Lithia Motors Inc (LAD) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Lithia Motors Fourth Quarter 2017 Conference Call.

Management may make statements about future events, including financial projections and expectations about the company's products, markets and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to differ materially from the statements made. The company discloses material risks and uncertainties in its filings with the Securities and Exchange Commission. The company urges you to carefully consider these disclosures and to not place undue reliance on forward-looking statements. Management undertakes no duty to update any forward-looking statements which are made as of the date of this release.

Management may also discuss non-GAAP financial measures. Please refer to the text of the earnings release for a reconciliation of comparable GAAP measures.

Management will provide prepared remarks and then open the call for questions. I will now introduce Bryan DeBoer, President and CEO. Mr. DeBoer, you may begin.

Good morning, and thank you for joining us today. On the call with me are Chris Holzshu, our Executive Vice President; and John North, Senior Vice President and CFO.

Earlier today we reported adjusted fourth quarter earnings of $2.15 per share, which marks our 29th consecutive quarter of record performance. We are excited to have added an 11th digit to our annual revenues, as we exceeded $10 billion this year. We increased quarterly revenue 18% and adjusted earnings 15% over our 2016 results, despite a sequentially lower full year SAAR of $17.1 million.

Fueled by our mission, growth powered by people, our organization is poised to continue its upward growth trajectory, regardless of new vehicle market conditions. We expect further moderation in SAAR for 2018 in a range of 16.5 million to 17 million units.

For the last several years the hallmark of our success has been high performing, empowered entrepreneurs making decisions closest to our consumers. We have more than tripled the size of our company, including purchasing over $6 billion in annualized revenues in the past 4 years alone. These acquisitions are strong franchise assets that historically underperformed their earnings potential. Despite the acquired stores' dilutive effects, we have maintained our strong performance in SG&A to growth in operating margin. We continue to identify, develop and challenge our leaders to capture the considerable earnings dry powder created from our value-based mergers and acquisition strategy.

From an operational perspective on a same-store basis, total sales grew 3%. New vehicle sales were up 3%. Retail used vehicle sales increased over 2%. F&I increased 8% and service and part sales were up 4%. We sold 67 used vehicles per store per month, up from 66 units in the comparable period last year. In the quarter, same-store certified units decreased 7%, core units increased 8% and value auto units increased 3%. Again, we continued to make incremental progress towards our goal of 85 used units per store, while offsetting the effects of our recent acquisitions that sell fewer than 40 units per month at the time of acquisition.

We continue to see growth in our service, body and parts business, which grew 4% despite 1 fewer service day compared to last year, which negatively impacted revenue by approximately 2%.

Last month our executive team and operational group leaders assembled in downtown Los Angeles at our new Toyota store, where we reviewed and modified strategies on how to capture the over $200 million in incremental dry powder that is available to our existing store base. The resulting efforts continue to focus on customer-driven, top line growth while effectively managing costs. Chris will comment on some of these areas shortly.

Online marketing continues to attract more customers as our same-store web traffic increased 15% in 2017, followed by another 20% gain in January. Our stores continue to deploy a variety of full-service online and home delivery models tailored to their markets, representing the hallmark of our entrepreneurial spirit. We emphasize the omnichannel nature of our retail offerings with personalized experiences, targeted marketing and intuitive, easy-to-use websites that connect with customers in convenient and engaging ways.

In the fourth quarter of 2017 we completed the acquisition of Armory Chrysler Jeep Dodge Ram in Albany, New York and Crater Lake Ford Lincoln and Crater Lake Mazda in our home town of Medford, Oregon. We also divested a small store in Eastern Washington, continuing to optimize our portfolio. Our cumulative total of annualized revenue acquired and disposed of in 2017 is approximately $1.7 billion.

2018 is also off to a robust start. In January we acquired Ray Laks Honda and Acura in Buffalo, New York, with estimated annual revenues of $140 million. The plateauing new vehicle sales environment seems to be further accelerating the number of acquisitions available and we believe 2018 activity may exceed 2017 total.

We anticipate being a significant beneficiary from the recent tax reform. Positive gains should be seen in both our existing store operations, as well as new acquisition opportunities. We estimate our effective tax rate will decrease from 38% to 27%, a savings of roughly 11%, or an incremental $40 million in annual cash flows.

Additionally, we estimate 90% of dealerships in the U.S. are structured as pass-through entities, which has historically meant we had a tax disadvantage to most competing acquirers. This change in our tax rate lowers the hurdle rate we apply to our acquisitions forecast, resulting in more deals meeting our disciplined annual return on equity target of 15% to 20%.

Looking forward, we are updating our 2018 earnings outlook to $10.50 per share, which John will also elaborate on in a few moments.

In summary, we remain focused on delivering the annual double-digit growth that we have accomplished for the last 7 years. We see a stable operational environment, a massive amount of earnings upside available through improvement in our unseasoned stores and a more robust acquisition market. These factors, coupled with the most liquidity in our history and sector-leading low leverage, gives us confidence that we can continue to drive significant top and bottom line improvement.

