Lithia Motors Inc (LAD) 2003 Q2 法說會逐字稿

Before we begin, the company wants you to know that this conference call includes forward-looking statements. These statements are necessarily subject to risk and uncertainty and actual results could differ materially due to certain risk factors. These risk factors are included in today's press release and in the company's filings with SEC. Now, I would like to turn this over to Sid Deboer, Chairman and CEO of Lithia Motors.

Hey, good morning everyone. I'd like to thank you for joining us today on our second quarter 2003 earning release and conference call. I'm joined today by Dick Heimann, our President and COO, Jeff DeBoer, our CFO, and Dan Retzlaff, our Investor Relations Manager.

We are very pleased with our second quarter 2003 earnings result. For the second quarter, net income increase 8 percent to 8.5 million and earnings per share increased 7 percent to 46 cents a share. This exceeded the first call estimate by 13 cents for the quarter.

We also are announcing at this time that Lithia's Board of Directors has approved payment of a dividend of 7 cents per share for the second quarter of 2003. The recent change in the tax law levels the playing field between dividends and share repurchases as a means to return capital to shareholders. As a result, we believe it is now advantageous to shareholders to have a dividend in place. Lithia is pleased to be able to offer an immediate and tangible return to our shareholders without reducing our market float which occurs when we repurchase shares. We expect to recommend to the Board the approval of a cash dividend each quarter.

The company has produced strong cash flows on a consistent and long-term basis even during the difficult economic period of the past two years. This cash flow, together with the 55 million in cash on the balance sheet and our largely unused acquisition credit line, provide us with capital to acquire over $2 billion in additional revenue in the future. This would nearly double our current size and still keep our long-term debt to total capitalization ratio below 50 percent. Payment of quarterly dividends should not affect then our acquisition growth plans for the future.

I'd like to now return to the financials. We posted record second quarter sales of 667 million, an increase of 14 percent over the same period last year. We experienced growth in all business lines this quarter. New vehicle sales increased 27 percent, used vehicles 6 percent, parts and service 17 percent and our F&I insurance sales increased 5 percent.

We continue to be aggressive in all our markets in the second quarter of the year. New vehicle, same store sales for Lithia increased 13.3 percent for the quarter and 10.7 percent for the first six months of the year. National new vehicle sales were down .6 percent and 2.3 for the year for the same period. This demonstrates our ability to continue to take market share and markedly outperform in a declining market. Our combined new and used retail vehicle same stores sales were up 6.4 percent for the quarter.

The vehicle market should be looked at on a combined basis because in a normal environment when new vehicles sales are down, used vehicle sales are often up and vice versa as it is now. They generally tend to offset each other and we can respond accordingly, even as we are now.

Even though new vehicle margins were lower, we continue to believe that going after volume and taking market share is the best strategic decision for Lithia and our manufacture partners. The volume strategy increases our ability to see F&I products. For the quarter, finance and insurance same store sales were up 6 percent. This was on top of growth of 7.3 in the first quarter of the year. We improved our finance and insurance penetration rate to 76 percent versus 73 percent in the same period last year.

We also saw a 41 percent service contract penetration rate which was the same as last year. We saw good gains in the penetration rate of our lifetime oil, filter product to 34 percent from 30 percent last year in the same period.

The strong new vehicle sales combined with greater penetration rates in finance and insurance, service contracts and our lifetime oil and filter products will ensure continued parts and service business and increase customer contact in the years to come.

Used vehicle same store sales were down 7.3 percent in the second quarter due largely to the increase in new car sales. This is much better than what we saw in the last couple of quarters which were each down just over 14 percent. The improving trend in used vehicle sales was most notable in the latter part of May and in June. Used vehicle margins also experienced a rebound in the second quarter versus the second quarter of last year. The increase in margin more than offset the decline in same store sales to produce positive same stores sales -- same store used vehicle gross profit for the quarter. I should point out that the improvement in used vehicle margins has been apparent since February of this year.

In the parts and service business, same store sales were down .3 percent for the quarter. They were negative in April and May but trended much better in June and then turned very positive in the latter part of June. The main cause of the decline continues to be a drop in domestic warranty work as the improved quality has resulted in less warranty repairs at our stores.

On the other hand, same stores sales in the parts and service customer pay side of the business were a positive 4.1 percent for the quarter. So the company's making positive improvements in this area of the business as well. Today, total same store retail sales then in the second quarter increased 5.7 percent which, as we have seen, was driven by the strong new vehicle and finance and insurance same store sales results. In June, total retail same store sales were up 12 percent.

Currently, our sales mix by state, including all acquisitions, is California 19 percent, Oregon 17, Washington 15, Colorado 12, Texas 11, Idaho 8, Nevada 5, South Dakota 4, Nebraska 3, Alaska 3, Montana 2 and Oklahoma 1 percent.

