10-Q 1 v023344_10-q.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 Commission file number: 000-24669 HOMETOWN AUTO RETAILERS, INC. (Exact name of Registrant as specified in its charter) Delaware 06-1501703 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1309 South Main Street Waterbury, CT 06706 (Address of principal executive offices) (Zip code) (203) 756-1300 (Registrant's telephone number including area code) 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes[ ] No [X] Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Title Outstanding ------------------------------------------------ ----------- Common Stock, Class A, par value $.001 per share 3,870,137 Common Stock, Class B, par value $.001 per share 2,579,252 INDEX Page PART I. FINANCIAL INFORMATION ITEM 1. Consolidated Balance Sheets at June 30, 2005 (Unaudited) and December 31, 2004 (Restated) (Audited) 3 Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2004 4 Unaudited Consolidated Statements of Stockholders' Equity for the six months ended June 30, 2005 and 2004 5 Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004 (Restated) 6 Notes to Unaudited Consolidated Financial Statements 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 31 ITEM 4. Controls and Procedures 31 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 32 ITEM 2. Unregistered Sales Of Equity Securities and Use of Proceeds 32 ITEM 3. Defaults Upon Senior Securities 32 ITEM 4. Submission of Matters to a Vote of Security Holders 32 ITEM 5. Other Information 32 ITEM 6. Exhibits 32 SIGNATURES 33 CERTIFICATIONS 34 FORWARD LOOKING STATEMENTS Certain statements made in this Quarterly Report on Form 10-Q are "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) regarding the plans and objectives of management for future operations. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of Hometown Auto Retailers, Inc. ("Hometown") to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of Hometown. Although Hometown believes that its assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements, the inclusion of such information should not be regarded as a representation by Hometown or any other person that the objectives and plans of Hometown will be achieved. Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, the factors set forth herein under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations." 2 HOMETOWN AUTO RETAILERS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data)
June 30, December 31, ASSETS 2005 2004 (Unaudited) (Restated) ---------- ---------- Current Assets: Cash and cash equivalents $ 5,050 $ 6,101 Accounts receivable, net 5,467 5,081 Inventories, net 32,013 43,440 Prepaid expenses and other current assets 1,011 634 Deferred and prepaid income taxes 1,464 1,464 ---------- ---------- Total current assets 45,005 56,720 Property and equipment, net 13,264 13,854 Other assets 2,955 3,649 ---------- ---------- Total assets $ 61,224 $ 74,223 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Floor plan notes payable - trade $ 8,440 $ 17,382 Floor plan notes payable - non-trade 21,907 25,092 Accounts payable and accrued expenses 4,784 5,106 Current maturities of long-term debt and capital lease obligations 5,400 5,505 Deferred revenue 562 735 ---------- ---------- Total current liabilities 41,093 53,820 Long-term debt and capital lease obligations 8,302 8,621 Long-term deferred income taxes 123 123 Other long-term liabilities and deferred revenue 714 726 ---------- ---------- Total liabilities 50,232 63,290 Commitments and Contingencies Stockholders' Equity Preferred stock, $.001 par value, 2,000,000 shares authorized, no shares issued and outstanding -- -- Common stock, Class A, $.001 par value, 12,000,000 shares authorized, 3,870,137 shares issued and outstanding 4 4 Common stock, Class B, $.001 par value, 3,760,000 shares authorized, 2,579,252 and 3,519,252 shares issued, respectively 2 3 Additional paid-in capital 28,975 30,017 Accumulated deficit (17,989) (19,091) ---------- ---------- Total stockholders' equity 10,992 10,933 ---------- ---------- Total liabilities and stockholders' equity $ 61,224 $ 74,223 ========== ==========
The accompanying notes are an integral part of these unaudited consolidated financial statements. 3 HOMETOWN AUTO RETAILERS, INC. UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data)
For the Three Months For the Six Months Ended June 30, Ended June 30, ----------------------------- ----------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- Revenues New vehicle sales $ 40,645 $ 44,776 $ 78,670 $ 85,891 Used vehicle sales 16,921 15,780 32,481 32,690 Parts and service sales 5,909 6,155 12,065 12,114 Other, net 1,815 2,011 3,840 3,905 ----------- ----------- ----------- ----------- Total revenues 65,290 68,722 127,056 134,600 Cost of sales New vehicle 37,911 41,960 73,503 80,315 Used vehicle 15,368 14,318 29,371 29,562 Parts and service 2,648 2,813 5,513 5,572 ----------- ----------- ----------- ----------- Total cost of sales 55,927 59,091 108,387 115,449 ----------- ----------- ----------- ----------- Gross profit 9,363 9,631 18,669 19,151 Selling, general and administrative expenses 7,699 8,493 15,708 17,141 ----------- ----------- ----------- ----------- Income from operations 1,664 1,138 2,961 2,010 Interest income 59 37 129 81 Interest (expense) (924) (857) (1,844) (1,631) Other income 589 1 591 3 Other (expense) -- -- -- (4) ----------- ----------- ----------- ----------- Pre-tax income 1,388 319 1,837 459 Provision for income taxes 554 86 735 124 ----------- ----------- ----------- ----------- Net income $ 834 $ 233 $ 1,102 $ 335 =========== =========== =========== =========== Earnings per share, basic $ 0.13 $ 0.03 $ 0.16 $ 0.05 =========== =========== =========== =========== Earnings per share, diluted $ 0.13 $ 0.03 $ 0.16 $ 0.05 =========== =========== =========== =========== Weighted average shares outstanding, basic 6,449,389 7,191,588 6,766,185 7,183,347 Weighted average shares outstanding, diluted 6,584,446 7,324,514 6,895,987 7,397,886
The accompanying notes are an integral part of these unaudited consolidated financial statements. 4 HOMETOWN AUTO RETAILERS, INC. UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Class A Class B Retained Common Stock Common Stock Additional Earnings Total ------------------------ ------------------------- Paid-in (Accumulated Stockholders' Shares Amount Shares Amount Capital Deficit) Equity ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 2003 3,656 $ 4 3,519 $ 3 $ 29,760 $ (22,839) $ 6,928 Exercise of Warrants 214 -- -- -- 257 -- 257 Net income -- -- -- -- -- 335 335 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 2004 3,870 $ 4 3,519 $ 3 $ 30,017 $ (22,504) $ 7,520 ========== ========== ========== ========== ========== ========== ========== Balance at December 31, 2004 3,870 $ 4 3,519 $ 3 $ 30,017 $ (19,091) $ 10,933 Net income -- -- -- -- -- 1,102 1,102 Litigation Settlement (Note 8) -- -- (940) (1) (1,042) -- (1,043) ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 2005 3,870 $ 4 2,579 $ 2 $ 28,975 $ (17,989) $ 10,992 ========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these unaudited consolidated financial statements. 5 HOMETOWN AUTO RETAILERS, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
For the Six Months ended June 30, 2005 2004 (Restated) ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,102 $ 335 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 657 628 Loss on sale of property and equipment -- 4 (Gain) on disposal of dealership (587) -- Deferred income taxes 735 124 Changes in assets and liabilities: Accounts receivable, net (540) 187 Inventories, net 4,977 (11,559) Prepaid expenses and other current assets (377) (15) Prepaid taxes (156) (191) Other assets 36 12 Floor plan notes payable - trade (2,278) 7,822 Accounts payable and accrued expenses (441) 17 Deferred revenue (173) 307 Other long-term liabilities and deferred revenue (12) 73 ---------- ---------- Net cash provided by (used in) operating activities 2,943 (2,256) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (91) (1,684) ---------- ---------- Net cash (used in) investing activities (91) (1,684) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from floor plan notes payable - non-trade 78,932 84,648 Payment of floor plan notes payable - non-trade (82,117) (79,915) Principal payments of long-term debt and capital lease obligations (943) (957) Proceeds from long-term borrowings 225 1,350 Exercise of warrants -- 257 ---------- ---------- Net cash provided by (used in) financing activities (3,903) 5,383 Net increase (decrease) in cash and cash equivalents (1,051) 1,443 CASH AND CASH EQUIVALENTS, beginning of period 6,101 5,639 ---------- ---------- CASH AND CASH EQUIVALENTS, end of period $ 5,050 $ 7,082 ========== ========== Cash paid for - Interest $ 1,891 $ 1,630 Cash paid for - Taxes $ 156 $ 191 Purchases financed by capital lease obligations $ 464 $ 590
The accompanying notes are an integral part of these unaudited consolidated financial statements. Supplemental Cash flow Information: On May 11, 2005 Hometown transferred certain assets and liabilities to the Vergopia's resulting in a gain of approximately $587,000 on the transaction. (See note 8 to the unaudited financial statements.) Hometown received 940,000 shares of Hometown Common Stock valued at $1,043,000 in exchange for Accounts Receivable of $154,000, New Vehicle and Parts Inventory of $6,786,000, Net Property and Equipment of $195,000, Floor Plan Notes Payable - Trade of $6,664,000 and Other Debt of $134,000. Costs of $119,000 are included in the computation of the gain. 6 HOMETOWN AUTO RETAILERS, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND ORGANIZATION Business of Hometown Auto Retailers, Inc. ("Hometown" or the "Company") Hometown sells new and used cars and light trucks, provides maintenance and repair services, sells replacement parts and provides related financing, insurance and service contracts through 8 franchised dealerships and 1 stand-alone service facility, located in New Jersey, New York, Connecticut, Massachusetts and Vermont. Hometown's dealerships offer 9 American and Asian automotive brands including Chevrolet, Chrysler, Dodge, Ford, Jeep, Lincoln, Mazda, Mercury and Toyota. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated balance sheet as of June 30, 2005, the consolidated statements of operations for the three and six months ended June 30, 2005 and 2004, the consolidated statements of stockholders' equity and the consolidated statements of cash flows for the six months ended June 30, 2005 and 2004, are unaudited. The consolidated financial statements include all significant majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments necessary to present fairly the financial position, results of operations and cash flows for the interim periods were made. Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. Due to seasonality and other factors, the results of operations for interim periods are not necessarily indicative of the results that will be realized for the entire year. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, were omitted. Accordingly, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2004, which are included in Hometown's filing of its annual report on Form 10-K. The financial statements have been prepared in conformity with generally accepted accounting principles and, accordingly, include amounts based on estimates and judgments of management. Actual results could differ from those estimates. Stock-based Compensation At June 30, 2005, Hometown has one stock-based employee compensation plan, the 1998 Stock Option Plan (the "Stock Option Plan"). As allowed by SFAS 148, Hometown has elected not to use one of the alternative methods of transition available for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Hometown accounts for this plan under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation. 7
