Lithia Motors Inc (LAD) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Lithia Motors second-quarter 2004 conference call. (OPERATOR INSTRUCTIONS). 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 the SEC.

Now I would like to turn the floor over to Sid DeBoer, Chairman and Chief Executive Officer of Lithia Motors Inc..

Good morning, everyone. Again I would like to thank you for joining us for our second-quarter 2004 earnings relates. I am joined today by Dick Heimann, our President and COO; Bryan DeBoer, our Executive Vice President, and Jeff DeBoer, our CFO, and Dan Retzlaff, our Investor Relations Manager.

We would like to report our second-quarter earnings results. The second-quarter net income for continuing operations increased 25 percent to 10.8 million, and earnings per share increased 19 percent to 56 cents. This exceeded analyst consensus mean estimates by 3 cents for the quarter.

For the second quarter of 2004, Lithia has increased its quarterly dividend a penny to 8 cents per share. That is a little over 10 percent. We initiated a quarterly dividend of 7 cents per share in the second quarter of last year.

Lithia's second-quarter performance resulted from overall sales growth, margin improvements in all business lines, and strength in the parts and service business. Although same-store sales were down, we were able to maximize the profits from the business we did have through strategic initiatives. This was demonstrated by a gross profit margin of 17 percent for the quarter, which was a record for Lithia since we have been a public company.

The vehicle sales environment was volatile in the second quarter of the year with the month of April and May showing greater strength and stability and then the month of June demonstrating unseasonable weakness. June is normally the strongest month of the quarter. I would like to add that business has picked up noticeably in July so far.

Our performance in this mixed sales environment serves to demonstrate how Lithia's operating model works. Lithia fully integrates each store on the day of acquisition, and we have been successful in our efforts to standardize and apply common operating systems across our entire store network. The benefits of this model are apparent in our ability to increase margins in this type of sales environment where margins are declining for many other retailers.

Our new and used vehicle gross margins increased 30 and 70 basis points respectively for the quarter as compared to the same period last year. Service and parts gross margins improved 190 basis points for the quarter. Our operating margin for the quarter improved 50 basis points to 3.6 percent. Lithia has now experienced year-over-year operating margin improvements for four consecutive quarters. We posted record second-quarter sales of 682 million, an increase of 7 percent over the same period last year. New vehicle sales increased 10 percent. Used vehicles declined 4 percent. Parts and service were up 18 percent, and finance and insurance increased 10 percent.

In the second quarter, new vehicle same-store sales were down 3.5, and new vehicle same-store units declined 6.8 percent. Last quarter was a difficult comparison because in the second quarter of last year same-store sales increased 13.3 percent, and units increased 9.8 percent. General Motors and Ford same-store sales were down for the quarter with our Chrysler stores posting positive results. This is speaking about our General Motors and Ford stores versus our Chrysler stores.

Year-to-date new vehicle same-store sales are down 1.3 percent, and new vehicle same-store units are down 5.7 percent. However, margins in the new vehicle business were up 30 basis points for the quarter and 20 basis points year-to-date, and back above the 8 percent level.

In the second quarter, the used vehicle market demonstrated continued weakness as the competition from highly incentivized new vehicle sales continued to pressure used vehicle sales. It seems everyone wants a new car if they can handle it. Used retail vehicle same-store sales declined 13.1, and used vehicle same-store units declined 13.8 for the quarter.

In the second quarter, incentive levels remained healthy and, in fact, increased. Year-to-date used vehicle retail same-store sales were down 7.1, and used retail same-store unit counts were down 7.6 percent. Once again I will note that used vehicle margins were an offset to the same-store sales decline and increased 70 basis points to 14.6 percent for the quarter to our highest historical level and 90 basis points year-to-date to 14.4 percent.

On a combined basis, new and used vehicle same-store sales for the quarter declined 6.4 percent and units declined 9.9. Year-to-date total retail vehicle same-store sales are down about 3.1 percent with units down 6.6 percent. For the quarter, finance and insurance same-store sales were down only 1.2 percent. This was on top of a large increase of 6 percent in the same period last year.

