 
14,425

 
38.9

Total SG&A
 
$
282,241

 
$
228,134

 
$
54,107

 
23.7
%
 
 
Three Months Ended September 30,
 
Increase
As a % of gross profit
 
2017
 
2016
 
Personnel
 
45.3
%
 
45.0
%
 
30
bp
Advertising
 
6.1

 
6.0

 
10

Rent
 
2.2

 
2.0

 
20

Facility costs
 
3.7

 
3.7

 

Other
 
12.7

 
10.9

 
180

Total SG&A
 
70.0
%
 
67.6
%
 
240
bp

 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Personnel
 
$
513,439

 
$
445,053

 
$
68,386

 
15.4
%
Advertising
 
67,516

 
59,229

 
8,287

 
14.0

Rent
 
23,216

 
20,040

 
3,176

 
15.8

Facility costs
 
44,371

 
30,920

 
13,451

 
43.5

Other
 
133,761

 
107,524

 
26,237

 
24.4

Total SG&A
 
$
782,303

 
$
662,766

 
$
119,537

 
18.0
%
 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
As a % of gross profit
 
2017
 
2016
 
Personnel
 
45.8
%
 
46.0
%
 
(20
)bp
Advertising
 
6.0
%
 
6.1
%
 
(10
)
Rent
 
2.1
%
 
2.1
%
 

Facility costs
 
4.0
%
 
3.2
%
 
80

Other
 
12.0
%
 
11.2
%
 
80

Total SG&A
 
69.9
%
 
68.6
%
 
130
bp
 

SG&A expense increased 23.7% and 18.0%, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. Overall, increases in SG&A expense were due primarily to growth through acquisitions. In the three-month period ended September 30, 2017 compared to the same period in 2016, increases related to rent expenses and other expenses outpaced the overall increase. Increased rent expense in the three-month period ended September 30, 2017 was a result of our

31



recent acquisitions in the current quarter with leased properties. Other expenses in the three-month period ended September 30, 2017 include acquisition expenses of $3.5 million, storm insurance reserve charges of $1.7 million and other reserve adjustments related to our auto loan receivables and medical insurance. For the nine-month period ended September 30, 2017, facility cost and other expenses increased more significantly than other components of SG&A. The increase in facility costs was mainly due to lower costs as a result of a $3.4 million gain for property-related insurance proceeds and a $1.1 million gain on the sale of stores in the first quarter 2016. For the nine-month period ended September 30, 2017, other expenses included $5.7 million of acquisition expenses, a $5.6 million increase in storm insurance reserve related charges and increases to other reserves related to our auto loan receivables.

SG&A expense adjusted for non-core charges was as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Personnel
 
$
182,443

 
$
151,803

 
$
30,640

 
20.2
%
Advertising
 
24,572

 
20,110

 
4,462

 
22.2

Rent
 
8,768

 
6,694

 
2,074

 
31.0

Adjusted facility costs
 
14,992

 
12,489

 
2,503

 
20.0

Adjusted other
 
46,246

 
37,038

 
9,208

 
24.9

Adjusted total SG&A
 
$
277,021

 
$
228,134

 
$
48,887

 
21.4
%
 
 
 
Three Months Ended
September 30,
 
Increase
As a % of gross profit
 
2017
 
2016
 
Personnel
 
45.3
%
 
45.0
%
 
30
bp
Advertising
 
6.1
%
 
6.0
%
 
10

Rent
 
2.2
%
 
2.0
%
 
20

Adjusted facility costs
 
3.7
%
 
3.7
%
 

Adjusted other
 
11.4
%
 
10.9
%
 
50

Adjusted total SG&A
 
68.7
%
 
67.6
%
 
110
bp

 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Personnel
 
$
513,439

 
$
445,055

 
$
68,384

 
15.4
%
Advertising
 
67,516

 
59,229

 
8,287

 
14.0
%
Rent
 
23,216

 
20,040

 
3,176

 
15.8
%
Adjusted facility costs
 
44,371

 
32,007

 
12,364

 
38.6
%
Adjusted other
 
122,526

 
105,616

 
16,910

 
16.0
%
Adjusted total SG&A
 
$
771,068

 
$
661,947

 
$
109,121

 
16.5
%

 
 
Nine Months Ended
September 30,
 
Increase (Decrease)
As a % of gross profit
 
2017
 
2016
 
Personnel
 
45.8
%
 
46.0
%
 
(20
)bp
Advertising
 
6.0
%
 
6.1
%
 
(10
)
Rent
 
2.1
%
 
2.1
%
 

Adjusted facility costs
 
4.0
%
 
3.3
%
 
70

Adjusted other
 
10.9
%
 
11.0
%
 
(10
)
Adjusted total SG&A
 
68.8
%
 
68.5
%
 
30
bp


32



Adjusted SG&A for the three months ended September 30, 2017 excludes acquisition expenses of $3.5 million and a storm insurance reserve related charge of $1.7 million. For the three months ended September 30, 2016 there were no adjustments to SG&A. Adjusted SG&A for the nine month period ended September 30, 2017 excludes $5.7 million of acquisition expense and $5.6 million of storm insurance related charges. In the nine month period ended September 30, 2016 adjusted SG&A excludes a $1.1 million gain for the disposal of stores, offset by a $1.9 million legal reserve adjustment. See “Non-GAAP Reconciliations” for more details.

Depreciation and Amortization
Depreciation and amortization is comprised of depreciation expense related to buildings, significant remodels or improvements, furniture, tools, equipment and signage and amortization of certain intangible assets, including customer lists and non-compete agreements.
 