With that, I'd like to turn the call over to John.

Thanks, Bryan.

I'd like to provide more detail on the results in the quarter. All numbers from this point forward will be on a same-store basis.

In the quarter new vehicle revenue increased 3%. Our unit sales increased 1%, better than national results, which decreased 2% from the prior year. Our average selling price increased 2% compared to the fourth quarter of 2016.

Gross profit for new vehicle retail was $2,182 compared to $1,910 in the fourth quarter of '16, an increase of $272. Retail used vehicle revenues increased 2%, of which 3% was due to greater unit sales offset by a 1% decrease in selling prices. Our used-to-new ratio was 0.80:1. Gross profit per unit was $2,003 compared to $2,209 last year, a decrease of $206.

Our F&I per vehicle was $1,342 compared to $1,258 last year, or an increase of $84. Of the vehicles we sold in the quarter we arranged financing on 71%, sold a service contract on 44% and sold a lifetime oil contract on 25%. Our penetration rates decreased 170 basis points for financing, increased 20 basis points for service contracts and increased 70 basis points for lifetime oil contracts.

In the fourth quarter our blended overall gross profit per unit was $3,451 compared to $3,297 last year, an increase of $154 per unit. Our service, body and parts revenue increased 4% over the fourth quarter of 2016. Customer pay work increased 4%, warranty increased 4%, wholesale parts increased 1%, and our body shop increased 6%. Our total gross margin was 14.8%, a decrease of 20 basis points from the same period last year.

As of December 31, consolidated new vehicle inventories were at a days supply of 69, an increase of 1 day from a year ago. Used vehicle inventories were at a days supply of 67, an increase of 11 days.

At December 31, 2017, we had approximately $280 million in cash and available credit, as well as unfinanced real estate that could provide another $236 million in 60 to 90 days, for an estimated total liquidity of over $0.5 billion. At the end of the fourth quarter we were in compliance with all of our debt covenants.

Our leverage to EBITDA, defined as adjusted EBITDA less used floor plan interest and capital expenditures, was $80 million for the fourth quarter of '17 and was $328 million for the year. Our free cash flow, as we defined in our investor presentation, was $32 million for the fourth quarter of 2017 and was $159 million for the full year.

Our net debt to EBITDA is 2.0x, which remains among the lowest in our sector and within our targeted range of 2.0x to 2.5x.

As Bryan previously mentioned, our 2018 earnings outlook has been updated to adjust for the recently passed tax legislation, anticipated interest rate increases and changing consumer behaviors on the East and West Coasts due to limitation on deductibility of state and local taxes. We anticipate revenues of $11 billion to $11.5 billion this year and earnings per share of $10.50. Achieving our target would provide approximately 11% top line growth and a 26% growth in earnings per share.

And with that, I'll hand it over to Chris.

Thank you, John.

We remain focused on cultivating a high performing culture to generate opportunities in our core business lines while leveraging our cost structure. This is the foundation of growth powered by people.

As Bryan mentioned, our operational leaders met last month to evaluate the opportunities across our 171 locations as we continue our relentless focus on continuous improvement. Our group leaders' primary role is to inspire department managers to capture dry powder and to achieve higher performance. We continuously realign our group leaders to best match individual strengths with the specific operational improvements targeted at each of our stores.

In the past 2 quarters we analyzed the incremental improvement in performance in our moderately seasoned stores and have observed some plateauing between the second and third year of ownership. SAAR stabilizing in the low 17-million-unit range the last 3 years has also made incremental improvement more gradual. The stores we acquire are strong franchise assets that historically underperform their earnings potential. The doubling of profit is occurring on schedule, but tripling and quadrupling is requiring growth in leadership, better utilization of technology and inspired teams to achieve the expected result.

As we demonstrated in our investor presentation, we see opportunity for significant dry powder in each business line. More specifically, new vehicle sales at acquisitions averaged 30% below the market share expected by our manufacturers, and 50% below are seasoned stores. In used vehicles, acquired stores averaged 38 cars per month, or over 50 units below our seasoned performers. In F&I these stores averaged $850 per unit compared to our seasoned store performance of $1,400. Our service retention at acquisition, a measure of consumer loyalty, is 20% below our seasoned store retention level. And finally, acquired stores averaged nearly 90% in SG&A to gross profit, or more than 30% higher than our seasoned stores.

All of these opportunities total up to more than $200 million in earnings dry powder that we are inspiring our stores to capture by developing entrepreneurial independent leaders across the organization.

This concludes our prepared remarks. We'd now like to open the call to questions. Operator?

(Operator Instructions) Our first question comes from the line of Steve Dyer with Craig-Hallum.

