Lithia Motors, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparisons are to the corresponding 2017 periods. The company operates a U.S. dealership network spanning domestic, import and luxury brands, with vehicle sales, finance and insurance, and service operations. At quarter-end it reported 182 locations across 18 states.
Financial performance
- Third-quarter revenue: $3.092 billion, up 15.4%; gross profit was $466.2 million, up 15.7%. Same-store revenue rose 1.1% and same-store gross profit rose 3.1%.
- Third-quarter earnings: Operating income was $137.6 million, up 29.8%; net income was $93.1 million versus $51.9 million; diluted EPS was $3.84 versus $2.07. Pretax income increased 25.9% to $109.0 million.
- Nine-month results: Revenue was $8.848 billion, up 19.8%; gross profit was $1.335 billion, up 19.2%; operating income was $339.9 million, up 14.8%. Net income was $205.8 million versus $155.8 million, and diluted EPS was $8.31 versus $6.19.
- Margins and expenses: Q3 gross margin was 15.1% versus 15.0%; nine-month gross margin was 15.1% versus 15.2%. Operating margin was 4.4% versus 4.0% in Q3 and 3.8% versus 4.0% for nine months. Nine-month SG&A increased 20.1% to $939.9 million, faster than revenue.
- Cash flow: Nine-month operating cash flow was $379.3 million, compared with $260.5 million. Management’s adjusted operating cash flow measure was $320.1 million versus $209.1 million. Investing used $514.6 million, including $374.0 million for acquisitions, $113.4 million in capital expenditures and a $54 million Shift investment. Cash declined $25.8 million to $31.4 million.
- Debt and liquidity: Total debt, including floor-plan financing, was $3.277 billion; floor-plan debt was $1.956 billion. Long-term debt, net of current maturities and issuance costs, was $1.287 billion. Available credit was $197.1 million; estimated total available funds were $455.3 million including estimated borrowing against unfinanced real estate. The company reported a 1.28 current ratio and compliance with its debt covenants at quarter-end.
Material changes and management commentary
- Growth was substantially acquisition-driven: Lithia acquired 17 stores, opened one and divested nine in the first nine months. Acquired stores contributed $634.5 million of revenue and a $1.9 million net loss after acquisition.
- Same-store new-vehicle revenue fell 2.5% in Q3 as unit sales declined 5.1%; management cited plateauing national new-vehicle sales. Same-store used-vehicle and finance-and-insurance revenue increased 5.1% and 8.7%, respectively.
- Luxury revenue rose 40.9% in Q3, largely reflecting acquisitions; domestic segment income fell 18.7%, while import segment income increased 1.1%. Acquisition integration and higher expenses weighed on results.
- Q3 operating results included a $15.7 million gain on store disposals. For the first nine months, floor-plan interest expense rose 61.1% and other interest expense rose 71.2%, with acquisitions, higher borrowing and rising LIBOR contributing.
- The effective tax rate was 14.6% in Q3 and 20.7% for nine months, versus 40.0% and 39.1% in 2017. Management cited tax-law changes, tax-return true-ups and other tax benefits; it estimated a 26.5% annual effective rate excluding non-core charges. The lower Q3 rate materially aided reported earnings.
Outlook, risks and unusual items
- No specific consolidated earnings or revenue guidance is provided. Management expected approximately $150 million of 2018 capital expenditures and cited an estimated $250 million of additional earnings potential at existing locations. It set targets of 85 used retail units per store monthly and $1,450 finance-and-insurance revenue per retail unit.
- The June 2018 credit-facility amendment increased commitments to $2.6 billion and extended maturity to July 2023. Borrowings have variable LIBOR-based rates; higher rates and inventory financing costs are relevant sensitivities.
- Lithia invested $54 million in digital retailer Shift Technologies and described a strategic partnership that could involve sharing technology, data, inventory and business relationships. The filing warns that Shift is a start-up with uncertain prospects and the investment may be impaired or yield no return.
- Other risks identified include consumer demand and credit availability, competition, manufacturer relationships and incentives, adverse weather or disasters, data-security breaches, regulation, and the ability to integrate acquisitions. The company reported ordinary-course legal proceedings and no material off-balance-sheet arrangements.
- After quarter-end, Lithia repurchased 423,863 shares at a weighted-average $76.85 and on October 22 increased its repurchase authorization by $250 million, bringing total authorization to $268 million.
Important facts for investors to verify
- How much of revenue and earnings growth reflects acquired stores versus same-store performance, especially given weaker same-store new-vehicle sales.
- The sustainability of earnings after separating the store-disposal gain and unusually favorable tax effects; review management’s non-GAAP reconciliations alongside GAAP results.
- Whether acquired-store integration improves expense efficiency, including the trend in SG&A as a percentage of gross profit and segment income.
- Debt, liquidity and covenant headroom as floor-plan borrowing and interest costs rise; assess the assumptions behind estimated real-estate borrowing availability.
- The valuation, governance, milestones and potential additional exposure associated with the Shift investment and partnership.
- The final purchase-price allocations for 2018 acquisitions, which the filing says remain preliminary, and the impact of the forthcoming lease-accounting standard.