Lithia Motors Inc (LAD) 2005 Q2 法說會逐字稿

Welcome to the Lithia Motors second-quarter 2005 conference call. At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation.

Before we begin the Company wants you to know that this conference call includes forward-looking statements. These statements are necessary subject to risk and uncertainty and the actual risks 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'd like to turn the floor over to Mr. Sid DeBoer, Chairman and Chief Executive Officer of Lithia Motors.

Good morning, everyone. Again I'd like to thank you for joining us today for our second-quarter 2005 conference call. I'm joined today by Dick Heimann, our President; Bryan DeBoer, our Executive Vice President; Jeff DeBoer, our CFO; and Dan Retzlaff, our Director of Investor Relations.

For the second quarter net income from continuing operations increased 18% to 12.8 million and our operating margin improved a solid 40 basis points to 3.9%. Earnings per share including discontinued operations and the dilutive effect of the change in accounting for convertible notes increased 11% to $0.60. Earnings per share, excluding discontinued operations, was $0.61.

Earnings per share excluding the effect of the additional convertible shares and the discontinued operations increased 14% to $0.65 and this was $0.04 above the high end of our guidance for this quarter. For the second quarter of '05 Lithia has increased its dividend by 50% to $0.12 per share. We initiated a quarterly dividend of $0.07 in the second quarter of '03 and raised that to $0.08 in the second quarter last year. We want to maintain a payout ratio of approximately 15% to 20% of annual net income. This level allows for ample capital for acquisitions to continue our growth plan. Investors can refer to our press release for record and payment dates.

Lithia's second-quarter performance results (technical difficulty) sales and gross profit growth across all business lines, margin improvements in the used vehicle and parts and service businesses and expense savings as a percent of gross profit in sales. Same-store sales also increased across all business lines. For the quarter total same-store sales were up 3.4% and total same-store gross profit was up 2.7%. Second quarter can be characterized by a reasonably strong month of April followed by a much weaker May and finishing with a strong June.

The General Motors employee pricing program was a major hit with consumers and benefited the Company in June. This was not the only brand, though, that performed well in the month of June. Excluding GM same-store new vehicle revenue for the month of June would have still been up by 1.7%.

I'll now go over the gross margins by business line. Gross margins for new vehicles in the second quarter were 7.9%, a 20 basis point decline over the second quarter of last year. Surprisingly the GM program has very little impact this quarter in terms of a reduction in gross margin. Year-to-date new vehicle gross margins are still up 20 basis points at 8%. Used vehicle second-quarter gross margin was 15.7%, a strong 100 basis point improvement over the second quarter of last year. The year-to-date margin is up 110 basis points to 15.5%.

We continue to manage this business very well. We have now increased second-quarter used retail margins for three straight years. The wholesale used vehicle business continues the strength that began back in the third quarter of '03. In the second quarter Lithia had wholesale used margin of 3.8% and gross profit per unit was $229. We have now had two full year -- some wholesale gross profit gains. We continue to manage the disposal of our units by using centralized control, holding our own local used vehicle auctions and managing the disposal of units at larger auctions.

The parts and service gross margin for the second quarter was 49.2% as compared to 48.7 in the same period last year, a 50 basis point improvement. This is the highest parts and service gross margin achieved by the Company since becoming a public company in late 1996. We experienced margin increases in both the service and parts businesses. Primary drivers to margin expansion here have been a focus on service adviser training which has led to gains in the sale of higher margin service items as well as a number of pricing and cost saving initiatives across the entire service and parts business.

The total gross profit for the Company was 17%, same as last year. SG&A as a percentage of gross profit improved 260 basis points and this led to an operating margin improvement of 40 basis points to 3.9% which was at near record levels for Lithia in the second quarter of the year. I'll turn things over now to Dick Heimann, our President, who will comment on our sales, brand mix and inventory position. Dick?

Good morning or good afternoon depending where you are. It's nice to have positive results in a positive market -- that's always nice. Our annualized sales mix by state including all announced acquisitions is currently Oregon with 16% of sales, California with 16%, Texas 12%, Washington 12%, Colorado 8%, Idaho 7%, Alaska with 7%, Montana 7%, Nebraska 6% and Nevada 5%, South Dakota 3% and New Mexico, our newest state, now at 1%. The most notable additions over the past 12 months have been to Montana, Alaska, Omaha and Nebraska, all cold weather states which increases the seasonality impact.