I'm wondering if you could elaborate on the SALT deduction comment. I guess I wouldn't have necessarily put 2 and 2 together. But maybe what are you seeing and what do you anticipate seeing in terms of changing behavior?

Yes, Steve, this is John. Yes, I think we'll talk a little bit more broadly about our guidance overall. We updated our outlook for '18 based on the current sales performance and market conditions. And certainly the tax reform is going to be accretive to us, but we also anticipate likely increases in interest rates this year. The Fed's talking about 3, even 4, interest rate increases. I'd remind you that a 1% move in interest rate is $15 million pretax for us, or about $0.40. And then we're tempering our expectations a little bit on the coasts, where the majority of our sales are, due to the limitation of the SALT, as you mentioned. We also didn't see a lot of the benefit it appears many of our peers have from replacement demand due to Hurricane Harvey. Inevitably we look at our kind of trends in the market. We're taking the opportunity to utilize some of our tax savings to invest in our team members and improve certain employee benefits. So we kind of put that all together. It appears the market is stable. We're certainly not seeing, as Bryan mentioned, an increase in SAAR in 2018. And I think it's too soon to tell anymore about what the ultimate impact might be on the coasts.

And then, I mean, as it relates I guess drilling down a little bit more on the tax deductibility limitations, et cetera, are you expecting just overall demand softness? Or are you expecting people are just sort of trading down, buying less car? What are you sort of baking in in your expectations there generally?

I think it's more that we haven't see real acceleration. And if you look at how the fourth quarter ended, I mean, I think SAAR ended the quarter at 17.8 million, which was up pretty dramatically. But it appears that a lot of that was concentrated in the middle part of the U.S., particularly around kind of hurricane replacement. We're estimating 200,000 to 300,000 cars were lost there. As we look at our coastal performance, it appears things are pretty steady in kind of the upper-16-low-17-million-unit range. And we think that some of that's a function of the fact that those are high state income tax locations that might be affected. So I wouldn't say that we've seen a big shift. I think it's more that we saw pretty consistent performance through the quarter, but it appears that the underlying demand is a little softer than it might have indicated in Q4 based on some of that hurricane replacement.

Got it. Okay. And then question on acquisitions. It looked like FTC okayed some what appeared to be acquisitions yesterday, nothing that you've press-released. Anything you can say about that?

Steve, this is Bryan. We sure look forward to more future M&A announcements. Hopefully we'll be able to help that achieve our $10.50 annual target. However, as usual, we don't announce our stores or groups until we've actually completed the deals. So stay tuned. Hopefully we'll have something in the coming periods.

Our next question is coming from the line of Bret Jordan with Jefferies.

On the used car mix, like you said, the CPO or the newer used cars were down, while core and value were up. Was that something that was strategic? Are you seeing a shift with new vehicle incentives taking away some of that younger vehicle demand?

Bret, this is Bryan. I think when we think back about how past new vehicle SAAR drives the supply chain for certified core and value. What we started to see almost a year ago was that certified was starting to fill up the pipeline. So we were able to grow that certified business. Now the core product is starting to fill up as well, which is wonderful, because that's a lower-cost vehicle that we make similar deal average on. So we make a higher margin on those vehicles, which we're excited about. The other thing is, we strategically focus most of our attention on core because, if you recall, our value auto cars, which is our highest margin and lowest cost vehicle, is how we get those, is through trade-ins on core product. Lastly, it's a lot less likely when you sell core and value auto vehicles that you're going to be cannibalizing on new like you do on certified, which can be difficult. So we always are preferential to core for that single reason.

Okay, great. And I guess, given the extra day or loss of a day, you would have been, whatever, 5-plus in the parts and service business. Is there anything -- are we seeing any volatility? I mean, are we seeing an improvement in service demand with a return of the weather in some of the northern markets? Can you talk to us maybe the early part of '18, what we see, a trajectory in that?

Yes. Our service and parts we're real pleased with because we're seeing that customer pay continue to grow. It was up 4% in the quarter. If you remember, we went through I believe over a dozen quarters of warranty increases in the double digit range. So there's always that fear that when warranty goes away that you're not going to be able to replace it with customer pay. But demand is strong for our consumers. We focus, as Chris said, on retaining those customers throughout the life cycle. And fortunately they're mechanical beasts that have tendencies to break. So that customer pay up 4% when warranty was also only up 4%, we're excited about what we're seeing. And obviously that dry powder that we build in our new acquisitions, there's always a lot of opportunity to reinvent ourselves in the way that we go to market with our customers, to continue to attract clientele.

Our next question comes from the line of Chris Bottiglieri with Wolfe Research.

Two-part question. On new, that was a pretty exceptional performance on that gross profit per unit. I also saw your luxury EBIT went up as well. Wondering if there's any connection there and to what extent you think it's sustainable, if that was, like, stair-step incentive driven or something else that maybe is more temporary in nature.