(in thousands, except per share data) Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Net income, as reported $ 834 $ 233 $ 1,102 $ 335 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (1) (2) (7) (5) (14) ---------- ---------- ---------- ---------- Pro forma net income $ 832 $ 226 $ 1,097 $ 321 ========== ========== ========== ========== Earnings per share: Basic, as reported $ 0.13 $ 0.03 $ 0.16 $ 0.05 Basic, pro forma $ 0.13 $ 0.03 $ 0.16 $ 0.04 Diluted, as reported $ 0.13 $ 0.03 $ 0.16 $ 0.05 Diluted, pro forma $ 0.13 $ 0.03 $ 0.16 $ 0.04
(1) All awards refer to awards granted, modified, or settled in fiscal periods since plan inception in 1998; that is, awards for which the fair value was required to be measured under Statement 123. New Accounting Pronouncements In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS 154"). This Statement replaces APB Opinion No. 20, "Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition through a cumulative adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods' financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the specific transition provisions of any existing or future accounting pronouncements. The adoption of this statement is not expected to have a material effect on our financial position or results of operations. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, "Share-Based Payments" ("SAB 107"). SAB 107 expresses views of the SEC regarding the interaction between SFAS and certain SEC rules and regulations and provides the SEC's views regarding the valuation of share-based compensation for public companies. We are currently evaluating the adoption of SFAS 123R and the impact that this statement will have on our results of operations. We will apply the principles of SAB 107 in conjunction with our adoption of SFAS 123R. In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"), "Accounting for Conditional Asset Retirement Obligations." FIN 47 clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, "Accounting for Assets Retirements Obligations," refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Furthermore, the uncertainty about the timing and or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. FIN 47 clarifies that an entity is required to recognize the liability for the fair value of a conditional asset obligation when incurred if the liability's fair value can be reasonably estimated. The adoption of this statement is not expected to have a material effect on our financial position or results of operations. We intend to implement the provisions of this statement in the first quarter of 2006. 8 In December 2004, the FASB issued SFAS 123R, "Share-Based Payment." This statement is a revision of SFAS 123, "Accounting for Stock-Based Compensation" and supersedes APB 25, "Accounting for Stock Issued to Employees," and is effective as of the next fiscal year that begins after June 15, 2005. SFAS 123R establishes standards on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, which is usually the vesting period. SFAS 123R also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. The adoption of this statement is not expected to have a material effect on our financial position or results of operations. We intend to implement the provisions of this statement in the first quarter of 2006. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. The objective of this interpretation is to provide guidance on how to identify a variable interest entity ("VIE") and requires the VIE to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs a majority of the VIE's expected losses and/or receives a majority of the entity's expected residual returns, if they occur. In December 2003, the FASB issued FIN 46(R) ("Revised Interpretations") delaying the effective date for certain entities created before February 1, 2003 and making other amendments to clarify the application of the guidance. In adopting FIN 46(R) Hometown has evaluated its variable interests to determine whether they are in fact VIE's and whether Hometown was the primary beneficiary of the VIE. This evaluation resulted in determining that Hometown has a VIE with a related party, whereby Hometown guarantees the mortgage debt of the company. The adoption of this interpretation did not have a material effect on Hometown's financial statements. 3. EARNINGS PER SHARE "Basic earnings per share" is computed by dividing net income by the weighted average common shares outstanding. "Diluted earnings per share" is computed by dividing net income by the weighted average common shares outstanding adjusted for the incremental dilution of potentially dilutive securities. Options to purchase approximately 538,000 shares of common stock were outstanding as of June 30, 2005. Options and warrants to purchase approximately 829,000 shares of common stock were outstanding as of June 30, 2004. Basic and diluted weighted average shares for the three and six months ended June 30, 2005 and 2004 are as follows:
Three Months Ended June 30, Six Months Ended June 30, ------------------------ ------------------------ 2005 2004 2005 2004 --------- --------- --------- --------- Basic, Weighted Average Shares 6,449,389 7,191,588 6,766,185 7,183,347 ========= ========= ========= ========= Common Stock Equivalents 135,057 132,926 129,803 214,539 --------- --------- --------- --------- Diluted, Weighted Average Shares 6,584,446 7,324,514 6,895,987 7,397,886 ========= ========= ========= =========
Basic weighted average shares reflect a reduction of 940,000 Class B shares from the settlement of the Vergopia litigation on March 3, 2005. These shares have been cancelled as of May 13, 2005. Also, the three and six months ended June 30, 2005 includes a gain on the transfer of the Westwood dealership of $587,000. See Note 8. The common stock equivalents are options and warrants whose exercise price is less than the average market price of the common shares during the period. For the three and six months ended June 30, 2005, options to purchase 217,000 shares of Hometown common stock were excluded from the calculation of diluted income per share due to the option prices being greater than the average market 9 price of the common shares during the period. For the three and six months ended June 30, 2004, options and warrants to purchase 549,000 and 133,000 shares, respectively of Hometown common stock were excluded from the calculation of diluted income per share due to the options and warrant prices being greater than the average market price of the common shares during the period. The basic and diluted income per share for the three months ended June 30, 2005 and 2004 is $0.13 and $0.03, respectively. The basic and diluted income per share for the six months ended June 30, 2005 and 2004 is $0.16 and $0.05, respectively. 4. INVENTORIES New, used and demonstrator vehicles are stated at the lower of cost or market, determined on a specific unit basis. Parts and accessories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Inventories, net consist of the following: (in thousands) 6/30/05 12/31/04 --------- --------- New Vehicles $ 21,834 $ 33,616 Used Vehicles 8,402 7,761 Parts, accessories and other 1,777 2,063 --------- --------- Total Inventories $ 32,013 $ 43,440 ========= ========= The lower of cost or market adjustment was $0.5 million and $0.7 million at June 30, 2005 and December 31, 2004, respectively. The decrease in the new vehicles inventory was primarily due to the transfer of the Westwood dealership ($6.5 million) along with an improvement (reduction) in inventory levels at our dealerships due to better inventory management. The decrease in the lower of cost or market adjustment was primarily due to the transfer of the Westwood dealership. See Note 8. 5. INTANGIBLE ASSETS As of June 30, 2005 and December 31, 2004, Hometown's intangible assets consisted of the following: (in thousands) 6/30/05 12/31/04 ------- ------- Deferred finance charges $ 272 $ 272 Accumulated amortization (131) (121) Non-compete agreement 381 381 Accumulated amortization (365) (333) Franchise Fee 10 10 Accumulated amortization (4) (3) ------- ------- Net intangible assets $ 163 $ 206 ======= ======= These assets are included in Other Assets in the consolidated financial statements. 10 6. FLOOR PLAN NOTES PAYABLE Hometown has a floor plan line of credit at each dealership with Ford Motor Credit Corporation ("FMCC"). The FMCC floor plan agreement provides financing for vehicle purchases and is secured by and dependent upon new and used vehicle inventory levels. Maximum availability under the FMCC agreement is a function of new and used car sales and is not a pre-determined amount. Hometown is subject to the FMCC standard financing agreement which provides for floor plan loans for new and used vehicles that have variable interest rates that increase or decrease based on movements in the prime or LIBOR borrowing rates. The FMCC agreement has no set maturity date and it is the intention of Hometown to continue with this financing on an ongoing basis. FMCC directly pays the manufacturers from which Hometown purchases new vehicle inventory. The process is done electronically where an Electronic Funds Transfer (EFT) is made whereby the vehicle is purchased with funds from the floor plan line. Hometown does not have the discretion to receive these funds prior to disbursement to the manufacturers. Hometown finances used vehicles acquired by trade-in at the time a customer is purchasing a new vehicle shortly after receipt of the used vehicle from the customer. Hometown will also acquire used vehicles at auction, where more likely than not, arrangements have been made with FMCC for payment to be made by FMCC on our behalf using funds available from the floor plan notes payable line of credit. Hometown typically makes monthly interest payments on the amount financed, but is not generally required to repay the principal prior to sale of the vehicle. Outstanding floor plan borrowings financing new vehicles of manufacturers that are affiliates of FMCC (Ford, Lincoln and Mercury) are classified as "floor plan notes payable - trade". All other floor plan borrowings are classified as "floor plan notes payable - non-trade". The Statement of Cash Flows reflects changes in "floor plan notes payable - trade" as a cash operating activity and the changes in "floor plan notes payable -non- trade" as a cash financing activity. 7. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS Hometown is subject to certain financial covenants calculated semi-annually at June 30th and December 31st, related to its real estate mortgages. Significant financial covenants are: (i) a Fixed Cost Coverage Ratio (a defined cash flow ratio) calculation and (ii) an Adjusted Net Worth calculation as defined. Hometown has been in default of its loan agreement for Baystate Lincoln Mercury since December 31, 2004 for failure to comply with the Fixed Cost Coverage Ratio covenant caused by losses incurred at the dealership. Accordingly, Hometown has reclassified $4,160,000 of related long-term debt to current at June 30, 2005. Total debt for this mortgage at June 30, 2005 is $4,469,000. On March 16, 2005, the lender notified Hometown that it is not declaring an event of default in connection with the loan, however, reserving all rights to declare an event of default in the future should the financial covenant default not be cured. If an event of default was declared and only at the lenders option, Hometown could be required to pay all outstanding debt plus a defeasance penalty and transaction costs totaling approximately $1,400,000. Although Hometown does not believe the lender will call the loan, in the event it is called, Hometown believes it would be able to secure alternate financing. 