For the quarter I'll list the states in order of same-store sales performance -- Alaska, our North state, was best followed by Idaho, Nevada, California, Nebraska, Oregon, Colorado, Texas and finally Washington, Montana and South Dakota. Most notable is that the Colorado market is now in an upswing for our Company and not particularly in that market; but we have demonstrated now positive same-store sales for two straight quarters there.

The strong performance in Alaska and Idaho was aided by our Chevrolet exposure in those markets. Nevada, California, Nebraska and all of Oregon all had very little or no exposure to the GM brand, performing well with other brands, however. Montana is a very good market for Lithia, but faced difficult comparisons from the second quarter of last year. The weakest markets for Lithia in the second quarter were Washington and South Dakota.

For the quarter our new vehicle mix by manufacturer as a percentage of total new vehicle units was 38% for Chrysler Dodge Jeep; 23% General Motors, Saturn; 10% Toyota Scion; 9% Ford Lincoln Mercury; 5% Hyundai; 4% each Nissan and Honda; 3% Subaru; 2% BMW; and Volkswagen Audi leaving approximately 1% of the brands. We continue to see a shift in unit sales from trucks and SUVs to smaller SUVs and sedans. 66% were truck SUV versus last year's 68%. On a sales basis 70% were truck SUV versus last year at 73% in the second quarter.

Our inventory planning for the quarter with our centralized inventory control process has been very successful. You may recall that we had taken an aggressive stance with inventory since December of '04. The decision to have higher inventories was strategically designed to improve our same-store sales as we moved into the seasonally stronger second and third quarters of the year. Our plan has been to increase the new vehicle volume throughout the year and aggressive inventories are key in helping us achieve that goal.

New vehicle inventories at the end of June were down approximately 11 days compared to June of last year and down 14 days from the beginning of the year. There are seven days above our average levels for this time of year, so we're still in a good position to take advantage of the strong incentive environment we are seeing in the third quarter of the year.

Used vehicle inventories at the end of June were seven days above June of last year and ten days above average levels for this time of year. You may recall that the first quarter we had indicated there was a shortage of used vehicles and that pricing had remained firm. Success of the GM employee pricing program has led to more good quality trade-ins that should benefit our used vehicle business in the longer-term, especially in the next 60 days.

Pricing continued to stay firm in the second quarter as demonstrated by a nearly 5% increase in used retail prices and a solid $271 increase in gross profit per unit. Lithia continues to generate consistent improvements on the profitability of our stores in the finance insurance area, F&I. Our F&I per vehicle for the second quarter was up to $1061 as compared to $1001 last year. This is driven by a high penetration rate to the financing of new and used vehicles of 77%, service contracts of 42% and our lifetime oil products of 39%.

I'll now let you hear from our CFO, Jeff DeBoer. He'll provide you with some more details on the financial results. Jeff?

Thank you, Dick, and good morning, everyone. We posted record second-quarter sales of 762 million, an increase of 13% over the same period last year. New vehicle sales increased 12%, used vehicles sales increased 12%, finance and insurance sales increased 15%, and parts and service sales increase 8%. I'd like to further break down these revenue numbers for you.

New vehicle sales comprised 58% of total sales; used vehicle sales comprised 27%; parts and service 10; finance and insurance 4%. These were all essentially unchanged from last year, so a very stable mix of businesses for us. The contribution to gross profit by business line this year by business was 27% from new vehicles versus 28% last year; 21% used vehicles, the same as last year; 30% from service and parts, also the same as last year; and finance and insurance increased to 22% from 21% last year.

In the second quarter new vehicle same-store sales were up 3.8% and new vehicle same-store units grew 2.8%. General Motors was our strongest brand for the quarter with same-store sales up 15%. Excluding GM, as Sid mentioned, same-store sales were up 0.4% for the quarter, so we still had good performance with our other brands.

Lithia now reports the used retail and used wholesale same-store sales numbers on a combined basis. In the second quarter the used vehicle market continued to demonstrate strength in pricing and margins. Total used vehicles same-store sales increased 3.7% and same-store units declined 2.9% for the quarter. Retail margins improved 100 basis points and retail prices increased 4.7% which led to a $271 increase, as Dick mentioned earlier, in gross profit per unit. The average wholesale price improved 13.4% for the quarter and gross profit per unit was $229.