Chris, this is John. No, I would point out -- I think if you look at our margin, and you can really see this when you drill into new and used, we do [apportionment] internally around some reconditioning work. And I certainly think the performance in the fourth quarter was pretty on par with what we've seen in the year. But we also had to readjust or reallocate some of our internal reconditioning. And I think you see a shift between new and used as a result of that. We also had a small recapture of LIFO from earlier in 2017 that also boosted the margin in the quarter. So I think if you look at the full year run rate you'll see that we're in kind of a high-5 range. And I think that's a pretty good estimate to use going forward based on our outlook. And I think that obviously, as we always say, looking at total deleverage, which is new and used and F&I added together, is really the best way to think about the business because it helps to normalize for changes in trade-in valuation and F&I performance, which is all part of the mix as far as think about, so I think you need to consider all those factors when you look at the fourth quarter performance.

That's really helpful. Then used, I think you just quantified some of it in terms of reconditioning and stuff like that. But to what extent do you think the fall-off in GPU -- like, there's been a lot of your peers who have been citing either lower volume or lower GPUs. Just want to get a sense for what's strategic, sacrificing GPU to drive volume, what's market factors. And maybe if you could just comment on the higher DSIs, like, anything you're seeing there that could be driving this, if it's regional in nature. Do you think there's certain factors that are driving this? That would be helpful.

Yes, Chris. This is John again. The biggest decline we saw in GPUs has been our luxury segment. And it really appears that a lot of that's a function of service loaners. Our stores are pushing those programs pretty aggressively. They do trigger a lot of the manufacturer's stair-step incentives, particularly in a couple of German OEMs. And the GMs manage those programs pretty efficiently. But they [run out of] supply of used cars they need to work through. And a significant amount of our certified vehicles are actually sold as a function of that. What we saw in 2017 is that they've taken a little less GP on the front end to continue those programs and move through them. It appears that they're managing them very healthy. But it is -- obviously (inaudible) the front end the more sooner that we see on the new vehicle side. So I think that's the biggest driver that we've seen. In terms of days supply, you're right. We're up a bit. It appears that a lot of that is concentrated in our Lithia division, as we drilled into kind of that group. And I think that's really a function of the plateau of the new vehicle sales environment and stores trying to figure out how to really aggressively attack the market. You have to have vehicles to grow that part of the business. And from our perspective that's a good tradeoff if they can bring in some additional unit volume.

Our next question comes from the line of Rick Nelson with Stevens.

I'd like to ask you about the regions, areas of strength and weakness. And in particular I'd be interested in how Downtown LA Auto Group is performing relative to your expectations. And any commentary on DCH, that would also be helpful.

Rick, this is Bryan. Real quickly, same-store revenues, let me just give you the top 5 states for us. California was up 5%, New Jersey and New York were both flat, Oregon was up 3% and Texas was up 5%. It was surprising. There was a pretty balanced mix. There's really no double-digit gains or losses like we've seen in the past. It was really nice to see Texas finally have some positive momentum, especially when we weren't seeing the storm-affected areas of Texas. So we're pleased to see that. If we move to the Southwest and Downtown LA, Eli and his team have really taken hold and they're really driving profitability, which is wonderful to see. Their volumes are growing, which is great. We moved into the new Toyota Store in late November. I believe they were top 10 in the country in Toyota sales and they'd never been at those volumes before. The Mercedes store is doing wonderfully, as are the rest of the stores. So we're pretty excited there of what's happening down there. In terms of DCH, as you'll recall, they were about 1.5% pretax margin when we combined. And we quickly were able to get them into the 2.5% to 3% margins. But over the last year it has plateaued and I think Chris spoke a little bit to that idea that when people move from a 1.5% to a 3%, they're excited about it, like we are. And that level of performance is what gets us to our ROE target. So we're very pleased with where we sit today. But many of the stores now have to reinvent themselves and find new ways to go to market by challenging their personnel to get out of their comfort zone, to push a little further, to figure out how to more with less, to some extent, and how to control those expenses while still growing our volume. So if we think about most acquisitions -- or we always look at the idea that conquest used vehicle sales and value auto sales are something that most new car dealers don't play in. Okay? That's taken hold in many of the DCH stores, but not all of them. As well as the idea of not just being a warranty claims center in service but being a one-stop, low-cost and quick service experience is an important part of the mix. And it takes time to get that all into place. So we're looking forward to DCH as well as many of our other stores to now step forward and break through the plateauing that can occur in year 2 or 3.

Thanks for that color, Bryan. The acquisition environment is really heating up. And if you could comment on the multiples and seller expectations, what you're seeing there.

