UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                  

Commission file number 0-20797

RUSH ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)

 

555 I.H. 35 South, Suite 500
New Braunfels, Texas 78130
(Address of principal executive offices)
(Zip Code)

(830) 626-5200
(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  o

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

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o          No  x

Indicated below is the number of shares outstanding of the registrant’s common stock, as of November 1, 2006.

		Number of
		Shares
Title of Class		Outstanding
Class A Common Stock, $.01 Par Value		17,041,269
Class B Common Stock, $.01 Par Value		8,067,148

 

RUSH ENTERPRISES, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets - September 30, 2006 (unaudited) and December 31, 2005
	Consolidated Statements of Operations - For the Three Months and Nine Months Ended September 30, 2006 and 2005 (unaudited)
	Consolidated Statements of Cash Flows - For the Nine Months Ended September 30, 2006 and 2005 (unaudited)
	Notes to Consolidated Financial Statements (unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
SIGNATURES

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

RUSH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
(In Thousands, Except Shares)

		September 30,			December 31,
		2006			2005
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	153,494		$	133,069
Accounts receivable, net		80,829			63,473
Inventories		443,418			338,212
Prepaid expenses and other		1,981			1,829
Deferred income taxes, net		6,646			3,856
Total current assets		686,368			540,439
Property and equipment, net		239,253			196,161
Goodwill, net		111,477			100,725
Other assets, net		2,771			2,909
Total assets		$	1,039,869		$	840,234
Liabilities and shareholders’ equity
Current liabilities:
Floor plan notes payable		$	423,545		$	315,985
Current maturities of long-term debt		26,185			18,807
Current maturities of capital lease obligations		3,241			2,277
Advances outstanding under lines of credit		—			2,755
Trade accounts payable		26,602			23,327
Accrued expenses		66,842			51,151
Total current liabilities		546,415			414,302
Long-term debt, net of current maturities		131,184			114,345
Capital lease obligations, net of current maturities		14,219			14,628
Deferred income taxes, net		25,157			23,339
Shareholders’ equity:
Preferred stock, par value $.01 per share; 1,000,000 shares authorized; 0 shares outstanding in 2006 and 2005		—			—
Common stock, par value $.01 per share; 40,000,000 Class A shares and 10,000,000 Class B shares authorized; and 17,039,189 Class A shares and 8,066,648 Class B shares outstanding in 2006; 16,770,060 Class A shares and 7,895,863 Class B shares outstanding in 2005		251			247
Additional paid-in capital		169,016			162,603
Retained earnings		153,627			110,770
Total shareholders’ equity		322,894			273,620
Total liabilities and shareholders’ equity		$	1,039,869		$	840,234

 

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

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RUSH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

(Unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Revenues:
New and used truck sales		$	504,281		$	365,786		$	1,291,345		$	1,008,657
Parts and service		113,183			94,426			330,499			269,425
Construction equipment sales		15,939			10,164			46,079			29,883
Lease and rental		10,978			8,735			30,546			24,825
Finance and insurance		4,717			4,256			13,787			11,492
Other		2,223			2,060			6,137			5,005
Total revenues		651,321			485,427			1,718,393			1,349,287
Cost of products sold:
New and used truck sales		470,208			338,907			1,197,678			937,758
Parts and service		65,330			54,593			193,677			157,772
Construction equipment sales		14,228			8,809			40,934			25,904
Lease and rental		8,472			6,759			23,506			18,797
Total cost of products sold		558,238			409,068			1,455,795			1,140,231
Gross profit		93,083			76,359			262,598			209,056
Selling, general and administrative		59,141			49,778			173,318			141,084
Depreciation and amortization		3,353			2,684			9,367			7,687
Operating income		30,589			23,897			79,913			60,285
Interest expense, net		4,235			3,632			11,299			9,343
Gain (loss) on sale of assets		(93		)	370			(43		)	455
Income before income taxes		26,261			20,635			68,571			51,397
Provision for income taxes		9,849			7,481			25,714			19,324
Net income		$	16,412		13,154			$	42,857		32,073
Earnings per common share – Basic		$	.65		$	.54		$	1.72		$	1.33
Earnings per common share – Diluted		$	.65		$	.53		$	1.70		$	1.29
Weighted average shares outstanding:
Basic		25,098			24,301			24,936			24,100
Diluted		25,266			25,041			25,221			24,899

 

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

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RUSH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

		Nine Months Ended
		September 30,
		2006			2005
Cash flows from operating activities:
Net income		$	42,857		$	32,073
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		19,595			15,397
(Gain) on sale of property and equipment		(290		)	(1,146		)
Stock-based compensation expense related to stock options and employee stock purchases		2,285			—
Provision for deferred income tax expense		(972		)	924
Tax benefit realized from exercise of stock options by employees		—			1,955
Excess tax benefits from stock-based compensation		(2,217		)	—
Change in accounts receivable, net		(17,360		)	(18,147		)
Change in inventories		(85,608		)	(91,003		)
Change in prepaid expenses and other, net		(152		)	(148		)
Change in trade accounts payable		3,275			7,030
Change in accrued expenses		17,756			4,363
Net cash (used in) operating activities		(20,831		)	(48,702		)
Cash flows from investing activities:
Acquisition of property and equipment		(68,741		)	(40,724		)
Proceeds from the sale of property and equipment		4,038			6,298
Business acquisitions		(27,807		)	(62,636		)
Change in other assets		121			(552		)
Net cash (used in) investing activities		(92,389		)	(97,614		)
Cash flows from financing activities:
Proceeds from long-term debt		57,500			38,081
Proceeds from capital lease obligations		2,431			12,784
Principal payments on long-term debt		(33,283		)	(28,565		)
Principal payments on capital lease obligations		(1,876		)	(929		)
(Payments) draws on lines of credit, net		(2,755		)	209
Draws on floor plan notes payable, net		107,560			85,518
Issuance of shares relating to employee stock options and employee stock purchases		1,915			1,999
Excess tax benefits from stock-based compensation		2,217			—
(Expenses) related to stock offering		—			(71		)
Debt issuance costs		(64		)	(207		)
Net cash provided by financing activities		133,645			108,819
Net increase (decrease) in cash and cash equivalents		20,425			(37,497		)
Cash and cash equivalents, beginning of period		133,069			158,175
Cash and cash equivalents, end of period		$	153,494		$	120,678
Supplemental disclosure of cash flow information:
Cash paid during the period for-
Interest		$	14,844		$	10,949
Income taxes		$	21,276		$	15,374

 

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

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RUSH ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1 – Principles of Consolidation and Basis of Presentation

The interim consolidated financial statements included herein have been prepared by Rush Enterprises, Inc. and its subsidiaries (collectively referred to as the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  All adjustments have been made to the accompanying interim consolidated financial statements, which, in the opinion of the Company’s management, are necessary for a fair presentation of the Company’s operating results.  All adjustments are of a normal recurring nature.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations.  It is recommended that these interim consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.  Results of operations for interim periods are not necessarily indicative of results that may be expected for any other interim periods or the full fiscal year.  Certain prior year balances have been reclassified for comparative purposes.

