Lithia Motors, Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results. Unless otherwise noted, amounts below are in U.S. dollars.
Business context
Lithia operates franchised dealerships and sells new and used vehicles, parts, maintenance and repair services, and financing and insurance products. At year-end it operated 154 stores across 17 states and represented 30 new-vehicle brands. Its growth strategy combines acquisitions with same-store sales growth, particularly in used vehicles and service operations.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $8.678 billion | $7.864 billion | +10.3% |
| Gross profit | $1.301 billion | $1.176 billion | +10.7% |
| Operating income | $338.4 million | $302.7 million | +11.8% |
| Continuing-operations net income | $197.1 million | $183.0 million | +7.7% |
| Diluted EPS from continuing operations | $7.72 | $6.91 | +11.7% |
| Gross margin | 15.0% | 14.9% | +10 basis points |
| Operating margin | 3.9% | 3.8% | +10 basis points |
| Cash from operating activities | $86.5 million | $74.5 million | +$12.0 million |
Adjusted same-store throughput, a company-defined non-GAAP measure of incremental gross profit retained after SG&A, was 24% in 2016 versus 48% in 2015. Management cited advertising and insurance costs growing faster than gross profit; its 2017 target was 45%–50%. Adjusted operating margin was 4.1% in 2016 versus 4.3% in 2015, excluding specified non-core items.
New-vehicle revenue rose 8.5%, but same-store new-vehicle gross profit fell 1.6% and gross margin declined to 5.9% from 6.2%. Used retail revenue increased 15.6%; same-store revenue rose 11.1%, while same-store margin declined to 11.9% from 12.5%. Finance and insurance revenue grew 16.9%, and service, body and parts revenue grew 14.3%. These higher-margin activities generated 25.4% and 31.5% of total gross profit, respectively.
Fourth quarter: Revenue was $2.292 billion versus $1.993 billion in Q4 2015; net income was $51.3 million versus $47.7 million; diluted EPS was $2.03 versus $1.80.
At December 31, 2016, cash was $50.3 million, working capital was $365.2 million, total assets were $3.844 billion and stockholders’ equity was $910.8 million. Total debt was $2.392 billion, including $1.601 billion of floor-plan debt; long-term debt including current maturities was $790.9 million. Approximately 88% of total debt was variable-rate. Debt excluding floor-plan notes was 46.5% of total capital, up from 43.7% in 2015. The company reported $188.4 million of cash and available credit, and estimated a further $168.4 million could be raised against unfinanced real estate.
Investing cash outflow was $351.7 million, including $234.7 million of acquisition cash payments and $100.8 million of capital expenditures. Financing cash inflow was $270.5 million, including net floor-plan borrowings; the company repurchased $112.9 million of stock and paid $24.1 million in dividends. Its $2.05 billion revolving syndicated credit facility matures in July 2021. Lithia reported compliance with its debt covenants at year-end, including a 1.26 current ratio against a 1.10 minimum and a 2.18 leverage ratio against a 5.00 maximum.
Material changes and unusual items
- Lithia acquired 15 stores and one franchise and opened one store in 2016. Acquired operations contributed $266.2 million of revenue and $1.7 million of operating income after acquisition. Acquisition spending, net of floor-plan financing associated with acquired inventory, was approximately $140.2 million.
- Revenue and unit growth were substantially acquisition-supported. Same-store new-vehicle unit sales increased 1.0%; same-store used retail vehicle units increased 9.5%.
- 2016 included $14.0 million of asset impairment charges and an $8.3 million share of operating losses from a New Markets Tax Credit equity investment. The company also recognized $28.5 million of related tax benefits and credits, and no longer held an interest in the investment at year-end. Reported effective tax rate was 30.5%; management’s adjusted rate excluding tax credits and other non-core items was 38.6%.
- 2015 included an $18.3 million charge for a transition agreement with Chairman Sidney B. DeBoer. The balance recorded for the agreement was $17.3 million at year-end 2016.
- Share repurchases rose materially: 1.4 million shares for $112.9 million in 2016, versus $31.5 million in 2015. Annual dividends declared per share increased to $0.95 from $0.76.
Outlook, risks and contingencies
Management targeted 45%–50% same-store throughput for 2017, an average of 75 retail used vehicles per store per month (versus 66 in 2016), and approximately $123 million of 2017 capital expenditures. It expressed continued interest in acquisitions and organic growth; the filing does not provide a specific full-year 2017 revenue or earnings forecast.
Key risks include cyclical vehicle demand and local-market concentration; pressure on vehicle margins from online price transparency and competition; dependence on manufacturers for inventory, incentives and franchise approvals; availability and cost of customer credit; acquisition integration and financing; and variable-rate debt exposure. Management estimated that an 18-basis-point increase in rates would increase annual interest expense by approximately $2.6 million, net of tax, based on year-end balances. The company also cited regulatory, employment, environmental, cybersecurity, weather and self-insurance exposures.
Pending matters include shareholder derivative litigation concerning the Chairman’s transition agreement and California wage-and-hour cases involving acquired DCH operations. The company stated it did not expect these matters to have a material adverse effect, but could not predict the outcome with certainty. Certain California wage claims were agreed in principle to be settled, subject to court approval; the seller is obligated to indemnify Lithia for related losses. A 2016 FTC settlement regarding disclosure of used vehicles with open safety recalls required specified disclosures; Lithia made no payment and admitted no wrongdoing.
KPMG issued an unqualified opinion on the consolidated financial statements and internal controls. Management and the auditor excluded the 15 stores acquired in 2016 from the internal-control assessment while they were being integrated; those stores represented approximately 8% of year-end assets and 3% of 2016 revenue.
Important facts for investors to verify
- How much future growth and earnings depend on further acquisitions versus same-store performance, and whether acquired-store integration improves margins and throughput.
- Whether vehicle gross-profit-per-unit and used-vehicle margins stabilize, and whether the 2017 throughput and used-unit targets are achieved.
- Debt levels, covenant headroom, refinancing needs and sensitivity to rising interest rates, including the substantial variable-rate exposure.
- The assumptions and potential cash implications of the New Markets Tax Credit investment, the DeBoer transition agreement, contract charge-back reserves and self-insurance reserves.
- Outcomes and final court approval of the disclosed litigation settlements, and the effectiveness of internal controls as acquired stores are brought into the assessment.