Well, you stated it best. There's no question that it's heating up and it's heating up at a pace that's followed by pricing that continues to come into line with what is more typical of our expectations. So I would say that our opportunities are full and we're able to pick and choose pretty closely to be able to take advantage and most likely be able to gain revenues of similar levels to what 2017 and, if all goes real well, maybe we'll exceed it by a fair amount. We also -- and in the prepared remarks I commented on it -- but the idea that our tax structure now doesn't put us at a competitive disadvantage, where we used to be. So we actually are able to pay about 15% more, which in theory if you think about that, that's almost a full turn when you look at future earnings, while still maintaining the same disciplined ROEs that Lithia has always enjoyed, to be able to create deals. So I would leave you with this. We have the people, we have the model, to be able to add at a more rapid rate. Plus, we have the liquidity of somewhere close to $500 million. And if you calculate our 10% to 20% of revenue purchase price that we typically pay all in for good will and working capital, that gets you to about a $2.5 billion to $5 billion of dry powder able to be able to be utilized to buy stores. So we really think that we're positioned nicely to be able to continue to grow as the market stabilizes.

Great. And just to be clear on the guidance, the $10.50 estimate, that does not include future acquisitions. That would be accretive to that.

This is Bryan again on that, Rick. Acquisitions that are not transformative are included in the $10.50. So we may need to buy stores to achieve the $10.50. Now a transformative acquisition like a DCH or larger, we would obviously be readjusting things.

Our next question is coming from the line of James Albertine, Consumer Edge.

Bryan, on that last point you just made, is that a change to how you've done it in the past, or has that always been the case, acquisitions that are not transformative are included in guidance?

So last quarter we announced that acquisitions, typical acquisitions, staple diet as we called it, would be included in our annual forecast. So when we moved to annual forecasting we made the decision that that could come from internal growth or it could come from external growth. And knowing that the market is flat to negative, we always knew that we could either get it from one or the other. And if we were a little short, we hoped to make it up in acquisitions and we're a little ahead then we can be a little more reserved in how we approach acquisitions.

Got you. So to be clear, December -- you announced two in the release today, December and one in January. They're both in the $10.50.

Yes.

Okay. No, it's helpful. Thank you for that. Really quickly, parts and service, I know you lost a day year-over-year, I think is what you said. And margins were down a little bit year-over-year. Could you just help us kind of cut through sort of was that mix-driven pressure or if there was something else going on there, and how we should think about modeling that for 2018?

Sure. So as you recall, we were up 4% in revenue in all parts, service and body shop work. And about 2% -- it would have been around 6% if we had that extra day. So I think that's always relative to look at. In terms of margins, it typically is a mix between the new and used -- or excuse me, the service, which is at 65%, 70% margin business, whereas parts is only a 30% business. And that's typically where the mix comes in. We aren't seeing any degradation of margin within those departments. It's more that parts would have become a bigger part of the mix rather than any other type of behavior.

Okay, very good. That's helpful. And last one for me is more of a strategic question. If we were just to think about it very high level, very broadly, if new vehicle sales, or SAAR, underperformed your expectations and used vehicle sales outperformed your expectations, net-net would you see your -- would you expect to outperform your guidance as it stands today or underperform?

I think it would be closer to neutral. Because I believe that our margins are somewhat similar. But new vehicles also has the service business that has a longer tail on it than used vehicles. So I think in the short term it may be a touch more beneficial for used to be better, but long term I think new would balance it out, because of the tail of in service and parts being more robust.

And then just to follow that line of thought, to the degree that you're outperforming on M&A, that helps to offset the long-term loss of service, I would think. Right? Because there's more low-hanging fruit from those deals.

That's 100% accurate. I mean, we are value-based investors and typically the stores that we buy take 3 to 5 years to get them to a seasoned level. And typically they're performing at somewhere between 1/4 and 1/2 the profit potential. So all of those factors come into play when we're looking at buying and how we operate. And then obviously 12 months later they start to roll into our same-store-sales numbers, which helps to keep that number pretty stable.

Our next question has come from the line of Irina Hodakovsky with KeyBanc.

Question for you around your guidance. Revenue outlook does not appear to have changed much, but your pretax income appears to be lower than before, about 6%. If you exclude the higher interest rate impact, can you talk a little bit about the areas of weakness you anticipate, perhaps the front-end gross profit per unit, maybe parts and service margin or perhaps less G&A cost leverage, you're seeing headwinds today that you weren't seeing 3, 4 months ago? If you could just offer a little more color around these specifics here.

Irina, this is John. I've obviously taken a look at the math that you guys have put together. And I think to start with the one kind of disconnect right out of the gate that we have maybe with where you were modeling things was our full year tax rate is higher as a function of our portion that's California. So I think you were using a kind of mid-30s, 37%, 38% rate. And we were anticipating something north of 40%, just given the concentration that we have there. So right out of the gate, if you do the math, I think we were significantly below where you were at $11.25. I was more like $11.07, something like that. Like I said, we're over $0.40 with every increase in rates just on new car flooring. So from our perspective I think we're anticipating something pretty similar to how we exited Q4 in terms of our performance. And we're tempering that a little bit with the interest rate increases that we're seeing, that appear they're going to be a little more robust than we had thought maybe 60, 90 days ago, as well as the tax cut. I noticed CPI was up 0.3% this morning in the month, which is more severe than it's been recently. And then again, as we mentioned on the call earlier, we are looking at increases around employee benefits and reinvesting part of this in our most important team members. So I think that those are the biggest drivers. Clearly we're seeing some moderation, as John mentioned, within DCH. But it's not really degradation. It's just taking the current trend and a barometer that we think we can reset just to make sure that we're going to deliver the $10.50.

