LITHIA MOTORS INC quarterly report, Q3 FY2016

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Lithia Motors, Inc. — Q3 2016 Form 10-Q

Reporting period: Three and nine months ended September 30, 2016. Unless stated otherwise, financial amounts are in U.S. dollars; statement amounts are in millions, converted from the filing’s thousands.

Business context and reporting period

Lithia operates automotive dealerships selling new and used vehicles, finance and insurance products, and service, body and parts. At October 28, 2016, it reported 152 U.S. stores and 30 new-vehicle brands. The company reported Domestic, Import and Luxury segments. Results include acquisitions from their respective acquisition dates; Lithia acquired 13 stores and one franchise during the first nine months of 2016.

Financial performance and liquidity

  • Revenue: Q3 revenue was $2.270 billion, up 8.9% year over year; nine-month revenue was $6.386 billion, up 8.8%. Acquisition-driven growth contributed. Q3 and nine-month gross profit was $337.3 million and $966.5 million, respectively.
  • Profit and margins: Q3 net income was $54.0 million versus $43.4 million; diluted EPS was $2.14 versus $1.64. Nine-month net income was $145.7 million versus $135.3 million; diluted EPS was $5.69 versus $5.10. Gross margin was 14.9% in Q3 (flat) and 15.1% year to date (up from 15.0%). Operating margin was 4.1% in Q3 versus 3.5%, and 4.0% year to date versus 3.9%.
  • Revenue mix and margin pressures: Q3 new-vehicle revenue rose 5.7%, but gross profit fell 1.7% and margin declined to 5.8% from 6.3%. Used retail revenue increased 14.8%, while margin declined to 11.8% from 12.3%. Service, body and parts revenue increased 14.4%; its margin declined to 48.1% from 49.5%. Finance and insurance revenue increased 14.5%.
  • Cash flow: Nine-month operating cash flow was $189.8 million, versus $106.9 million. Investing used $289.5 million, primarily reflecting $199.4 million of acquisition payments and $81.4 million of capital expenditures. Financing provided $78.8 million. Cash declined $20.9 million to $24.1 million. Management’s adjusted operating cash flow measure, including specified floor-plan financing adjustments, was $195.5 million.
  • Debt and liquidity: Total reported debt was $2.180 billion, including $1.352 billion of non-trade floor-plan notes, $73.8 million of other floor-plan notes, and $727.2 million of long-term debt and current maturities. Cash plus available credit was $146.3 million; credit availability was $122.1 million. Management estimated another $193.2 million could potentially be raised against unfinanced real estate, subject to valuation and financing availability. The credit facility was amended in July 2016, increasing commitments by $300 million to $2.05 billion and extending maturity to July 2021. Lithia reported compliance with its debt covenants.
  • Capital returns: The company repurchased 1.36 million Class A shares for approximately $108.6 million during the first nine months. It paid $17.8 million in dividends and declared a further $0.25-per-share dividend after quarter-end, totaling approximately $6.3 million.

Material changes versus comparable periods

  • Q3 revenue increased 8.9%, while net income increased 24.5%; year-to-date revenue increased 8.8%, while net income increased 7.7%. Share repurchases also reduced weighted-average shares.
  • Same-store Q3 new-vehicle revenue rose 1.3%, but unit sales fell 1.7% and gross profit declined 6.0%. For nine months, same-store revenue rose 3.1% and gross profit was nearly flat, up 0.1%.
  • Same-store used retail revenue increased 10.6% in Q3 and 11.1% year to date; gross profit per unit declined in both periods. Service, body and parts same-store sales also grew, supported in part by increased recall-related warranty work.
  • Q3 segment income was mixed: Import increased 4.4%, while Domestic declined 2.5% and Luxury declined 10.8%. For nine months, Import increased 12.7%, while Domestic declined 7.6% and Luxury declined 15.6%.
  • Reported Q3 operating income benefited from comparison with a $18.3 million transition-agreement charge recorded in 2015. The 2016 nine-month period included $10.5 million of equity-method investment impairment charges; the comparable 2015 period included $12.4 million of such charges plus $2.0 million of property impairments. These items affect period comparability.

Outlook, commentary, risks and unusual items

  • No specific earnings or revenue guidance was provided. Management expected approximately $100 million of 2016 capital expenditures, primarily for acquired-store improvements, facility work, real estate and equipment.
  • Management described national new-vehicle sales growth as moderating. It cited increased inventory and interest rates as drivers of higher floor-plan interest expense, which rose $1.2 million in Q3 and $4.0 million year to date versus 2015.
  • Management’s strategy emphasizes acquisition growth, used-vehicle sales, market-share gains and service operations. It noted that pursuing vehicle volume had reduced gross profit per unit in some vehicle categories.
  • The NMTC equity-method investment generated tax benefits and credits, but also operating losses and impairment charges. Nine-month tax credits and benefits from the investment were $20.4 million; the reported effective tax rate was 33.0%, compared with 39.3% after excluding the credits and specified other items.
  • A proposed Oregon ballot measure would impose a 2.5% minimum gross-receipts tax on qualifying C corporations. Lithia estimated passage could increase its annual Oregon tax liability from approximately $3.3 million to $34 million; the proposal was not presented as an enacted tax.
  • Shareholder derivative litigation concerning a transition agreement with the chairman survived motions to dismiss and was in discovery. The filing said management did not anticipate material adverse effects from the described or ordinary-course litigation, while noting outcomes cannot be predicted with certainty. Certain California wage-and-hour matters were subject to indemnification provisions and were considered immaterial by the company.
  • Other disclosed risks include seasonality, economic and consumer conditions, interest rates, inventory management, acquisition execution, debt-covenant compliance and changing tax policies. Management cautioned that interim results are not necessarily indicative of full-year results.

Important facts for investors to verify

  • How much revenue and earnings growth came from acquisitions versus same-store performance, and whether acquired stores meet return expectations.
  • Whether vehicle and service growth can be sustained without further deterioration in gross profit per unit, margins or segment income.
  • Liquidity and leverage after acquisitions, share repurchases and capital spending; the availability and terms of additional real-estate financing should not be assumed.
  • The operating and valuation outlook for the NMTC investment, related impairment exposure and tax-credit contribution to the effective tax rate.
  • The outcome of the Oregon tax proposal, the derivative litigation and the California wage-and-hour matters, including any changes to expected exposure.