Stock-Based Compensation Expense

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including grants of stock options and employee stock purchases under the Company’s Employee Stock Purchase Plan based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in 2006.  In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006.  The Company’s Consolidated Financial Statements as of September 30, 2006 and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123(R).  In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).  As a result of adopting SFAS 123(R), the Company’s income before income taxes is $391,000 lower for the three months ended September 30, 2006 and net income is $244,000 lower for the three months ended September 30, 2006, than if it had continued to account for share-based compensation under APB 25.  As a result of adopting SFAS 123(R), the Company’s income before income taxes is $2,285,000 lower for the nine months ended September 30, 2006 and net income is $1,428,000 lower for the nine months ended September 30, 2006, than if it had continued to account for share-based compensation under APB 25.    Basic and diluted earnings per share for the three months ended September 30, 2006 are each $0.01 lower than if the Company had continued to account for share-based compensation under APB 25.  Basic and diluted earnings per share for the nine months ended September 30, 2006 are each $0.06 lower than if the Company had continued to account for share-based compensation under APB 25.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  The fair value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations.  Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).  Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statement of Operations because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized during the three months and nine months ended September 30, 2006 is based on the fair value of the portion of share-based payment awards that is ultimately expected to vest during the period.  Stock-based compensation expense recognized in the Company’s Consolidated Statement of Operations for the three months and nine months ended September 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).  In conjunction with the adoption of SFAS 123(R), compensation expense for all share-based payment awards is recognized using the straight-line single-option method.  As stock-based compensation expense recognized in the Consolidated Statement of Operations for the

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three months and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.  SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  In the Company’s pro forma information required under SFAS 123 for the periods prior to 2006, the Company accounted for forfeitures as they occurred.

Upon adoption of SFAS 123(R), the Company continues to use the Black-Scholes option-pricing model which was previously used for the Company’s pro forma information required under SFAS 123. For additional information, see Note 5. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables.  These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected stock option exercise behaviors.  Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable.  Because the Company’s stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s stock options.  Although the fair value of stock options is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a market transaction between a willing buyer and a willing seller.

2 – Goodwill and Other Intangible Assets

The Company is required to perform an annual impairment review of goodwill.  The Company performs its annual review during the fourth quarter of each year and, therefore, did not record an impairment charge related to goodwill during the third quarter of 2006.  Management is not aware of any impairment charge that may be required; however, a change in economic conditions, if one occurs, could result in an impairment charge in the future.

3 – Commitments and Contingencies

The Company is contingently liable to finance companies for certain notes initiated on behalf of such finance companies related to the sale of trucks and construction equipment. The majority of finance contracts are sold without recourse against the Company. The Company’s liability related to finance contracts sold with recourse is generally limited to 5% to 20% of the outstanding amount of each note initiated on behalf of the finance company. The Company has a finance program that accepts 100% liability, with some restrictions, for the outstanding amount of each note initiated on behalf of the finance company.  In order for a contract to be accepted into this finance program, a customer must meet strict credit requirements or maintain a significant equity position in the truck being financed; consequently, less than 1% of the Company’s portfolio balance related to finance contracts sold by the Company are under this 100% liability finance program.  The Company does not expect to finance a significant percentage of its truck sales under this 100% liability finance program in the future.  The Company provides an allowance for repossession losses and early repayment penalties that it may be liable for under finance contracts it has sold.

As part of the acquisition of certain assets of American Truck Source, Inc. (“ATS”), which was effective January 1, 2005, the Company assumed certain contingent liabilities to finance companies for notes that ATS initiated on behalf of such finance companies related to the sale of trucks.  ATS’s portfolio to which the contingent liability is related is made up of contracts sold with and without recourse, and the Company expects a majority of the portfolio to be liquidated by January 1, 2008.  As part of the acquisition, the Company assumed a specific allowance for repossession losses and early repayment penalties related to ATS’s portfolio.

The Company is involved in various claims and legal actions arising in the ordinary course of business.  The Company believes it is unlikely that the final outcome of any of the claims or proceedings to which the Company is a party would have a material adverse effect on the Company’s financial position or results of operations; however, due to the inherent uncertainty of litigation, there can be no assurance that the resolution of any particular claim or proceeding would not have a material adverse effect on the Company’s financial condition or results of operations for the fiscal period in which such resolution occurred.

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4 – Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Numerator:
Numerator for basic and diluted earnings per share, net income available to common shareholders		$	16,412,000		$	13,154,000		$	42,857,000		$	32,073,000
Denominator:
Denominator for basic earnings per share, adjusted weighted average shares outstanding		25,098,408			24,300,624			24,935,825			24,100,103
Effect of dilutive securities:
Employee and Director stock options		167,248			740,575			285,565			799,045
Denominator for diluted earnings per share, adjusted weighted average shares outstanding and assumed conversions		25,265,656			25,041,199			25,221,390			24,899,148
Basic earnings per common share		$	.65		$	.54		$	1.72		$	1.33
Diluted earnings per common share and common share equivalents		$	.65		$	.53		$	1.70		$	1.29

 

5 – Stock Options

Employee Stock Purchase Plan

The Company has implemented an Employee Stock Purchase Plan that allows eligible employees to contribute up to 10% of their base earnings toward the semi-annual purchase of the Company’s Class A Common Stock. The employee’s purchase price is 85% of the lesser of the closing price of the Class A Common Stock on the first business day or the last business day of the semi-annual offering period, as reported by The Nasdaq National Market®. Employees may purchase shares having a fair market value of up to $25,000 (measured as of the first day of each semi-annual offering period) for each calendar year.  Under the Employee Stock Purchase Plan, 600,000 shares of the Company’s Class A Common Stock have been reserved for issuance.  During the nine months ended September 30, 2005, the Company issued 29,926 shares under the Employee Stock Purchase Plan.  During the nine months ended September 30, 2006, the Company issued 38,031 shares under the Employee Stock Purchase Plan.

