Lithia Motors, Inc. — 2018 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2018. Lithia operated 181 stores at year-end, representing 28 brands in 18 states, with Domestic, Import and Luxury reporting segments. The filing also reports fourth-quarter results; this is an annual filing, not a standalone quarterly report.
Financial performance
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $11.821 billion | $10.087 billion | +17.2% |
| Gross profit | $1.777 billion | $1.516 billion | +17.2% |
| Operating income | $447.0 million | $409.0 million | +9.3% |
| Income before taxes | $337.5 million | $347.1 million | -2.8% |
| Net income | $265.7 million | $245.2 million | +8.4% |
| Diluted EPS | $10.86 | $9.75 | +11.4% |
| Gross margin | 15.0% | 15.0% | Flat |
| Operating margin | 3.8% | 4.1% | -0.3 percentage points |
Acquisitions materially contributed to growth. Same-store revenue rose 1.2% and same-store gross profit rose 2.5%; same-store new-vehicle revenue declined 1.9% and unit sales declined 4.4%. Service, body and parts, and finance and insurance generated approximately 59% of gross profit on approximately 14% of revenue. SG&A increased 19.4% to $1.253 billion and rose to 70.5% of gross profit from 69.2%.
Fourth-quarter 2018 revenue was $2.973 billion versus $2.703 billion in Q4 2017; gross profit was $441.9 million versus $396.1 million. Operating income was $107.1 million versus $112.9 million, pretax income $78.0 million versus $91.4 million, net income $59.9 million versus $89.4 million, and diluted EPS $2.54 versus $3.56.
Cash flow, debt and liquidity
- Operating cash flow was $519.7 million, compared with $148.9 million in 2017. Management’s adjusted operating cash flow measure, which adjusts for specified floor-plan financing activity, was $377.8 million versus $279.4 million. The reported increase was affected by cash-flow classification changes related to Ford floor-plan financing.
- Investing cash outflow was $557.1 million, including $373.8 million of acquisition payments and $158.0 million of capital expenditures. Financing cash inflow was $11.7 million.
- Year-end cash was $31.6 million; available credit was $179.6 million, for $211.2 million of immediately available funds. Lithia estimated another $247.7 million could be raised by financing unencumbered real estate, subject to availability and terms.
- Total debt was $3.442 billion, including $2.058 billion of floor-plan debt. Long-term debt, including current maturities, was $1.384 billion. Debt-to-total-capital excluding floor-plan notes was 53.6%, up from 49.2%.
- Management reported 79% of total debt was variable rate. A 38-basis-point rate increase was estimated to raise annual interest expense by approximately $7.7 million, net of tax.
- Credit-facility covenants were met at year-end: current ratio 1.27 (minimum 1.10), fixed-charge coverage 1.91 (minimum 1.20), and leverage ratio 2.86 (maximum 5.00).
Material changes, outlook and risks
- Lithia acquired 17 stores and opened one in 2018, and divested eight stores. Acquisition investment was $253.8 million net of floor-plan debt; the company expected acquired stores to add more than $1.2 billion in annual revenue. Divestitures generated approximately $34 million in proceeds and reduced forecast facility capital expenditures by approximately $15 million.
- The $54 million investment in digital retailer Shift Technologies was a significant strategic investment; Lithia cautioned that Shift is a start-up with uncertain profitability and funding prospects.
- Rising rates and acquisition-related inventory contributed to higher floor-plan interest expense; other interest expense also increased. Domestic and Import segment income declined slightly, while Luxury segment income increased.
- The effective tax rate fell to 21.3% from 29.3%, benefiting from U.S. tax reform and related tax adjustments. The filing reports no quantified company earnings or revenue guidance. It notes that industry analysts expected U.S. new-vehicle sales to fall below 17 million in 2019; this is not company guidance.
- Key risks include sensitivity to vehicle demand and local economic conditions, new-vehicle margin pressure and manufacturer incentives, competition from online retailers, consumer credit availability, manufacturer/franchise dependence, acquisition integration and financing, variable-rate debt, regulatory and environmental exposure, cybersecurity, and potential goodwill or franchise-value impairment. The company reported $434.9 million of goodwill and $288.7 million of franchise value.
- Unusual items included $15.1 million of gains on store disposals, a $1.3 million property impairment, and a $9.1 million OEM legal-settlement gain in 2017 that did not recur in 2018. The 2018 acquisitions contributed $913.5 million of revenue and an operating loss of $2.6 million after acquisition.
Most important facts for investors to verify
- Whether same-store operating trends and acquired-store integration can offset weaker same-store new-vehicle volume and margin pressure.
- Whether higher SG&A, floor-plan costs and interest expense continue to outpace gross-profit growth, particularly if rates rise.
- The quality and sustainability of reported operating cash flow, including the effect of floor-plan financing classifications and inventory changes.
- Debt covenant headroom, refinancing needs, and the practical availability of estimated real-estate-backed liquidity.
- Returns and impairment risk on the Shift investment, and final purchase-price allocations and performance of 2018 acquisitions.
- Whether operating-lease liabilities recorded upon adoption of the new lease accounting standard materially affect reported balance-sheet leverage.
KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. The auditor’s control assessment excluded the 17 stores acquired during 2018.