Lithia Motors, Inc. — FY 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; filed March 2, 2015. This is an annual filing, not a standalone fourth-quarter report. Unless stated otherwise, figures are in U.S. dollars.
Business context
Lithia operates franchised new- and used-vehicle dealerships and provides financing, insurance products, service, body and parts. At year-end it operated 129 stores; the filing reports 130 stores as of March 2, 2015. In 2014, the company acquired 35 stores, including 27 DCH Auto Group locations acquired October 1, and opened one store. Management estimated these acquisitions would add more than $2.7 billion in annual revenue once fully reflected.
Financial and operating results
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Revenue | $5.390 billion | $4.006 billion | +34.6% |
| Gross profit | $823.3 million | $631.0 million | +30.5% |
| Operating income | $231.9 million | $183.5 million | +26.4% |
| Income from continuing operations | $135.5 million | $105.2 million | +28.8% |
| Net income | $138.7 million | $106.0 million | +30.9% |
| Diluted EPS from continuing operations | $5.14 | $4.02 | +27.9% |
Gross margin was 15.3%, down from 15.8%; operating margin was 4.3%, down from 4.6%. SG&A was $563.2 million, or 68.4% of gross profit, versus 67.7% in 2013. Management attributed the higher ratio principally to acquired stores and related operating costs.
- New-vehicle revenue rose 36.4%, while gross margin declined to 6.4% from 6.7%. Same-store new-unit sales grew 8.2%.
- Used retail revenue increased 32.0%; same-store retail revenue rose 14.6%. Retail gross margin fell to 13.2% from 14.6%, partly reflecting a mix shift toward late-model vehicles.
- Finance and insurance revenue grew 37.0%; same-store finance and insurance per retail unit increased 7.4% to $1,205.
- Service, body and parts revenue increased 33.5%; same-store revenue grew 11.3%, and the reported gross margin improved to 48.8% from 48.4%.
- Fourth-quarter revenue was $1.793 billion versus $1.025 billion in 2013; net income was $41.1 million versus $27.4 million. The year-over-year comparison includes the DCH acquisition in the 2014 quarter.
Cash flow, liquidity and debt
- Cash from operating activities was $30.3 million, compared with $32.1 million in 2013. Management’s adjusted operating-cash-flow measure, which incorporates certain floor-plan financing activity and excludes acquired inventory financing, was $213.3 million versus $135.5 million.
- Investing cash outflow was $736.3 million, including $659.6 million of cash paid for acquisitions and $86.0 million of capital expenditures. Financing cash inflow was $712.2 million. Year-end cash was $29.9 million.
- Working capital was $172.9 million, down from $209.0 million. Immediately available cash and credit totaled $100.3 million; management estimated a further $109.4 million could potentially be raised against unfinanced operating real estate, subject to financing availability and terms.
- Reported total debt was approximately $1.823 billion, including $1.179 billion of floor-plan debt; long-term debt, including current maturities, was $641.0 million. Debt to total capital, excluding floor-plan notes, rose to 48.7% from 32.0%.
- Approximately 84.5% of total debt was variable-rate after interest-rate swaps. The filing estimates a 16-basis-point rate increase would add approximately $1.6 million of annual after-tax interest expense, based on year-end balances.
Material changes, outlook and risks
- Acquisition-driven expansion: Revenue, assets, inventory and debt increased substantially with the 2014 acquisition program, particularly DCH. Acquired operations represented approximately 14% of reported 2014 revenue and 22% of year-end assets; management excluded the 35 acquisitions from its internal-control assessment while integrating them.
- Operating targets: For 2015, management expected SG&A at a lower-70% range of gross profit due to a full year of DCH, and targeted same-store throughput near 50%. It also targeted 75 used retail units per store per month, versus 56 in 2014. The filing does not provide a formal revenue or EPS forecast.
- Covenant issue: The year-end current ratio was 1.16 against a 1.20 minimum. Lithia obtained a lender waiver and amended the minimum to 1.10 for the first quarter of 2015 and beyond. The company stated it expected continued covenant compliance, but provided no assurance.
- Unusual items: A $1.9 million impairment related to an equity-method investment was recorded in 2014. The NMTC investment generated $6.5 million of tax benefits and credits, while also producing reported operating losses and a future equity-contribution obligation. Discontinued operations included $3.2 million of after-tax income, including a disposal gain; the filing notes a $6.8 million gain related to disposed goodwill and other intangible assets.
- Key risks: Results depend on consumer demand, credit availability, vehicle supply and manufacturer relationships; the business is competitive and seasonal. Other material exposures include acquisition integration and financing, high variable-rate debt, covenant compliance, regulatory and litigation matters, environmental liabilities, cybersecurity, self-insurance claims and the financial health of a third-party warranty provider. Revenue is concentrated in a limited number of states, and three states represented about 57% of 2014 revenue.
- KPMG issued unqualified opinions on the consolidated financial statements and on internal control over financial reporting. The internal-control assessment and audit excluded the 35 stores acquired in 2014.
Important facts for investors to verify
- How DCH and the other acquired stores perform over a full year, including integration costs, returns on invested capital and progress toward the stated SG&A and throughput targets.
- Current covenant compliance, post-waiver liquidity, and the availability and terms of additional real-estate financing.
- Debt maturities, variable-rate exposure and the effect of higher interest rates on earnings and cash generation.
- Whether same-store vehicle volumes and service growth can offset declining vehicle gross margins and the lower used-vehicle gross profit per unit.
- The assumptions and ongoing economics of the NMTC investment, including tax-credit realization, impairment risk and remaining contribution commitments.
- Manufacturer and geographic concentration, warranty-insurer exposure, and the potential effects of regulatory, legal, environmental or cyber events.