Non-Employee Director Stock Option Plan

The Board of Directors and shareholders adopted the Rush Enterprises, Inc. 2006 Non-Employee Director Stock Option Plan (the “Director Plan”), reserving 1,000,000 shares of Class A Common Stock for issuance upon exercise of any awards granted under the Plan. This Director Plan replaced the Company’s Amended and Restated 1997 Non-Employee Director Stock Option Plan (the “1997 Director Plan”) effective May 17, 2006.  The Director Plan is designed to attract and retain highly qualified non-employee directors.  Each non-employee director receives options to purchase 20,000 shares of the Company’s Class A Common Stock upon their respective date of appointment and each year on the date that they are elected or reelected by the shareholders to serve on the Board of Directors.  Each option has a ten year term from the grant date and vests immediately.  During the nine months ended September 30, 2005, the Company granted 80,000 options of Class A Common Stock under the 1997 Director Plan.  During the nine months ended September 30, 2006, the Company granted 80,000 options of Class A Common Stock under the 1997 Director Plan.

Employee Stock Option Plans

In April 1996, the Board of Directors and shareholders adopted the Rush Enterprises, Inc. Long-Term Incentive Plan (the “Incentive Plan”). The Incentive Plan provides for the grant of stock options (which may be nonqualified stock options or incentive stock options for tax purposes), stock appreciation rights issued independent of or in tandem with such options (“SARs”), restricted stock awards and performance awards.

The aggregate number of shares of common stock subject to stock options or SARs that may be granted to any one participant in any year under the Incentive Plan is 100,000 shares of Class A Common Stock and 100,000 shares of Class B Common Stock.  Each option has a ten year term from the grant date and vests in three equal annual installments beginning

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on the third anniversary of the grant date.  The Company has 2,600,000 shares of Class A Common Stock and 1,400,000 shares of Class B Common Stock reserved for issuance upon exercise of any awards granted under the Company’s Incentive Plan.  During the nine months ended September 30, 2005, the Company granted 288,325 options under the Incentive Plan.  During the nine months ended September 30, 2006, the Company granted 319,125 options under the Incentive Plan.

Valuation and Expense Information under SFAS 123(R)

On January 1, 2006, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including stock options and employee stock purchases related to the Employee Stock Purchase Plan based on estimated fair values.  Stock-based compensation expense related to stock options and employee stock purchases under SFAS 123(R) for the three months ended September 30, 2006 was $391,000 and for the nine months ended September 30, 2006 was $2,285,000.  There was no stock-based compensation expense related to stock options and employee stock purchases recognized during the three and nine months ended September 30, 2005.

Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows.  SFAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.  For the nine months ended September 30, 2006, the $2.2 million excess tax benefit classified as a financing cash inflow would have been classified as an operating cash inflow if the Company had not adopted SFAS 123(R).  Cash received from options exercised and shares purchased under all share-based payment arrangements for the nine months ended September 30, 2006 was $1.9 million.

In March 2005, the Company granted options under the Incentive Plan to purchase an aggregate of 288,325 shares of Class A Common Stock.  In March 2006, the Company granted options under the Incentive Plan to purchase an aggregate of 319,125 shares of Class A Common Stock.  In each of May 2005 and May 2006, the Company granted options under the 1997 Director Plan to purchase an aggregate of 80,000 shares of Class A Common Stock.

The table below reflects pro forma net income and diluted net income per share for the three months and nine months ended September 30, 2005 as follows (in thousands except per share amounts):

		Three Months Ended			Nine Months Ended
		September 30, 2005			September 30, 2005
Net income as reported for the prior period (1)		$	13,154		$	32,073
Stock-based compensation expense related to stock options and employee stock purchases		331			1,395
Tax benefit		131			549
Stock-based compensation expense related to stock options and employee stock purchases, net of tax		200			846
Net income, including the effect of stock-based compensation expense		$	12,954		$	31,227
Basic net income per share – as reported for the prior period (1)		$	0.54		$	1.33
Basic net income per share, including the effect of stock-based compensation expense		0.53			1.30
Diluted net income per share – as reported for the prior period (1)		$	0.53		$	1.29
Diluted net income per share, including the effect of stock-based compensation expense		0.52			1.25

 

(1)          Net income and net income per share prior to 2006 did not include stock-based compensation expense for stock options and employee stock purchases under SFAS 123(R) because the Company did not adopt the recognition provisions of SFAS 123(R).

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Upon adoption of SFAS 123(R), the Company continues to use the Black-Scholes option-pricing model which was previously used for the Company’s pro forma information required under SFAS 123.

The following table reflects the weighted-average fair value of stock options granted during each period using the Black-Scholes option valuation model with the following weighted-average assumptions used:

		Three Months Ended				Nine Months Ended
		September 30, 2006		September 30, 2005		September 30, 2006			September 30, 2005
Expected stock volatility		—		—		25.5% -  32.2		%	22.5% - 34.5		%
Weighted-average stock volatility		—		—		26.86		%	31.89		%
Expected dividend yield		—		—		0.0		%	0.0		%
Risk-free interest rate		—		—		4.69		%	4.03		%
Expected life (years)		—		—		5.0 – 7.0			7.0
Weighted-average fair value of stock options granted		—		—		$	7.42		$	6.53

 

The Company computes its historical stock price volatility in accordance with SFAS 123(R).   The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.  The expected life of stock options represents the weighted-average period the stock options are expected to remain outstanding.

A summary of the Company’s stock option activity and related information as of September 30, 2006 and changes during the nine months ended September 30, 2006 follows:

							Weighted
				Weighted			Average
				Average			Remaining		Aggregate
				Exercise			Contractual		Intrinsic
Options		Shares		Price			Life (in Years)		Value
Balance at January 1, 2006		1,719,820		$	7.48
Granted		399,125		19.20
Exercised		(401,967	)	3.62
Forfeited		(30,950	)	11.18
Balance at September 30, 2006		1,686,028		$	11.11		7.52		$	9,692,028
Vested and Exercisable at September 30, 2006		442,571		$	9.10		6.90		$	3,304,714

 

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on an average of the closing price as of September 30, 2006 of the Company’s Class A and Class B Common Stock of $16.14.  The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $6.0 million and the total intrinsic value of options exercised during the nine months ended September 30, 2005 was $5.2 million.