 
Three Months Ended September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Depreciation and amortization
 
$
14,828

 
$
12,206

 
$
2,622

 
21.5
%
 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Depreciation and amortization
 
$
41,598

 
$
36,372

 
$
5,226

 
14.4
%

The increases in depreciation and amortization in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016 were primarily due to capital expenditures and acquisitions that occurred since September 30, 2016. Our largest capital investments were related to expanding and improving facilities subsequent to the acquisition of stores, as well as investments in improvements at our existing facilities. These investments increase the amount of depreciable assets and amortizable expenses. In the full year of 2016 and the first nine months of 2017, we had capital expenditures of $100.8 million and $72.2 million, respectively.

Operating Margin
Operating income as a percentage of revenue, or operating margin, was as follows:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Operating margin
 
4.0
%
 
4.1
%
 
4.0
%
 
4.0
%
Operating margin adjusted for non-core charges 1
 
4.1
%
 
4.3
%
 
4.2
%
 
4.2
%

1 See “Non-GAAP Reconciliations” for more details.
 
Operating margin declined slightly in the three months ended September 30, 2017 compared to the same period in 2016 and was consistent with prior year for the nine months ended September 30, 2017. Adjusting for non-core charges, as detailed below in Non-GAAP Reconciliations, adjusted operating margin declined slightly in the three months ended September 30, 2017 compared to the same period in 2016 and was consistent with the prior year for the nine months ended September 30, 2017. Our recent acquisitions of the Baierl Auto Group and DTLA Auto Group impacted our operating margin as we continue to integrate these stores into our cost structure. We continue to focus on cost control, which allows us to leverage our cost structure in an environment of improving sales.

Floor Plan Interest Expense and Floor Plan Assistance

 
 
Three Months Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
(Dollars in thousands)
 
2017
 
2016
 
% Change
 
2017
 
2016
 
% Change
Floor plan interest expense (new vehicles)
 
10,629

 
6,186

 
71.8
%
 
28,013

 
18,304

 
53.0
%


33



Floor plan interest expense increased $4.4 million and $9.7 million, respectively, in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016. The 72% increase in floor plan interest expense for the three-month period ended September 30, 2017 compared to the same period in 2016 was due to a 31% increase in inventory levels related to acquisitions, a 22% increase in existing store inventory levels, and a 19% increase related to increasing LIBOR rates as compared to the same period of 2016. The 53% increase in floor plan interest expense for the nine-month period ended September 30, 2017 compared to the same period in 2016 was due to a 21% increase related to acquisitions, an 17% due to increasing inventory levels at existing stores and a 15% increase due to increasing LIBOR rates.
 
Floor plan assistance is provided by manufacturers to support store financing of new vehicle inventory. Under accounting standards, floor plan assistance is recorded as a component of new vehicle gross profit when the specific vehicle is sold. However, because manufacturers provide this assistance to offset inventory carrying costs, we believe a comparison of floor plan interest expense to floor plan assistance is a useful measure of the efficiency of our new vehicle sales relative to stocking levels.

The following tables detail the carrying costs for new vehicles and include new vehicle floor plan interest net of floor plan assistance earned.
 
 
Three Months Ended September 30,
 
 
 
%
(Dollars in thousands)
 
2017
 
2016
 
Change
 
Change
Floor plan interest expense (new vehicles)
 
$
10,629

 
$
6,186

 
$
4,443

 
71.8
 %
Floor plan assistance (included as an offset to cost of sales)
 
(15,130
)
 
(12,044
)
 
(3,086
)
 
25.6

Net new vehicle carrying costs
 
$
(4,501
)
 
$
(5,858
)
 
$
1,357

 
(23.2
)%

 
 
Nine Months Ended
September 30,
 
 
 
%
(Dollars in thousands)
 
2017
 
2016
 
Change
 
Change
Floor plan interest expense (new vehicles)
 
$
28,013

 
$
18,304

 
$
9,709

 
53.0
 %
Floor plan assistance (included as an offset to cost of sales)
 
(40,186
)
 
(33,614
)
 
(6,572
)
 
19.6

Net new vehicle carrying costs
 
$
(12,173
)
 
$
(15,310
)
 
$
3,137

 
(20.5
)%

Other Interest Expense
Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle inventory financing facility and our revolving line of credit.
 
 
Three Months Ended September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Mortgage interest
 
$
4,964

 
$
3,787

 
$
1,177

 
31.1

Other interest
 
5,092

 
1,939

 
3,153

 
162.6

Capitalized interest
 
(151
)
 
(79
)
 
72

 
91.1

Total other interest expense
 
$
9,905

 
$
5,647

 
4,258

 
75.4
%

 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Mortgage interest
 
$
14,049

 
$
11,034

 
$
3,015

 
27.3
%
Other interest
 
10,040

 
5,889

 
4,151

 
70.5

Capitalized interest
 
(344
)
 
(315
)
 
29

 
9.2

Total other interest expense
 
$
23,745

 
$
16,608

 
7,137

 
43.0
%

The increases of $4.3 million and $7.1 million, respectively, in other interest expense in the three and nine-month periods ended September 30, 2017 compared to the same periods of 2016 were primarily due to higher volumes of borrowing on our credit

34



facility and higher mortgage interest due to additional mortgage financings and increased interest rates. In July 2017, we issued $300 million in 5.25% Senior Notes, which contributed $3.0 million of additional interest expense in the third quarter of 2017.

