Lithia Conference Call - Has the Recession Started?

[XDCX]

Lithia held their Fourth Quarter Conference Call this afternoon and many in the media cited the company's results as further evidence that the economy is in a recession. Lithia reported a loss for the Fourth Quarter and cut their Earnings Estimate for 2008.

I had a chance to listen to both the AutoNation and the Lithia Conference Calls and I thought it was interesting that there were some distinct similarities:

• Both companies reported that gross margins declined on New and Used Cars
• Both companies reported higher Used Car Inventories
• Both companies reported a soft Wholesale Auction Market in the Fourth Quarter
• Both companies are interested in adding stores but feel that prices have not fallen in relation to potential earnings

Concerning the last point, Lithia's Management Team indicated that the limited number of Buy/Sells is evidence that sellers need to lower the price of their dealerships in order to find buyers. Like AutoNation, Lithia reported that they are still interesting in acquiring dealerships but they do not feel the prices have dropped to reflect the current market.

[XDCX]

Lithia's stock was down sharply in extended hours trading after the company released their Fourth Quarter Earnings Release - down over 20% at one point.

Although a sell-off might be expected after an earnings miss, I think the magnitude of the sell-off can be attributed to two words - Reporting Irregularities.

Here's the excerpt from Lithia's Press Release:

Sid DeBoer, Lithia's Chairman and CEO stated that, "The Company is completing a review of potential reporting irregularities associated with retail sales at certain store locations and until the review and analysis is finalized, the Company's financial statements and the audit can not be completed. While we do not expect the completion of the review to result in a material additional charge to income, no assurances can be given. Our final audited results will be included in our Form 10-K filing."

It wasn't until the third analyst asked a question on the Conference Call that we received a clear idea of what the concern is. It appears that it's not a question of what was sold, or how much it was sold for, the question is when was it sold?

Given that sliver of information, my guess is that the issue may involve Factory to Dealer Incentives that were pinned to end of the year sales targets. In that environment there can be an incentive to "move" sales from one period to another in an effort to reach a sales goal.

Again, that's just my guess - I could be 100% wrong.

If that were the case, however, how difficult could it be to sort out? The Fourth Quarter ended seven weeks ago.

Maybe this will turn out to be a non-event, but I'm convinced it was the primary reason for the sharp sell-off of Lithia's shares in the extended hours session.

[SHACOS]

I'd love to comment but I'll stay out of this one because I am directly working on the reporting irregularities.

[XDCX]

Originally Posted by SHACOS

I'd love to comment but I'll stay out of this one because I am directly working on the reporting irregularities.

I totally understand and respect your professionalism.

It will be interesting to see how this sorts out - I'm sure that we'll find out when the 10K is released. Management didn't seem too concerned on the Conference Call - perhaps this will be a non-event.

I'm still convinced, however, that this is the reason for the sell-off in Lithia's shares - Wall Street hates accounting issues. If it's just an issue with Factory Incentives, it's too bad they couldn't have set up a reserve account for potential chargebacks and eliminated this as a discussion topic.

Again, it's all just a guess on my part - I'll just have to wait for the 10K.

[XDCX]

OK, I know that this is supposed to be a Forum about Car Dealerships, not the Stock Market.

That said, I couldn't help but to take notice of Lithia's trading this morning - the shares have had some major swings.

Most interesting to me was the action when the stock was trading at $10.01. As soon as the first trade went through at $10.00 it must have triggered some Stop Loss Orders because the stock dropped to $9.78 in a matter of seconds.

A minute later and it's trading above $10 and an hour later and it's trading above $11.

Stop Loss Orders definitely have a purpose, but in this case they may have taken an investor out of the market at the stock's lowest price of the day.

[XDCX]

If you're a publicly traded company that's listed on the NYSE, there's one list that you never want to be at the top of - the NYSE Top Ten Declines.

With a share price drop in excess of 31% Lithia topped the chart and more than doubled the percentage loss of the stock listed in the #2 position.

It will be interesting to see if the shares can recover once Lithia provides more information about the "Reporting Irregularities."

[XDCX]

Originally Posted by XDCX

I totally understand and respect your professionalism.

It will be interesting to see how this sorts out - I'm sure that we'll find out when the 10K is released. Management didn't seem too concerned on the Conference Call - perhaps this will be a non-event.

I'm still convinced, however, that this is the reason for the sell-off in Lithia's shares - Wall Street hates accounting issues. If it's just an issue with Factory Incentives, it's too bad they couldn't have set up a reserve account for potential chargebacks and eliminated this as a discussion topic.

Again, it's all just a guess on my part - I'll just have to wait for the 10K.

I read through the Conference Call notes supplied by Seeking Alpha and answered my question regarding the "Reporting Irregularities."

Here's an excerpt from the Conference Call:

Rex Henderson - Raymond James and Associates

I wanted to quickly return to the issue of the review of the revenue from some of the stores. Could you characterize that for us a little bit about what kind of issue that is? Is it an accounting issue, a revenue recognition, a timing issue, or perhaps is there some employees getting creative out there in terms of inventing revenues that weren't there?

Sid DeBoer

No. It was nothing really to do with revenue, it’s more to do with gross profit and whether we had earned a manufacturing incentive or not, in the time period that it was allocated in. And that's really it is. It ultimately ends up with the same amount of money probably in the company. But time might be different.

Rex Henderson - Raymond James and Associates

Okay. So, it's a timing issue and an accounting issue, not a fraud issue or something like that?

Jeff DeBoer

That's our read on it. I don't know how you define the word fraud. But that's another discussion.

It seems clear from the above excerpt that the issue is the timing of vehicle sales and the dealership's eligibility for Factory to Dealer Incentives.

Hopefully the 10K will resolve this concern and LAD shares can trade on projected earnings and growth.

[SHACOS]

I better get back to work then.