8. COMMITMENTS AND CONTINGENCIES Litigation During the fourth quarter of 2004, Hometown announced that it had resolved in principle to settle the litigation matters described in Footnote 9 in the Notes to Unaudited Consolidated Financial Statements as contained in Hometown's Form 10-Q as filed with the Securities and Exchange Commission on November 12, 2004. On March 3, 2005 the execution and delivery of a settlement agreement and applicable releases of claims from all parties to the litigation was completed. The settlement agreement settled all claims made by Salvatore A. Vergopia and 11 Edward A. Vergopia, former directors and executive officers of the Corporation, and Janet Vergopia, the wife of Salvatore A. Vergopia (the "Vergopias"). The settlement also finally resolved the related insurance coverage litigation with Universal Underwriters Group and The Chubb Group of Insurance Companies. The gross payment to the Vergopias by all parties was $4 million of which $600,000 was paid by Hometown in March 2005. The settlement with the Vergopias and the insurers included an exchange of mutual releases of claims among the parties and a withdrawal of all claims with prejudice and without costs or attorneys fees to any party. On May 11, 2005, the parties completed the transfer to the Vergopias of certain Westwood Lincoln Mercury Sales, Inc. assets, including its Lincoln Mercury franchise and the termination of Hometown's Westwood, New Jersey lease. Hometown received all of the 940,000 shares of Class B Common Stock owned by the Vergopias in March 2005. The Settlement Agreement does not constitute an admission of liability or wrongdoing by any party. The 940,000 shares of Hometown stock was recorded at fair market value on March 3, 2005, the date of the executed settlement agreement, and is shown as a reduction of Stockholders' Equity of $1,043,000, primarily Additional Paid-in-Capital. (See Unaudited Statements of Stockholders Equity) The assets and liabilities transferred to the Vergopias was recorded as a reduction of those accounts at book value on May 11, 2005 resulting in a gain of approximately $600,000 from the transaction. Hometown wrote off the goodwill associated with this franchise in 2002 and expensed the aforementioned $600,000 March payment in prior periods. Hometown Auto Retailers, Inc. d/b/a Muller Toyota, Inc. has been named as one of 1,667 defendants in a complaint filed by Maryann Cerbo, et. al. in the Superior Court of New Jersey in Bergen County and allegedly served upon Hometown on December 30, 2004. The action has been brought on behalf of about 111 named plaintiffs and, purportedly on behalf of a class of individuals and companies who have purchased or leased a motor vehicle from the defendants. Plaintiffs contend that the defendants (a) overcharged for registration and/or title fees; (b) failed to properly itemize documentary costs and governmental costs; (c) charged grossly excessive documentary fees not reasonably related to costs; and (d) failed to disclose that the defendants are not required to perform certain documentary services. It appears from the complaint that plaintiffs have attempted to name as defendants all franchised automobile dealers in the State of New Jersey, as well as a large assortment of other persons and entities. There are no allegations that Hometown ever performed any services for any of the plaintiffs. The complaint makes certain class action allegations and alleges violations of the New Jersey Consumer Fraud Act as well as common law fraud. The Court has dismissed the portions of the complaint alleging violations of the New Jersey Consumer Fraud Act, common law fraud and conspiracy to commit common law fraud. Hometown does not believe that the eventual outcome of this case will have a material adverse effect upon Hometown's consolidated financial position or results of operations. On July 8, 2005 Hometown issued a press release in which it announced its receipt of notice of the commencement of a lawsuit against Hometown and an indefinite delay in the mailing to Hometown's stockholders of the Information Statement prepared in connection with the Exchange Agreement announced by Hometown on June 2, 2005. The press release was filed with the Securities and Exchange Commission as part of Hometown's Form 8-K filed on July 8, 2005. Further information about the Exchange Agreement is set forth below under Note 9 - "Exchange Agreement". The complaint was filed on June 30, 2005 in the Court of Chancery of the State of Delaware by Steven N. Bronson, Louis J. Meade and Leonard Hagan against Hometown Auto Retailers, Inc. and its directors, Corey E. Shaker, William C. Muller, Jr., Joseph Shaker, Bernard J. Dzinski, Jr., Steven A. Fournier, H. Dennis Lauzon and Timothy C. Moynihan. Plaintiffs purport to bring the action individually, derivatively and as a class action on behalf of the public stockholders of Hometown's Class A shares. The Plaintiffs allege in their complaint that the directors and controlling stockholders have breached their fiduciary duties to Hometown and the Class A stockholders, have failed to seek a transaction that would maximize value for Hometown and all it stockholders, and have initiated a transaction that is not fair to Hometown and its public stockholders. The plaintiffs seek equitable and monetary relief, including, rescission of the Exchange Agreement, a preliminary and permanent injunction against the Exchange Agreement transactions, a declaration that the defendants have breached their fiduciary duties, a constructive trust on any assets transferred pursuant to the Exchange Agreement transactions, damages for the injury suffered by plaintiffs and the Class as a result of defendants' breach of fiduciary duties, certification of the action as a class action, and an order requiring defendants to pay attorneys' fees and expenses to plaintiffs. 12 On July 19, 2005, a copy of the complaint as filed in the Court of Chancery of the State of Delaware was filed with the Securities and Exchange Commission by Steven N. Bronson as an Exhibit to Amendment No. 4 to Mr. Bronson's Schedule 13D filing. Hometown from time to time may be a defendant in lawsuits arising from normal business activities. Management reviews pending litigation with legal counsel and believes that the ultimate liability, if any, resulting from such actions will not have a material adverse effect on Hometown's consolidated financial position or results of operations. Guarantees Hometown may guaranty or partially guaranty loans advanced by financial institutions to certain customers. It is Hometown's policy to provide reserves for potential future default losses based on available historical information. In connection with the acquisition in 1999 of real estate used by Baystate Lincoln Mercury, Hometown guaranteed the mortgage debt of Rellum Realty Company. The 1999 guaranty was given in substitution for a February 1998 guaranty of that debt by the Muller Group, a subsidiary of Hometown. In the event of default by Rellum Realty Company, Hometown is required to make the mortgage payments, but does not take ownership of the property. Hometown recorded the lease as a capital lease. As of June 30, 2005 the mortgage debt balance is $4.2 million, which agrees to the capital lease obligation. Hometown makes annual lease payments of $864,000 to the landlord. The annual mortgage payments made by the landlord total approximately $774,000. The mortgage matures March 2013. Total undiscounted payments (principal plus interest) that would have to be made under the guaranty as of June 30, 2005 is $6.0 million. Warranties Hometown's new vehicle sales and certain used vehicle sales have manufacturer warranties that specify coverage and period. In these instances, Hometown is reimbursed by the manufacturer for the cost of parts and service on the vehicle covered by these warranties, as specified by the manufacturer. Hometown also provides a limited warranty on used vehicles sold at retail. The warranty period is as agreed upon by the customer and may be subject to a minimum period as mandated by the state. The typical warranty period ranges up to three months. Hometown also sells parts and service. Manufacturer parts are covered by limited warranties, as specified by the manufacturer. Service also has a limited warranty; whereby the part and certain labor costs are covered under the limited manufacturer warranty. Also, certain Hometown dealerships provide a three or five year 100,000-mile limited warranty on new and/or used vehicles. The cost of this warranty is charged to the cost of sale of the vehicle. The warranty covers certain parts and service for three or five years or until the vehicle reaches an odometer reading of 100,000 miles, whichever comes sooner. The warranty is insured, making the cost of the warranty fixed for Hometown. The insurance company pays costs associated with the warranty work to Hometown. An insurance company that is wholly owned by Ford Motor Company reinsures the insurance policy. If the insurance company were to fail, Hometown would be responsible for the costs of the service. Hometown has not recorded any additional reserve for this warranty program. Hometown records a reserve referred to as "policy" for used vehicle warranties and the labor portion of service warranties based on available historical information. Also included in this reserve are (i) the costs associated with free products or services that may be offered to a retail customer for purposes of maintaining goodwill with that particular service customer or new or used vehicle customer, or (ii) the free products or service may be part of a service maintenance program whereby the customer may receive certain services for free if he maintains a certain level of service at the dealership. At June 30, 2005 and December 31, 2004, Hometown has a reserve of $298,000 and $208,000, respectively. The reserve is based on the last three months of used vehicle units sold and the average cost of repairs, including free parts and service, over the last twelve months. While Hometown believes its estimated liability for product warranties and free parts and service is adequate and that the judgment applied is appropriate, the estimated liability for product warranties and free parts and service could differ materially from future actual costs. 13
Balance At Additions To Costs Balance At End Reserve for Policy Work Beginning of Year and Expenses Deductions of Quarter ------------------------------ ------------------ ---------------- ------------- -------------- Six Months Ended June 30, 2005 $208,000 $628,000 $(538,000) $298,000