For the quarter, I'd like to list the states in their order of performance from the best to the worst. Texas being the strongest state for us followed by Alaska, South Dakota, Nevada, California, Oregon, Washington, Idaho and, finally, Colorado.

Colorado and Idaho experienced the only negative same store sales for the quarter. However, Lithia was able to make progress in those markets in the second quarter as compared to the first quarter of the year and we saw positive trends even in these markets throughout the month of the second quarter.

In the month of June Colorado was down only 1 percent and we may be close to a bottom in that market. Texas was up 36 percent on same store sales as the integration of our new acquisitions there last year have progressed very well and those economies there are much stronger than some other areas that we are in. Alaska was up 20 in same store sales as well. The new Dodge store there is really picking up steam.

Now, I'll turn you over to Jeff, our CFO. He'll provide you with some more details on our quarterly financial results.

Thank you and good afternoon everyone.

I'd like to break down the quarterly revenue numbers a little more by product line. New vehicle sales comprised 57 percent of total sales. This was 51 percent last year. So we saw a move towards more new vehicles which are lower margin for us.

Retail used vehicle sales were 24 percent and this was 28 percent second quarter of last year. Parts and service sales represented 10 percent of total sales versus 9 percent last year. So we saw a positive mix shift here.

Finance and insurance sales made up 4 percent and it was the same in the last period of the prior year. You can see the continued shift from our higher margin used vehicle business to our lower margin new vehicle business that occurred in the first quarter. Despite this, we were able to keep growth and operating margins flat with last year by gaining improvements in used margins and SG&A improvements.

The contribution to gross profits by business is as follows: new vehicles 28 percent, used 21 percent, service and parts 29 percent and F&I 22 percent. The comparable numbers for the prior year were 27 percent for new, 20 percent for used, 29 percent for service and parts and 24 percent for finance and insurance.

72 percent of our gross profit was from non-new vehicle growth in the second quarter as compared to 73 percent last year. You can see the diversity of businesses in our business model that provides us stability. I'll now go over the gross margins by business line.

Gross margins for new vehicles in the second quarter were 7.8 percent as compared to 8.8 percent in the same period last year. The year over year decline continues to be a result of our aggressive volume-driven new vehicle marketing program as we go after market share and volume in many of the depressed markets in which we operate. I would point out that our new vehicle same store sales in June were actually up 22 percent. So we're really seeing benefits in this strategy.

Our new vehicle gross margin increased 40 basis points from the first quarter of the year so we did see improvement in margins off the bottom and we saw a sequential improvement throughout the second quarter. In fact, the new vehicle margin in June was 8.4 percent which is not too far our off our historical average, so we're making clear progress in getting our margins back to normal levels and maintaining the volume -- the volume growth which is quite an achievement.

In the used vehicle business, second quarter gross margin was 13.8 percent. A substantial 110 basis point increase from the second quarter of last year and a sequential increase of 80 basis points. Our historical average gross margin for this business is -- in the second quarter is 13.2 percent so we're above our historic levels even. In addition, wholesale losses are back to normal levels, inventories are at all time lows and we are feeling much better about this business.

Parts and service gross margin for the second quarter was 46.9 percent as compared to 48.5 percent in the same period last year. This quarter, we started to defer the revenue from quantity parts purchase discounts from the manufacturers in accordance with the new EITF . This resulted in an approximately $500,000 charge to service and parts income for the quarter. Excluding this charge, earnings per share for the quarter would have increased 2 cents for a total of 48 cents for the quarter.

In addition, our service and parts gross margin for the quarter would have been 47.7 percent, the same as in the first quarter so there are no trends here to be concerned about. Still very stable. Our historical average gross margin in this business is 46.3 percent so the 47.7 percent is still above our historical averages.

Total gross margin for the quarter was 15.9 percent. Even with -- even with last year and only 10 basis points lower than our historical average for the second quarter of the year.

I'd like to point out that this quarter we reclassified advertising credits that are directly tied to specific vehicles from SG&A to new vehicle cost of sales. We have done this to align our accounting of these credits to other companies in the sector who made a similar change in the first quarter of this year. The effect on new vehicle margins this quarter was an approximate increase of 30 basis points. The effect of taking out the advertising credits from the SG&A line is an approximate 20 basis point increase and please note this is a reclassification, there's no change in the bottom line as a result of this change.

Our SG&A was 12.5 percent as a percentage of sales. Our historical average second quarter SG&A is 12.2 percent so you can see we are still a little higher than normal. This continues to be largely due to increased advertising and sales compensation expenses related to our volume driven new vehicle sales approach that we continued in the second quarter. And this continues to be the largest opportunity to improve margins going forward and we're very much focused on that.