Year-to-date F&I same-store sales are up .6 percent for the quarter. We arranged the financing on 76 percent of all-new and used vehicles that we sold. This is just above our historical average of 75 percent. We also had 44 percent service contract penetration as compared to our historical average of 39 percent, and life time oil filter product penetration of 39 percent as compared to an historical average of 31 percent.

Lithia's strategy of producing high penetration rates in F&I, service contracts and our oil and filter product is producing results in the parts and service department. One of the highlights, in fact, was that parts and service same-store sales which were up 3.3 percent. Parts and service same-store sales have now grown for four consecutive quarters.

The focus on service advisory training and margin improvements in the wholesale parts business have led to increases in the parts and service business. Year-to-date parts and service same-store sales are up 5.6 percent.

We continue to experience gains in the customer pay side of the parts and service business. Same-store sales here were up 4.8 percent for the quarter and 8.6 percent year-to-date, an almost 10 percent increase in customer pay. The improvements in the quality of Chrysler, General Motors, Ford and even Toyota vehicles continues to be apparent as they all had declining warranty work on a same-store basis. Other brands continued to demonstrate increases in their same-store warranty sales.

Total same-store retail gross profit for the quarter is down .9 percent; however, year-to-date same-store retail gross profit has actually grown even in the face of sales declines by 2 percent. So in spite of declines in our same-store retail sales, we are increasing those same-store retail gross profits.

I would like now to turn things over to Dick Heimann, our President and COO, my partner of many years, who will comment on our sales, brand mix and inventory position. Dick?

Good day, everybody, and thanks for listing. Currently our annualized sales mix by state, including all announced acquisitions, is Oregon leading with 16 percent of sales, California and Washington each with 15 percent, Texas 14 percent, Colorado 9 percent, Alaska now has 8 percent, Idaho 7 percent, Nevada 6 percent, South Dakota 4 percent, Montana 3 percent, Nebraska 2 percent, and Oklahoma 1 percent. Now we feel like we're getting good diversification across a wide range of markets.

For the quarter, I will list the states in order of same-store sales performance. Montana was the best, followed by Nebraska, Oregon, California, Texas, Alaska, Nevada, Idaho, Colorado, South Dakota, Washington, and finally Oklahoma.

Montana is new to the same-store sales mix this quarter and has been a very successful market for us over the past year. Oregon is still a very strong market for us as it performed well in the second quarter of this year despite difficult comps from last year. Texas, California, Alaska, South Dakota and Nevada were also up against difficult comps for the same period last year. The softest markets for Lithia were Washington and Oklahoma.

Our new vehicle sales mix by manufacturer for the quarter as a percentage of total new vehicle sales was 40 percent Chrysler Dodge Jeep, 23 percent General Motors Saturn, 8 percent Ford, 7 percent Toyota, 4 percent BMW, 3 percent each for Hyundai, Subaru, Honda and Nissan, and 2 percent Volkswagen, leaving 4 percent other brands for a total of 25 different brands.

73.4 percent of our sales were truck/SUV sales versus 70.6 percent last year. This increase in trucks/SUV these sales is also partially responsible for the 4.8 percent increase in year-over-year new vehicle average prices for Lithia. As apparent from the numbers, we operate mostly in regions where trucks, SUVs and domestic brands dominate the sales environment and are a way of life.

Our current inventory position going into the second quarter is good. We have taken an aggressive stance going into the third quarter with a greater stock 2004 vehicles in order to take advantage of the strong incentive environment. You may recall that during this period last year we were able to take advantage of the heightened incentive levels that as manufacturers tried to clear inventories of older vehicles to make way for the new models. Dealers that were light on older inventory during this period suffered in the third quarter of last year as highly incentivized older models sold better than the new models' introductions.

Our new vehicle inventories at the end of June were up approximately nine days compared to the year-end 2003 inventory levels. Our used vehicle inventories at the end of June were five days above year-end 2003 levels. We are proud of our new centralized inventory control process that was rolled out in the first quarter of last year. It has been very effective in helping us to manage our inventory levels taking into account changing market conditions in conjunction with seasonality. As you all know, the control of inventory in a retail business is critical.