Irina, this is Chris. Just adding on to what John's talking about as well, is our philosophy is -- remains the same, which is to look at the current store performance that we have to set the expectations that we have for the remainder of the year. But we acquired $6 billion in revenue over the last 4 years which means, as Bryan talked about, not all of the stores are going to be seasoned in 2018. And just kind of things that we look at as far as opportunity to get us that $200 million in earnings dry powder, our cohort of acquisitions that we did in '14, which included DCH which was one of the largest acquisition years that we had in history, are performing at a metric we look at internally, which is net to gross, which is about 14%, whereas seasoned stores are doing north of 25%, 26%. And I think if I translate that on a leveraged basis over to SG&A it's something like they're doing in the high 70s while our seasoned stores are doing in the low 60s. So while we want to definitely talk about our outlook for 2018, I think based on the level of acquisitions that we have when you look beyond '18 and you start looking about integration of stores and getting them closer to our seasoned levels. And what we're spending time and energy with our teams on, there's going to be a lot of upside potential without the acquisitions in the outer years. And so I hope you balance that in the outlook that you have in our guidance in the future.

And then one other question for you around Texas. Your exposure in Texas as you mentioned, not as impressive as some of the other

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Harvey hurricane. Can you talk about Texas conditions and overall energy markets excluding the replacement demand? Are you seeing potential maybe a little bit of recovery, giving easier year-over-year comps for Texas or at least stabilization? Are the declines over? Should we anticipate a little bit of a better outlook in that region?

Irina, this is Bryan. So Texas makes up about 12%, 13% of our revenue. And as I have said, it was up about 5% in revenue. We have a few stores in Corpus Christi, which didn't get the brunt of the floods. It did get a little bit of wind damage, but we were back in business within hours rather than days. We didn't have total losses on cars, so we didn't see big spikes there. The majority of our business that we own in Texas is in the Permian Basin, which is oil country. We are seeing stabilization there, which is exciting finally. Our stores there are doing a much better job in capturing not only the new vehicle market but expanding into used vehicles. They've also become very customer-centric in their service and parts businesses, which is allowing them to become more rounded business entities. In fact, our profitability in Texas, though it was up 5% in revenues, we were up over 35% in net profit in Texas. And it's because of that well rounded approach. We've seen that over the last few quarters where they were flat in revenues, but we were still making gains in profitability. And I think that's maturity and seasoning of stores and leadership, to be able to capture the market and mirror consumers' demands in a more effective way.

And our next question comes from the line of John Murphy with Bank of America.

Just a first question on acquisitions. I mean, I understand that your tax rate makes acquisitions a little bit more attractive. But it sounds like sellers are a little bit more willing and willing to accept slightly more reasonable prices. I'm just curious why that's occurring in the market. And then also on acquisitions, are there any transformative deals sort of out there or in the pipeline that you've sort of talked to or if there are any that are sort of on the horizon for you that you're thinking of.

Let me start with your second question. I think transformative deals are far and few between. We do believe that those can happen in the future. We don't believe that they're in the immediate future. What we're finding is these $1 billion or less groups as well as our staple diet of $100 million stores, those type of things are very prevalent. And I think the key drivers, it appears, are now tax codes have changed a little bit. They believe it's the right time to exit. They may have been on the market for quarters or even years at certain pricing and there's not a lot of buyers out there. And I think the biggest fundamental competitor that we had over the last 3 years were VC firms. And now the VC firms, most of them have been in the business for somewhere in the 4 to 7 year range, which is typically their life cycle. They're now exiting in certain cases, which I believe is flooding some of the market and creating a greater supply, which is creating different dynamics for us to be able to be really the only buyers, when a lot of times that was who we were competing with. And fortunately, they typically bought cash flows. So they bought a lot of what we would call toxic assets at times. While they also bought some strong assets, typically the strong assets that they bought were performing at a very high level, whereas we typically only buy very strong assets or franchises, the 6 majors in mainline franchises as well as the 3 primary luxuries, that underperform, okay, which allows us to buy them at attractive ROEs. Well now, without a lot of that competition out there we believe that the market is pretty ripe. And as I started, our pipeline is full. And we believe that it can become even more full as we look at greater flattening and that 3 years' historic earnings outlet starting to decline a little bit with some of those sellers to be able to really attract new partners that want to join our team.