Hometown also sells extended service contracts as an agent for a third party for which it receives a commission. The primary obligor is the institution underwriting the service contract. These revenues are recorded in Revenues, Other in the Statement of Operations. Revenues from sales of third party extended service contracts was $1.2 million and $1.1 million for six months ended June 30, 2005 and June 30, 2004, respectively. Connecticut dealerships operate under state laws, which make the dealers responsible for providing warranty service and insurance in the event of default by the insurance carriers. Accordingly, commissions on insurance and service contract sales are required to be recognized over the life of the related insurance product. For these dealerships, Hometown records the revenue as a liability and amortizes the amount into revenue over a five-year period. At June 30, 2005 and December 31, 2004, Hometown had $1,110,000 and $1,140,000 of related deferred revenue, respectively. During the six months ended June 30, 2005, these dealerships generated approximately $188,000 of related warranty service and insurance revenue, which was deferred. During the same period, approximately $218,000 of deferred revenue was amortized to Other Revenues, net. At June 30, 2005 and December 31, 2004, Hometown also had other deferred revenue of $165,000 and $319,000, respectively. Franchise Agreements Toyota Motor Sales, U.S.A., Inc. has extended Hometown's current Toyota Dealer Agreement on a periodic basis since March of 2003. The most recent extension was for a period of two months through September 18, 2005. Previously on March 13, 2003, Hometown was notified by Toyota Motor Sales, U.S.A., that Hometown must correct certain operational deficiencies or make substantial progress toward rectifying such deficiencies. Toyota had previously expressed concerns that the financial resources of the Toyota dealerships were being used to finance the cash flow deficits of other Hometown dealerships and that because of this the financial health of the Toyota dealerships were detrimentally affected by a net working capital deficiency. Toyota requested and Hometown provided a written action plan and consolidated financial forecast. Toyota also expressed concerns about the impact of Ford Motor Credit's financing terms upon the Toyota dealerships and the existing litigation, which has now been settled, including the Vergopias as discussed above. Hometown developed and implemented plans to correct the operational deficiencies that would bring Hometown into compliance. Hometown has obtained written confirmations from Ford Motor Credit in response to Toyota's requests for information relating to financing arrangements. In addition, Hometown has improved net working capital through the sale of a Chrysler/Jeep sales and service franchise in the second quarter of 2003 and advances on warranty income from Hometown's Extended Service Plan vendor. Hometown has been in regular contact with Toyota to review the efforts of Hometown to resolve the deficiencies alleged by Toyota. The two Toyota dealerships for the fiscal year ended December 31, 2004 had combined revenues of $98.1 million and pre-tax income before allocation of corporate costs of $2.2 million. Hometown believes that it has corrected the alleged net working capital deficiency for the Toyota dealerships and that it has undertaken reasonable steps to alleviate the concerns expressed by Toyota. However, there can be no assurance that Toyota will enter into a new dealer agreement with Hometown and Toyota has reserved the right to terminate the Toyota Dealership Agreements if sufficient progress is not made to correct the alleged deficiencies. Should Hometown be notified by Toyota that they intend to terminate the Toyota Dealership Agreements, Hometown believes it would have a reasonable amount of time to cure the defaults. 14 9. EXCHANGE AGREEMENT On June 2, 2005 Hometown entered into an Exchange Agreement with the New England Subsidiaries of Hometown (as described below) and the stockholders of Hometown in the Shaker Group (as described below). The Exchange Agreement was also approved by the written consent of stockholders owning a majority of the voting power of the shares of stock of Hometown. Pursuant to the Exchange Agreement, Hometown will organize a new corporation to be called Shaker Auto Group, Inc. Hometown will then transfer to Shaker Auto Group, Inc. all of the shares of stock of the New England Subsidiaries, plus $5 million in cash (subject to adjustment for fluctuations in the value of certain assets and liabilities of the New England Subsidiaries) in exchange for all of the outstanding shares of stock of Shaker Auto Group, Inc. Immediately following this transfer, Hometown will transfer all of the outstanding shares of stock of Shaker Auto Group, Inc. to the Shaker Group in exchange for all of their shares of stock of Hometown. Following the exchanges, the Shaker Group will be the beneficial owners of all of the outstanding shares of stock of Shaker Auto Group, Inc. and the New England Subsidiaries, and will cease to own any shares of stock of Hometown. In addition, the Muller Group (as defined below) will control a majority of the voting power of the shares of stock of Hometown, and Hometown will cease to own any shares of stock of Shaker Auto Group, Inc. or the New England Subsidiaries. The New England Subsidiaries consist of the business operations and real estate holdings of Hometown located in the States of Connecticut, Massachusetts and Vermont. They include ERR Enterprises, Inc., Family Ford, Inc., Shaker's, Inc., Shaker's Lincoln/Mercury Auto Care, Inc., Hometown Brattleboro, Inc., Hometown Auto Framingham, Inc., Bay State Realty Holdings, Inc. and Brattleboro Realty Holdings, Inc. The automobile franchises operated by the New England subsidiaries include: o Bay State Lincoln Mercury (Framingham, Mass.), o Brattleboro Chrysler Jeep Dodge (Brattleboro, Vt.), o Family Ford (Waterbury, Conn.), o Shaker's Lincoln Mercury (Watertown, Conn.), o Wellesley Mazda (Wellesley, Mass.), o Shaker's Auto Care (Naugatuck, Conn.). The New England subsidiaries also include the following real estate holding companies: o Baystate Realty (Framingham, Mass.), and o Brattleboro Realty (Brattleboro, Vt.). Following the split-off of the above-described assets and liabilities to Shaker Auto Group, Hometown Auto will operate the following automobile franchises: o Muller Chevrolet (Stewartsville, N.J.); o Muller Toyota (Clinton, N.J.), and o Toyota of Newburgh, (New Windsor, N.Y.). The consummation of the exchanges is subject to various contingencies, including approval of Hometown's manufacturers to the transfer of the automobile franchises to Shaker Auto Group, Inc., and approval of various lenders to the release of Hometown from certain liabilities and the assumption of certain liabilities by Shaker Auto Group, Inc. In connection with the transactions, Hometown anticipates that it will secure a term loan of up to $6.5 million, with $5 million to be used for the cash contribution to be made to Shaker Auto Group (as explained above), $700,000 for financing the split-off costs, and the $800,000 balance for working capital for Hometown. 15 Following the split-off, Hometown Auto will have a total of 3,845,153 Class A common shares, with William C. Muller, Jr. (and his immediate and extended family) holding 367,500 Class A common shares and 776,752 Class B common shares of Hometown Auto. [Note: Hometown Auto Class B common shares have 10 for 1 voting rights versus Class A common shares which are voted on a 1 to 1 basis.] The Shaker Group consists of the following individuals and trusts: Corey Shaker (individually and as custodian for Lindsay Shaker, Kristen Shaker and Edward Shaker), Edward Shaker Family Trust, Joseph Shaker, Shaker Irrevocable Trust, Richard Shaker Family Trust, Steven Shaker, Janet Shaker, Paul Shaker, Edward D. Shaker, Edward Shaker, Lillian Shaker, Richard Shaker and Rose Shaker. The Muller Group consists of the following individuals and trust: William C. Muller, Jr., Douglas D. Muller, Angela P. Muller, Rose Muller Trust, Robert Scott Doyle, Andrea L. Pantuso and Michelle Muller. On June 2, 2005, Hometown issued a press release describing the general terms of the proposed exchange transactions and disclosing the approval of the transactions by the Board of Directors and by a majority of the voting power to the Company's Common Stock. The press release and the Exchange Agreement were filed with the Securities and Exchange Commission, as part of the Company's Form 8-K filed on June 2, 2005. On June 17, 2005, Hometown filed a Preliminary Schedule 14C Information Statement ("Information Statement") with the Securities and Exchange Commission which describes the proposed exchange transactions. The Preliminary Schedule 14C Information Statement included the disclosure that the members of the Board of Directors of the Company were sent a letter dated June 14, 2005 signed by Steven Bronson, Louis J. Meade and Leonard Hagan, which letter was included in an amendment to a Schedule 13D filed by Steven Bronson with the Securities and Exchange Commission on June 15, 2005. In the letter, Messrs. Bronson, Meade and Hagan (the "Holders") stated that they own an aggregate of 16.31% of the Company's Class A Common Stock. In the letter, the Holders also stated their belief that the Exchanges will have a material adverse effect on the Company and the shareholders who are not parties to the Exchanges, and are not in the best interests of the Company and its shareholders. They further stated their belief that the Exchanges violate the Board's statutory and common law fiduciary duties and demand that the Company abandon the Exchanges, that the Board appoint a new Compensation Committee, that the President of the Company resign, that the Board appoint a Special Committee to explore all options for maximizing shareholder value, including conversion of the Company's Class B Common Stock into Class A Common Stock, that provision be made for minority shareholder representation on the Board, and that the Shaker Group reimburse the Company for its costs in pursuing the Exchanges. On July 8, 2005 Hometown issued a press release in which it announced (i) its receipt of notice of the lawsuit which is described above, see Note 8 - "Litigation", in which the plaintiffs seek equitable and monetary relief, including rescission of the Exchange Agreement, and (ii) an indefinite delay in the mailing of the Information Statement to Hometown's stockholders. The press release was also filed with the Securities and Exchange Commission, as part of Hometown's Form 8-K filed on July 8, 2005. The Press Release also announced that the staff of the Securities and Exchange Commission had asked the Company to delay sending the information statement describing the proposed exchanges to its shareholders pending the resolution of certain issues that had been raised by the staff with respect to the Company's annual report on Form 10-K for the period ended December 31, 2004 and its quarterly report on Form 10-Q for the period ended March 31, 2005. In light of the request of the staff of the Securities and Exchange Commission to delay the mailing of the information statement, which the Company intends to honor, the potential adverse effects which the commencement of the Delaware litigation may have upon the Company and the proposed exchanges, as well as a variety of other factors, the Company is unable to predict when it will send the information statement concerning the proposed exchanges to its shareholders or when the proposed exchanges will be consummated. 16 As of June 30, 2005, Hometown has incurred approximately $321,000 in relation to the Exchange Agreement transaction, which amount has been deferred and is included in Prepaid Expenses and Other Current Assets on Hometown's June 30, 2005 Balance Sheet. 10. RECLASSIFICATION OF BALANCE SHEETS AND STATEMENTS OF CASH FLOWS Hometown is in the process of restating its Balance Sheets and Statements of Cash Flows in its filings in its December 31, 2004 Form 10-K and March 31, 2005 Form 10-Q. The balance sheets reclassification is to breakdown its floor plan notes payable into trade and non-trade components, where it had previously been shown as a single line item, which is consistent with industry practice. The Statements of Cash Flows reclassification is to show the non-trade component of floor plan notes payable as a financing activity, where it had been shown as an operating activity. This reclassification is being done to comply with guidance under SFAS 95, "Statement of Cash Flows", which states that payments to suppliers should be classified as an operating activity. The floor plan lender is FMCC, an affiliate of Ford, Lincoln and Mercury; therefore; floor plan notes payable amounts due from purchases of inventory from Ford, Lincoln and Mercury are classified as floor plan - trade and the related borrowings and payments are to be classified as operating activities in the Statements of Cash Flows. Amounts due for inventory purchases from all other manufacturers are classified as floor plan notes payable - non-trade and the related borrowings and payments are to be classified as financing activities in the Statements of Cash Flows. See Note 6. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis of financial condition and results of operations is based on the historical financial statements of Hometown Auto Retailers, Inc. and contains forward-looking statements that involve risks and uncertainties. Hometown's actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, as described under "Risk Factors" as detailed on Hometown's annual report on Form 10-K for the year ended December 31, 2004. Overview Hometown sells new and used cars and light trucks, provides maintenance and repair services, sells replacement parts and provides related financing, insurance and service contracts through 8 franchised dealerships and 1 stand-alone service facility located in New Jersey, New York, Connecticut, Massachusetts and Vermont. Hometown's dealerships offer 9 American and Asian automotive brands including Chevrolet, Chrysler, Dodge, Ford, Jeep, Lincoln, Mazda, Mercury and Toyota. Hometown's operations are subject to seasonal variations, with the second and third quarters generally contributing more revenues and operating profit than the first and fourth quarters. This seasonality is driven primarily by: (i) manufacturer related factors, primarily the historical timing of major manufacturer incentive programs and model changeovers, (ii) weather-related factors, which primarily affect parts and service and (iii) consumer buying patterns. Sales also fluctuate due to other items such as availability of credit, consumer confidence in the economy, industry competition, international conflicts and fuel prices among others. We assess the growth of our revenues and gross profit by comparing the year-to-year results of our dealerships that have operated continuously during the periods being compared. Hometown's operating results reflect the closing of a used vehicles outlet in August 2004. Also, during the fourth quarter of 2004, Hometown announced that it had resolved in principal to resolve certain litigation matters (See Note 8 to the unaudited consolidated financial statements), which resulted in the transfer of the Westwood Lincoln Mercury dealership during the second quarter of 2005. Both contribute to decreases in sales and gross profit from 2004 to 2005, as well as a decrease in selling, general and administrative expenses. We have segregated both operations in the analysis that follows to allow for a better comparison of the results. Revenues are generated from: (i) the sale of new vehicles to (a) retail customers and (b) commercial customers, referred to as fleet; (ii) the sale of used vehicles to (a) retail customers and (b) other dealers at auctions, referred to as wholesale; (iii) parts and service sales; and (iv) other revenues, including the sale of third-party extended warranty products and the arrangement of third-party financing and insurance for which the company receives a fee among other items. We assess revenue results by a year-to-year comparison as follows: new and used vehicle revenues on unit volumes, parts and service revenues on aggregate revenues and other on per retail vehicle. The past few years has shown a decrease in used vehicle sales as manufacturers have continued to promote demand for new vehicles through offering various incentive programs including cash rebates and low interest financing. It is not expected that the manufacturers will stop these promotions. New vehicle cost of sales primarily includes the cost of the vehicle, net of any manufacturer incentives including floor plan assistance. Used vehicle cost of sales primarily includes the cost of the vehicle, including the labor and parts associated with preparing a used vehicle for sale. Parts and service cost of sales primarily includes the cost of the part and cost of labor incurred on the service. Our gross profit percentage varies with product mix and varies across product lines. Parts and service revenues generate the highest gross profit percentages, followed generally by used vehicle sales and new vehicle sales. Other revenues are recorded net. We assess gross profit results by a year-to-year comparison as follows: new and used vehicle gross profit per retail vehicle, parts and service on aggregate gross profit and other on gross profit per retail vehicle. 18 Selling, general and administrative expenses ("SG&A") consist of: compensation and related taxes and benefits, advertising, building costs (rent, utilities, real estate taxes, depreciation), data processing and other operating expenses. A large amount of compensation is variable in that it is commission based and certain significant expenses, such as advertising, are controllable. Hometown also includes certain distribution costs in SG&A which other similar companies may include in cost of sales. These costs total less than $0.1 million in the three months ended June 30, 2005 and 2004, and $0.1 million and $0.2 million in the six months ended June 30, 2005 and 2004, respectively. Interest expense primarily relates to indebtedness incurred in connection with new and used vehicle inventories. Other interest expense consists of all other interest charges on interest bearing debt including capitalized leases. Three months ended June 30, 2005 compared with three months ended June 30, 2004.
Revenues For the Three Months Ended June 30, ---------------------- Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change --------- --------- --------- --------- New vehicle data: Retail revenues - same store $ 35,705 $ 33,918 $ 1,787 5.3% Retail revenues - other stores (1) 3,927 10,273 (6,346) (61.8)% --------- --------- --------- --------- Total new retail revenues 39,632 44,191 (4,559) (10.3)% Fleet revenues - same store 1,013 585 428 73.1% --------- --------- --------- --------- Total new vehicles revenues, as reported $ 40,645 $ 44,776 $ (4,131) (9.2)% ========= ========= ========= ========= New retail units - same store 1,384 1,336 48 3.6% New retail units - other stores (1) 103 286 (183) (64.0)% Fleet units 53 33 20 60.6% --------- --------- --------- --------- Total new vehicle units 1,540 1,655 (115) (6.9)% Used vehicle data: Retail revenues - same store $ 12,383 $ 10,707 $ 1,676 15.7% Retail revenues - other stores (1) 104 1,188 (1,084) (91.2)% --------- --------- --------- --------- Total used retail revenues 12,487 11,895 592 5.0% Wholesale revenues - same store 4,158 3,614 544 15.1% Wholesale revenues - other stores (1) 276 271 5 1.8% --------- --------- --------- --------- Total wholesale revenues 4,434 3,885 549 14.1% Total used vehicle revenue, as reported $ 16,921 $ 15,780 $ 1,141 7.2% ========= ========= ========= ========= Used retail units - same store 751 701 50 7.1% Used retail units - other stores (1) 6 80 (74) (92.5)% Used wholesale units - same store 911 887 24 2.7% Used wholesale units - other stores (1) 35 45 (10) 22.2% --------- --------- --------- --------- Total used units 1,703 1,713 (10) 0.6% ========= ========= ========= =========
19
Revenues - (continued) For the Three Months Ended June 30, ------------------------ Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change --------- --------- --------- --------- Parts and service: Parts and service revenues - same store $ 5,419 $ 5,114 $ 305 6.0% Parts and service revenues - other stores (1) 490 1,041 (551) (52.9)% --------- --------- --------- --------- Total parts and service revenue $ 5,909 $ 6,155 $ (246) (4.0)% ========= ========= ========= ========= Other revenues, net: Other revenues, net - same store $ 1,792 $ 1,853 $ (61) (3.3)% Other revenues, net - other stores (1) 23 158 (135) (85.4)% --------- --------- --------- --------- Total other revenues, net, as reported $ 1,815 2,011 $ (196) (9.8)% ========= ========= ========= ========= Total revenue: Same store $ 60,470 $ 55,791 $ 4,679 8.4% Other stores (1) 4,820 12,931 (8,111) (62.7)% --------- --------- --------- --------- Total revenue, as reported $ 65,290 $ 68,722 $ (3,432) (5.0)% ========= ========= ========= =========
(1) Represents the Westwood Lincoln Mercury dealership operations transferred on May 11, 2005 and the used car outlet closed August 2004. The percentages used in the revenues discussion below are from the above table. Total revenue decreased $3.4 million, or 5.0% to $65.3 million for three months ended June 30, 2005 from $68.7 million for three months ended June 30, 2004. Same store total revenues increased $4.7 million or 8.4% to $60.5 million for the three months ended June 30, 2005 from $55.8 million for the three months ended June 30, 2004. Same store new retail revenues increased $1.8 million, or 5.3% to $35.7 million for three months ended June 30, 2005 from $33.9 million for three months ended June 30, 2004. This increase was primarily due to the 3.6% additional units ($1.2 million) sold in 2005 compared to 2004 and a 1.6% increase in average selling price ($0.6 million) in 2005 compared to 2004 reflecting a slight change in product mix within the brands. The increase in same store new retail revenues was primarily due to increases at our Toyota dealerships ($2.4 million). Hometown's new retail revenues are indicative of sales reported by our manufacturers nationally, Toyota continues to be experiencing growth in the United States while the domestics remain stagnant or decline. Same store used vehicle retail revenues increased $1.7 million, or 15.7% to $12.4 million for three months ended June 30, 2005 from $10.7 million for three months ended June 30, 2004. This increase was split between a 7.1% increase in units ($0.8 million) sold in 2005 compared to 2004 and a 7.9% increase in average selling price ($0.9 million) in 2005 compared to 2004. Although the used vehicle market has been difficult, personnel changes in certain dealerships enabled Hometown to show an increase for the quarter. Same store wholesale revenues increased $0.5 million, or 15.1% to $4.1 million for three months ended June 30, 2005 from $3.6 million for three months ended June 30, 2004 due to increased strength in the wholesale market. The increase in average selling price for wholesale units is also a function of the retail sales unit volume, which although up over the prior year is still lower than historical levels. High quality vehicles that were taken as trade-ins at the time of new vehicle purchases, were not all sold at retail, necessitating being sold at wholesale, generating higher prices. Parts and service revenue decreased $0.2 million or 4.0% to $5.9 million for the three months ended June 30, 2005 from $6.1 million for the three months ended June 30, 2004. On a same store basis, parts and service revenue increased $0.3 million or 6.0% to $5.4 million for the three months ended June 30, 2005 from $5.1 million for the three months ended June 30, 2004. The increase was primarily due to the Toyota dealerships ($0.2 million), and is attributable to the increase in the dealerships new vehicles revenues. These dealerships have been working to have these customers remain with the dealership for their vehicles maintenance needs. As part of the new car sales process you also strive to gain that customer as a service customer as well. 20 Other dealership revenues decreased $0.2 million, or 9.8% to $1.8 million for the three months ended June 30, 2005 from $2.0 million for the three months ended June 30, 2004. On a same store basis, other dealership revenues decreased less than $0.1 million or 3.3% to $1.8 million for the three months ended June 30, 2005 from $1.9 million for the three months ended June 30, 2004. This decrease is primarily attributable to decreases in sales of third party extended service plans for new vehicles (due to a decrease in service plan penetration per new vehicle sold) and finance income for new vehicles.
