Lithia Motors, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Lithia operated 182 stores representing 28 brands in 19 states. Financial amounts below are in millions, except per-share amounts and percentages.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Revenue | $3,221.7 | $3,096.5 | $6,071.4 | $5,756.2 |
| Gross profit | $493.6 | $460.7 | $944.3 | $868.8 |
| Operating income | $116.9 | $108.6 | $225.5 | $202.3 |
| Net income | $61.9 | $60.7 | $118.3 | $112.7 |
| Diluted EPS | $2.63 | $2.44 | $5.08 | $4.50 |
| Operating margin | 3.6% | 3.5% | 3.7% | 3.5% |
| Gross margin | 15.3% | 14.9% | 15.6% | 15.1% |
- Revenue mix: Q2 used retail vehicle revenue rose 10.5%, finance and insurance 12.7%, and service, body and parts 7.7%; new vehicle revenue declined 1.1%. New-vehicle retail units fell 6.4%, while used-vehicle units increased 9.6%.
- Profitability: Q2 gross profit increased 7.1% and operating income 7.6%; net income rose 2.0%. Diluted EPS increased 7.8%, alongside a lower diluted weighted-average share count (23.5 million versus 24.9 million). New-vehicle gross margin declined 30 basis points to 5.6%; service, body and parts margin improved 140 basis points to 50.8%.
- Cash flow: First-half operating cash flow was $244.4, versus $236.3; investing cash outflow was $109.8, versus $451.5, reflecting substantially lower acquisition spending. Financing cash outflow was $121.5, compared with $187.9 of inflow in the prior period. Cash ended the period at $44.7, up from $31.6 at year-end 2018.
- Balance sheet and liquidity: Total assets were $5,774.6 and stockholders’ equity $1,274.7. Inventory was $2,431.9. Reported total debt was $3,478.7 before $5.5 of unamortized issuance costs, including $1,709.6 of non-trade floor-plan notes and $414.1 of other floor-plan notes. Available cash and credit totaled $262.5; management estimated a further $247.1 could be raised against unfinanced real estate, subject to availability and acceptable terms.
- Interest and leases: Floor-plan interest expense increased 24.4% in Q2 and 28.4% in the first half, primarily due to higher rates and inventory/volume factors. Adoption of lease accounting on January 1, 2019 added $259.7 of right-of-use assets and $258.8 of liabilities at transition; June 30 operating lease liabilities were $266.2.
Material changes versus prior periods
- Growth was led by used vehicles, finance and insurance, service operations, and the Luxury segment; new-vehicle unit sales weakened. Same-store Q2 revenue rose 5.8% and gross profit 8.8%.
- First-half segment income increased 30.4% in Import and 24.5% in Luxury, but 3.9% in Domestic. Consolidated first-half income before taxes increased 8.5%.
- Q2 SG&A increased 7.0% to $356.5, while SG&A as a share of gross profit edged down to 72.2% from 72.4%. First-half SG&A as a share of gross profit improved to 71.8% from 72.6%.
- First-half acquisitions were two stores, versus 17 in the first half of 2018. Cash paid for acquisitions, net of cash acquired, was $75.0, compared with $374.6.
Outlook, management commentary and risks
- The filing does not provide specific numerical revenue or earnings guidance. Management described continued focus on operational performance, used-vehicle growth, acquisitions, digital initiatives, and disciplined capital allocation. Its stated capital allocation target is 65% acquisitions, 25% capital expenditures/innovation/diversification, and 10% shareholder returns.
- Management estimated a 27.6% annual effective tax rate excluding non-core charges. It noted seasonality, with first-quarter results historically lower, and identified interest rates, consumer debt and confidence, manufacturer incentives, and broader economic conditions as factors affecting results.
- Notable items included $8.4 of storm-insurance reserve charges in the first half, $1.7 of acquisition expenses, and a $0.5 property impairment. In May, the company paid a $36.5 net premium for a structured stock repurchase agreement using capped-call options; the options remained outstanding at quarter-end.
- The company entered a five-year, $300 notional interest-rate collar to hedge a portion of variable-rate debt. The filing reports a $1.2 derivative liability at June 30.
- At quarter-end, Lithia reported compliance with its credit covenants: current ratio 1.25 versus a 1.10 minimum, fixed-charge coverage 2.09 versus a 1.20 minimum, and leverage ratio 2.66 versus a 5.00 maximum. The company cited risks from rising interest rates, market and consumer conditions, acquisition execution, and potential covenant noncompliance. It reported ordinary-course legal proceedings and said it could not predict their outcomes with certainty.
Important facts for investors to verify
- Whether used-vehicle, finance and insurance, and service growth can offset falling new-vehicle unit volumes and lower new-vehicle gross margins.
- How higher interest rates and inventory levels affect floor-plan costs, especially as manufacturer floor-plan assistance no longer fully offset those costs in the periods shown.
- The sustainability of improved same-store results and SG&A leverage, including the effect of storm-related reserves and other items management excludes from adjusted measures.
- The final purchase-price allocations and subsequent performance of the two 2019 acquisitions, and the availability and cost of the estimated real-estate borrowing capacity.
- The economics and eventual settlement of the $36.5 capped-call arrangement, as well as lease liabilities and compliance with debt covenants.