Lithia continues to generate consistent improvement on the profitability of the new stores in the finance and insurance area and, as we all call it, F&I. Our F&I revenue per vehicle this quarter was $1004 per. This is the highest level achieved by Lithia in its history as a public company and was driven by strong improvements in the penetration rates of our key F&I components.

Now I will turn you over to our Chief Financial Officer, Jeff DeBoer, and he will do the final details on our quarterly results.

Thank you, Dick, and good morning and good afternoon to all of you on the East Coast. I would like to go to the revenue breakdown that Sid discussed and give you a little more detail there and then talk about the balance sheet and other items in our guidance later.

New vehicle sales were 59 percent of our total sales this quarter. This was compared to 57 percent last year in the same period. Total used vehicle sales comprised 27 percent this year and 30 percent last year. Parts and service sales represented 10 percent of sales this quarter. It was 9 percent last year. You can see the increase here. Finance and insurance was about 4 percent of total sales for both periods.

There was a notable shift towards the new vehicle sales this quarter away from used vehicle sales as Sid has already described. Contribution to gross profits by business is as follows. New cars 28 percent. It was 28 percent last year as well, so very stable; 20 percent from used vehicles this quarter; 22 percent last year. 30 percent of gross profit came from service and parts this quarter. It was 28 percent last year. 21 percent from F&I, and this was 22 percent last year.

The increase in the parts and service margin is most notable this quarter. 72 percent of our gross profit now comes from non new vehicle growth, the same as last year.

I will now go over the gross margins by business line for you. Sid mentioned earlier that we experienced gains in gross margins across all business lines this quarter. Gross margins for new vehicles were up 30 basis points to 8.1 percent, and this number was 7.8 percent last year in the second quarter. This is the second straight quarter of year-over-year increases in new vehicle margins. Our new vehicle gross margin increased 60 basis points from the first quarter of the year sequentially. Our historical average gross margin in the second quarter for new vehicles is 8.7 percent, so you can see there is potential for margin improvements in new cars.

The used retail vehicle second-quarter gross margin was 14.6 percent, a substantial 70 basis point increase from the second quarter of last year and a sequential increase of 40 basis point. Our historical average gross margin for the used vehicle business in the second quarter is 13.4 percent, so the 14.6 percent that we were at is 120 basis points higher than our historical average.

In addition, the wholesale used vehicle business continues to be strong, and we see the same strength that we saw from the third quarter of last year. In the second quarter, Lithia had a wholesale used margin of 4 percent and a gross profit per unit of $215 per versus a loss of $14 per unit in the second quarter of last year. A significant portion of the gains here are due to the success we have had at holding our own local used vehicle auctions in select markets and managing the disposal of units at larger auctions.

The parts and service gross margin for the second quarter was 48.7 percent as compared to 46.8 percent in the same period last year, a 190 basis point improvement. Our historical average gross margin in this business is 46.6 percent, so we remain well above our second-quarter average levels for the year.

The primary driver to margin expansion in this business has been our focus on service advisory training which has led to gains in the sale of higher margin service items and margin improvements in the wholesale parts business. Total gross margin for the company was 17 percent, an all-time record for Lithia. That is an 110 basis point improvement over last year and 30 basis point improvement sequentially.

Our SG&A as a percentage of sales was 13 percent. This is 60 basis points higher than the same period last year. So when you look at it on an SG&A as a percent of gross profit basis, which is how we manage our business, we actually saw 180 basis point improvement, and you can see that in the press release. It was 76.4 percent, down from 78.2 percent. So we made good strides in our cost control this quarter.

The combined effect from the gross margins and the SG&A was an improvement in operating margin to 3.6 percent. This is a 50 basis point improvement, and it is also an improvement over the last three years as we work our way back to normalized levels following the recession in the West. Historically we average 3.5 percent in the second quarter of the year.

For the quarter, the total of flooring and other interest expense as a percent of revenue was .9 percent as compared to .8 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 five-year interest rate swaps for a total of 50 million. This brings our total of interest rate swaps to $175 million.