Other Income (Expense), Net
 
 
Three Months Ended September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Other Income (Expense), net
 
$
1,125

 
$
(1,513
)
 
$
2,638

 
NM
 
 
Nine Months Ended
September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Other Income (Expense), net
 
$
11,357

 
$
(4,534
)
 
$
15,891

 
NM

Other income (expense), net in the nine-month period ended September 30, 2017 included a $9.1 million gain related to legal settlements with OEMs recorded in the first quarter of 2017. Other income (expense), net in 2016 included the gains and losses related to equity-method investments, which we exited in December 2016.

Income Tax Provision
Our effective income tax rate was as follows:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
Effective income tax rate
 
40.0
%
 
32.5
%
 
39.1
%
 
33.0
%
Effective income tax rate excluding tax credits generated through our equity-method investment and other non-core items 1
 
40.3
%
 
39.3
%
 
39.1
%
 
39.3
%

1 See “Non-GAAP Reconciliations” for more details.
 
Our 2016 tax rate was positively affected by new markets tax credits that were generated through our equity-method investment with U.S. Bancorp Community Development Corporation. Our effective tax rates for the three and nine-month periods ended September 30, 2017 were negatively impacted by an increasing presence in states with higher income tax rates. Our effective tax rate for the nine-month period ended September 30, 2017 was favorably impacted by excess tax benefits related to our stock-based compensation as a result of the adoption of new guidance that was applied prospectively beginning in 2017. See Note 13 of the Condensed Notes to the Consolidated Financial Statements for additional information.
 
Excluding the tax credits generated by our equity-method investment and adjusting for other non-core items, our effective tax rate was slightly impacted by the recognition of excess tax benefits related to our stock-based compensation offset by our increasing presence in states with higher state income tax rates.

Non-GAAP Reconciliations
We believe each of the non-GAAP financial measures below improves the transparency of our disclosures, provides a meaningful presentation of our results from the core business operations because they exclude adjustments for items not related to our ongoing core business operations and other non-cash adjustments, and improves the period-to-period comparability of our results from the core business operations. We use these measures in conjunction with GAAP financial measures to assess our business, including our compliance with covenants in our credit facility and in communications with our Board of Directors concerning financial performance. These measures should not be considered an alternative to GAAP measures.
 

35



The following tables reconcile certain reported non-GAAP measures to the most comparable GAAP measure from our Consolidated Statements of Operations:
 
 
Three Months Ended September 30, 2017
(Dollars in Thousands, Except per Share Amounts)
 
As reported
 
Insurance reserves
 
Acquisition expenses
 
Adjusted
Selling, general and administrative
 
$
282,241

 
$
(1,704
)
 
$
(3,516
)
 
$
277,021

Operating income
 
105,952

 
1,704

 
3,516

 
111,172

 
 
 
 
 
 
 
 
 
Income before income taxes
 
$
86,543

 
$
1,704

 
$
3,516

 
$
91,763

Income tax provision
 
(34,657
)
 
(943
)
 
(1,380
)
 
(36,980
)
Net income
 
$
51,886

 
$
761

 
$
2,136

 
$
54,783

 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
2.07

 
$
0.03

 
$
0.08

 
$
2.18

Diluted share count
 
25,076

 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2016
(Dollars in thousands, except per share amounts)
 
As reported
 
Equity-method investment
 
Adjusted
Asset impairment
 
$
3,498

 
$
(3,498
)
 
$

Operating income
 
93,423

 
3,498

 
96,921

Other income (expense)
 
(1,513
)
 
2,066

 
553

 
 
 
 
 
 
 
Income before income taxes
 
$
80,077

 
$
5,564

 
$
85,641

Income tax provision
 
(26,036
)
 
(7,592
)
 
(33,628
)
Net income (loss)
 
$
54,041

 
$
(2,028
)
 
$
52,013

 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
2.14

 
$
(0.08
)
 
$
2.06

Diluted share count
 
25,290

 
 
 
 

 
 
Nine Months Ended September 30, 2017
(Dollars in thousands, except per share amounts)
 
As reported
 
Insurance reserves
 
Acquisition expenses
 
OEM settlement
 
Adjusted
Selling, general and administrative
 
$
782,303

 
$
(5,582
)
 
$
(5,653
)
 
$

 
$
771,068

Operating income
 
296,043

 
5,582

 
5,653

 

 
307,278

Other (expense) income, net
 
11,357

 

 

 
(9,111
)
 
2,246

 
 
 
 
 
 
 
 
 
 


Income (loss) before income taxes
 
$
255,642

 
$
5,582

 
$
5,653

 
$
(9,111
)
 
$
257,766

Income tax (provision) benefit
 
(99,829
)
 
(2,174
)
 
(2,201
)
 
3,423

 
(100,781
)
Net income (loss)
 
$
155,813

 
$
3,408

 
$
3,452

 
$
(5,688
)
 
$
156,985

 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
6.19

 
$
0.14

 
$
0.14

 
$
(0.23
)
 
$
6.24

Diluted share count
 
25,158

 
 
 
 
 
 
 
 
 

36



 
 
Nine Months Ended September 30, 2016
(Dollars in thousands, except per share amounts)
 
As reported
 
Disposal gain on sale of stores
 
Equity-method investment
 
Legal reserve adjustment
 
Adjusted
Asset impairment
 
$
10,494

 
$

 
$
(10,494
)
 
$

 
$

Selling, general and administrative
 
662,766

 
1,087

 

 
(1,906
)
 
661,947

Operating Income (expense)
 