The combined effect was an operating margin of 3.0 percent. Historically, we average 3.4 percent in the second quarter of the year so we still have good room for improvement in the operating margins. It's also important to keep in mind that generally the second quarter has the second lowest operating margins of the year after the first quarter and we expect improvements in this number throughout the year. The operating margin for reference was 3.3 percent, so the trend is very positive.

Our new vehicle sales mix by manufacturer for the quarter is as follows: Chrysler Dodge Jeep, 35 percent; General Motors and Saturn, 22 percent; Ford 13 percent; Toyota, 8 percent; BMW four; Hyundai four; Volkswagen Audi three; Subaru, 3 percent; Honda three and Nissan two. And with 3 percent of a few other brands for a total of 24 different brands. This mix is largely unchanged from the first quarter of the year.

Our gross profit mix by new vehicle brand as a percent of total gross profit for this quarter was 9 percent Chrysler Dodge Jeep, 5 percent General Motors Saturn, 3 percent Ford, 2 percent Toyota and on down the line. The important point here is that no one brand represents more than 9 percent of our total gross profit due to the diversity of businesses that we're involved in.

Of the three domestic brands on a new vehicle same store sales basis, Ford performed the best followed by General Motors and then Chrysler. All three demonstrated very positive same store sales growth.

Of the major import brands, Hyundai, Nissan and Honda performed the best followed by Subaru, BMW and Toyota in that order. At Lithia, new vehicle same stores sales for both domestics and imports were positive for the quarter with growth rates stronger for the domestic brands. Domestic brands were up 15 percent on same stores sales for the quarter and import brands were up 9 percent.

New vehicle inventories at the end of June were down 20 days compared to the year end inventory levels and 10 days compared to the first quarter end inventory levels. Our new centralized inventory control process that was rolled out in the first quarter of this year has been very effective in helping us to manage our inventory levels through the sudden changes that happen in the economy.

And this takes into account the changing market conditions in conjunction with seasonality; our new system. At the end of the second quarter, we were at the historical midpoint on new vehicle inventories for the past six years and very comfortable with our current position.

Used vehicle inventories at the end of June were 11 days below the beginning of the year and at their lowest levels of the year. They are actually at the lowest levels we have seen for used vehicle inventories in the last four years.

Lithia continues to generate consistent improvements on the profitability of the new stores in the finance and insurance area. Our F&I revenue per vehicle this quarter was $916 per vehicle, our highest level ever achieved in the second quarter of a year.

As Sid mentioned earlier, this was driven by strong improvements in the penetration rates of our key products. For the quarter, the total of flooring and other interest expense as a percent of revenue was 0.8 percent as compared to .7 percent last year. In the first quarter we took advantage of the low interest rate environment to further lock in fixed rates on more of our flooring debt by entering into two 5 year interest rate swaps for a total of $50 million.

This resulted in an increase to our flooring expense for the quarter. However, we believe it is a prudent strategy to progressively protect more of our flooring debt against rising interest rates over time. Even with the added expense from the swaps our flooring credit to expense ratio for the quarter was 103 percent so we actually made money on our flooring.

We currently have hedged approximately 24 percent of our new vehicle flooring debt including all fixed rate debt obligations, largely the mortgages, which we've moved more towards fixed rates as well recently. Approximately 24 percent of our total debt has fixed rates currently. At year end this number was at 14 percent so we are gradually hedging against rising interest rates.

I'll now turn to the balance sheet. We had nearly $55 million in cash on the balance sheet at the end of the quarter as compared to 16 million at year end. Our long-term debt, excluding used vehicle flooring which is a short-term asset, is largely composed of real estate and equipment financing and was 137 million versus 105 million at the end of 2002. The $12 million increase is due to the addition of mortgage debt from acquisitions from last year and the first -- and the first quarter that we've financed -- and also we had an increase in our credit line with US Bank and that's part of the additional ...

What's that?

OK. Sorry, the increase there on the debt is 22 million. Our long-term debt to total capital ratio increased slightly to 29 percent versus 25 percent at the end of 2002 but is still among the lowest in the sector. Our goodwill as a percent of total assets is the lowest in the sector and improved to 19 percent of total assets compared to 20 percent in 2002.

We continue to have a very healthy balance sheet with plenty of capital for future acquisition growth. Shareholders' equity for the quarter rose by 4.4 percent to 334 million from 320 million at the end of the year. Retained earnings now total $130 million.

As a final note, for the full year 2003 we are now forecasting from $1.65 to $1.75 per fully diluted share and have increased confidence about the third quarter. That concludes the financial summary and I will now turn things back over to Sid who will comment on acquisitions, operations and make some final closing comments.