Additionally, in May of 2004, we sold 85 million of 2.88 percent senior subordinated convertible notes due 2014 through a Rule 144-A offering to qualified institutional buyers. Net proceeds from this offering were approximately 82.5 million, and we used these proceeds to pay down our working capital, used vehicle line and new vehicle flooring notes outstanding, as well as some mortgages there were at much higher rates than the convertible. The notes are convertible into shares of our Class A common stock at a price of 37.69 per share. You can refer to our SEC filings for further information relating to this offering.

Including all fixed-rate debt obligations, notably the convertible and the interest rate swaps, we currently have 43 percent of our total debt which is fixed, and this compares favorably to the 28 percent that we had fixed at the end of the year. So we are making progress on our hedging strategy and getting ready for higher rates. The higher floating debt ratio was advantageous to Lithia in the past as rates went down. But we are now able to lock in more fixed rates at a good time we believe in the interest rate cycle.

I would like to reiterate briefly our thinking behind the convertible debt offering we announced in May and completed in May. First, with our steady 15 to 20 percent growth plans into the future, Lithia has an ongoing need for growth capital. With interest rates at historical lows, we felt it was a good time to pay down our higher price debt and further lock in fixed-rate financings at very low levels for our capital structure.

Now I would like to look at our balance sheet. We had nearly $10 million in cash on the balance sheet at the end of the quarter, after having paid down quite a lot of debt. Our long-term debt, excluding used vehicle flooring, is largely comprised of debt from the offering, real estate and equipment financing and in total 249 million versus 178 million at the end of last year.

On the balance sheet, you will notice that we paid down the used vehicle flooring line completely with part of the proceeds from the offering. Our long-term debt to total cap ratio now stands at 39 percent versus 33 percent at the end of 2003. Our goodwill as a percent of total assets is 18 percent as compared to 19 percent at the end of 2003, and the lowest in our sector.

Shareholders equity for the first six months rose by 6.5 percent to 382 million. Lithia's book value per share now is over the $20 mark at $20.38 for book value.

Free cash flow measured as net income plus depreciation and amortization less non-financeable CapEx was approximately $11 million for the quarter. On average for the year, depreciation from the income statement tends to be about the same as non-financeable CapEx, so net income is a good indicator of cash flow for our Company.

As a final note, for the full-year 2004, we are raising our earnings guidance from continuing operations to $2.11 to $2.16 per diluted share. We expect third-quarter earnings in the range of 68 to 70 cents per share. This forecast takes into account all announced acquisitions and additional acquisitions that may occur through the end of the year. The forecast also gives a better picture of the changed seasonality of the company that will occur in the fourth quarter in particular because we have added more stores in the very cold winter states of Alaska and Montana, mainly in Anchorage and Fairbanks, Alaska.

That concludes the financial summary, and I will now turn over to Bryan who will comment on acquisitions and the operations. Bryan is our Executive Vice President of Mergers and Acquisitions.

Thank you, Jeff. I would like to comment on acquisitions and then briefly touch on used vehicle operations.

In the first quarter of the year, we acquired two stores with approximately $95 million in revenue. At the end of January, we acquired a Chrysler Jeep store located in Reno, Nevada with approximately $55 million in annualized revenue. This was our fifth store in that market as well.

Then in the middle of March, we completed the acquisition of a Chevrolet store in Helena, Montana with approximately $40 million in annualized revenue. Again, that was the third store in the state of Montana, a real target market for us in the future as well.

In the second quarter, we acquired two more stores. Chevrolet of Anchorage and Chevrolet of Wasilla with approximately $125 million in annualized revenue. Lastly, in July we acquired Lithia Toyota of Odessa with sales of approximately $20 million annually. This is Lithia's fifth dealership in the Odessa midland market and now gives us approximately $200 million in revenues in what has become a very very successful market for us. With this acquisition, Lithia has acquired approximately $240 million in annualize revenue so far in 2004. More importantly, each of these acquisitions are perfect examples of our core growth strategy of small to medium-sized markets.

