Lithia Motors, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; comparisons are with the same 2015 periods. Lithia operated 139 U.S. stores offering 31 new-vehicle brands as of July 29, 2016. Financial amounts below are in U.S. dollars; millions are used unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $2,133.3 million | $1,996.9 million | $4,116.2 million | $3,786.1 million |
| Gross profit | $322.0 million | $297.6 million | $629.2 million | $571.0 million |
| Operating income | $90.5 million | $85.6 million | $163.4 million | $153.5 million |
| Income before taxes | $77.3 million | $75.6 million | $137.3 million | $133.7 million |
| Net income | $51.4 million | $51.2 million | $91.7 million | $91.9 million |
| Diluted EPS | $2.01 | $1.93 | $3.56 | $3.47 |
- Revenue rose 6.8% in Q2 and 8.7% in the first half. Gross profit increased 8.2% and 10.2%, respectively. Overall gross margin was 15.1% in Q2 versus 14.9%; first-half gross margin was 15.3% versus 15.1%.
- Q2 operating margin slipped to 4.2% from 4.3%; first-half margin was 4.0% versus 4.1%. SG&A increased 10.2% in Q2 and 12.2% in the first half, reaching 66.9% and 69.1% of gross profit, respectively.
- Q2 net income was nearly unchanged year over year, while diluted EPS rose, supported in part by fewer weighted-average shares. First-half net income was slightly lower despite higher revenue and operating income.
- Cash flow: First-half operating cash flow was $66.4 million, compared with $29.3 million in 2015. Investing used $66.7 million; financing used $29.7 million. Cash fell by $30.0 million to $15.0 million.
- Inventory and liquidity: Inventory was $1.582 billion at June 30, up from $1.471 billion at year-end. New-vehicle supply was 77 days, 10 days above year-end; used supply was 57 days, up two days. Available credit was $134.6 million. Management estimated another $163.5 million could potentially be raised against unfinanced real estate, subject to financing availability and terms.
- Debt: Total debt, including floor-plan financing, was $2.028 billion. Long-term debt excluding current maturities was $626.5 million. Debt to total capital excluding floor-plan notes was 44.5%. The company reported compliance with all credit covenants; its current ratio covenant measure was 1.25 against a 1.10 minimum.
Material changes versus the prior period
- Growth was supported by higher vehicle volumes, acquisitions, and stronger finance and insurance and service, body and parts revenue. Same-store new-vehicle revenue rose 2.3% in Q2 and 4.1% in the first half; same-store used retail revenue rose 10.2% and 11.3%.
- Used retail sales grew faster than gross profit: reported gross margin fell to 12.1% from 12.8% in both Q2 and the first half, and average gross profit per unit declined. Management attributed this partly to a volume-focused strategy.
- Service, body and parts revenue increased 10.7% in Q2 and 12.0% in the first half, while margins eased. Warranty growth was partly driven by manufacturer recalls.
- Segment results were mixed. First-half Import segment income increased 12.5%; Domestic income declined 15.8% and Luxury income declined 21.9%. Higher personnel, advertising, and floor-plan interest weighed on segment profitability.
- Floor-plan interest expense increased 33.4% in Q2 and 30.2% in the first half, primarily reflecting higher average balances. Inventory growth also contributed to operating cash use.
- Share repurchases totaled $104.9 million in the first half, compared with $16.8 million in 2015; dividends paid were $11.5 million versus $9.5 million. The company repurchased 1.316 million shares at an average $79.69 per share during the first half.
Outlook, risks, contingencies and unusual items
- No specific consolidated earnings or revenue guidance is provided. Management expected 2016 capital expenditures of approximately $102 million and described opportunities for continued used-vehicle, service and acquisition growth. It targeted 75 used retail units per store per month, compared with 64 as of June 2016.
- On July 27, 2016, the company amended its credit facility, increasing commitments by $300 million to $2.05 billion and extending maturity to July 2021. Total availability may be expanded to $2.4 billion subject to lender approval.
- The company recorded $7.0 million of first-half impairment charges on an equity-method investment tied to the New Markets Tax Credit program. Related tax benefits and credits reduced the reported effective tax rate; management’s adjusted rate excluding these benefits and other items was 39.3% for the first half.
- Q2 SG&A included $1.7 million of hail-storm losses. First-half SG&A was affected by $5.8 million of reserve adjustments for hail, legal claims and doubtful accounts, partly offset by a $1.1 million store-sale gain. Prior-year periods included larger store-sale gains.
- A proposed Oregon ballot measure could impose a 2.5% minimum tax on gross receipts of qualifying C corporations. Lithia estimated passage could increase its annual Oregon tax liability from approximately $3.3 million to $34 million; the measure’s outcome was uncertain at filing.
- Legal matters include consolidated shareholder derivative litigation concerning a transition agreement with the chairman, and California wage-and-hour claims. The company stated it did not expect these matters to have a material adverse effect; California claims were subject to indemnification, and a proposed representative-claim settlement still required approval.
- Management cited risks from market conditions, consumer confidence and credit, manufacturer incentives, inventory and interest costs, acquisition execution, tax changes, and access to financing. Results are seasonal and interim results are not necessarily indicative of full-year performance.
Important facts for investors to verify
- Whether used-vehicle unit growth can be sustained without further erosion in per-unit gross profit and margins.
- Whether inventory levels, floor-plan borrowing costs and cash conversion improve, particularly given recall-related stop-sale and parts constraints.
- How much reported earnings benefited from New Markets Tax Credits and other unusual items, and whether the investment impairment or tax benefits recur.
- The status and potential financial exposure of the shareholder derivative case and California wage-and-hour matters.
- The outcome and financial impact of the proposed Oregon gross-receipts tax, alongside the terms and availability under the amended credit facility.
- Execution of the stated approximately $102 million 2016 capital-spending plan, acquisition integration, and planned shareholder distributions and repurchases.