OK. In the first quarter of the year we acquired three stores with approximately 75 million in revenues. In the second quarter, we've acquired three more stores with approximately 100 million in revenues. Those stores were Autocenter in Mazola in Montana with approximately 25 million in revenues which was largely Dodge and Lincoln Mercury. Lithia Dodge of Broken Arrow, just outside of Tulsa, Oklahoma with 40 million revenues and Lithia Dodge of Billings with 35 million in revenues.

We expect to continue to complete new acquisitions throughout the rest of the year and, as you can see, those are in our sweet spot those acquisitions, right in those small, mid-size communities where the single point offering of the franchise of those markets.

On a long-term basis, we are still targeting a goal of 15 to 20 percent growth in earnings per share. Approximately 15 percent of this growth can be accomplished through a combination of internally generated cash flow and organic growth without having to access the capital markets or our credit lines.

Currently, our five year average same store sales growth stands at 4.7 percent and we have a significant number of stores who have not yet -- that we have yet to fully integrate with substantial margin improvements that will be realized over time. Any additional growth from more aggressive acquisitions will be funded from our credit line.

To finish, I'd like to common on what we've been seeing so far this year. In the first quarter of this year, we demonstrated what the impact of a severe economic slowdown for Lithia looks like and this looks similar to what occurred in the first quarter of 2001. We adjusted our operations to maximize the benefits of our model in the quarter and for the year ahead an in the second quarter we were able to get our inventories in line. We were also able to adjust our operations to the new lower sales environment and the result was improvements and better trends in all of our business lines and sequential improvements in our new and used vehicle margins.

We are in a good position for the rest of the year and will continue to add stores to our operational base in a consistent and disciplined manner. That concludes the presentation portion of the conference call.

I would like to comment on July. July continues to trend very strong as June. We'd like to open the floor now to your questions. , you can take it from there.

Thank you. The floor is now open for questions. If you have a question or a comment please press the number one followed by four on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. Questions will be taken in the order they are received.

We do ask that while you pose your question that you pick up your handset to provide optimum sound quality. Please hold while we poll for questions.

Our first question comes from David Pearl of . Mr. Pearl, your line is live.

David ...? Go to the next one.

Our next question is from Scott Stember of Sidoti & Company.

Good afternoon, guys, and great job on the quarter.

Thanks, Scott.

Could you talk about the used business right now? I guess maybe that comes as a little bit of a surprise the way that things have been rebounding in that sector. Maybe just break it up by, I guess, two segments, maybe the -- you know the lower end sub-prime and the higher end of the market and what you can attribute to the improvements in gross margin? You know, talk about the pricing ?

You know the analysis on that isn't as complete as you might want, Scott. I mean, I don't know the mix of the older vehicles because they have a higher gross margin. And I have a feeling that's the trend that we're seeing is that the market on used cars has moved down to a little older vehicle and hopefully that's giving us that increase in margin. But, overall, we just worked really hard. I'm not sure the market's improved, I think it's us. I think we're just doing a much better job of choosing what we keep in inventory, what we focus on, how we price it and how we market it. And I think in the face of, you know, a market that's probably not any better, we're making improvement.

On the pricing side we have seen stability in the -- in the auction prices and that's -- you can see that in the wholesale losses. They're almost none which is -- which is good. So it's a much more stable environment.

Some of it is seasonal, Scott. I mean, we are in the strongest period for used vehicle improvements during the year. This is generally when they happen.

OK. And let's talk about the warranty work. You mentioned how the domestic brands are down, what are you seeing on the foreign side of the business as far as warranty claims?

There's actually a small increase in warranty claims on the -- on the domestic -- I mean on the import side. The decreases are all coming on the domestic side right now. Certainly, nothing to alarm us that the -- you know, imports aren't as good a quality as they were but.

OK.

Domestic we're down 7.3 percent, imports were up 5.9 percent in warranty sales. That's same store.

OK. And maybe just about the balance sheet real quick there, Jeff; as far as, do you have any figures on free cash flow which would just be, I guess, including capital expenditures?

Sure, Scott. We had $3 million in capital expenditure for the -- for the first half of the year and you can calculate our cash flow. But there's quite a lot of free cash flow that we paid down debt with during the quarter.

OK.

You take the profit and add the depreciation.

Yeah. The net income plus depreciation and amortization is $11 million. Cap ex of 3 million so about 14 ...

It's eight.

... is 8 million free cash flow in the quarter.

That's the quarter.

For the first half I think it's more than that, is that right, Dan?

OK. That's all I have. Thanks guys.

You bet, Scott. Thank you.

Thank you. Our next question comes from Mr. Rick Nelson of Stephens, Inc.

Hi, guys. It's actually Joe Franger for Rick Nelson.

Hi, Joe.