256,847

 
(1,087
)
 
10,494

 
1,906

 
268,160

Other (expense) income, net
 
(4,534
)
 

 
6,197

 

 
1,663

 
 
 
 
 
 
 
 
 
 


Income (loss) before income taxes
 
$
217,401

 
$
(1,087
)
 
$
16,691

 
$
1,906

 
$
234,911

Income tax (provision) benefit
 
(71,662
)
 
426

 
(20,374
)
 
(747
)
 
(92,357
)
Net income (loss)
 
$
145,739

 
$
(661
)
 
$
(3,683
)
 
$
1,159

 
$
142,554

 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
5.69

 
$
(0.03
)
 
$
(0.14
)
 
$
0.05

 
$
5.57

Diluted share count
 
25,598

 
 
 
 
 
 
 
 

Liquidity and Capital Resources
We manage our liquidity and capital resources to fund our operating, investing and financing activities. We rely primarily on cash flows from operations and borrowings under our credit facilities or in capital markets as the main sources for liquidity. We use those funds to invest in capital expenditures, increase working capital and fulfill contractual obligations. Remaining funds are used for acquisitions, debt retirement, cash dividends, share repurchases and general business purposes.
 
Available Sources
Below is a summary of our immediately available funds:
 
 
As of September 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2017
 
2016
 
 
Cash and cash equivalents
 
$
38,577

 
$
24,116

 
$
14,461

 
60.0
%
Available credit on the credit facilities
 
268,831

 
122,138

 
146,693

 
120.1

Total current available funds
 
307,408

 
146,254


161,154

 
110.2

Estimated funds from unfinanced real estate
 
211,379

 
193,247

 
18,132

 
9.4

Total estimated available funds
 
$
518,787

 
$
339,501


$
179,286

 
52.8
%
 
Cash flows generated by operating activities and borrowings under our credit facility and other types of debt are our most significant sources of liquidity. We also have the ability to raise funds through mortgaging real estate. As of September 30, 2017, our unencumbered owned operating real estate had a book value of $282 million. Assuming we can obtain financing on 75% of this value, we estimate we could have obtained additional funds of approximately $211 million at September 30, 2017; however, no assurances can be provided that the appraised value of these properties will match or exceed their book values or that this capital source will be available on terms acceptable to us.
 
In July 2017, we issued $300 million in aggregate principal amount of 5.25% senior notes due 2025 in a private placement under Rule 144A and Regulation S of the Securities Act of 1933. We used the net proceeds for general corporate purposes, including funding acquisitions, capital expenditures and debt repayment.

In addition to the above sources of liquidity, potential sources include the placement of subordinated debt or loans, the sale of equity securities and the sale of stores or other assets. We evaluate all of these options and may select one or more of them depending on overall capital needs and the availability and cost of capital, although no assurances can be provided that these capital sources will be available in sufficient amounts or with terms acceptable to us.
 

37



Information about our cash flows, by category, is presented in our Consolidated Statements of Cash Flows. The following table summarizes our cash flows:
 
 
Nine Months Ended September 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
in Cash Flow
Net cash provided by operating activities
 
$
260,536

 
$
194,240

 
$
66,296

Net cash used in investing activities
 
(464,917
)
 
(289,484
)
 
(175,433
)
Net cash provided by financing activities
 
192,676

 
74,352

 
118,324

 
Operating Activities
Cash provided by operating activities for the nine months ended September 30, 2017 increased $66.3 million compared to the same period of 2016, primarily related to changes in inventory.
 
Borrowings from and repayments to our syndicated lending group related to our new vehicle inventory floor plan financing are presented as financing activities. To better understand the impact of changes in inventory and the associated financing, we also consider our adjusted net cash provided by operating activities to include borrowings or repayments associated with our new vehicle floor plan credit facility.

Adjusted net cash provided by operating activities is presented below (in thousands):
 
 
Nine Months Ended September 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
in Cash Flow
Net cash provided by operating activities – as reported
 
$
260,536

 
$
194,240

 
$
66,296

Add: Net borrowings on floor plan notes payable, non-trade
 
34,056

 
93,817

 
(59,761
)
Less: Borrowings on floor plan notes payable, non-trade associated with acquired new vehicle inventory
 
(85,527
)
 
(88,147
)
 
2,620

Net cash provided by operating activities – adjusted
 
$
209,065


$
199,910


$
9,155

 
Inventories are the most significant component of our cash flow from operations. As of September 30, 2017, our new vehicle days supply was 69, or one day higher than our days supply as of December 31, 2016. Our days supply of used vehicles was 63 days as of September 30, 2017, or seven days higher than our days supply as of December 31, 2016. We calculate days supply of inventory based on current inventory levels, excluding in-transit vehicles, and a 30-day historical cost of sales level. We have continued to focus on managing our unit mix and maintaining an appropriate level of new and used vehicle inventory.
 
Investing Activities
Net cash used in investing activities totaled $464.9 million and $289.5 million, respectively, for the nine-month periods ended September 30, 2017 and 2016. Cash flows from investing activities relate primarily to capital expenditures, acquisition and divestiture activity and sales of property and equipment.
 