A summary of the status of the Company’s non-vested shares as of September 30, 2006 and changes during the nine months ended September 30, 2006 follows:

				Weighted
				Average
				Grant Date
Non-vested Shares		Shares		Fair Value
Non-vested at January 1, 2006		1,365,950		$	4.05
Granted		399,125		7.42
Vested		(490,668	)	3.19
Forfeited		(30,950	)	5.41
Non-vested at September 30, 2006		1,243,457		$	5.44

 

10

As of September 30, 2006, there was $3.6 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Incentive Plan.  That cost is expected to be recognized over a weighted-average period of 3.4 years.  The total fair value of options vested during the nine months ended September 30, 2006 was $1.6 million and during the nine months ended September 30, 2005 was $1.3 million.

6 – Acquisitions

In September 2006, the Company purchased certain assets of Mountain State Ford Truck Sales, Inc. which consisted of a Ford and Isuzu truck dealership in Denver, Colorado.  The Company is operating the facility as a full-service Rush Medium-Duty Truck Center offering medium-duty trucks, parts and service.  The transaction was valued at approximately $5.3 million, with the purchase price paid in cash.

The Mountain State Ford Truck Sales, Inc. acquisition was accounted for as a purchase; operations of the business acquired are included in the accompanying consolidated financial statements from the date of the acquisition.  Pro forma information is not included because Mountain State Ford Truck Sales, Inc.’s results of operations would not have a material effect on the Company’s financial statements.  The purchase price was allocated based on the fair values of the assets at the date of acquisition as follows (in thousands):

Inventories		$	4,051
Property and equipment		160
Accrued expenses		(140		)
Goodwill		1,257
Total		$	5,328

 

All of the goodwill acquired in the Mountain State Ford Truck Sales, Inc. acquisition will be amortized over 15 years for tax purposes.

In March 2006, the Company purchased certain assets of Great Southern Peterbilt, Inc., which consisted of a Peterbilt and Hino truck dealership in Jacksonville, Florida.  The Company is operating the facility as a full-service Rush Truck Center offering heavy-duty and medium-duty trucks, parts and service.  The transaction was valued at approximately $22.0 million, with the purchase price paid in cash.

The Great Southern Peterbilt, Inc. acquisition was accounted for as a purchase; operations of the business acquired are included in the accompanying consolidated financial statements from the date of the acquisition.  Pro forma information is not included because Great Southern Peterbilt’s results of operations would not have a material effect on the Company’s financial statements.  The purchase price was allocated based on the fair values of the assets at the date of acquisition as follows (in thousands):

Inventories		$	10,525
Property and equipment		2,475
Accrued expenses		(18		)
Goodwill		9,001
Total		$	21,983

 

All of the goodwill acquired in the Great Southern Peterbilt, Inc. acquisition will be amortized over 15 years for tax purposes.

7 – Segment Information

The Company currently has two reportable business segments: the Truck Segment and the Construction Equipment Segment. The Truck Segment operates a network of Rush Truck Centers that provide an integrated one-stop source for the trucking needs of its customers, including retail sales of new and used medium-duty and heavy-duty trucks; aftermarket parts, service and body shop facilities; and a wide array of financial services, including the financing of new and used truck purchases, insurance products and truck leasing and rentals. The Construction Equipment Segment operates a full-service John Deere construction equipment dealership that serves the Houston, Texas metropolitan area. Construction Equipment Segment operations include the retail sale of new and used construction equipment, aftermarket parts and service facilities, and the financing of new and used construction equipment.

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The accounting policies of the segments are the same as those described in the summary of significant accounting policies contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The Company evaluates performance based on income before income taxes not including extraordinary items.

The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties; that is, at current market prices. There were no material intersegment sales during the quarters ended September 30, 2006 and 2005.

The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business unit requires different technology and marketing strategies. Business units were maintained through expansion and acquisitions.  The following table contains summarized information about reportable segment profit or loss and segment assets for the periods ended September 30, 2005 and 2006 (in thousands):

		Truck Segment			Construction Equipment Segment			All Other			Totals
Three months ended September 30, 2006
Revenues from external customers		$	625,595		$	20,662		$	5,064		$	651,321
Segment income before taxes		23,997			1,742			522			26,261
Segment assets		989,707			27,848			22,314			1,039,869
Nine months ended September 30, 2006
Revenues from external customers		$	1,643,700		$	59,849		$	14,844		$	1,718,393
Segment income before taxes		62,852			4,968			751			68,571
Segment assets		989,707			27,848			22,314			1,039,869
Three months ended September 30, 2005
Revenues from external customers		$	467,787		$	14,249		$	3,391		$	485,427
Segment income before taxes		19,263			1,221			151			20,635
Segment assets		748,951			21,734			13,248			783,933
Nine months ended September 30, 2005
Revenues from external customers		$	1,298,749		$	41,817		$	8,721		$	1,349,287
Segment income before taxes		47,105			3,699			593			51,397
Segment assets		748,951			21,734			13,248			783,933

 

Revenues from segments below the quantitative thresholds requiring them to be reported separately are attributable to three operating segments of the Company. These segments include a tire sales company, an insurance agency, and a hunting lease operation. None of these segments has ever met any of the quantitative thresholds that would require them to be reported separately.

8 – Other New Accounting Pronouncements

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition , classification, interest and penalties, accounting in interim periods, disclosure, and transition.  This Interpretation is effective for fiscal years beginning after December 31, 2006.  The Company is currently assessing the impact of the Interpretation on its future results of operations and financial position.

In June 2006, the FASB ratified its consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation)” (“EITF No. 06-3”). The scope of EITF No. 06-3 includes any tax assessed by a governmental authority that is imposed concurrent with or subsequent to a revenue-producing transaction between a seller and a customer. For taxes within the scope of this issue that are significant in amount, the consensus requires the following disclosures: (i) the accounting policy elected for these taxes and (ii) the amount of the taxes reflected gross in the income statement on an interim and annual basis for all periods presented. The disclosure of those taxes can be done on an aggregate basis. The consensus is effective for interim and annual periods beginning after December 15, 2006, with earlier application permitted.  The Company is currently assessing the impact of the EITF No. 06-3 on its future results of operations and financial position.