Gross Profit For the Three Months Ended June 30, ------------------------- Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change --------- --------- --------- --------- New vehicle data: Retail gross profit - same store $ 2,487 $ 2,431 $ 56 2.3% Retail gross profit - other stores (1) 239 381 (142) (37.3)% --------- --------- --------- --------- Total new retail gross profit 2,726 2,812 (86) (3.1)% Fleet gross profit 8 4 4 100% --------- --------- --------- --------- Total new vehicles gross profit, as reported $ 2,734 $ 2,816 $ (82) (2.9)% ========= ========= ========= ========= Gross profit percentage 6.7% 6.3% --------- --------- New retail units - same store 1,384 1,336 48 3.6% New retail units - other stores (1) 103 286 (183) (64.0)% Fleet units 53 33 20 60.6% --------- --------- --------- --------- Total new vehicle units 1,540 1,655 (115) (6.9)% ========= ========= ========= ========= Used vehicle data: Retail gross profit - same store $ 1,366 $ 1,277 $ 89 7.0% Retail gross profit - other stores (1) 73 106 (33) (31.1)% --------- --------- --------- --------- Total used retail gross profit 1,439 1,383 56 4.0% Wholesale gross profit - same store 135 66 69 * Wholesale gross profit - other stores (1) (21) 13 (34) * --------- --------- --------- --------- Total wholesale gross profit 114 79 35 44.3% Total used vehicle gross profit, as reported $ 1,553 $ 1,462 $ 91 6.2% ========= ========= ========= ========= Gross profit percentage 9.2% 9.3% ========= ========= Used retail units - same store 751 701 50 7.1% Used retail units - other stores (1) 6 80 (74) (92.5)% Used wholesale units - same store 911 887 24 2.7% Used wholesale units - other stores (1) 35 45 (10) 22.2% --------- --------- --------- --------- Total used units 1,703 1,713 (10) 0.6% ========= ========= ========= ========= Parts and service: Parts and service gross profit - same store $ 2,986 $ 2,756 $ 230 8.3% Parts and service gross profit - other stores (1) 275 586 (311) (53.1)% --------- --------- --------- --------- Total parts and service revenue $ 3,261 $ 3,342 $ (81) (2.4)% ========= ========= ========= ========= Gross profit percentage 55.2% 54.3% ========= =========
21
Gross Profit -(continued) For the Three Months Ended June 30, ------------------------- Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change --------- --------- --------- --------- Other gross profit: Other gross profit - same store $ 1,792 $ 1,853 $ (61) (3.3)% Other gross profit - other stores (1) 23 158 (135) (85.4)% --------- --------- --------- --------- Total other gross profit, as reported $ 1,815 $ 2,011 $ (196) (9.7)% ========= ========= ========= ========= Gross profit percentage 100.0% 100.0% ========= ========= Other gross profit PVR - same store $ 839 $ 910 (71) (7.8)% Other gross profit PVR - other stores (1) 211 432 (221) (51.2)% --------- --------- --------- --------- Total other gross profit PVR, as reported $ 809 $ 823 (14) (1.7)% ========= ========= ========= ========= Total gross profit: Same store $ 8,774 $ 8,387 $ 387 4.6% Other stores (1) 589 1,244 (655) (52.7)% --------- --------- --------- --------- Total gross profit, as reported $ 9,363 $ 9,631 $ (268) (2.8)% ========= ========= ========= ========= Gross profit percentage 14.3% 14.0% ========= =========
(1) Represents the Westwood Lincoln Mercury dealership operations transferred on May 11, 2005 and the used car outlet closed August 2004. * - Percentage exceeds 100%. The percentages used in the gross profit discussion below are from the above table. Total gross profit decreased $0.3 million, or 2.8%, to $9.4 million for the three months ended June 30, 2005, from $9.6 million for the three months ended June 30, 2004. Same store total gross profit increased $0.4 million, or 4.6% to $8.8 million for the three months ended June 30, 2005, from $8.4 million for the three months ended June 30, 2004. Same store gross profit on new retail vehicle sales increased less than $0.1 million, or 2.3%, to $2.5 million for the three months ended June 30, 2005, from $2.4 million for the three months ended June 30, 2004. The increase in gross profit is primarily attributable to a 3.6% increase in unit sales (less than $0.1 million) partially offset by a 1.3% decrease in new retail gross profit per unit. It is expected that margins on new vehicles will continue to be under pressure as the manufacturers continue to contend with competitive pricing issues. Similar to revenues, the gain is mostly attributable to the Toyota dealerships. Same store gross profit on used vehicle retail sales increased $0.1 million, or 7.0%, to $1.4 million for the three months ended June 30, 2005, from $1.3 million for the three months ended June 30, 2004. The overall increase is directly attributable to the 7.1% increase in units sold. Average gross profit per unit remained unchanged during the quarter. In addition, strength in the wholesale market enabled the company to double its wholesale gross profit compared to the prior year during the quarter. Same store parts and service gross profit increased $0.2 million, or 8.3%, to $3.0 million for the three months ended June 30, 2005, from $2.8 million for the three months ended June 30, 2004 primarily due the 6.0% increase in parts and service revenues. Selling, General and Administrative Expenses ("S,G&A") S,G&A decreased $0.8 million, or 9.4%, to $7.7 million for the three months ended June 30, 2005 from $8.5 million for the three months ended June 30, 2004. This decrease was primarily attributable to the closing of the used car outlet in August 2004 and the transfer of the Westwood dealership in May 2005 (together totaling $0.7 million). Additional decreases totaled less than $0.1 million. Decreases in rent and related building costs (less than $0.1 million) 22 and legal and professional fees (less than $0.1 million) were partially offset by an increase in payroll and related taxes (less than $0.1 million). The decrease in rent is due to purchasing a building in June 2004, which Hometown had previously rented. The decrease in legal and professional fees was due to the settlement of certain litigation at the end of 2004. The increase in payroll and related taxes is associated with commissions paid on increased gross profit. Other Income In May 2005, Hometown completed the transfer of certain assets in relation to the settlement of litigation matters resulting in a gain of approximately $587,000 recorded in Other Income. See Note 8 to the unaudited consolidated financial statements. Interest Expense Interest expense increased less than $0.1 million, remaining constant at $0.9 million for the three months ended June 30, 2005 and June 30, 2004. The increase is primarily due to an increase of floorplan interest expense resulting from higher interest rates partially offset by decreased borrowings resulting from one less dealership in 2005 compared to 2004 and lower average inventories at the remaining dealerships. Provision for income tax The effective income tax rate was 40% in the quarter ended June 30, 2005 and 27% in the same period of 2004. The rates were based on current forecasts of income before taxes, and current forecasts of permanent differences between tax and book income. The 2005 rate reflects the expected effective tax rate for the year. The 2004 rate reflects the expected full year effective tax rate of 40% adjusted for a reduction in the valuation allowance associated with the 2004 amortization of goodwill for tax purposes. At December 31, 2004 deferred taxes were adjusted primarily to reflect a reduction of the valuation allowance on the deferred tax asset due to the ability to project sufficient income to recover the deferred tax asset. Deferred taxes, including the valuation allowance, will be reviewed throughout fiscal 2005. Net Income Net income increased $0.6 million to $0.8 million for the three months ended June 30, 2005, from $0.2 million for the three months ended June 30, 2004. A substantial amount of the increase is due to a gain on transfer of certain assets in relation to settlement of litigation recorded in Other Income. See above for explanation of other changes. Earnings Per Share, Basic and Diluted and Weighted Average Shares "Basic earnings (loss) per share" is computed by dividing net income (loss) by the weighted average common shares outstanding. "Diluted earnings (loss) per share" is computed by dividing net income (loss) by the weighted average common shares outstanding adjusted for the incremental dilution of potentially dilutive securities. See Note 3 to the unaudited consolidated financial statements. The basic and diluted income per share for the three months ended June 30, 2005 and 2004 is $0.13 and $0.03, respectively. 23 Six months ended June 30, 2005 compared with six months ended June 30, 2004.
Revenues For the Six Months Ended June 30, ------------------------ Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change ---------- ---------- ---------- ---------- New vehicle data: Retail revenues - same store $ 67,955 $ 66,878 $ 1,077 1.6% Retail revenues - other stores (1) 9,022 18,390 (9,368) (50.9)% ---------- ---------- ---------- ---------- Total new retail revenues 76,977 85,268 (8,291) (9.7)% Fleet revenues - same store 1,693 623 1,070 171.7% ---------- ---------- ---------- ---------- Total new vehicles revenues, as reported $ 78,670 $ 85,891 $ (7,221) (8.4)% ========== ========== ========== ========== New retail units - same store 2,638 2,603 35 1.3% New retail units - other stores (1) 245 513 (268) (52.2)% Fleet units 94 35 59 * ---------- ---------- ---------- ---------- Total new vehicle units 2,977 3,151 (174) (5.5)% Used vehicle data: Retail revenues - same store $ 24,030 $ 23,046 $ 984 4.3% Retail revenues - other stores (1) 789 2,416 (1,627) (67.3)% ---------- ---------- ---------- ---------- Total used retail revenues 24,819 25,462 (643) (2.5)% Wholesale revenues - same store 7,243 6,734 509 7.6% Wholesale revenues - other stores (1) 419 494 (75) (15.2)% ---------- ---------- ---------- ---------- Total wholesale revenues 7,662 7,228 434 6.0% Total used vehicle revenue, as reported $ 32,481 $ 32,690 $ (209) (0.6)% ========== ========== ========== ========== Used retail units - same store 1,449 1,535 (86) (5.6)% Used retail units - other stores (1) 45 161 (116) (72.0)% Used wholesale units - same store 1,580 1,762 (182) (10.3)% Used wholesale units - other stores 59 73 (14) (19.2)% ---------- ---------- ---------- ---------- Total used units 3,133 3,531 (398) (11.3)% ========== ========== ========== ========== Parts and service: Parts and service revenues - same store $ 10,559 $ 10,075 $ 484 4.8% Parts and service revenues - other stores (1) 1,506 2,039 (533) (26.1)% ---------- ---------- ---------- ---------- Total parts and service revenue $ 12,065 $ 12,114 $ (49) (0.4)% ========== ========== ========== ========== Other revenues, net: Other revenues, net - same store $ 3,722 $ 3,577 145 4.1% Other revenues, net - other stores (1) 118 328 (210) (64.0)% ---------- ---------- ---------- ---------- Total other revenues, net, as reported $ 3,840 $ 3,905 (65) (1.7)% ========== ========== ========== ========== Total revenue: Same store $ 115,202 $ 110,933 $ 4,269 3.8% Other stores (1) 11,854 23,667 (11,813) (49.9)% ---------- ---------- ---------- ---------- Total revenue, as reported $ 127,056 $ 134,600 $ (7,544) (5.6)% ========== ========== ========== ==========
(1) Represents the Westwood Lincoln Mercury dealership operations transferred on May 11, 2005 and the used car outlet closed August 2004. * - Percentage exceeds 100%. 24 The percentages used in the gross profit discussion below are from the above table. Total revenue decreased $7.5 million, or 5.6% to $127.1 million for six months ended June 30, 2005 from $134.6 million for six months ended June 30, 2004. Same store total revenues increased $4.3 million or 3.8% to $115.2 million for the six months ended June 30, 2005 from $110.9 million for the six months ended June 30, 2004. Same store new retail revenues increased $1.1 million, or 1.6% to $68.0 million for six months ended June 30, 2005 from $66.9 million for six months ended June 30, 2004. This increase was primarily due to a 1.3% increase in additional units ($0.9 million) sold in 2005 compared to 2004. The increase in same store new retail revenues was primarily due to increases at our Toyota dealerships ($3.6 million) offset by decline at our Lincoln Mercury dealerships ($2.7 million). Hometown's new retail revenues are indicative of sales reported by our manufacturers nationally, Toyota continues to be experiencing growth in the United States while the domestics remain stagnant or decline. Same store used vehicle retail revenues increased $1.0 million, or 4.3% to $24.0 million for six months ended June 30, 2005 from $23.0 million for six months ended June 30, 2004. This increase was primarily due to a 10.5% increase in average selling price ($2.3 million) in 2005 compared to 2004, partially offset by a 5.6% decrease in units sold ($1.3 million). Although the used vehicle market has been difficult, personnel changes in certain dealerships enabled Hometown to show an increase over the prior year. Same store wholesale revenues increased $0.5 million, or 7.6% to $7.2 million for six months ended June 30, 2005 from $6.7 million for six months ended June 30, 2004 due to increased strength in the wholesale market. The increase in average selling price is also a function of the retail sales unit volume. High quality vehicles that were taken as trade-ins at the time of new vehicle purchases, were not all sold at retail, necessitating being sold at wholesale, generating higher prices. Parts and service revenue decreased less than $0.1 million or 0.4% to $12.1 million for the six months ended June 30, 2005 from $12.1 million for the six months ended June 30, 2004. On a same store basis, parts and service revenue increased $0.5 million or 4.8% to $10.6 million for the six months ended June 30, 2005 from $10.1 million for the six months ended June 30, 2004. The increase was primarily due to the Toyota dealerships ($0.3 million), and is attributable to the increase in the dealerships new vehicles revenues. These dealerships have been able to attract these customers to remain with the dealership for their vehicle maintenance needs. As part of the new car sales process you also strive to gain that customer as a service customer as well. Other dealership revenues decreased less than $0.1 million, or 1.7% to $3.8 million for the six months ended June 30, 2005 from $3.9 million for the six months ended June 30, 2004. On a same store basis, other dealership revenues increased $0.1 million or 4.1% to $3.7 million for the six months ended June 30, 2005 from $3.6 million for the six months ended June 30, 2004. This is primarily attributable to an increase in extended service plan revenue in the first quarter of 2005, which decreased through the second quarter.