For the trailing 12 months including the latest acquisition, we have added a total of $395 million in annualized revenues from acquisitions. Trailing 12 months revenues for the same period has been $2.52 billion, so we have added approximately 16 percent revenue growth through acquisitions for the period. We have added revenues of $140 million in Alaska, $90 million in Texas, another $55 million in Nevada, $50 million in California, $40 million in Montana, and finally $20 million in Washington.

For the rest of 2004, we will continue to emphasize two initiatives in the used vehicle businesses that are already starting to produce results. First, we will continue with our strategy of conducting our own local used vehicle auctions and continue to use a third-party auction as Jeff mentioned earlier. This process is now centralized and controlled at the management company level. We no longer allow stores to dispose of their own excess inventories. This new focus has proven to be effective as it saves time, it saves expense as we maximize the value of our wholesale used vehicle operations.

In the first half of the year, the benefits of our focus on this area were evident as we have added -- excuse me, as we had wholesale profits per unit of $185 as compared to a loss of $42 per unit in the same period last year.

Secondly, we will continue to roll out our used vehicle promo pricing strategy to all of our new stores and existing stores as well. This strategy takes a new approach by marketing used vehicles with a $99 down payment and then grouping vehicles by payment levels. Vehicles are marketed with attractive, clear, and understandable pricing. Promo pricing reduces haggling, it speeds up the sales process, and most importantly it enhances the customers buying experience.

Keep in mind that this is not a nonnegotiable pricing strategy, but what it does do is resolve the issue of price, down payment, and monthly payments for the customer and our salespeople in a very simple way. We are excited to see what we can do with this strategy as we move ahead and fully implement this strategy throughout the organization.

Now I would like to turn it over to Sid for some closing comments.

On the guidance for this year, the range is 211 to 216. We did not raise it from 211 to 216. Our range is 211 to 216.

Thanks, Bryan. In closing, I would like to add that on a long-term basis we're 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.

Through cash flow, we can fund approximately 10 percent in acquisition growth, and our five-year average same-store sales growth rate still stands at 4.1 percent in spite of the lower performance the last couple of years. We have a significant number of stores that we have yet to fully integrate with improvements that will be realized over time. At this point, any additional growth for more aggressive acquisitions would be funded from our credit lines. And as we said earlier, we are continuing to execute our plan and are seeing a strong start in July that indicates that our strategies are fully working.

This concludes the presentation now, and we will open the floor for questions.

(OPERATOR INSTRUCTIONS). Rick Nelson, Stephens.

Thanks. Congratulations, guys, and good to hear you all on the call, include you, Dick. I was wondering how you are able to show this gross margin improvements in new cars, when others in the industry are reporting declines?

Rick, basically we have got a no panic strategy you know, and we are going to stick with our plan on pricing and the way we work our auto deal with each customer, and we refuse to give in on price before we actually have to. And I think a lot of people panic in this business when sales slow down and change their strategies and go ahead and lower prices. We don't find it really helps, that the market kind of dictates the volume, and we need to take advantage of -- not take advantage, but we need to be sure we take care of every customer in the right way and write up each deal in the proper procedure and the gross profits will return I think to our historic levels over time in the new car side. We continue to see improvement, so it is a good sign that we are not giving into the temptation to just lower prices to try to somehow get more business.

How do you feel about inventory levels, particularly on the new car side?

Well, you know basically we have real strong inventories in the Dodge Chrysler lines and the General Motors lines at this time because we are bidding on occurring what took place last year that these manufacturers will go forward with incentives and hold share and that we can maximize new cars sales during this third quarter. I think the strategy is going to work. It is working so far in July. It is very important not to run out in September like we have in the past in some stores. So we're pretty strong in inventory, but it is the right stuff, and we've got it priced right and we're marketing it properly. I think it's a good time to take a little risk on inventory.

How much heavier are you compared to a year ago? I realize you don't put out a days supply number, but --?

Well, we gave you the one. We are nine days heavier than we were at the end of the year, and that is not a major swing by any means. But it's a higher level than we had last year at this time. I don't have the exact numbers.

And why do you think car business is picking up in July?

Because I think it was an aberration in June. I don't think it indicated much of anything. People must have got tired. Something must have happened. Incentives must have wore out short-term. It was only really a couple of weeks of June that was terrible, and it actually got better as the month went on. So I just -- I don't know. There are always hiccups.