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

Certain statements contained in this Form 10-Q (or otherwise made by the Company or on the Company’s behalf from time to time in other reports, filings with the SEC, news releases, conferences, website postings or otherwise) that are not statements of historical fact constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended (the “Exchange Act”), notwithstanding that such statements are not specifically identified. Forward-looking statements include statements about the Company’s financial position, business strategy and plans and objectives of management of the Company for future operations.  These forward-looking statements reflect the best judgments of the Company about the future events and trends based on the beliefs of the Company’s management as well as assumptions made by and information currently available to the Company’s management.  Use of the words “may,” “should,” “continue,” “plan,” “potential,” “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.  Forward-looking statements reflect the current view of the Company with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those in such statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those set forth under Item 1A—Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 (as updated in Part II, Item 1A of the Company’s Quarterly Report on Form 10-Q filed for the quarter ended June 30, 2006) as well as future growth rates and margins for certain of our products and services, future demand for our products and services, competitive factors, general economic conditions, cyclicality, economic conditions in the new and used truck and equipment markets, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, technological change, changes in industry practices, onetime events and other factors described herein and in the Company’s other reports filed with the SEC (collectively, “Cautionary Statements”). Although the Company believes that its expectations are reasonable, it can give no assurance that such expectations will prove to be correct. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the applicable Cautionary Statements. The Company does not intend to update these forward-looking statements.

The following comments should be read in conjunction with the Company’s consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

Note Regarding Trademarks Used in This Form 10-Q

Peterbilt® is a registered trademark of Peterbilt Motors Company. PACCAR® is a registered trademark of PACCAR, Inc. GMC® is as registered trademark of General Motors Corporation. Hino® is a registered trademark of Hino Motors, Ltd. UD® is a registered trademark of Nissan Diesel Motor Co., Ltd. Isuzu® is a registered trademark of Isuzu Motors Limited. John Deere® is a registered trademark of Deere & Company. Kenworth® is a registered trademark of PACCAR, Inc. doing business as Kenworth Truck Company. Volvo® is a registered trademark of Volvo Trademark Holding AB. Freightliner® is a registered trademark of Freightliner Corporation. Mack® is a registered trademark of Mack Trucks, Inc. Navistar® is a registered trademark of Navistar International Corporation. Caterpillar® is a registered trademark of Caterpillar, Inc. Cummins® is a registered trademark of Cummins Engine Company, Inc. PacLease® is a registered trademark of PACCAR Leasing Corporation. CitiCapital® is a registered trademark of Citicorp.  Ford® is a registered trademark of Ford Motor Company.

General

Rush Enterprises, Inc. was incorporated in Texas in 1965 and currently consists of two reportable segments: the Truck Segment and the Construction Equipment Segment.

The Company is a full-service, integrated retailer of premium transportation and construction equipment and related services.  The Company’s Rush Truck Centers primarily sell heavy-duty trucks manufactured by Peterbilt Motors Company (“Peterbilt”), a division of PACCAR, Inc.  Certain Rush Truck Centers sell medium-duty trucks manufactured by Peterbilt, GMC, Hino, UD, Isuzu or Ford. The Company also operates a John Deere construction equipment dealership at its Rush Equipment Center in Houston, Texas. Through its strategically located network of Rush Truck Centers and its Rush Equipment Center, the Company provides one-stop service for the needs of its customers, including retail sales of new and used trucks and construction equipment, aftermarket parts sales, service and repair facilities, financing, leasing and rental, and insurance services.

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In September 2006, the Company purchased certain assets of Mountain State Ford Truck Sales, Inc., which consisted of a Ford and Isuzu medium-duty truck dealership in Denver, Colorado, for a total purchase price of $5.3 million.  The Company is operating the facility as a full-service Rush Medium-Duty Truck Center offering medium-duty trucks, parts and service.   See Note 6, “Acquisitions” of the Notes to the Consolidated Financial Statements for a detailed discussion of the allocation of the purchase price of certain assets of Mountain State Ford Truck Sales, Inc.

In March 2006, the Company purchased certain assets of Great Southern Peterbilt, Inc., which consisted of a Peterbilt and Hino truck dealership in Jacksonville, Florida, for a total purchase price of $22.0 million.  The Company is operating the facility as a full-service Rush Truck Center offering heavy-duty and medium-duty trucks, parts and service.   See Note 6, “Acquisitions” of the Notes to the Consolidated Financial Statements for a detailed discussion of the allocation of the purchase price of certain assets of Great Southern Peterbilt, Inc.

The Company’s Rush Truck Centers are principally located in high traffic areas throughout the southern United States. Since commencing operations as a Peterbilt heavy-duty truck dealer in 1966, the Company has grown to operate more than 40 Rush Truck Centers in Alabama, Arizona, California, Colorado, Florida, New Mexico, Oklahoma, Tennessee and Texas.

The Company’s Rush Equipment Center in Houston, Texas provides a full line of John Deere construction equipment, as well as a variety of construction equipment trailers.

Critical Accounting Policies

The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles.  The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  There can be no assurance that actual results will not differ from those estimates.  The Company believes the following accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Inventories

Inventories are stated at the lower of cost or market value.  Cost is determined by specific identification of new and used truck and construction equipment inventory and by the first-in, first-out method for tires, parts and accessories.  An allowance is provided when it is anticipated that cost will exceed net realizable value.

Goodwill

The Company applies the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets (“SFAS 142”), in accounting for goodwill.  SFAS 142 requires that goodwill and other intangible assets that have indefinite useful lives may not be amortized, but instead must be tested at least annually for impairment, and intangible assets that have finite useful lives should continue to be amortized over their useful lives.  SFAS 142 also provides specific guidance for testing goodwill and other non-amortized intangible assets for impairment.  SFAS 142 requires management to make certain estimates and assumptions in order to allocate goodwill to reporting units and to determine the fair value of a reporting unit’s net assets and liabilities, including, among other things, an assessment of market condition, projected cash flows, interest rates and growth rates, which could significantly impact the reported value of goodwill and other intangible assets.  SFAS 142 requires, in lieu of amortization, an annual impairment review of goodwill.  The Company performs its annual review during the fourth quarter of each year and, therefore, did not record an impairment charge related to goodwill during the third quarter of 2006.  Management is not aware of any impairment charge that may be required; however, a change in economic conditions, if one occurs, could result in an impairment charge in the future.