Below are highlights of significant activity related to our cash flows from investing activities:
 
 
Nine Months Ended September 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
in Cash Flow
Capital expenditures
 
$
(72,174
)
 
$
(81,363
)
 
$
9,189

Cash paid for acquisitions, net of cash acquired
 
(400,558
)
 
(199,435
)
 
(201,123
)
Cash paid for other investments
 
(7,929
)
 
(22,279
)
 
14,350

Proceeds from sales of stores
 
3,417

 
11,837

 
(8,420
)


38



Capital Expenditures
Below is a summary of our capital expenditure activities:
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2017
 
2016
Post-acquisition capital improvements
 
$
19,893

 
$
37,714

Facilities for open points
 
714

 
32

Purchases of previously leased facilities
 

 
27,381

Existing facility improvements
 
26,400

 
11,810

Maintenance
 
25,167

 
4,426

Total capital expenditures
 
$
72,174

 
$
81,363

 
Many manufacturers provide assistance in the form of additional incentives or assistance if facilities meet specified standards and requirements. We expect that certain facility upgrades and remodels will generate additional manufacturer incentive payments. Also, tax laws allowing accelerated deductions for capital expenditures reduce the overall investment needed and encourage accelerated project timelines.
 
We expect to use a portion of our future capital expenditures to upgrade facilities that we recently acquired. This additional capital investment is contemplated in our initial evaluation of the investment return metrics applied to each acquisition and is usually associated with manufacturer standards and requirements.

If we undertake a significant capital commitment in the future, we expect to pay for the commitment out of existing cash balances, construction financing and borrowings on our credit facility. Upon completion of the projects, we believe we would have the ability to secure long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended, although no assurances can be provided that these financings will be available to us in sufficient amounts or on terms acceptable to us.

We expect to make expenditures of approximately $93 million in 2017 for capital improvements at recently acquired stores, purchases of land for expansion of existing stores, facility image improvements, purchases of store facilities, purchases of previously leased facilities and replacement of equipment.
 
Acquisitions
We focus on acquiring stores at attractive purchase prices that meet our return thresholds and strategic objectives. We look for acquisitions that diversify our brand and geographic mix as we continue to evaluate our portfolio to minimize exposure to any one manufacturer and achieve financial returns.
 
We are able to subsequently floor new vehicle inventory acquired as part of an acquisition; however, the cash generated by this transaction is recorded as borrowings on floor plan notes payable, non-trade.

Adjusted net cash paid for acquisitions, as well as certain other acquisition-related information is presented below:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Number of stores acquired
 
15

 
13

Number of stores opened
 
1

 
1

Number of franchises added
 

 
1

 
 
 
 
 
(Dollars in thousands)
 
 
 
 
Cash paid for acquisitions, net of cash acquired
 
$
400,558

 
$
199,435

Less: Borrowings on floor plan notes payable: non-trade associated with acquired new vehicle inventory
 
(85,527
)
 
(88,147
)
Cash paid for acquisitions, net of cash acquired – adjusted
 
$
315,031

 
$
111,288

 
We evaluate potential capital investments primarily based on targeted rates of return on assets and return on our net equity investment.

39




Financing Activities
Net cash provided or (used) in financing activities, adjusted for borrowing on floor plan facilities: non-trade was as follows:
 
 
Nine Months Ended September 30,
 
Increase
(Dollars in thousands)
 
2017
 
2016
 
in Cash Flow
Cash provided in financing activities, as reported
 
$
192,676

 
$
74,352

 
$
118,324

Adjust: Repayments (borrowings) on floor plan notes payable: non-trade
 
(34,056
)
 
(93,817
)
 
59,761

Cash provided (used) in financing activities – adjusted
 
$
158,620

 
$
(19,465
)
 
$
178,085

 
Below are highlights of significant activity related to our cash flows from financing activities, excluding net borrowings on floor plan notes payable: non-trade, which are discussed above:
 
 
Nine Months Ended September 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2017
 
2016
 
in Cash Flow
Net (repayments) borrowings on lines of credit
 
$
(126,853
)
 
$
97,129

 
$
(223,982
)
Principal payments on long-term debt and capital leases, unscheduled
 
(46,471
)
 
(5,903
)
 
(40,568
)
Proceeds from issuance of long-term debt
 
395,905

 
22,816

 
373,089

Repurchases of common stock
 
(31,521
)
 
(108,597
)
 
77,076

Dividends paid
 
(19,803
)
 
(17,823
)
 
(1,980
)
 
Borrowing and Repayment Activity
During the first nine months of 2017, we raised net proceeds of $349.4 million from our Senior Notes offering and real estate mortgage debt. We used the funds to pay down our outstanding balances on our long-term debt and our lines of credit, acquire stores and fund repurchases of common stock. Our debt to total capital ratio, excluding floor plan notes payable, was 49.5% at September 30, 2017 compared to 46.5% at September 30, 2016.
 
Equity Transactions
On February 25, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. We repurchased a total of 342,300 shares of our Class A common stock at an average price of $92.08 per share in the first nine months of 2017. This included 310,000 shares as part of the repurchase plan at an average price per share of $91.33 and 32,300 shares related to tax withholding on vesting RSUs at an average price of $99.33. As of September 30, 2017, we had $164.8 million remaining available for repurchases and the authorization does not have an expiration date.
 
In the first nine months of 2017, we declared and paid dividends on our Class A and Class B common stock as follows:
Dividend paid:
 
Dividend amount
per share
 
Total amount of dividend
(in thousands)
March 2017
 
$
0.25

 
$
6,292

May 2017
 
$
0.27

 
$
6,760

August 2017
 
$
0.27

 
$
6,751

 
We evaluate performance and make a recommendation to the Board of Directors on dividend payments on a quarterly basis.
 

