Lithia Motors, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; comparisons are to the same periods of 2014 unless noted. Dollar amounts below are in millions except per-share data. Lithia operated 135 stores and offered 31 new-vehicle brands as of October 30, 2015.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $2,084.8 | $1,297.1 | $5,871.0 | $3,597.0 |
| Gross profit | $311.2 | $197.8 | $882.2 | $562.2 |
| Operating income | $72.8 | $60.1 | $226.3 | $165.9 |
| Continuing-operations net income | $43.4 | $34.5 | $135.3 | $94.4 |
| Diluted continuing-operations EPS | $1.64 | $1.31 | $5.10 | $3.58 |
| Gross margin | 14.9% | 15.3% | 15.0% | 15.6% |
| Operating margin | 3.5% | 4.6% | 3.9% | 4.6% |
Reported revenue rose 60.7% in Q3 and 63.2% year to date, driven substantially by the October 2014 acquisition of DCH Auto Group. Same-store new-vehicle revenue grew 11.4% in Q3 and 10.1% year to date; same-store used retail revenue grew 12.8% and 13.6%, respectively. Same-store service, body and parts revenue increased 10.2% in Q3 and 10.3% year to date.
Profit growth was accompanied by lower reported margins. New-vehicle, used-retail and wholesale gross margins declined year to date; service, body and parts margins improved. SG&A was $223.7 million in Q3 and $611.0 million year to date. Management reported SG&A at 71.9% of gross profit in Q3 and 69.3% year to date, including unusual items.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $106.9 million, versus $87.7 million a year earlier. Management’s adjusted operating cash flow, including net non-trade floor-plan borrowings, was $143.1 million, versus $118.1 million.
- Investing cash outflow was $104.6 million, including $62.2 million of capital expenditures, $34.9 million paid for acquisitions and $20.7 million of other investments. Financing cash flow was $0.5 million. Cash ended the period at $32.7 million, up $2.8 million from year-end 2014.
- Total debt, including floor-plan financing, was $1.845 billion. This included $1.168 billion of non-trade floor-plan notes and $46.7 million of trade floor-plan notes. Long-term debt and current maturities together were approximately $630.0 million. Debt to total capital excluding floor-plan notes was 44.4% at September 30, 2015, compared with 30.4% at September 30, 2014.
- Available credit was $163.0 million; cash plus available credit totaled $195.7 million. Management estimated a further $108.6 million could potentially be raised against unfinanced real estate, subject to valuation, financing availability and acceptable terms.
- The reported current ratio was 1.25, above the 1.10 covenant minimum. Fixed-charge coverage was 3.38 against a 1.20 minimum; leverage was 1.84 against a 5.00 maximum. Lithia reported compliance with all covenants at quarter-end.
Material changes and unusual items
- The DCH acquisition materially expanded the business and drove much of reported growth. Lithia completed four store acquisitions and added a franchise in the first nine months of 2015, for total consideration of $37.1 million. Acquired stores contributed $10.5 million of revenue during that period.
- Q3 results included an $18.3 million charge for a transition agreement with Executive Chairman Sidney B. DeBoer. The agreement takes effect January 1, 2016, with initial payments expected in Q3 2016; the recorded amount reflects estimated future payments.
- Asset impairment charges totaled $14.4 million year to date: $12.4 million related to the New Markets Tax Credit equity-method investment and $2.0 million related to properties. The investment generated tax benefits and credits of $22.3 million year to date, reducing the reported effective tax rate to 31.1%; excluding the investment and other non-core items, management reported an adjusted rate of 38.7%.
- Sale of two stores generated a $5.9 million gain year to date. The stores held for sale at December 31, 2014 had both been sold by September 30, 2015.
- Management’s adjusted non-GAAP results excluded specified items, including the transition-agreement charge, investment impairments and related tax credits, and the store-sale gain. These adjustments materially change the presentation of operating performance and should be assessed alongside GAAP results.
Outlook, commentary and risks
- Management expected 2015 capital expenditures of approximately $100 million. It said operating margin was expected to remain in the low-4% range during 2015 as DCH integration continued; adjusted operating margin was 4.6% for Q3 and 4.3% year to date.
- Management’s same-store throughput target was 45%–50%; reported adjusted same-store throughput was 49.3% in Q3 and 41.4% year to date. Management also targeted 75 used retail units per store per month; the annualized average at September 30 was 61, versus 55 a year earlier.
- Management cited the improving economic environment, new product introductions, greater availability of late-model used vehicles and operational execution as business supports. It also noted that DCH stores’ high-volume, low-margin strategy and higher historical cost structure weighed on segment profitability, particularly in Luxury.
- Risks highlighted include uncertainty from Volkswagen’s emissions issues and possible effects on Lithia’s five Volkswagen and three Audi stores; the company said about 3% of its 2015 year-to-date and 2014 full-year new-vehicle unit sales were those brands. Use of New Markets Tax Credit benefits depends on program compliance and future taxable income.
- Other stated risks include seasonal sales fluctuations, changes in interest rates and consumer credit, manufacturer incentives, economic conditions, acquisition integration and maintaining compliance with debt covenants. Management cautioned that forward-looking statements are uncertain and actual results may differ.
Important facts for investors to verify
- How much reported growth and future earnings depend on acquired DCH stores versus organic, same-store performance, and whether integration improves margins.
- Whether vehicle gross-margin declines and elevated SG&A persist, and how the $18.3 million transition-agreement estimate may change as payments begin.
- The sustainability and cash economics of the New Markets Tax Credit investment, including required future contributions of $49.8 million through October 2016 and the ability to realize related tax benefits.
- Debt and liquidity capacity under the credit facility, including inventory-related borrowing needs, covenant headroom and the conditional nature of potential real-estate financing.
- Effects of Volkswagen/Audi demand changes, vehicle inventory levels, consumer credit availability and the company’s planned capital expenditures on future cash flow.