That's incredibly helpful color. I mean, how -- I mean, do you think the automakers are going to view these VCs in the future? Because I mean, they must have had GMs or owner operators that were allowing them to get these approvals, because they wouldn't get approvals on their own. So, I mean, do you think that all of a sudden that -- not all of a sudden -- that the automakers might be even more skeptical of these guys that are coming in and out and almost essentially trading these dealers, which is exactly what they don't want?

I think that's a fair assessment of how they would view VCs or any consolidator. I think, again, we look at ourselves as totally different, that we're greenfield growth-engine type of company, where we're trying to add value to the relationship with the manufacturer, so they want us to buy stores and they know that we'll be the owner of the store in perpetuity. Whereas -- and I don't mean to generalize when I talk about VCs, because many of them have wonderful operators and have some strategies similar to ours where they're looking for good assets. But typically they do buy cash flows and then they look for an exit point when those cash flows are better than they were when they bought them. And I think that is the model of the VC. And I think from the manufacturer's perspective that probably in the future won't be quite as sought after. But to be fair, the exiting of those stores so far hasn't really taken place. Despite there being a lot of marketability of those companies or portions of those companies, there's not really buyers for them because when you pay as much as many of them did to get revenues, they also made it really sale-proof to some extent, to be able to ever exit. So we'll have to see how that plays out. But I think your assumptions regarding outlook from the manufacturers is probably somewhat valid.

That's helpful. And then the second question around SALT, I mean, are you actually seeing anything occur in the SALT space as far as showroom traffic or customers' desire to maybe delay purchases? And also on this tax reform on a SALT basis, I know it's a very basic question, but we don't have a lot of companies like this. Are you paying a higher tax rate in the SALT states in your dealerships than you are in your non-SALT states? And does that have a sort of an impact on your aggregate -- your tax rate, which seems to be a little bit higher than we were expecting?

John, this is John. I'll take the tax question and maybe let Bryan give you the color on kind of the trends we're seeing. We apportion our income based on revenue in most states. We do have a high concentration of revenue in the coastal areas that tend to have a higher state tax drag. And so that's how we came up with the 27%. It's spread across and if you assume we're going to buy more stuff on the coasts, it's likely our rate will continue to skew up because in many of those states you're seeing a rate of around 9% to even 10%. So that's kind of what's driving the tax behavior there. And the tax regime hasn't really changed. It's more just about how much revenue is in a particular state.

John, additionally, I mean, over 35% of our business is in California and Oregon, which as John spoke to, are some of the highest tax rates in the country. So that goes into that apportionment. But in terms of the consumers' behaviors, so far we're not seeing the impact of that. Now, I will say this. The impact hasn't taken hold because it's, what, 14 months away until they have to pay their tax bills and it's probably 2 months away until they have to pay estimated if they pay estimated. So I think those are when realizations start to take hold and we should be able to give you some more color in April.

Okay. And then just in the used target of 85 cars sold per store, I was just curious. What is your best performing store doing at this point? And what's sort of like the average or the median and what's the worst? So if we can just get sort of an understanding of how much potential improvement there is on this focus on used.

Oh, great, John. I love used cars, so I don't mind answering this question any time you need it. So when we buy stores, they average 38 units. So our blend right now on same store is 67 units, or about 75% higher than that. Our seasoned stores, which we consider about 35 of our stores seasoned, or about 20% of our total store base today, so just under 100 units. And our best stores, which I'll give creds to our Founder's Cup winner, which is our #1 store in the company. [Jim Sterk] and his team out in Boise, Idaho sold, I believe, 2,475 units or about 200 units a month, which was the driver of not only their used car business, but also their new car business, because when you're able to turn your used cars you can be more competitive on what you value used vehicles at. Plus it generates lots of reconditioning and service and so many other wonderful things happen. We also have another 2 stores that's selling around that 200 units per month out in New Jersey and in California. And to be fair, I think many of our stores are starting to see that those opportunities are not fictitious, that they're realities. I mean, we have a gentleman in Salem, Oregon that sells 40 Volkswagens a month and has become a partner in our Lithia Partners Group this year, J. J. Hunsaker. He sold 1,780, I think, used cars last year and only sold 550 new cars. So if you look at a 3.5:1 used-to-new ratio, it's about your people believing that they can stock all conquest models, not just Volkswagen, or not just Ford, like a Jim [Sterkster] in Boise, or not just Hondas like at [Bobby's] store out in Paramus at Honda. Okay? It's that they can expand their reach. And there really is no limit to what the upside is. And that's why that 85 units -- our seasoned stores do more than that. So we believe it's realistic. And a year and a half ago we moved it from 75 to 85 because we know our assets that we buy are in great locations, are strong and the people are growing and learning about the opportunities in each of the 4 departments.