Revenue Recognition Policies

Income on the sale of a truck or a piece of construction equipment is recognized when the customer executes a purchase contract with us, the unit has been delivered to the customer and there are no significant uncertainties related to financing or collectibility. Lease and rental income is recognized over the period of the related lease or rental agreement. Parts and service revenue is recognized at the time the Company sells the parts to its customers or at the time the Company completes the service work order related to service provided to the customer’s unit. Payments received on prepaid maintenance plans are deferred as a component of accrued expenses and recognized as income when the maintenance is performed.

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Finance and Insurance Revenue Recognition

Finance income related to the sale of a unit is recognized when the finance contract is sold to a finance company.  During 2005 and 2006, finance contracts were not retained by the Company for any significant length of time because finance contracts are generally sold to finance companies concurrent with the sale of the related unit. The majority of finance contracts are sold without recourse against the Company. The Company’s liability related to finance contracts sold with recourse is generally limited to 5% to 20% of the outstanding amount of each note initiated on behalf of the finance company. The Company has instituted a finance program that accepts 100% liability, with some restrictions, for the outstanding amount of each note initiated on behalf of the finance company.  In order for a contract to be accepted into this finance program, a customer must meet strict credit requirements or maintain a significant equity position in the truck being financed; consequently, less than 1% of the Company’s portfolio balance related to finance contracts sold by the Company are under this 100% liability finance program and the Company does not expect to finance a significant percentage of its truck sales under this 100% liability finance program in the future. The Company provides for an allowance for repossession losses and early repayment penalties that it may be liable for under finance contracts it has sold.

As part of the acquisition of certain assets of ATS, the Company assumed certain contingent liabilities to finance companies for notes that ATS initiated on behalf of such finance companies related to the sale of trucks.  ATS’s portfolio to which the contingent liability is related is made up of contracts sold with and without recourse, and the Company expects a majority of the portfolio to be liquidated by January 1, 2008.  As part of the acquisition, the Company assumed a specific allowance for repossession losses and early repayment penalties related to ATS’s portfolio.

The Company arranges financing for customers through various financial institutions and receives a commission from the lender equal to either the difference between the interest rates charged to customers over the predetermined interest rates set by the financing institution or a commission for the placement of contracts. The Company also receives commissions from the sale of various insurance products and extended service contracts to customers.  Revenue is recognized by the Company upon the sale of such finance and insurance contracts to the finance and insurance companies net of a provision for estimated repossession losses and interest charge backs. The Company is not the obligor under any of these contracts. In the case of finance contracts, a customer may prepay, or fail to pay, thereby terminating the contract. If the customer terminates a retail finance contract or other insurance product prior to scheduled maturity, a portion of the commissions previously paid to the Company may be charged back to the Company depending on the terms of the relevant contracts. The estimate of ultimate charge back exposure is based on the Company’s historical charge back expense arising from similar contracts, including the impact of refinance and default rates on retail finance contracts and cancellation rates on other insurance products. The actual amount of historical charge-backs has not been significantly different than the Company’s estimates.

Insurance Accruals

The Company is partially self-insured for medical, workers compensation, and property and casualty insurance and calculates a reserve for those claims that have been incurred but not reported and for the remaining portion of those claims that have been reported. The Company uses information provided by third-party administrators to determine the reasonableness of the calculations they perform.

Accounting for Income Taxes

Significant management judgment is required to determine the provisions for income taxes and to determine whether deferred tax assets will be realized in full or in part.  Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  When it is more likely than not that all or some portion of specific deferred income tax assets will not be realized, a valuation allowance must be established for the amount of deferred income tax assets that are determined not to be realizable.  The Company has a valuation allowance related to deferred tax assets in certain states.  Accordingly, the facts and financial circumstances impacting state deferred income tax assets are reviewed quarterly and management’s judgment is applied to determine the amount of valuation allowance required in any given period.

Additionally, despite the Company’s belief that its tax return positions are consistent with applicable tax law, management believes that certain positions may be challenged by taxing authorities.  Settlement of any challenge can result in no change, a complete disallowance, or some partial adjustment reached through negotiations.  Significant judgment is required in evaluating the Company’s tax contingencies.  The Company’s tax contingencies are adjusted in light of changing facts and circumstances.  The Company’s income tax expense includes the impact of reserve provisions and changes to reserves that it considers appropriate, as well as related interest.  Unfavorable settlement of any particular issue would require

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use of the Company’s cash and a charge to income tax expense.  Favorable resolution would be recognized as a reduction to income tax expense at the time of resolution.

Stock-Based Compensation Expense

On January 1, 2006, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including grants of stock options and employee stock purchases under the Company’s Employee Stock Purchase Plan based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under APB 25 for periods beginning in 2006. In March 2005, the SEC issued SAB 107 relating to SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006.  The Company’s Consolidated Financial Statements as of September 30, 2006 and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123(R).  In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).  Stock-based compensation expense recognized under SFAS 123(R) for the three months ended September 30, 2006 was $391,000 and for the nine months ended September 30, 2006 was $2,285,000, which consisted of stock-based compensation expense related to grants of stock options and employee stock purchases under the Employee Stock Purchase Plan.  There was no stock-based compensation expense related to grants of stock options or employee stock purchases under the Employee Stock Purchase Plan recognized during the three and nine months ended September 30, 2005.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  The fair value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations.  Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).  Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statement of Operations because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized during the three months and nine months ended September 30, 2006 is based on the fair value of the portion of share-based payment awards that is ultimately expected to vest during the period.  Stock-based compensation expense recognized in the Company’s Consolidated Statement of Operations for the three months and nine months ended September 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).  In conjunction with the adoption of SFAS 123(R), compensation expense for all share-based payment awards is recognized using the straight-line single-option method.  As stock-based compensation expense recognized in the Consolidated Statement of Operations for the three months and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.  SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  In the Company’s pro forma information required under SFAS 123 for the periods prior to 2006, the Company accounted for forfeitures as they occurred.

