Lithia Motors, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Lithia operated 201 locations representing 30 brands in 21 states. Comparisons below are with the same periods of 2019 unless noted. Amounts are in millions except per-share data.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $3,620.2 | $3,332.4 | $9,182.5 | $9,403.8 |
| Gross profit | $651.6 | $510.9 | $1,576.9 | $1,455.2 |
| Operating income | $239.6 | $146.8 | $462.1 | $372.3 |
| Net income | $158.8 | $85.2 | $282.7 | $203.5 |
| Diluted EPS | $6.86 | $3.64 | $12.18 | $8.72 |
- Revenue increased 8.6% in Q3, while nine-month revenue decreased 2.4%. Q3 gross profit rose 27.5%; nine-month gross profit rose 8.4%.
- Gross margin expanded to 18.0% in Q3 from 15.3%, and to 17.2% for nine months from 15.5%. Operating margin was 6.6% and 5.0%, respectively, versus 4.4% and 4.0%.
- Q3 same-store revenue grew 0.7%, while same-store gross profit increased 17.5%. Higher vehicle gross profit per unit and lower floor-plan interest supported results; SG&A declined as a share of gross profit.
- Vehicle mix diverged: Q3 new retail unit sales fell 1.2% company-wide, while used retail units rose 11.8%. New-vehicle gross profit per unit increased 41.8% and used-vehicle gross profit per unit 29.8%.
- For the first nine months, operating cash flow was $800.6, versus $453.5. Inventory reductions contributed $457.0 to operating cash flow; management’s adjusted operating cash flow, including specified floor-plan adjustments, was $349.2 versus $293.5.
- Investing cash outflow was $728.3, including $609.5 for acquisitions and $125.6 of capital expenditures. Financing cash outflow was $99.2. Cash declined from $84.0 at year-end 2019 to $57.1.
- At September 30, total debt was $3,471.8 before $12.8 of unamortized issuance costs; the filing reports total debt of $3,459.0 after those costs. Cash was $57.1. Revolving credit availability was $565.6, with a further $72.0 available under used- and service-loaner financing commitments.
Changes, strategy, and outlook
- Q3 earnings improved substantially despite COVID-19-related disruption earlier in the year. Management said September same-store new-vehicle unit sales had returned to prior-year levels; used-vehicle sales improved significantly in Q2 and Q3.
- Management attributed stronger vehicle margins to pent-up demand, lower inventory following temporary production closures, and increased manufacturer incentives. Lower interest rates and inventory levels reduced floor-plan interest expense.
- Results also benefited from acquisitions: Lithia acquired 17 stores in the first nine months, versus four in the comparable 2019 period. Those acquisitions contributed $261.3 of revenue and $9.2 of operating income after acquisition.
- The company introduced Driveway, an ecommerce platform intended to complement its physical network. Its stated capital allocation targets are 65% acquisitions, 25% capital expenditures/modernization/diversification, and 10% shareholder returns. Approximately $65 of planned discretionary capital expenditures had been deferred.
- No quantified revenue or earnings forecast is provided. Management estimated an annual effective tax rate, excluding non-core charges, of 28.5%–29.0%. It said it expected to remain in compliance with debt covenants, while cautioning that future compliance is not assured.
Debt, liquidity, and subsequent events
- The company remained within its credit-facility covenants at quarter-end: current ratio 1.38 against a 1.10 minimum; fixed-charge coverage 3.33 against a 1.20 minimum; leverage ratio 2.33 against a 5.75 maximum.
- During Q3, Lithia established a real-estate-backed facility with commitments up to $254.7, with nothing drawn at quarter-end, and a securitization facility initially committed up to $100, with $12.5 drawn.
- After quarter-end, Lithia completed a public offering of 3,659,091 Class A shares, generating approximately $777 in net proceeds, and issued $550 of 4.375% senior notes due 2031. Management described the two financings as providing approximately $1.3 billion of additional liquidity, net of applicable transaction costs.
- Other notable items included $7.9 of non-cash goodwill and franchise-value impairments in the first half of 2020, a $9.2 fair-value liability on interest-rate derivatives, and adoption of the expected-credit-loss standard, which reduced opening retained earnings by $4.8.
Risks and contingencies
- COVID-19 remains a material uncertainty. The filing cites potential renewed restrictions, demand and operating disruption, and unknown effects dependent on the pandemic’s spread, severity, duration, and government or consumer responses.
- Results are sensitive to consumer demand, vehicle supply and incentives, interest rates, consumer confidence, and general economic conditions. The business is seasonal, with typically weaker first-quarter results.
- Debt agreements include financial and restrictive covenants; a breach that is not cured or waived could permit acceleration, termination of credit availability, or enforcement against collateral. The company also cautions that future financing may not be available on acceptable terms.
- Lithia is party to ordinary-course legal proceedings and does not expect them to materially adversely affect the business, but says outcomes cannot be predicted with certainty.
Investor verification checklist
- Assess how much of Q3’s margin and earnings improvement reflects sustainable pricing, mix, and cost control versus temporary supply constraints and manufacturer incentives.
- Reconcile reported operating cash flow with inventory movements, floor-plan financing, and the company’s adjusted cash-flow measure.
- Review acquisition integration, returns, purchase-price allocations, and the financing and dilution effects of the post-quarter share and debt offerings.
- Monitor COVID-19 effects, vehicle availability, same-store service performance, deferred capital spending, and covenant headroom.
- Confirm the subsequent-event financing proceeds and their use, and track the valuation of the Shift investment, which became a publicly traded minority equity investment after quarter-end.