I wanted to ask, the 13.3 percent increase in new vehicle comps, is there anything in particular that drove that? I know it's the season is a part of that factor, but any particular models or any other factors?

Joe, there's no seasonality to that factor because that's the comparable to the same period last year.

Yes. OK.

So, that's strictly our marketing strategy to improve share. You know, we buy -- tend to buy stores that are a little under-improve -- under-performing and they all have upside in our mind. And so we're pushing the window to get that upside and we're seeing it. It's taking place and, you know, we're taking advantages of those incentives and using the maximum we can to move the needle with customers and making deals where everything's stretching every way we can.

Most of our customers have credit issues in terms of their affordability in automobiles and all those rebates and manufacturer kickbacks are really helping us expand that new car side and we're making every deal we can. And that's largely too to help our manufacturer partners because there's a lot of concern about public companies not increasing sales and we want to continue to demonstrate the public companies can do that; particularly us.

OK. And my second question, I know that everyone keeps talking about the used business turning around, can you foresee when your used comps will turn positive; is that too far off in the future?

sure by this time -- by next time -- this time, next year, obviously, selling at such a slow rate relative to new, we should see an increase as we get back to comparisons, you know. But we're comparing against a period that was fairly strong last year and so we're still showing, you know, loss of sales.

The one area that I want to be sure you understood in my speech that I gave earlier is that it's a combined total, new and used vehicle market, that we're dealing with and we're aggressive retailers in both segments and there is a trade off. You won't sell as many used when new is booming and we're pushing the new. So we're putting a lot of people in that would have bought a used car in a new car.

Yes.

And you're going to get that. So I'm looking at the total gross aggregate. I'm not even really looking at the percentages as much as I am, how many total gross dollars we can produce out of a fixed cost because that's the real way we manage the business. The percentages come afterwards, you know. So we're after total gross dollars and we'll get there by selling new cars, used cars or whatever we have.

I've seen stores that do 10 percent gross total, you know, on new and used combined and I've seen them at 7 percent total gross. As long as they keep their costs down and they get total gross dollars they're still -- it still works. So, --

That's the other thing that's interesting is, counter to the national trends, our domestics are up more than our import stores. And you have to remember the markets we're in, the smaller rural markets where the trucks are the key thing and we're over 80 percent truck in those markets. And that's very stable and the new products and the domestic stores. We're very good at selling domestic product. And, you know, they were up 15 percent and the imports are only up 9 percent. So that -- that's certainly a strength of Lithia is selling domestic product in smaller rural markets and not necessarily rural. I mean, we're still talking towns of two hundred to a million people. But very good communities and the popular product seems to be the domestic.

Yeah. OK.

Quality's improving as well so I see only good things for them.

All righty. Thank you, guys.

Thanks, Joe.

I wanted to go back to the cash flow question earlier. I have the six month number. It may be helpful. We had $17 million in net income plus depreciation for the first half of the year. The $3 million was for the six months. So the free cash flow on that basis is $14 million in the first half.

That'll answer whoever had that question earlier?

Yeah.

Thank you. Our next question comes from Gerry Marks of Raymond James.

Good afternoon or morning.

Hi, Gerry.

So, Brian's not on the call today?

Yeah. Brian's out on an acquisition today.

Oh, OK. Average selling price for your new vehicles seemed to have been down sequentially and year over year to like $25,600 if I calculated it right; is that primarily because of mix or price or why is that?

It's the mix.

Actually, if you look on a same store sale basis, the 13 percent same store sale increase, 10 percent of that is volume, 3 percent of that is a price increase. And so on a same store basis, we've -- it's $26,256 and that's a 3 percent increase in price. So on a same store basis, anyway, we've actually seen a pretty good price -- average increase.

So I would say the acquisitions are affecting that. Some of the new stores that we bought have a lower mix of higher-priced SUVs or what have you but I don't have the details on that.

OK. And actually that -- that brings me right to the next question which is: You mentioned Texas is doing really well, I presume a lot of that's, kind of, the acquisition and could you give us a little more of an idea in terms of what you guys are doing over there? And I don't know if you calculated before from some of your more recent acquisitions like an incremental return on invested capital from something like the acquisition?

That's only about half there because we bought four or five other stores there just right after, at the same time and we've got a nice presence there in those mid-size cities, San Angelo, Odessa and Midlands, Texas and they're all performing very well.

We've got a strong group of people there and I think that's largely the reason. And I think the markets are about level from the prior year but we're making marked improvements. And a lot of that's marketing on a consistent basis there as well.

Return on investment's very good on that acquisition.

If they continue trending the way they are, they'll be well above 30 percent this year on ROI.