Maybe May was real strong. Maybe the tax refunds they spent them earlier in May, and we did not see that impact you know in June that we may have had in the past. Maybe May was better than it should have been. I think that would be my guess, and I am guessing really, Rick. We just have to respond to what happens, and right now we're seeing good strong trends.

And the incentives, are they more aggressive now in July than they were in June?

I think it was about an average of another $500, and still there is still that extra $1000 if you finance it, particularly with the Chrysler. That's a huge benefit, and we are picking up a lot of finance opportunities with that extra $1000. There is an extra $1000 rebate if you let Chrysler Financial finance it.

Gerry Marks, Raymond James.

Just a couple of questions. Sid or Jeff, in terms of the guidance for the third and fourth quarters, you alluded to some seasonality. I was just wondering, it doesn't seem like you are really looking for any growth, and you have made some acquisitions and you indicated you are betting that the incentives come on stronger as we progress through the next couple of months. How come you're not really looking for any earnings growth?

Basically, as we indicated, we have not changed our guidance from last quarter. We have left everything the same, and what we have pointing out some of the analysts that are being a little too aggressive in the fourth quarter is that we have added stores in the Alaska and Montana markets, and those stores quite honestly don't do very well in the winter. So you cannot put more normal margins on those stores and come up with higher numbers than we are guiding. So that's really the only factor that we can see.

It is only like 50 below in Fairbanks in the winter too. That's part of it. And I were adding in Montana is the one that Jeff mentioned. And the big stores we added in Wasilla, and Wasilla is north of Anchorage for those of you who don't know. It's a growing part of the Anchorage area, and it's a separate market, but the store in Anchorage, the large Chevy store, and those things. We know there is a real cycle in Alaska.

We just think that we need to be conservative and continue to guide to what we know we can achieve and work our way along with that, barring any changes in the economy. If the economy is a lot better than what we anticipate, we should be able to exceed. But we are not going to make those forecasts any higher than they are.

And I would like to reiterate, we have not changed our outlook at all. We are giving the same guidance that we gave before, and we have factored in rising interest rates and other factors in our normal conservative manner.

Right. No, I just want to kind of understand in terms of seasonality. So basically you have acquired these stores, and so you're still going to have the additional integration oversight expense, and then that is why you would be expecting maybe a modest decline in EPS in the fourth quarter?

I think you'll see more seasonality in our numbers period going forward, Gerry. The fourth quarter is the weakest quarter. I just think we all need to learn that, and it is going to take a little while to demonstrate it. But we are just not -- we are being real cautious on that fourth quarter.

Okay. Two other quick questions. First of all, regarding promo price, is that just on used, or are you also trying that on new?

The promo pricing strategy on used vehicle is more focused around the payment even though it has a price as well. The new car promo pricing strategy is focused around a specific price. So it is on new vehicles as well, Gerry.

Promo pricing actually began from the new vehicle side. We rolled it out into the used vehicles for the first time last year. So it's very successful on the new vehicle side, and it is pretty well fully integrated at every store, and we have not backed off on that at all.

And then the final question, I mean your F&I numbers are really great. I'm sure you know all the debate that is going on in terms of disclosure. What are your thoughts about adding additional disclosure and what that might do in terms of your F&I numbers going forward?

We don't anticipate disclosure being an issue. We are already fully disclosed as much as we -- we don't tell people how much we are making on a loan. But you know we still are the creditor, and I think that point continues to get missed. We're not a broker earning a fee. We are the creditor making the loan to the customer, and it is fully negotiated at the time of sale. There's no pretense that they cannot go elsewhere.

I don't know that disclosure actually will come. If it does, we will deal with it. We have had issues like this in the past, and I'm sure we can get through without a real erosion. We will find other products we can sell. It is mostly payment-driven basis, and our average margin on the F&I portion is around $350 to $400 on the reserve part, which is the interest earned per deal, and you know that is not as big as some organizations.

We pay on a balanced pay plan so that each F&I guy needs to focus on selling service time, lifetime oil changes, and he cannot make his money on an interest rate margin because we cap that at 3 percent.