Gross Profit For the Six Months Ended June 30, --------------------- Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change -------- -------- -------- -------- New vehicle data: Retail gross profit - same store $ 4,646 $ 4,746 (100) (2.1)% Retail gross profit - other stores (1) 506 826 (320) (38.7)% -------- -------- -------- -------- Total new retail gross profit 5,152 5,572 (420) (7.5)% Fleet gross profit 15 4 11 * -------- -------- -------- -------- Total new vehicles gross profit, as reported $ 5,167 $ 5,576 (409) (7.4)% ======== ======== ======== ======== Gross profit percentage 6.6% 6.5% -------- --------
25
Gross Profit - (continued) For the Six Months Ended June 30, -------------------------- Increase % (in thousands, except per vehicle data) 2005 2004 (Decrease) Change ---------- ---------- ---------- ---------- New retail units - same store 2,638 2,603 35 1.3% New retail units - other stores (1) 245 513 (268) (52.2)% Fleet units 94 35 59 168.6% ---------- ---------- ---------- ---------- Total new vehicle units 2,977 3,151 (174) (5.5)% ========== ========== ========== ========== Used vehicle data: Retail gross profit - same store $ 2,689 $ 2,760 (71) (2.6)% Retail gross profit - other stores (1) 135 221 (86) (38.9)% ---------- ---------- ---------- ---------- Total used retail gross profit 2,824 2,981 (157) (5.3)% Wholesale gross profit - same store 293 127 166 * Wholesale gross profit - other stores (1) (7) 20 (27) * ---------- ---------- ---------- ---------- Total wholesale gross profit 286 147 139 94.6% Total used vehicle gross profit, as reported $ 3,110 $ 3,128 (18) (0.6)% ========== ========== ========== ========== Gross profit percentage 9.6% 9.6% ========== ========== Used retail units - same store 1,449 1,535 (86) (5.6)% Used retail units - other stores (1) 45 161 (116) (72.0)% Used wholesale units - same store 1,580 1,762 (182) (10.3)% Used wholesale units - other stores 59 73 (14) (19.2)% ---------- ---------- ---------- ---------- Total used units 3,133 3,531 (398) (11.3)% ========== ========== ========== ========== Parts and service: Parts and service gross profit - same store $ 5,690 $ 5,407 283 5.2% Parts and service gross profit - other stores (1) 862 1,135 (273) (24.1)% ---------- ---------- ---------- ---------- Total parts and service revenue $ 6,552 $ 6,542 10 0.2% ========== ========== ========== ========== Gross profit percentage 54.3% 54.0% ========== ========== Other gross profit: Other gross profit - same store $ 3,722 $ 3,577 145 4.1% Other gross profit - other stores (1) 118 329 (211) (64.1)% ---------- ---------- ---------- ---------- Total other gross profit, as reported $ 3,840 $ 3,906 (66) (1.7)% ========== ========== ========== ========== Gross profit percentage 100.0% 100.0% ========== ========== Other gross profit PVR - same store $ 911 $ 864 47 5.4% Other gross profit PVR - other stores (1) 407 488 (81) (16.6)% ---------- ---------- ---------- ---------- Total other gross profit PVR, as reported $ 877 $ 812 65 8.0% ========== ========== ========== ========== Total gross profit: Same store $ 17,055 $ 16,621 434 2.6% Other stores (1) 1,614 2,530 (916) (36.2)% ---------- ---------- ---------- ---------- Total gross profit, as reported $ 18,669 $ 19,151 (482) (2.5)% ========== ========== ========== ========== Gross profit percentage 14.8% 15.0% ========== ==========
(1) Represents the Westwood Lincoln Mercury dealership operations transferred on May 11, 2005 and the used car outlet closed August 2004. * - Percentage exceeds 100%. 26 The percentages used in the gross profit discussion below are from the above table. Total gross profit decreased $0.5 million, or 2.5%, to $18.7 million for the six months ended June 30, 2005, from $19.2 million for the six months ended June 30, 2004. Same store total gross profit increased $0.4 million, or 2.6% to $17.0 million for the six months ended June 30, 2005, from $16.6 million for the six months ended June 30, 2004. The increase is mostly from the second quarter of 2005. Same store gross profit on new retail vehicle sales decreased $0.1 million, or 2.1%, to $4.6 million for the six months ended June 30, 2005, from $4.7 million for the six months ended June 30, 2004. The decrease in gross profit is primarily attributable to a 3.4% decrease in new retail gross profit per unit partially offset by a 1.3% increase in unit sales. It is expected that margins on new vehicles will continue to be under pressure as the manufacturers continue to contend with competitive pricing issues. Similar to revenues, the decline was due mostly to the Lincoln Mercury dealerships partially offset by a gain at the Toyota dealerships. Same store gross profit on used vehicle retail sales decreased less than $0.1 million, or 2.6%, to $2.7 million for the six months ended June 30, 2005, from $2.8 million for the six months ended June 30, 2004. The overall decrease is attributable to the 5.6% decrease in units sold partially offset by a 3.2% increase in average gross profit per unit. In addition, strength in the wholesale market enabled the company to increase its wholesale gross profit compared to the prior year. Same store parts and service gross profit increased $0.3 million, or 5.2%, to $5.7 million for the six months ended June 30, 2005, from $5.4 million for the six months ended June 30, 2004 primarily due to the 4.8% increase parts and service revenues. Similar to revenues, most of the increase came during the second quarter and is primarily attributable to the Toyota dealerships. Selling, General and Administrative Expenses ("S,G&A") S,G&A decreased $1.4 million, or 8.2%, to $15.7 million for the six months ended June 30, 2005 from $17.1 million for the six months ended June 30, 2004. This decrease was primarily attributable to the closing of the used car outlet in August 2004 and the transfer of the Westwood dealership in May 2005 (together totaling $1.1 million). Additional decreases totaled approximately $0.3 million, comprising primarily of decreases in rent and related building costs ($0.1 million) and legal and professional fees ($0.2 million). The decrease in rent is primarily due to purchasing a building in June 2004, which Hometown had previously rented. The decrease in legal and professional fees was due to the settlement of certain litigation at the end of 2004. Other Income In May 2005, Hometown completed the transfer of certain assets in relation to the settlement of litigation matters resulting in a gain of approximately $587,000 recorded in Other Income. See Note 8 to the unaudited consolidated financial statements. Interest Expense Interest expense increased $0.2 million, or 13%, to $1.8 million for the six months ended June 30, 2005, from $1.6 million for the six months ended June 30, 2004. The increase is primarily due to an increase of floorplan interest expense resulting from higher interest rates partially offset by decreased borrowings resulting from one less dealership in 2005 compared to 2004 and lower average inventories at the remaining dealerships. Provision for income tax The effective income tax rate was 40% in the six months ended June 30, 2005 and 27% in the same period of 2004. The rates were based on current forecasts of income before taxes, and current forecasts of permanent differences between tax and book income. The 2005 rate reflects the expected effective tax rate for the year. The 2004 rate reflects the expected full year effective tax rate of 40% adjusted for a reduction in the valuation allowance associated with the 2004 amortization of goodwill for tax purposes. At December 31, 2004 deferred taxes were adjusted primarily to reflect a reduction of the valuation 27 allowance on the deferred tax asset due to the ability to project sufficient income to recover the deferred tax asset. Deferred taxes, including the valuation allowance, will be reviewed throughout fiscal 2005. Net Income Net income increased $0.8 million to $1.1 million for the six months ended June 30, 2005, from $0.3 million for the six months ended June 30, 2004. A substantial amount of the increase is due to a gain on transfer of certain assets in relation to settlement of litigation recorded in Other Income. See above for explanation of other changes. Earnings Per Share, Basic and Diluted and Weighted Average Shares "Basic earnings (loss) per share" is computed by dividing net income (loss) by the weighted average common shares outstanding. "Diluted earnings (loss) per share" is computed by dividing net income (loss) by the weighted average common shares outstanding adjusted for the incremental dilution of potentially dilutive securities. See Note 3 to the unaudited consolidated financial statements. The basic and diluted income per share for the three months ended June 30, 2005 and 2004 is $0.16 and $0.05, respectively. Cyclicality Hometown's operations, like the automotive retailing industry in general, are affected by a number of factors relating to general economic conditions, including consumer business cycles, consumer confidence, economic conditions, availability of consumer credit and interest rates. Although the above factors, among others, may affect Hometown's business, Hometown believes that the impact on Hometown's operations of future negative trends in such factors will be somewhat mitigated by its (i) strong parts, service and collision repair services, (ii) variable cost salary structure, (iii) geographic regional focus, and (iv) product diversity. Seasonality Hometown's operations are subject to seasonal variations, with the second and third quarters generally contributing more revenues and operating profit than the first and fourth quarters. This seasonality is driven primarily by: (i) Manufacturer related factors, primarily the historical timing of major Manufacturer incentive programs and model changeovers, (ii) weather-related factors and (iii) consumer buying patterns. Effects of Inflation Due to the relatively low levels of inflation experienced in the 2005 and 2004 periods, inflation did not have a significant effect on the results of Hometown during those periods. 28 Liquidity and Capital Resources The principal sources of liquidity are cash on hand, cash from operations and floor plan financing. Cash and Cash Equivalents Total cash and cash equivalents was $5.1 million and $6.1 million at June 30, 2005 and December 31, 2004, respectively. Cash Flow from Operations The following table sets forth the consolidated selected information from the unaudited statements of cash flows:
Six months ended (in thousands) June 30, ----------------------- 2005 2004 --------- --------- Net cash provided by (used in) operating activities $ 2,943 $ (2,256) Net cash (used in) investing activities (91) (1,684) Net cash provided by (used in) financing activities (3,903) 5,383 --------- --------- Net increase (decrease) in cash and cash equivalents $ (1,051) $ 1,443 ========= =========
For the six months ended June 30, 2005, net cash provided from operations of $2.9 million primarily consists of: (i) net income of $1.1 million plus non-cash items of $0.8 million (totaling $1.9 million), (ii) a decrease in inventory of $5.0 million less the decrease in floor plan liability - trade of $2.3 million; partially offset by (iii) a decrease in accounts payable and accrued expenses of $0.4 million, primarily due to payment of litigation settlements, (iv) an increase in accounts receivable of $0.5 million, primarily due to the funds to be received from Lincoln Mercury related to the transfer of the Westwood dealership, (v) an increase in prepaid expenses and other current assets of $0.4 million, primarily due to payment of costs associated with the pending exchange agreement, (vi) prepaid income taxes of $0.2 million, and (vii) amortization of deferred revenue of $0.2 million. Inventory and related floor plan liability (trade and non-trade) decreased due to improved new vehicle inventory management. Total floor plan liability decreased more than the decrease in inventory due to an increase in used vehicle inventory in excess of the used floor plan limit. This was primarily due to a planned used vehicle special event sale that took place in July 2005. Net cash used in investing activities of $0.1 million is due to miscellaneous capital expenditures. Net cash used in financing activities of $3.9 million is due to: (i) the net change in non-trade floorplan notes payable of $3.2 million (which decreased due to a similar change in related inventory, see operating activities) and (ii) principal payments of long-term debt and capital lease obligations of $0.9 million; partially offset by proceeds from long-term borrowings of $0.2 million (used to fund the build-out of the corporate office which was built in December 2004). For the six months ended June 30, 2004, net cash used in operations of $2.3 million primarily consists of: (i) net income of $0.3 million plus non-cash items of $0.8 million (totaling $1.1 million); (ii) an increase in inventory of $11.6 million less the increase in floor plan liability - trade of $7.8 million; and (iii) an increase in other long term liabilities and deferred revenue of $0.4 million, primarily due to an advance from Hometown's extended service plan provider. Inventory and related floor plan liability (trade and non-trade) increased due to dealerships increasing inventory levels in anticipation of increased sales which did not materialize. Total floor plan liability increased more than the increase in inventory due to timing of floor plan payments. Net cash used in investing activities of $1.7 million is due to capital expenditures, primarily the Brattleboro, VT. building purchased in June 2004 for $1.5 million. Net cash provided by financing activities of $5.4 million is due to: (i) the net change in non-trade floorplan notes payable of $4.7 million (which increased due to a similar change in related inventory, see operating activities), (ii) proceeds from long-term borrowings of $1.4 million and (iii) exercise of warrants of $0.3 million; partially offset by principal payments of long-term debt and capital lease obligations of $1.0 million. The long-term borrowings were used to acquire the Brattleboro, VT. building discussed above. 29 Capital Expenditures Capital expenditures for fiscal 2005 are expected to be $0.3 million, consisting primarily of equipment purchases and building and leasehold improvements. Receivables Hometown had $5.5 million in accounts receivable at June 30, 2005 compared to $5.1 million at December 31, 2004. The increase in receivables is due to: (i) the increase in sales that takes place in June compared to December, and (ii) approximately $0.5 million due from Lincoln Mercury that will be paid approximately 180 days subsequent to the close of the Westwood dealership transfer; partially offset by a reduction of accounts receivable due to the transfer of the Westwood dealership. The majority of accounts receivables, $2.6 million and $2.4 million as of June 30, 2005 and December 31, 2004, respectively, are due from finance companies that provide or secure financing for customer purchases, and primarily represent contracts-in-transit. These amounts are typically received within seven days of the transaction. Also included are amounts due from manufacturers, which was $1.9 million and $1.7 million as of June 30, 2005 and December 31, 2004. These amounts primarily represent payments of rebates and other incentives that are paid on a monthly or quarterly basis. (Also included in due from manufacturers in 2005 is the aforementioned $0.5 million due from Lincoln Mercury related to the Westwood dealership transfer.) The allowance for doubtful accounts is $0.2 million at June 30, 2005 and $0.3 million December 31, 2004. The decrease in the allowance is primarily due to an improvement in the accounts receivable ageing. Inventories Hometown had $32.0 million in inventories, net at June 30, 2005 compared to $43.4 million at December 31, 2004. The majority of inventory, $21.8 million and $33.6 million as of June 30, 2005 and December 31, 2004, respectively, is new vehicle inventory. The decrease is primarily due one less dealership (Westwood Lincoln Mercury - $6.5 million) along with an improvement (reduction) in inventory levels at our dealerships due to better inventory management. New, used and demonstrator vehicle values are stated at the lower of cost or market, determined on a specific unit basis. Parts and accessories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Hometown assesses the lower of cost or market reserve requirement for vehicles, on an individual unit basis, taking into consideration historical loss rates, the age and composition of the inventory and current market conditions. The lower of cost or market adjustment was $0.5 million and $0.7 million at June 30, 2005 and December 31, 2004, respectively. The decrease in the lower of cost or market adjustment was primarily due to the transfer of the Westwood dealership. See Note 8 to the unaudited consolidated financial statements. Floor Plan Financing See Note 6 to the unaudited consolidated financial statements. Long-Term Debt and Capital Lease Obligations See Note 7 to the unaudited consolidated financial statements. Commitments and Contingencies See Note 8 to the unaudited consolidated financial statements. 30 Forward Looking Statement When used in the Quarterly Report on Form 10Q, the words "may", "will", "should", "expect", "believe", "anticipate", "continue", "estimate", "project", "intend" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act regarding events, conditions and financial trends that may affect Hometown's future plans of operations, business strategy, results of operations and financial condition. Hometown wishes to ensure that such statements are accompanied by meaningful cautionary statements pursuant to the safe harbor established in the Private Securities Litigation Reform Act of 1995. Prospective investors are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors including the ability of Hometown to consummate, and the terms of, acquisitions. Such forward-looking statements should, therefore, be considered in light of various important factors, including those set forth herein and others set forth from time to time in Hometown's reports and registration statements filed with the Securities and Exchange Commission (the "Commission"). Hometown disclaims any intent or obligation to update such forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk from changes in interest rates on our amounts outstanding under our floor plan financing arrangement, which bears interest at variable rates based on the prime or LIBOR borrowing rates. Based on floor plan (trade plus non-trade) amounts outstanding at June 30, 2005 of $30.3 million, a 1% change in the prime rate would result in a $0.3 million change to annual floor plan interest expense. At June 30, 2005, Hometown invested $3.6 million of excess cash, of which $1.1 million was invested in money market accounts paying a weighted average interest rate of 1.59% at June 30, 2005, and $2.5 million was invested in a Ford Motor Credit Company cash management account paying interest of 7.00% at June 30, 2005. The cash management account interest rate is tied to the rate charged on Hometown's floor plan financing arrangement. ITEM 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, are recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to use its judgment in evaluating the cost to benefit relationship of possible controls and procedures. At June 30, 2005, management, with the participation of the CEO and CFO, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation and subject to the foregoing, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective at the reasonable assurance level to accomplish their objectives. There have been no changes in our internal controls over financial reporting during the most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. 31 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 8 - Commitments and Contingencies - Litigation, to the notes to the unaudited consolidated financial statements. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS NONE ITEM 3. DEFAULTS UPON SENIOR SECURITIES NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS NONE ITEM 5. OTHER INFORMATION NONE ITEM 6. EXHIBITS 31.1 Chief Executive Officer Certification 31.2 Chief Financial Officer Certification 32.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Hometown Auto Retailers, Inc. August 10, 2005 By: /s/ Corey E. Shaker ------------------------ ------------------------------------- Date Corey E. Shaker President and Chief Executive Officer August 10, 2005 By: /s/ Charles F. Schwartz ------------------------ ------------------------------------- Date Charles F. Schwartz Chief Financial Officer 33