Wow. And then the last question I just had is, you guys were talking a little bit about the used environment. You know, it's been -- one of your competitors this morning said that they weren't sure if we were, kind of, through the woods yet and, you know, the model changeover is coming up in August. What are your thoughts about the used pricing environment and are you -- if you're still a little bit nervous are you taking any actions to keep inventories in check?

Well, as you noted, our inventories on used are at the low point actually historically in all of our record keeping as far as day supply goes. So we're obviously very concerned with the late model, near current model year vehicles. We have to keep that under control because it's volatile based on how well the new is doing.

But, you know, if we can focus on the older products, the older used cars, that's an expansion area for every public retailer and particularly us. I mean, we can focus on those and that's a market that's totally unaffected by new vehicle sales. And those vehicles, we just have to get better and better at retailing those.

And the hardcore stores that were originally here are still doing really good with those. But when we add stores that have no real experience in selling older used cars and just traditionally wholesaled them, it takes time for us to develop that side. So, I think there's still a lot of opportunity for us in used vehicle sales and we should begin to see some same store sales expansion in some of these older stores -- I mean, the stores we've acquired come up to speed next year.

So, I mean, there's two different markets there on used cars. There's the current and late model used car market and it's heavily impacted by the new car incentives. And it even means people won't trade because they can't afford to get enough out of their old car to make a trade. So you're going to see fewer and fewer of those on the market and eventually that thing balances itself out again.

So they sell it on e-Bay or something or what do they do with it if they can't trade?

Well, they just don't buy a car.

Oh. As I -- you just made me think of another question. You had mentioned on the call the new centralized inventory management initiative. Could you go into a little bit more detail in terms of what that is?

We've got a couple of people here that are focused on -- we've developed a software to be able to track every store on an ongoing, daily basis. And those stores that have a higher days supply than has been allocated are being watched and monitored and, in some cases, we even order the cars for them until they can do it themselves in a correct way.

And then, secondly, we're tracking on our days supply internally on a forecasted -- based on our forecast of the economy. We're not using a trailing day supply to forecast what we have in stock. We're using a future day supply based on what we think the markets are going to do. And we do that by individual market and by individual store.

We also grade each stores by it's -- by it's -- we go A to C -- A to D and A means you can order anything you want. D means you can't order without us helping you. And somewhere in the middle, you know, most of our stores fall. And that has something to do with both the manufacturer and the current inventory. So, we've got our hands into that a little more deeply. We're not just letting the general managers determine our future in terms of inventory control.

Great. Thanks a lot. Congrats on the quarter.

Thank you.

Our next question comes from Michael Millman of Millman Research.

Thank you. I have a few questions and even just follow up on a couple of things you said. One, in terms of your days of inventory, what's your assumptions about future sales that gives you the calculation? And, secondly, maybe you could define better for us what you mean by late model and older used cars in terms of price, in terms of margins?

Could you also tell us roughly what percentage of your business is in the smaller markets which you've talked about? And then maybe given your constant discussions, I guess, with the domestic car manufacturers, how they feel -- are they getting frustrated at all with the continuing acceleration in incentives? How General Motors, we all saw, reported about a billion dollars less in profit in the second quarter in North America and attributed that to had incentives?

OK. Let me deal with those one at a time. The days inventory, our looks at that, looking forward and we look out based on -- we look at what we've done for the last 90 days and then we forecast relative to that how will we do in the next 90 days. So, right now, we just issued one. We do this bi-weekly.

We just issued one and we used 107 percent for our forecasted sales rate based on what we'd done because we had a pretty weak April. So April dropped off. Now, we're coming into the tail end of the year we'll drop that down to in the 80s based on the run rate so that we're forecasting based on a lot of seasonality largely.

Most of it's seasonality.

Most of it's seasonality. But some of it, you know, a short term economic group call on our side. And we think we can look out at least 90 days and be a little better at it than we have in the past. The past models all used historic days supply and we'd again always make that mistake that you base what you're ordering for October, November and December on what you sold in July and August and it's not a very good model. So we've really fixed that internally.

We compare your inventory with some of the other companies?

Well, the day supply numbers are all over the board. I mean, here we got an announcement from Auto Nation today that they're going to change to a method just using the number of selling days as, I guess, the industry does. Well, that's the first time I'd ever heard that one. And I don't know -- I mean, everyone's got a different number for day supply. That's why we only talk about improvement and changes in it because somebody -- some people count in transit units. Some don't. You know, we had a study done public companies and every one of them did it differently. And some use ...

Do you count in transit as well?

... sales rate, some use 90 day sales rates. So, I mean, I think it's safest for us to just talk about our trends and our inventory and not go to a day supply number. We're using one internally. We use a 90 day trail in but we're actually using a 90 day forward one to forecast -- to actually do our ordering from.