Okay. So part of the strategy might also be then if more disclosure is required, that you would go from 40 percent service penetration in terms of those extended warranties to maybe 50, 60, or more like your 70 percent range?

Yes. There is lots of potential, and you know there is a certain amount you can do with one customer, and you have to limit what you present. So we have to look at how we would go about that if it did take place. But it is really premature, and we are not seeing any signs it's actually happening. We are seeing a lot of talk about it. I see Ford lowered it to 2.5 percent, their max cap on Ford financing. But we are not seeing any -- there is a lot of talk about it, but I don't sense that it is going to go anywhere.

Gerry, this is Bryan as well. To reiterate on Sid's point, even if there was disclosure on finance reserves or that type of issue or a flat fee, we don't see that that would affect things that much. We currently have fixed prices on all F&I product now, and you know there was some fear of that 10 years ago when we went to that. It never affected things. I mean it was just a matter of negotiating things fairly, and that is what we really do and that is how we disclose things. We don't see that really affecting our F&I, our reserves either if that was to happen.

(OPERATOR INSTRUCTIONS). John Tomilson (ph), Prudential Equity Group.

Good morning, guys. Congratulations on the quarter. I might have missed this and I apologize. Can you talk about some of the things that you are doing on the cost side that impacts the SG&A as a percent of gross? Can you elaborate a little bit more on that first?

Yes, Bryan will take that.

Over the past year, John, we have implemented a couple of different things. One on the accounting side and it is something that we call keeping the net, and it is really a focus and driven out of the managerial accounting side of each dealership where they are trying to make the operational people more aware of where their expense structure is. That is going very well. Each month we actually take a different expense item and really dissect how that expense is accumulated, and that is really working well.

Secondly, we have added two personal in an expense controlled department that are really focusing on that bottom quarter percentile in our dealerships that really have an issue month over month regarding expense, and they are really making some headway. So our poor performing stores are not quite as poor performing anymore, and that is really starting to take hold.

Another area, John, corporate-wide, we have taken all of our vendor relations and put them under my wing to be in charge of all the negotiations with our vendors and to make sure that we are continuing to get discounts as we get larger and add stores. We are already starting to see the results of that, and that is one area I'm excited about getting more results with our vendors.

The uniform bookkeeping systems that we have both with Hyperion and the ADP system identify all expenses at every store in an identical way, and we have comparisons across the board. We also in our general manager meetings that we hold semi-annually are doing 20 group breakouts which is similar to what NADA does with 20 groups. By brand and manufacturing, the guys are actually able to compare their store to exactly what each department is doing and what each expense line is. And they go home and try to get themselves in line wherever it is out. So the traditional methods of controlling expenses are fully in place, and I think the heightened advantage of having common bookkeeping systems and common ways of measuring things is really going to be an advantage for us in trying to grind down SG&A.

Do you guys have a longer-term target where you think that number can go?

Well, the mix of business determines some of that. Obviously if your service and parts business is a bigger space, the SG&A should fall because you've got a lot higher gross margin. But that is a function of that. But I don't have a target specifically. We would love to return to those historic operating margins that we had.

And the low 70s, between 72 and 75 on SG&A as a percentage of growth, we have been there before. Our operating margin you know 4 percent or higher certainly is something that we think we can achieve.

Also some of our costs are related to our growth, and if we grow faster, we have to have additional personnel and support services staff to handle the new acquisitions, and I have always made that point that we probably carry 100 basis points more than the average dealer that is not integrating stores and taking them apart and putting them in a system when they buy them. They are buying roll-up stores. They don't need those people. They are just letting them run them. And we're not doing that. So it takes a lot of extra effort and energy.

If we stop growing, we could pull at least 100 basis points out. But we want to grow. That is the plan. So we need to keep those people and those resources.

Okay. Just one other follow-up question and I am not sure if you talked about this. What kind of lift are you seeing on a per unit basis for F&I once you're making these acquisitions on the new stores? Can you talk about that at all?