As a result of both sales and margin improvements same-store gross profits in the used vehicle business showed high single digit growth this quarter. Finance and insurance same-store sales grew 2.1% in the quarter, a high penetration rate in F&I, service contracts and our lifetime oil product led to an F&I per unit increase of $60. Parts and service same-store sales for the quarter increased 1%. We faced a somewhat difficult comparison of 3.5% growth in the second quarter of last year. We continue to apply our efforts on service adviser training in our lifetime oil program which have paid dividends in the service side of the business. Most importantly, total same-store gross profit for the Company was up 2.7%.

I'll now discuss the debt and capital side of our business. For the quarter the total of flooring and other interest expense as a percentage of revenue was 1.2% as compared to 0.9% last year. We have seen an increase in interest expense which is to be expected in the current rate environment. However, we have minimized the impact of higher rates by fixing a substantial amount of our flooring debt with interest rate swaps. We currently have outstanding 175 million in interest rate swaps with fixed rates. Including all fixed-rate debt obligation and hedges approximately 44% of our total debt now has fixed-rate.

For the quarter we have an increase in flooring and other interest expense of approximately $3 million. Of the total increase about 51% was due to higher rates and 49% due to higher outstandings. Our average interest rate -- this is the most important point -- our average interest rate increased by 90 basis points year-over-year, market rates went up over 190 basis points for the same period. So we increased less than half of what the market did, so you can see the positive impact of our marketing strategy.

We had $30 million in cash on the balance sheet at the end of the quarter; our long-term debt, excluding used vehicles flooring, is largely composed of debt from the convertible offering, real estate, mortgages and equipment financing and totaled $280 million versus 267 million at the end of last year, so very little increase in debt. The breakdown of our debt currently is 143 million in real estate mortgages, 50 million in equipment debt, 85 million from the convertible bonds and 2 million of other debt. Our long-term debt to total cap ratio, excluding real estate, was 24%, the same as at the end of last year. So we still maintain a very unlevered balance sheet. Our goodwill as a percentage of total assets is 18%. I would mention that our acquisition credit line of 150 million is currently totally undrawn.

Shareholders equity rose by 6% to 431 million. Lithia's book value per basic share is now $22.55. Our price to book ratio as of the close of market yesterday was only 1.3 times. Looking at free cash flow, net income plus depreciation and amortization for the quarter was 16.2 million and nonfinanceable CapEx for the quarter was 5.6 million. Dividends paid were 1.5 million, so we had free cash flow this quarter of approximately 9.1 million.

As a final note, for the full year 2005 we are providing earnings guidance of $2.29 to $2.34 per fully diluted share which assumes a steady pace of acquisitions. This guidance includes the effect of accounting for convertible notes. For guidance excluding this effect please see the press release. The effect of including the convertible notes will be to reduce fully diluted EPS by approximately $0.17. For the third quarter we are also providing earnings per share guidance in the range of $0.73 to $0.75, that includes the effect of the convertible note which reduces earnings per share by $0.07.

That concludes the financial summary. I'll now turn it over to Bryan who will comment on operations and acquisitions.

Thank you, Jeff. I'd be amiss if I didn't reiterate Dick's comments -- it sure is an exciting time to be in automotive retailing. Welcome, everyone, again. I'll begin by commenting on a few operational and human development issues and then I'll finish up quickly with acquisitions. Lithia's long-established promo pricing strategies blended and are blending well with the manufacturers' employee pricing programs and generated solid new vehicles sales. This pricing has added legitimacy and simplicity to the automotive retailing environment and is obviously being well-received by consumers.

We are excited about the direction the manufacturer pricing programs may take us in the future as these pricing models complement the Lithia promo pricing strategies very, very well. The rest of 2005 presents an opportunity to expand our used vehicle business by taking advantage of the influx of new vehicle trade-ins. Our used vehicle promo pricing strategy will be the key to converting this increase into profits. These used vehicles will be sold with the hassle free customer experience of promo pricing and guaranteed by the Lithia 60-day used vehicle warranty.

Additionally, our existing used vehicle inventory optimization plan will maintain our used lots with the correct mix of vehicles. Remember, our regionalized independent used vehicle wholesaling should aid in the liquidation of any excess or lower demand used vehicles and keep our front lines very, very fresh. This cultural change over the past 18 months has elevated our wholesaling operations as Sid had previously mentioned as well, and this provided us with more flexible ability on new and used vehicle retail volumes and trade-ins.

We are very focused on all used vehicle price points. Our certified used vehicle sales are up nearly 60% for the first six months of the year. Selling of older vehicles under our silver plan which have over 75,000 miles in the first months of the year have also increased nearly 38%. Our procurement specialists are working diligently to secure additional high demand used vehicles to support the store's efforts. We believe this is a key to our future and the used vehicle operations.