Your question on late model. Late model is 2001 through 2003 right now. And there are current model ones out as used cars already. And anything three years and older I would consider an older car. We particularly like the four to six year old vehicles and we're focusing on trying to learn to acquire those. We don't get enough of them in trade. We have to be able to find those out on the open market.

Generally, as a rule, the margins are higher, the older the vehicle. Because we target a dollar amount of profit no matter what the selling price, so we prefer the older models in terms of that perspective and we average around -- between four and five years average age. So we are deeper in the market and sell more of the -- the older used cars which are higher margin. That's why our new vehicle margins -- one reason why it's higher than anyone else in the sector.

There's much less value risk in an older used car. It's more based on mileage and the usability of it that's left.

of the difference in margins?

The margins are better. If you make $2,000 on a $10,000 car it's 20 percent. If you make 10,000 on a $20,000 car you only make 10 percent and that's how car salesmen think is how much I'm going to make on a car. So you get better margins when you sell the older cars.

The next question on smaller markets, 75 percent -- it's actually come up a little bit, probably approaching 78 -- it's almost 80 percent of our current stores are exclusive to the cities that they're in which means they're the only dealer for that brand in that city. And so almost 80 percent of our business is this type of middle -- middle, you know, less competitive type of market.

Non-metro is the best term. Rather than -- because metro is easy to define. But non-metro. Fresno is the closest we have to a non-metro. I mean, there's a million people but we still call it a non-metro because there's only two of each brand sold there. You know, you're the only -- there's two dealers for each brand in that community.

Is there a significant difference in sales per dealer in these?

Well, obviously the dealer sells -- you know, I can't answer that. In some of the big metro markets you get sales per dealer of 700, 800 cars a store. But, you know, overall, no. There isn't. I mean, I think your average in those smaller markets is probably very similar to what is in the metro because, you know, an average store in those mid-size markets they sell, 200, 300 cars a month. 150, 200 is not uncommon.

But that's still very common in the metro areas because they over-dealered so much in those metro areas that, you know, you're getting growth areas like Phoenix, Arizona then you're going to see a store in Vegas, the average is probably more like 500 cars a month a store.

We really prefer the regional markets. The non-metro markets. We're doing business in metros in Denver and in the Bay area and in Seattle.

The domestic car manufacturers on incentives, that was your last question that I wrote down and, you know, I think it's built in now. I don't know that any of them are pleased about it, but it's a pricing model that they've built. They've increased prices but the net selling price has not increased. In fact, has declined when you factor in the incentives. But, in reality, that's the competitive environment they're in unless they have unique and differentiated products they can't get the extra margins.

So they're forced to battle it out for market share and I don't see that changing. And I see the imports getting into it even more because they've got issues too and some models that age in the end and the domestic manufacturers are coming up with fresh models all the time as well.

So, I don't think -- I don't think that's changing. I've been saying this for five years, so hopefully nothing out there will change it. I mean, I -- not that it would matter, we can sell used cars for a while if it gets softer on the new car side because that will make them more valuable if they don't have incentives. And that'll just take off.

People are going to buy cars. The markets have grown. Affordability's still there. Interest rates are low, markets are good for us.

OK. Great. Thank you.

Our next question comes from Richard Keim of Kensington Management.

The name's Keim. Hi and congratulations.

Hi, Dick.

Hi, Dick.

Good numbers. Good numbers. I have a few industry questions if I may. First of all, automakers such as Ford and General Motors have been talking about significant production declines in the current -- in the third quarter and are you expecting to have any trouble getting the hot cars that you are looking -- that you're looking for?

No, Dick. I don't think that's an issue, particularly this year. There's going to be plenty of anything. There's enough hot products. They're still building that. The only thing they'll cut back on is the ones that are selling poorly. And I don't -- there's no issues there. I would just love to run out of cars once.

What's your expectation for the F150?

It's a great vehicle. They've really done a great job of engineering it. Whether they can get the adequate price out of it to get a return on that extra investment they've made in product; I don't know. I mean, it's so competitive. I think it's very smart of them to produce both models for a while so that they can, you know, keep price competitive and hopefully build demand for the new model. There's nine different specific models and it's a tremendously complicated job. I mean, that's a fully developed truck product line as strong as anyone has ever produced in the world. And it's got to work. It's just whether they can make money at it because Dodge and Chevy have got, you know, all kinds of price incentives and what not going on. They might not have quite as much invested in new product costs.

The -- I'm sort of and I don't know what your feeling is that they will be a -- automobile strike and I'm guessing it would be General Motors; what's your thinking, number one? And are you doing any advance planning on this?

I've been through this way of negotiation how many times in the last 30 years? I think only one time did we actually end up with a shortage of cars. And it's always that fear and I've learned not to respond to it, Dick, because if you bulk up you're right back in problems and in the wrong time of the year to be in problems again. If you're going to bulk up, it would be with 2004 models and they're not going to be built until September, you now or August.