Upon adoption of SFAS 123(R), the Company continues to use the Black-Scholes option-pricing model which was previously used for the Company’s pro forma information required under SFAS 123. For additional information, see Note 5, “Stock Options” of the Notes to Consolidated Financial Statements. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company’s stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s stock options. Although the fair value of stock options is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a market transaction between a willing buyer and a willing seller.

See Note 1, “Principles of Consolidation and Basis of Presentation,” of the Notes to Consolidated Financial Statements for additional information regarding the adoption of SFAS 123(R).

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Results of Operations

The following discussion and analysis includes the Company’s historical results of operations for the three months and nine months ended September 30, 2006 and 2005.

The following table sets forth for the periods indicated certain financial data as a percentage of total revenues:

		Three Months EndedSeptember 30,				Nine Months Ended September 30,
		2006		2005		2006		2005
New and used truck sales		77.4	%	75.3	%	75.2	%	74.8	%
Parts and service		17.4		19.5		19.2		20.0
Construction equipment sales		2.5		2.1		2.7		2.2
Lease and rental		1.7		1.8		1.8		1.8
Finance and insurance		0.7		0.9		0.8		0.8
Other		0.3		0.4		0.3		0.4
Total revenues		100.0		100.0		100.0		100.0
Cost of products sold		85.7		84.3		84.7		84.5
Gross profit		14.3		15.7		15.3		15.5
Selling, general and administrative		9.1		10.3		10.1		10.4
Depreciation and amortization		0.5		0.6		0.5		0.6
Operating income		4.7		4.8		4.7		4.5
Interest expense, net		0.7		0.7		0.7		0.7
Gain on sale of assets		0.0		0.1		0.0		0.0
Income before income taxes		4.0		4.2		4.0		3.8
Provision for income taxes		1.5		1.5		1.5		1.4
Net income		2.5	%	2.7	%	2.5	%	2.4	%

 

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

Revenues

Revenues increased $165.9 million, or 34.2%, from $485.4 million in the third quarter of 2005 to $651.3 million in the third quarter of 2006. Sales of new and used trucks increased $138.5 million, or 37.9%, from $365.8 million in the third quarter of 2005 to $504.3 million in the third quarter of 2006.  This increase in new and used truck revenue is due to strong demand for Class 8 trucks, increased sales of medium-duty trucks due to acquisitions and strong demand, and strong demand for used trucks.

Unit sales of new Class 8 trucks increased 32.6%, from 2,648 units in the third quarter of 2005 to 3,512 units in the third quarter of 2006.  Based on estimates from A.C.T. Research Co., LLC, a truck industry data and forecasting service provider (“A.C.T. Research”), the Company believes that sales of Class 8 trucks in the United States will increase from approximately 259,000 units in 2005 to approximately 286,000 units in 2006.  In 2005, the Company retained a 3.9% share of the Class 8 truck sales market in the U.S.  The Company expects to maintain this share of the Class 8 truck sales market in 2006, which would result in the sale of approximately 11,000 Class 8 trucks based on retail sales of 286,000 units as estimated by A.C.T. Research.  Industry expectations are for Class 8 truck retail sales to decline in 2007 primarily due to new diesel emissions laws, which are expected to increase the cost and potentially reduce the fuel efficiency and reliability of diesel engines built on or after January 1, 2007.  Industry analysts believe that new Class 8 truck retail sales will decrease in the second and third quarters of 2007, but will recover in the fourth quarter of 2007.  A.C.T. Research currently estimates U.S. Class 8 truck retail sales to total approximately 175,000 units in 2007.

Unit sales of new medium-duty trucks increased 65.3%, from 671 units in the third quarter of 2005 to 1,109 units in the third quarter of 2006.  The Company continues its concerted effort to improve its medium-duty truck sales by adding experienced medium-duty sales personnel and introducing new medium-duty franchises at some of the Company’s Rush Truck Centers to complement the existing medium-duty lines sold at such dealerships.  Since July of 2005, the Company has acquired medium-duty truck franchises in Dallas and Texarkana, Texas, Orlando and Jacksonville, Florida, Fontana, California and Denver, Colorado.  Overall, new medium-duty truck sales revenue increased approximately $20.7 million, or

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53.2%, in the third quarter of 2006 compared to the third quarter of 2005.  A.C.T. Research currently expects United States retail sales of Class 4, 5, 6, and 7 medium-duty trucks to increase from approximately 263,000 in 2005 to 277,000 in 2006.  The Company expects to sell approximately 4,500 medium—duty trucks in 2006, compared to 2,807 in 2005.  A.C.T. Research expects United States retail sales of Class 4, 5, 6, and 7 medium-duty trucks to decrease approximately 11% in 2007 to 246,000 units, however, the Company expects to continue to add medium-duty franchises to certain dealerships and to increase medium-duty sales and market share compared to 2006.

Unit sales of used trucks increased 12.2%, from 890 units in the third quarter of 2005 to 999 units in the third quarter of 2006.  Used truck average revenue per unit increased by approximately 7.2%.  Historically, used truck demand is consistent with new truck demand.  In 2007, used truck sales volumes and prices will be primarily driven by the consumer’s acceptance of the new diesel emission engines in 2007.  Currently, the Company expects to sell approximately 4,000 used trucks in 2006.

Parts and service sales increased $18.8 million, or 19.9%, from $94.4 million in the third quarter of 2005 to $113.2 million in the third quarter of 2006.  The parts and service sales increase was consistent with management’s expectations, which take into account general economic conditions, successful business development and price increases for parts and labor.  The Company expects parts and service sales to maintain a 20% to 22% growth level during the remainder of 2006.

Sales of new and used construction equipment increased $5.7 million, or 55.9%, from $10.2 million in the third quarter of 2005 to $15.9 million in the third quarter of 2006.  During the third quarter of 2006, the Company made a concerted effort to increase its market share in the Houston area.  Approximately 2,700 units of construction equipment were put into use in the Company’s area of responsibility in 2005, and the construction equipment industry expects to sell approximately 2,840 units of new construction equipment in the Houston area in 2006.  John Deere’s market share in the Houston area construction equipment market increased from 19.6% in the third quarter of 2005 to 22.5% in the third quarter of 2006.  The Company believes it can keep John Deere’s market share, in the Houston area, at approximately 22.5% in 2006.