Yes, we get none of that in the same-store because that happens pretty much immediately after we buy the stores because we changed the system over immediately. I think the average (inaudible) is around 400 or 500 per retail unit, and we get to that increase within six months at the most on a new acquisition.

A lot of the stores we are buying, some are doing better than others, but as an average, they are probably doing 500 or 600. But we pick up 400 or 500 a car right away on F&I income, and that never shows up in same-store. That shows up in the acquisition in the first-year.

So there is not a lot of same-store growth out of F&I I don't think potentially there. I think we can keep up with by 10, 15 years from now we might be making a couple of grand, but it just will grow gradually. There is no maximum. I mean there is no huge leaps are going to happen there.

Jonathan Steinmetz, Morgan Stanley.

A few questions on the used business to start. The first is, was used generally weak in the same brands and in the same time periods as when the new side was weak for you?

I don't know if I have that answer. I don't think so. I cannot answer. I don't know, Jon. I would have to do some analysis.

Okay. On the second on used, are you happy to go here with a strategy of sort of letting the volume go down a little but getting our gross? Are there going to be any initiatives where you're willing to prop the volume up at the expense of gross?

We are trying to prop volume up but not at the expense of gross, and we think we can achieve that. We gave up some gross to get where we are in prior years. I know that same-store sales number on new vehicle increased quite a bit last year. We have a requirement that we do is certain job for each manufacturer in each area that we do business. So it is critical that we achieve continued growth in all of our stores and maximize the marketshare that we are responsible for. So it is a mixed bag. We think you can do both. I don't think you have to choose between the two.

It is more a selling process and the way you price your vehicles and the way you market. We are learning a lot about it, and I think we are getting better and better at it.

Switching gears, Jeff, just quickly I take it the guidance is without any impact for any change in accounting on the contingent convert?

Yes, that is correct.

That is not a done deal yet incidentally. (multiple speakers). Yes, it seems pretty irrational to me. I don't understand how you could count those shares when they may or may not ever be in the money, and it seems like you ought to have a Black-Schoales method of some kind where it grew into the share count. To just have it all in or all out makes no sense to me.

It is really beyond our control. In fact, all companies that have them are the same, so.

We are getting input to the people on it. You know our accounting firms agree that it does not make sense, but it may happen. If it does, it really has no effect on cash flow or our real earnings. It just has an effect on how we bookkeep the share count.

Sure. And the last question, just on the Chrysler product, can you talk a little bit about what you're seeing with the Magnum or the 300C, what type of traffic lift if any it has given you? What sort of sales you're seeing? Maybe what people are trading for those products?

From what we can read, the 300C is very popular. The Magnum is still too new to rate. I think it's doing fine as well. We certainly don't see any rejection of the vehicle. I think it would help if Dodge had a four-door as well. I think the station wagon thing is a nice unique thing, but it does not fit as many people. They don't all want that.

So I think the Magnum may not be as strong as the 300, but the 300 is still a homerun. We are pretty well sold out everywhere. There is a wait-list for the one with the Hemi. The Hemi is much more popular, and I think it's a homerun car for Chrysler and us, and it's a great vehicle. Have you driven one, had a chance to?

I have yes. I thought it was excellent.

And it is really quiet. It is like an E-Class, I think, Mercedes as much as anything. It is that quiet, and you have to spend at least 50,000 to get anything equal to it in a German-made car, and this thing is in the 30, low 30 range.

So I think there's a huge upside for Chrysler on that car, particularly in markets like Burlingame where we struggled anyway. It is not a very good truck market, and we bought a store there a few years back because Chrysler wanted us to buy it. We are trying to get extra inventory in the 300 there because we've got lots of sold orders, and we know we can gain share with that product there against Audi and against BMW. It is like 80 percent import in that market. By import, mostly luxury import. So those kinds of markets I think the car side can really grow.

Thank you. I am showing no further questions at this time. I would like to pass the floor back over to our speakers for any closing remarks.

Okay. Thanks again for listening and we will be in touch. Any of you have questions, feel free to call Jeff or Dan or myself, and we will be able to happy to field them within the framework of what we can say. But we will be continue to execute our plan as we have, and thanks for your participation.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.