And it doesn't make sense for us to try to anticipate what might happen. We'll run the risk if there's a strike and we'll run short.

Got you. Final question, you said Brian's out today?

Yep.

Is that a big acquisition?

No, Dick. You know better. Just working overtime. He's out doing something he couldn't avoid doing. He had appointments so.

Oh no. You said acquisition guy.

Actually, he has another guy doing most of that now. Brian's backing me up on almost everything. I find myself saying, I have to ask, Brian before I can say yes to that.

OK. Thanks and congratulations again.

Thanks, Dick.

Thank you. Our next question comes from Peter from Capital.

I don't know why you waste time answering Keim's questions, but ...

Hey, he's a good a friend as this company has. A loyal stockholder.

God, you guys have problems. No, I'm kidding. The -- I wanted to ask about two things. First, you guys have been pushing sales very aggressively, gaining market share and, you know, I mean, it -- the things that are obvious in the numbers. But, looking at some of the issues that other companies have had; are there some other advantages in terms of your relationships with the dealers that we don't see at this point that will benefit -- your relationships with the manufacturers that we don't see at this point that will benefit you long-term from pushing sales so hard?

Well, we believe that. We believe we have no choice but to gain share and certainly represent those manufacturers the way they need to be in every market. We want to be way above market share in every market we do business in with every manufacturer and, you know -- because I think long-term our ability to buy stores is going to be dictated by that.

I mean, you just saw the deal with down in the Baker area and that's all an issue with some of the stores not performing that they currently have and -- you know, and I just think it's critical that all of us get on that wagon. We're going to have to be producing market share. I don't want to be lumped with a group. I think we can stand apart because we've got a good strategic plan to just grow steadily and to keep executing the way we're doing and we don't have to fall off.

I think we can continue to improve market share.

Well, let me ask you this then; I mean, are you, in terms of gaining market share, are you guys, sort of, in a unique position because of you're small market strategy? In other words, you know, if -- if or or AutoNation or one of these other guys wants to gain share in a lot of markets, they're going to go up against each other. In your markets -- in your markets you're going up head to head, is it mostly mom and pops; right?

Well, Jeff just gave that number. We're over 70 percent exclusively selling a product in a given market. So, you're dead on. That's a very good point. And I think that it gives us a competitive advantage and the ability to buy share.

We won't, for instance, buy three domestic stores in the same town because I can't get all three of them to perform at those higher levels that we're demanding. So we've got to strategically be careful in every market we're in. I mean, 's a mass market. We're about 50 percent of market share on new cars and it's a real juggling act to keep all the manufacturers above share because there's only 100 percent to split up. Everybody can't be at 150 percent. That's not possible.

's like what, 2 million population, metro.

I wish. No. It's about 300,000.

I have one more question which is: I see that these guys at CarMax are -- seem to be doing very well at, you know, growing share in the used car business. What are they doing in their ability to get used cars that you guys are not doing?

Well, Dick, if we only sold used cars, we'd be doing the same thing. But since we have the alternatives and we have a limited amount of resources in terms of personnel and space, we're going with new cars right now. But that's a great model that they're demonstrating; that opportunity to expand shares with a professionally run organization in a used car environment is there. And every new car dealer could take advantage of it and we're certainly working on plans and we have, in several markets, taken advantage of it.

But as we're adding stores that don't do it now, it takes time. But I think there's a tremendous opportunity for public auto retailers to do used cars. And, you think about it, there's no franchise requirements. There's no other restrictions. There's no rules. There's just happy customers and volume and growth.

So it would seem to me, in a lot of your markets that this might be a growth opportunity on a go forward basis?

Certainly is, Dick. And we're putting all the resources we can in and we're already carrying fairly high SG&A so you've got to balance it against current earnings, you know. And so you just keep working on it. We're building quite an infrastructure in the used car side that we finally have three or four senior executives focused solely on used cars. And that's -- a lot of that's educating, teaching and learning how. We just promoted another internal guy up to a Vice President of Used Vehicle Acquisitions and we've got one guy -- two people, really, that buy about 90 percent of the -- the what I call, the program cars which are the 2002, 2003 rental returns. And, I mean, the guys bought, I don't know how many, 12,000, 15,000 cars last year.

So, I mean, you can do a lot, centralized and we can do a lot better in the older car market as we go. There's still an upside, no question about it.

Thanks.

Once again, press one followed by four on your touchtone phone for any questions.

I'm showing no further questions at this time.

OK. I'd like to thank you all again for listening and we'll be here in three more months and we'll continue to sell cars and do as well as we can. Thank you.

Thank you. This does conclude today's teleconference. Please disconnect your lines and have a wonderful day.