That's also very helpful. Just one real last one quick. On parts and service, I mean, I understand sort of mix may depress margins a little bit, but on a same-store basis gross in parts and service was 47.2, but the total was only 46. So it seems like there's some real stinkers in the acquisition, in the acquired revenue. I'm just curious, is there anything that kind of stands out on the acquired stores, where there could be a real improvement in parts and service margin? I mean, that's one factor you didn't talk about in the seasoned stores versus the acquired stores and what the relative benefit could be.

I love the stinkers comment, because that it is how we look at things initially. And it's funny how even their teams that were in those stinkers' stores, now they do wonderful. So it just takes them a little bit while to get there. So when you look at margins, there's two things we look at. One is pricing, as to how do they price their vehicles, how do they price their labor work. We have something that we call matrix pricings that we typically introduce early in the process, which is a way to price our services at a competitive level on quick service or maintenance work where we may only be charging some lower labor rate to be able to attract and compete with the Jiffy Lubes and the Pep Boys and the other companies. And on higher-price items where we're pretty much the only offerer of that service because we have the technology to do it, the labor rates adjust. So repricings, that can increase margins. So I think a typical store, if you look at those service and parts -- the service business, it's typically in the high 60s. And after a period of time it would move into the low 70s. That's not huge moves. The biggest moves are when you get the blend of service and parts and parts have similar what we call grid pricing, which small parts will have high margin and large parts that are expensive have a lower margin because they have a higher cost point and we still have to handle those things and so on and so on. But the biggest thing that we see is expansion of our customer base. And we do that because we're able to grow the relationship into commodities. So we sell tires. We sell batteries. We sell wipers. We sell all the other things that go along with the service experience, not just do warranty or not fix broken cars. We provide greater service and that comes with what I would call more world class facilities that integrate the customer into the service experience, whether it's us going to getting vehicles in their homes or whether coming into our dealership we can provide more value. So margin is a misnomer in service and parts. I would say that. What's important is can you grow your highest margin business and whether it's 46% or 48%, given how we focus on it. And as Chris said, when we buy stores, the retention of the consumers is about 25% worse than what is average within that manufacturer. Our seasoned stores are about 15% to 18% better than what's average. That's just top line pure growth. And those 60% or 70% gross margins in service, when blended with parts to get us 46% to 47%, is what drives the profitability improvement, because service and parts is stable. Okay? It's easy to predict. It's easy to manage your expenses and plan your expenses to be able to generate net profits. So and that takes units in operations over a 3-to-5-year period to achieve.

Our next question comes from the line of David Whiston with Morningstar.

Wanted to go back to the question on new vehicle GPU, John. Because I do get that you want to look at all 3 areas of the business, but I guess I wasn't totally clear on what drove a really good performance just on the new side.

Yes, David. I think the way to look at it is that the performance in new cars was pretty consistent. We typically have a little bit of margin improvement in the fourth quarter because you tend to skew a bit more to luxury. I think if you look back historically you've seen those upticks. The full year margin I think on a 12-month basis came in at 5.8 to 5.9 and I think that's a pretty good kind of outlook for us going forward.

Okay. And very curious about, given your FCA exposure, the new Ram truck really got a lot of great chatter at the Detroit show. Really seems like they took it up a couple notches there to go head to head with the other 3 brands in that segment. So I'm just curious. I know you are on the dealer council, too. Just what are the dealers talking about and what are your Ram customers talking about? Are they really eager to get their hands on this truck?

David, this is Bryan. I mean, we're excited about the truck, too, and everything that we heard back from the different shows around the country was that it's pretty well received by the consumers. We don't have any data on that yet, because the truck really hasn't hit the ground in our showrooms. But it does look like there's initial demand and deposits coming in. But that's pretty typical with most product changeover. So hopefully we'll be able to give you some good color on that in April and then probably again in July once we have our pipelines full of those Rams.

Okay. And just one more question related to acquisitions. Geographically you don't have any presence in Florida and the Southeast. And you're expanding into smaller Northeast markets. I was just curious. Is there a big difference in real estate costs between those two areas?

So you're right. We don't have a footprint in the Southeast. We're looking to expand into the Southeast to I think round out our national footprint and be able to take some of our innovations and initiatives across the nation someday. But like we've always talked about, when we go into a new area, we want local people. So I think it's going to be the right fit with the right smaller midsized group that can take us into there. I think if you think about the real estate costs, I think the benefits that we've seen in the stores that we've been able to look at in the Southeast, it looks like that the performance on the top line greatly outweighs the real estate costs or fixed expenses. We do have a distinct advantage once you get outside of the New York Metropolitan area in the Northeast, that real estate costs are extremely attractive. And I think that is something that our traditional model of exclusive markets typically gets the benefit of. So we'll continue to be able to hopefully provide information as we can delineate the differences between the Southeast, Northeast and other parts of the country.

Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the floor back to management for closing comments.

Thank you, everyone, for joining us today and we look forward to talking to you again in April.

Thank you. That concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.