40



Summary of Outstanding Balances on Credit Facilities and Long-Term Debt
Below is a summary of our outstanding balances on credit facilities and long-term debt:
 
 
As of September 30, 2017
 
 
(Dollars in thousands)
 
Outstanding
 
Remaining Available
 
 
Floor plan note payable: non-trade
 
$
1,598,111

 
$

 
1 
Floor plan notes payable
 
114,833

 

 
 
Used vehicle inventory financing facility
 
5,000

 
45,000

 
2 
Revolving lines of credit
 
221,654

 
223,831

 
2, 3 
Real estate mortgages
 
476,559

 

 
  
5.25% Senior Subordinated Notes due 2025
 
300,000

 

 
 
Other debt
 
12,699

 

 
  
Total debt outstanding
 
2,728,856

 
268,831

 
 
Less: unamortized debt issuance costs
 
(6,960
)
 

 
 
Total debt
 
$
2,721,896

 
$
268,831

 
 
 

1 As of September 30, 2017, we had a $1.9 billion new vehicle floor plan commitment as part of our credit facility.
2 The amount available on the credit facility is limited based on a borrowing base calculation and fluctuates monthly.
3 Available credit is based on the borrowing base amount effective as of August 31, 2017. This amount is reduced by $8.3 million for outstanding letters of credit.

Credit Facility
On August 1, 2017, we amended our existing credit facility to increase the total financing commitment by $350 million to $2.4 billion and extend the maturity to August 2022. This syndicated credit facility is comprised of 18 financial institutions, including seven manufacturer-affiliated finance companies. Under our credit facility we are permitted to allocate the total financing commitment among floor plan financing for new vehicle inventory, floor plan financing for used vehicles (up to a maximum of 16.5% of the total aggregate commitment) and revolving financing for general corporate purposes, including acquisitions and working capital (up to a maximum of 18.75% of the total commitment). Our credit facility may be expanded to $2.75 billion total availability, subject to lender approval. All borrowings from, and repayments to, our lending group are presented in the Consolidated Statements of Cash Flows as financing activities.

Our obligations under our revolving syndicated credit facility are secured by a substantial amount of our assets, including our inventory (including new and used vehicles, parts and accessories), equipment, accounts (and other rights to payment) and our equity interests in certain of our subsidiaries. Under our revolving syndicated credit facility, our obligations relating to new vehicle floor plan loans are secured only by collateral owned by borrowers of new vehicle floor plan loans under the credit facility.

We have the ability to deposit up to $50 million in cash in Principal Reduction (PR) accounts associated with our new vehicle inventory floor plan commitment. The PR accounts are recognized as offsetting credits against outstanding amounts on our new vehicle floor plan commitment and would reduce interest expense associated with the outstanding principal balance. As of September 30, 2017, we had no balances in our PR accounts.

If the outstanding principal balance on our new vehicle inventory floor plan commitment, plus requests on any day, exceeds 95% of the loan commitment, a portion of the revolving line of credit must be reserved. The reserve amount is equal to the lesser of $15.0 million or the maximum revolving line of credit commitment less the outstanding balance on the line less outstanding letters of credit. The reserve amount will decrease the revolving line of credit availability and may be used to repay the new vehicle floor plan commitment balance.

The interest rate on the credit facility varies based on the type of debt, with the rate of one-month LIBOR plus 1.25% for new vehicle floor plan financing, one-month LIBOR plus 1.50% for used vehicle floor plan financing; and a variable interest rate on the revolving financing ranging from the one-month LIBOR plus 1.25% to 2.50%, depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment was 2.48% at September 30, 2017. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 2.73% and 2.48%, respectively, at September 30, 2017.

Under the terms of our credit facility we are subject to financial covenants and restrictive covenants that limit or restrict our incurring additional indebtedness, making investments, selling or acquiring assets and granting security interests in our assets.

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Under our credit facility, we are required to maintain the ratios detailed in the following table:
Debt Covenant Ratio
 
Requirement
 
As of September 30, 2017
Current ratio
 
Not less than 1.10 to 1
 
1.32
 to 1
Fixed charge coverage ratio
 
Not less than 1.20 to 1
 
2.82
 to 1
Leverage ratio
 
Not more than 5.00 to 1
 
2.93
 to 1
 
As of September 30, 2017, we were in compliance with all covenants. We expect to remain in compliance with the financial and restrictive covenants in our credit facility and other debt agreements. However, no assurances can be provided that we will continue to remain in compliance with the financial and restrictive covenants.

If we do not meet the financial and restrictive covenants and are unable to remediate or cure the condition or obtain a waiver from our lenders, a breach would give rise to remedies under the agreement, the most severe of which are the termination of the agreement, acceleration of the amounts owed and the seizure and sale of our assets comprising the collateral for the loans. A breach would also trigger cross-defaults under other debt agreements.

Floor Plan Notes Payable
We have floor plan agreements with manufacturer-affiliated finance companies for new vehicles at certain stores and vehicles designated for use as service loaners. The variable interest rates on these floor plan notes payable commitments vary by manufacturer. At September 30, 2017, $114.8 million was outstanding on these arrangements. Borrowings from, and repayments to, manufacturer-affiliated finance companies are classified as operating activities in the Consolidated Statements of Cash Flows.
 
