Lithia Motors, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Unless noted otherwise, amounts are in millions of dollars. Lithia operated 101 stores across 12 states as of August 8, 2014.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $1,221.8 | $1,008.5 | $2,299.9 | $1,911.6 |
| Gross profit / margin | $192.3 / 15.7% | $159.8 / 15.8% | $364.4 / 15.8% | $306.3 / 16.0% |
| Operating income | $61.0 | $45.7 | $105.7 | $86.2 |
| Continuing income, after tax | $35.2 | $25.3 | $59.9 | $47.2 |
| Net income, including discontinued operations | $38.3 | $25.6 | $63.0 | $47.6 |
| Diluted continuing EPS | $1.34 | $0.97 | $2.27 | $1.81 |
Revenue grew 21.1% in Q2 and 20.3% for the six months. Operating income grew 33.7% and 22.6%, respectively. Q2 operating margin improved to 5.0% from 4.5%; gross margin was slightly lower. Service, body and parts and finance-and-insurance revenue grew strongly. Same-store new-vehicle units rose 8.5% in Q2, while same-store used-retail units rose 4.8%.
Management attributed new-vehicle growth partly to a volume strategy that involved lower pricing: same-store new-vehicle gross profit per unit declined slightly. Used-retail gross margin also declined, partly reflecting a higher mix of certified pre-owned vehicles. Finance-and-insurance revenue per retail unit increased to $1,200 from $1,100 in Q2.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was negative $4.2 million, versus positive $24.4 million in 2013. Management’s adjusted operating-cash-flow measure, adding net non-trade floor-plan borrowings, was positive $108.7 million versus $30.4 million; the increase was primarily driven by higher floor-plan borrowings.
- Investing cash outflow was $107.4 million, including $79.5 million for acquisitions and $35.2 million in capital expenditures. Financing cash inflow was $116.2 million. Cash increased to $28.2 million from $23.7 million at year-end.
- At June 30, total assets were $1,940.1 million; inventory was $981.2 million, up from $859.0 million at year-end. Total liabilities were $1,348.3 million and equity was $591.9 million.
- Total debt was $1,095.7 million, including $827.3 million of floor-plan notes. Long-term debt, including current maturities, was approximately $268.4 million. The company reported a 31.2% debt-to-total-capital ratio excluding floor-plan notes, versus 38.7% a year earlier.
- Cash and available credit totaled $112.2 million. Lithia separately estimated another $161.8 million of potential financing from unencumbered operating real estate; this is an estimate, not committed liquidity. The $1.0 billion revolving credit facility matures in December 2018.
- Credit-facility covenant measures were within stated limits: current ratio 1.29 (minimum 1.20), fixed-charge coverage 4.22 (minimum 1.20), and leverage ratio 1.29 (maximum 5.00). Management expected continued compliance but gave no assurance.
Changes, outlook and notable items
- Seven dealerships were acquired in the first half for total consideration of $82.6 million; the acquired stores contributed $53.3 million of revenue. Acquisition-related goodwill increased by $15.5 million.
- Lithia signed an agreement to acquire DCH Auto Group, estimated at approximately $362.5 million, principally cash-funded. Management estimated annualized revenue of about $2.3 billion and a full-year earnings impact of $0.65–$0.75 per share. Closing was targeted for Q4 2014, subject to financing, regulatory and manufacturer approvals. Planned funding included a proposed $600 million credit-facility expansion, $200 million of mortgage financing and operating cash flows. Management estimated year-end net debt to EBITDA of about 1.8 times, excluding floor-plan debt, after the transaction.
- Management expected 2014 capital expenditures of approximately $110 million for the combined Lithia/DCH organization. It forecast a full-year 2014 tax rate of approximately 39%, anticipated SG&A at a mid-to-upper-60% range of gross profit, and targeted same-store throughput of approximately 50%. These are forward-looking statements, not guarantees.
- Q2 net income included $3.1 million after tax from discontinued operations. The May sale of a store generated a $5.7 million pretax disposal gain; cash proceeds were $10.6 million. The company reported no locations held for sale at June 30.
- The company recorded $6.7 million of expense for settlement of Alaska consumer-protection litigation; $0.7 million was recorded in the first half of 2014, and the estimated liability for unused vouchers was $1.3 million at June 30. Management said normal-course litigation was not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- A $25 million interest-rate swap, fixed at 5.587%, matures in June 2016. The swap’s fair-value liability was $2.4 million. Management described it as a hedge, not a speculative position.
Key investor verification points
- Confirm DCH transaction financing, approvals, closing timing, purchase price and realized earnings contribution against the company’s estimates.
- Assess the sustainability and cash conversion of earnings, given negative reported operating cash flow, inventory growth and reliance on floor-plan financing.
- Track covenant headroom, available credit and the actual availability and terms of prospective real-estate financing.
- Compare same-store unit growth and gross profit per unit, especially as management pursues market share through pricing and targets higher used-vehicle throughput.
- Monitor capital spending, acquisition integration, litigation settlement costs and the effect of the discontinued-store gain on reported net income.