Lithia Motors, Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; it is not a standalone fourth-quarter filing. Lithia operates franchised new- and used-vehicle dealerships and related finance, service, body and parts businesses. At year-end it operated 169 stores; by February 23, 2018, it reported 171 stores representing 30 brands across 18 states.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $10.09 billion | $8.68 billion | +16.2% |
| Gross profit | $1.516 billion | $1.301 billion | +16.5% |
| Operating income | $409.0 million | $338.4 million | +20.9% |
| Net income | $245.2 million | $197.1 million | +24.4% |
| Diluted EPS | $9.75 | $7.72 | +26.3% |
| Gross margin | 15.0% | 15.0% | Flat |
| Operating margin | 4.1% | 3.9% | +0.2 percentage points |
- Revenue mix and profitability: New vehicles generated $5.764 billion in revenue and $339.8 million in gross profit; used retail generated $2.544 billion and $286.8 million; finance and insurance generated $385.9 million in revenue/gross profit; service, body and parts generated $1.016 billion in revenue and $493.1 million in gross profit. Finance and insurance and service/body/parts together contributed 58.0% of gross profit.
- Cash flow: Operating cash flow was $148.9 million, versus $90.9 million in 2016. Management’s adjusted operating-cash-flow measure, which incorporates certain non-trade floor-plan financing flows and excludes borrowing for acquired inventory, was $279.3 million versus $249.2 million. Investing cash outflow was $538.2 million and financing cash inflow was $396.3 million.
- Liquidity: Cash was $57.3 million and available credit was $222.5 million, or $279.8 million in current available funds. Lithia estimated a further $236.1 million could be raised against unfinanced real estate, for estimated total available funds of $515.9 million; access and value are not assured. Working capital was $481.8 million.
- Debt: Year-end debt totaled approximately $2.966 billion, including $1.919 billion of floor-plan debt and $1.047 billion of other long-term debt. Debt to total capital excluding floor-plan notes was 49.2%, up from 46.5%. 76% of total debt was variable rate. The company issued $300 million of 5.25% senior notes due 2025.
- Capital returns and investment: Capital expenditures were $105.4 million; cash dividends were $26.5 million ($1.06 per share); and share repurchases totaled $33.8 million. The company also paid $33.4 million for capped-call options tied to a structured share-repurchase agreement.
Material changes versus the prior comparable period
- Growth was substantially acquisition-supported: Lithia acquired 18 stores and opened one in 2017. Acquired operations contributed $617.3 million in revenue and $9.3 million in operating income after acquisition dates. Same-store new-vehicle revenue rose 1.3%, while same-store unit sales fell 0.3%.
- Same-store used retail revenue increased 3.8%, but used retail gross margin declined 0.4 percentage points to 11.5%; gross profit per unit fell 2.9%. Management cited increased off-lease supply and weaker margins across used-vehicle categories.
- Same-store service, body and parts revenue increased 5.1%, and related gross profit rose 5.5%. Finance-and-insurance revenue increased 16.6% reported and 5.6% same-store.
- SG&A rose 16.7% to $1.049 billion; SG&A as a share of gross profit increased slightly to 69.2% from 69.1%. Excluding identified non-core items, the ratio was 68.8% versus 68.9%.
- Floor-plan interest expense rose 54.1% to $39.3 million, reflecting higher interest rates, inventory and acquisition-related volume. Other interest expense increased 49.9% to $34.8 million.
- Reported net income included a $32.9 million provisional tax benefit from remeasuring deferred taxes after U.S. tax reform. Excluding the tax-reform item and other adjustments shown in the filing’s non-GAAP reconciliation, adjusted net income was $210.9 million and adjusted diluted EPS was $8.39, compared with reported $245.2 million and $9.75.
Guidance, outlook, management commentary and risks
- No specific full-year 2018 revenue or earnings guidance is provided. Management expects approximately $131 million of 2018 capital expenditures, primarily for acquired-store upgrades, facilities and equipment.
- Management targets used retail sales of 85 units per store per month; the 2017 average was 67. Its F&I-per-retail-unit target is $1,450, compared with $1,299 in 2017. It aims to keep SG&A in the upper-60% range as a share of gross profit and to improve acquired-store efficiency through integration.
- Management described acquisition growth and organic gains in used vehicles and service as priorities. It also noted that acquired stores may initially be less cost-efficient and that new-vehicle market growth is moderating.
- Principal risks include cyclical vehicle demand and local-market concentration (the top three states represented 52% of 2017 revenue); competition and Internet-driven pricing pressure; vehicle supply, manufacturer incentives and franchise-renewal dependence; consumer-credit availability; rising rates on variable-rate borrowings; acquisition integration and financing needs; and regulatory, environmental, litigation and cybersecurity exposure.
- Additional sensitivities include used-vehicle supply and margins, manufacturer recalls or warranty-rate changes, severe weather and natural disasters, and industry shifts such as electric, shared and autonomous vehicles. The company reported $31.2 million of self-insurance reserves and a $52.7 million reserve for contract charge-backs. The California wage-and-hour representative claims were settled with court approval in December 2017; Lithia stated its exposure, considering indemnification, was immaterial.
- Year-end covenant ratios were compliant: current ratio 1.21 (minimum 1.10), fixed-charge coverage 2.82 (minimum 1.20), and leverage 2.59 (maximum 5.00). A 10% increase in variable interest rates (27 basis points) was estimated to increase annual interest expense by approximately $4.1 million, net of tax.
Most important facts for investors to verify
- Separate acquisition-led growth from same-store performance, especially used-vehicle margins and luxury-brand unit trends.
- Reconcile reported earnings and EPS with the $32.9 million tax-reform benefit and the company’s adjusted figures; assess how much of the earnings increase is recurring.
- Track debt, variable-rate exposure, floor-plan interest costs, covenant headroom and the availability of real-estate financing.
- Monitor acquisition integration, planned 2018 capital spending, and progress toward the used-unit and F&I-per-unit targets.
- Review the complete financial statements and notes for purchase-price allocation, lease commitments, reserves, contingencies and post-year-end developments. KPMG issued unqualified opinions on the financial statements and internal controls; the control assessment excluded the 18 stores acquired in 2017.