5.25% Senior Notes Due 2025
On July 24, 2017, we issued $300 million in aggregate principle amount of 5.25% Senior Notes due 2025 ("the Notes") to eligible purchasers in a private placement under Rule 144A and Regulation S of the Securities Act of 1933. Interest accrues on the Notes from July 24, 2017 and is payable semiannually on February 1 and August 1. The first interest payment is due on February 1, 2018. We may redeem the Notes, in whole or in part, at any time prior to August 1, 2020 at a price equal to 100% of the principal amount plus a make-whole premium set forth in the Indenture and accrued and unpaid interest. After August 1, 2020, we may redeem some or all of the Notes subject to the redemption prices set forth in the Indenture. If we experience specific kinds of changes of control, as described in the Indenture, we must offer to repurchase the Notes at 101% of their principal amount plus accrued and unpaid interest to the date of purchase.

We paid $5.0 million of underwriting and other fees in connection with this issuance, which is being amortized as interest expense over the term of the Notes. The Notes will be fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our existing and future restricted subsidiaries that is a borrower under, or that guarantees obligations under, our credit facility or other indebtedness. The terms of the Notes, in certain circumstances, may restrict our ability to, among other things, incur additional indebtedness, pay dividends, repurchase our common stock, or merge, consolidate or sell all or substantially all our assets.

We used the net proceeds for general corporate purposes, which included funding acquisitions, capital expenditures and debt repayment.

Real Estate Mortgages and Other Debt
We have mortgages associated with our owned real estate. Interest rates related to this debt ranged from 3.0% to 5.0% at September 30, 2017. The mortgages are payable in various installments through October 2034. As of September 30, 2017, we had fixed interest rates on 78% of our outstanding mortgage debt.
 
Our other debt includes capital leases and sellers’ notes. The interest rates associated with our other debt ranged from 3.1% to 8.0% at September 30, 2017. This debt, which totaled $12.7 million at September 30, 2017, is due in various installments through December 2050.

Recent Accounting Pronouncements
See Note 13 of the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
 

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Critical Accounting Policies and Use of Estimates
There have been no material changes in the critical accounting policies and use of estimates described in our 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017

Seasonality and Quarterly Fluctuations
Historically, our sales have been lower in the first quarter of each year due to consumer purchasing patterns and inclement weather in certain of our markets. As a result, financial performance is expected to be lower during the first quarter than during the second, third and fourth quarters of each fiscal year. We believe that interest rates, levels of consumer debt, consumer confidence and manufacturer sales incentives, as well as general economic conditions, also contribute to fluctuations in sales and operating results.
 
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
There have been no material changes in our reported market risks or risk management policies since the filing of our 2016 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 28, 2017.

Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
We evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
 
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings

See Note 11 of the Condensed Notes to the Consolidated Financial Statements for additional information.

Item 1A. Risk Factors
 
The risk factors below are modified from those that are included in our 2016 Annual Report on Form 10-K which was filed with the Securities and Exchange Commission on February 28, 2017 to account for our recent note placement and the expansion of our credit facility. The information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed in that report.

Our indebtedness and lease obligations could materially adversely affect our financial health, limit our ability to finance future acquisitions and capital expenditures and prevent us from fulfilling our financial obligations. Much of our debt is secured by a substantial portion of our assets. Much of our debt has a variable interest rate component that may significantly increase our interest costs in a rising rate environment.


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Our indebtedness and lease obligations could have important consequences to us, including the following:
limitations on our ability to complete acquisitions;
impaired ability to obtain additional financing for acquisitions, capital expenditures, working capital or general corporate purposes;
reduced funds available for our operations and other purposes, as a larger portion of our cash flow from operations would be dedicated to the payment of principal and interest on our indebtedness; and
exposure to the risk of increasing interest rates as certain borrowings are, and will continue to be, at variable rates of interest.

In addition, our loan agreements and the indenture governing our 5.25% notes due in 2025 contain covenants that limit our discretion with respect to business matters, including incurring additional debt, granting additional security interests in our assets, acquisition activity, disposing of assets and other business matters. Other covenants are financial in nature, including current ratio, fixed charge coverage and leverage ratio calculations. A breach of any of these covenants could result in a default under the applicable agreement. In addition, a default under one agreement could result in a default and acceleration of our repayment obligations under the other agreements under the cross-default provisions in such other agreements. For example, a default under our $2.4 billion syndicated credit facility could trigger a default and acceleration of our repayment obligations under the indenture governing our $300 million aggregate principal amount 5.25% Notes due in 2025, and vice versa.

We have granted in favor of certain of our lenders and other secured parties, including those under our $2.4 billion revolving syndicated credit facility, a security interest in a substantial portion of our assets. If we default on our obligations under those agreements, the secured parties may be able to foreclose upon their security interests and otherwise be entitled to obtain or control those assets.

Certain debt agreements contain subjective acceleration clauses based on a lender deeming itself insecure or if a “material adverse change” in our business has occurred. If these clauses are implicated, and the lender declares that an event of default has occurred, the outstanding indebtedness could become immediately due and owing.

If these events were to occur, we may not be able to pay our debts or borrow sufficient funds to refinance them. Even if new financing were available, it may not be on terms acceptable to us. As a result of this risk, we could be forced to take actions that we otherwise would not take, or not take actions that we otherwise might take, in order to comply with these agreements.

In addition, the lenders’ obligations to make certain loans or other credit accommodations under our credit facility is subject to the satisfaction of certain conditions precedent including, for example, that our representations and warranties in the agreement and related loan documents are true and correct in all material respects as of the date of the proposed credit extension. If any of our representations and warranties in those agreements are not true and correct in all material respects as of the date of a proposed credit extension, or if other conditions precedent are not satisfied, we may not be able to request new loans or other credit accommodations under those credit facilities, which could have a material adverse impact on our business, results of operations, financial condition and cash flows.