Lease and rental revenues increased $2.3 million, or 26.4%, from $8.7 million in the third quarter of 2005 to $11.0 million in the third quarter of 2006.  This increase in lease and rental revenue is consistent with management’s expectations.  The Company expects lease and rental revenue to increase approximately 23% during 2006 compared to 2005 due to an increased number of units in the lease and rental fleet.

Finance and insurance revenues increased $0.4 million, or 9.3%, from $4.3 million in the third quarter of 2005 to $4.7 million in the third quarter of 2006.  The Company expects finance and insurance revenues to continue to increase relative to 2005 as sales of new and used trucks remain strong.  Finance and insurance revenues have limited direct costs and, therefore, contribute a disproportionate share of the Company’s operating profits.

Other income increased $0.1 million, or 4.8%, from $2.1 million in the third quarter of 2005 to $2.2 million in the third quarter of 2006.  Other income is primarily related to the gain on sale realized on trucks from the lease and rental fleet, commissions earned from John Deere for direct manufacturer sales in our area of responsibility, document fees related to truck sales and purchase discounts.

Gross Profit

Gross profit increased $16.7 million, or 21.9%, from $76.4 million in the third quarter of 2005 to $93.1 million in the third quarter of 2006.  Gross profit as a percentage of sales decreased from 15.7% in the third quarter of 2005 to 14.3% in the third quarter of 2006.  In addition, truck sales, a lower margin revenue item, increased as a percentage of total revenue from 75.4% in the third quarter of 2005 to 77.4% in the third quarter of 2006.  Parts and service revenue, a higher margin revenue item, decreased as a percentage of total revenue from 19.5% in the third quarter of 2005 to 17.4% in the third quarter of 2006.

Gross margins on Class 8 truck sales decreased from 7.1% in the third quarter of 2005 to 6.6% in the third quarter of 2006.  The decrease in gross margin is partially due to deliveries to several large fleet customers during the third quarter of 2006.  The Company expects to deliver a large number of fleet trucks in the fourth quarter of 2006 as well.  For the remainder of 2006, the Company expects overall gross margins from Class 8 truck sales of approximately 6.5% to 7.5% compared to 6.7% for fiscal year 2005.

Gross margins on medium-duty truck sales decreased from 6.5% in the third quarter of 2005 to 6.0% in the third quarter of 2006.  For 2006, the Company expects overall gross margins from medium-duty truck sales of approximately 6.0% to 7.5% compared to 6.2% for fiscal year 2005.  Gross margins on medium-duty truck sales are impacted by the mix of

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models sold and the Company’s 2006 gross margins on medium-duty trucks could vary significantly depending upon the ultimate product mix of medium-duty trucks actually sold.

Gross margins on used truck sales decreased from 10.4% in the third quarter of 2005 to 9.3% in the third quarter of 2006.  The current challenge for the Company’s used truck business is procuring a sufficient quantity of quality used trucks for resale at acceptable prices.  The Company believes it will be able to continue to achieve margins of approximately 8.0% to 10.0% during the remainder of 2006.

Gross margins from the Company’s parts, service and body shop operations increased from 42.2% in the third quarter of 2005 to 42.3% in the third quarter of 2006.  Gross profit for the parts, service and body shop departments increased from $39.8 million in the third quarter of 2005 to $47.9 million in the third quarter of 2006.  The Company expects to maintain gross margins of approximately 39.0% to 42.0% for the remainder of 2006.

Gross margins on new and used construction equipment sales decreased from 13.3% in the third quarter of 2005 to 10.7% the third quarter of 2006.  The lower gross margins for the third quarter of 2006 are due to the Company’s efforts to increase its market share in the Houston area.  The Company expects 2006 gross margins to remain in a range of 10.0% to 12.0% depending on the mix of products sold.

Gross margins from lease and rental sales increased from approximately 22.6% in the third quarter of 2005 to 22.8% in the third quarter of 2006.  The Company expects to maintain gross margins from lease and rental sales of approximately 22.0% to 24.0% for the remainder of 2006.  The Company’s policy is to depreciate its lease and rental fleet using the shortest depreciable life established by generally accepted accounting principles.  This policy results in the Company realizing small gross margins while the unit is in service and a corresponding larger gain on sale when the unit is sold at the end of the lease term.

The increase in finance and insurance revenues and other income, as described above, has limited direct costs and, therefore, contributes a disproportionate share of gross profit.

Selling, General and Administrative Expenses

Selling, General and Administrative (“SG&A”) expenses increased $9.3 million, or 18.7%, from $49.8 million in the third quarter of 2005 to $59.1 million in the third quarter of 2006.  This increase is attributable in part to commissions on increased truck sales, expansion of facilities in Mobile, Alabama and Nashville, Tennessee and new store openings in Alice and Texarkana, Texas, Orlando and Jacksonville, Florida and Denver, Colorado.  Additionally, on January 1, 2006, the Company implemented SFAS 123(R), which resulted in stock-based compensation expense of $391,000 for the third quarter of 2006. SG&A expenses as a percentage of sales decreased from 10.3% in the third quarter of 2005 to 9.1% in the third quarter of 2006.  SG&A expenses as a percentage of sales have historically ranged from 10.0% to 16.0%; however, when new and used truck revenue is high, SG&A expenses as a percentage of sales are low.  The Company expects SG&A expenses as a percentage of sales to remain low through the remainder of 2006; however, in 2007 the Company expects SG&A expenses as a percentage of sales to increase due to the expected decrease in new truck revenue.

Interest Expense

Net interest expense increased $0.6 million, or 16.7%, from $3.6 million in the third quarter of 2005 to $4.2 million in the third quarter of 2006.  In the third quarter of 2006, floor plan interest expense increased compared to the third quarter of 2005 due to the increase in floor plan debt and increasing interest rates.  To take advantage of increased truck demand, the Company currently maintains higher levels of truck inventory than it has traditionally maintained, which increases the Company’s floor plan debt.  The increase in net interest expense in the third quarter of 2006 was offset by earnings on the Company’s investment of available cash.

Income before Income Taxes

Income before income taxes increased $5.7 million, or 27.7%, from $20.6 million in the third quarter of 2005 to $26.3 million in the third quarter of 2006, as a result of the factors described above.  The Company believes that income in 2006 will continue to increase compared to 2005.

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