Additionally, our real estate debt generally has a five to ten-year term, after which the debt needs to be renewed or replaced. A decline in the appraised value of real estate or a reduction in the loan-to-value lending ratios for new or renewed real estate loans could result in our inability to renew maturing real estate loans at the debt level existing at maturity, or on terms acceptable to us, requiring us to find replacement lenders or to refinance at lower loan amounts.

As of September 30, 2017, approximately 86% of our total debt was variable rate. The majority of our variable rate debt is indexed to the one-month LIBOR rate. The current interest rate environment is at historically low levels, and interest rates will likely increase in the future. In the event interest rates increase, our borrowing costs may increase substantially. Additionally, fixed rate debt that matures may be renewed at interest rates significantly higher than current levels. As a result, this could have a material adverse impact on our business, results of operations, financial condition and cash flows.

We may not be able to satisfy our debt obligations upon the occurrence of a change in control or another event of default under our credit agreement or indenture.

Upon the occurrence of a change in control or another event of default as defined in our credit agreement, the agent under the credit agreement will have the right to declare all outstanding obligations immediately due and payable and to terminate the availability of future advances to us. There can be no assurance that we would have sufficient resources available to satisfy all of our obligations under the credit agreement in the event of a change in control or fundamental change. A "change in control" as defined in our credit agreement includes, among other events, the acquisition by any person, or two or more persons acting in concert, in either case other than Lithia Holdings Company, L.L.C., Sid DeBoer or Bryan DeBoer, of beneficial ownership (within

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the meaning of Rule 13d-3 of the SEC under the Securities Exchange Act of 1934) of 20% or more of the outstanding shares of our voting stock on a fully diluted basis.

Upon a change of control as defined in the indenture governing our 5.25% Senior Notes due in 2025, the holders of the notes may require us to repurchase all or a portion of the notes at a purchase price of 101% of their principal amount plus accrued and unpaid interest, if any, to the date of purchase. Generally, if an event of default occurs under the indenture, the trustee or the holders of at least 25% in principal amount of the then outstanding notes may declare all of the notes to be due and payable.

In the event we were unable to satisfy the above obligations, it could have a material adverse impact on our business and our common stock holders.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
We repurchased the following shares of our Class A common stock during the third quarter of 2017:
 
 
Total number of shares purchased 2
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans 1
 
Maximum dollar value of shares that may yet be purchased under publicly announced plan (in thousands) 1
July
 
20,000

 
$
97.69

 
20,000

 
$
169,411

August
 
23,157

 
103.23

 
23,000

 
167,037

September
 
20,000

 
113.16

 
20,000

 
164,774

 
 
63,157

 
$
104.62

 
63,000

 
$
164,774

 

1 Effective February 29, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. This authorization does not have an expiration date and it replaced the previous authorizations, which limited the number of shares we were authorized to repurchase.
2 Of the shares repurchased in the third quarter of 2017, 157 shares were related to the tax withholdings on vesting RSUs.

Item 5. Other Information
Subsequent to the earnings release filed on a Current Report on Form 8-K on October 25, 2017, and prior to the filing of this Quarterly Report on Form 10-Q, we recorded an elimination of internal used vehicle wholesale transactions and new and used vehicle retail sales. The transactions had no impact on gross profits and were primarily associated with recently acquired stores. This elimination resulted in a reduction of both revenues and cost of sales for the three and nine months ended September 30, 2017 of $10.0 million for used vehicle wholesales, or 15.2% and 4.8%, respectively, of used vehicle wholesale revenues; $3.6 million for new vehicles or 0.2% and 0.1%, respectively, of new vehicle revenues and $0.4 million for used vehicle retail or 0.1% and less than 0.1%, respectively, of used vehicle retail revenues. Adjusted for this elimination, total revenues were $2.7 billion and $7.4 billion, respectively, and total cost of sales were $2.3 billion and $6.3 billion, respectively, for the the three and nine months ended September 30, 2017. This elimination had no other impact to our Consolidated Statements of Operations.


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Item 6. Exhibits
 
The following exhibits are filed herewith and this list is intended to constitute the exhibit index.
3.1
Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999 (incorporated by reference to
exhibit 3.1 to our Form 10-K for the year ended December 31, 1999).
2017 Amended and Restated Bylaws of Lithia Motors, Inc. (incorporated by reference to exhibit 3.1 to Form 8-K dated April 28, 2017 and filed with Securities and Exchange Commission on May 3, 2017).
Indenture, dated as of July 24, 2017, among Lithia Motors, Inc., the Guarantors and the Trustee (incorporated by reference to exhibit 4.1 to Form 8-K dated July 24, 2017 and filed with the Securities and Exchange Commission on July 24, 2017).
Form of 5.250% Senior Notes due 2025 (included as part of Exhibit 4.1)(incorporated by reference to exhibit 4.1 to Form 8-K dated July 24, 2017 and filed with the Securities and Exchange Commission on July 24, 2017).
Sixth Amendment to Amended and Restated Loan Agreement dated July 12, 2017.
Seventh Amendment to Amended and Restated Loan Agreement dated August 1, 2017 (incorporated by reference to exhibit 10.1 to Form 8-K dated August 1, 2017 and filed with the Securities and Exchange Commission on August 3, 2017)
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.

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SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 7, 2017
LITHIA MOTORS, INC.
 
 
 
By: /s/ John F. North III
 
John F. North III
 
Senior Vice President and Chief Financial Officer
 
(Duly Authorized Officer and Principal Financial and
 
Accounting Officer)

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