These combined initiatives have been adopted to foster sales and are the reason our profit margins in used vehicles continue to increase. In human development we are continuing to solidify our strategy. Lithia's long-time focus on growing people from within the organization is what sets us apart from the competition. In the first half of the year we have strengthened the execution of what we've referred to internally as AMP, or accelerated management program. We have developed each component to accelerate opportunities for existing and new employees.

For college and high school students we have an internship program that provides valuable experience within our Company and a taste of the automotive industry. Students who successfully complete this program have the opportunity to join Lithia upon graduation with a visible career path. Lithia career paths include timelines, earnings potential, progressive training modules and employee job expectation at each step of the way all developed to improve the likelihood of their success.

The most important element of our human development strategy is focusing on our existing employees. We provide many avenues for individual development and career growth. Our management training program or bench strength focuses on preparing current employees for a management position within their store or another future location. Employees follow a predetermined training, testing plan and are mentored by the department manager to ensure their preparation for the next position.

Our senior leadership program encourages our high performing employees to visit other Lithia stores on a temporary basis, be a go to person, be a trainer and mentor while maintaining their current position in their store. Our impact manager program -- this is viewed as the elite acceleration opportunity within our Company -- sends employees to Lithia stores with a directive of improving the store's performance while stepping into a full-time position. Employees gain a vast amount of knowledge and experience due to the wide variety of challenges and situations they will face on a day-to-day basis.

Lithia's latest human development initiative has been the creation of Lithia's core leadership competencies. They reflect the most important skills and behaviors necessary for continued success and growth as a leader within Lithia. These competencies provide a common vocabulary to discuss and develop leadership expectations and abilities within our workforce. These competencies will assist us in better identifying candidates for employment, developing high potential people within the Company, evaluating performance and promoting leaders using consistent, objective and relevant criteria.

Lastly, we provide our people with organized systems to ensure their success. One of these, the Lithia store management system or LSMS, has been developed to improve measurements, increase productivity, focus training and streamline the sales processes in our stores. First, it involves the sourcing and tracking of advertising dollars to most effectively deploy these funds in the right areas. Second, it measures customer traffic and the effectiveness of our personnel and inventories in meeting our customers' needs. This helps us better focus training and inventory which allows our people to become more productive and successful.

Finally, we create daily work plans for our managers and sales personnel that highlight and clarify the most important things to be doing at any given time throughout the day. LSMS is the foundation that will give Lithia a competitive advantage concerning customer and employee interaction and satisfaction. We are excited about each of these initiatives as they are made possible by Lithia's common language which keeps all stores working from the exact same playbook. We look forward to watching them further enhance our operations over the coming years. These initiatives will allow us to continue our growth with the successful integration of new acquisitions.

Now I'll move on to acquisitions. Thus far in 2005 we have added one large Chrysler Dodge Jeep store in Omaha, Nebraska; the Chrysler and Jeep franchises to our Dodge store in Concord, California; and a Chrysler franchise to our Dodge store in Eugene, Oregon. More recently we acquired two stores, one in Eureka, California and the other in Butte, Montana. Both were Chrysler and Dodge franchises. Year-to-date these acquisitions approximate $200 million in annualized revenues. Our pace of acquisition should continue at the same rate as the previous few years.

That's all for me today and now I'd like to turn things back over to Sid for closing comments. Sid?

Thanks, Bryan and Dick and Jeff. I hope we provided with information. There's a lot there and some of the things that we've talked about are really core to a long-term success for a company like Lithia that has this common language and common plans throughout an organization that is fully integrated.

In closing I'd like to add that on a long-term basis we're still targeting a goal of 15% to 20% growth in earnings per share. We will accomplish this through a combination of acquisitions and same store sales growth. Our acquisition strategy will continue to focus on regional markets and import and luxury brands in Metro markets. Our operating model will continue to drive same-store sales, cost savings and value from these acquisitions and also from our current operations. We are seeing a good start in July as a result of the employee pricing methods.

I want to comment further about the success of the GM employee pricing program. At Lithia we supported these programs 100% and we hope that the industry will continue to trend closer to a fixed-price model. It really mirrors much of what Lithia had already accomplished with its promo pricing on new vehicles sales. The biggest point of contention between a customer and the sales person is price negotiation and once this obstacle is removed both sales satisfaction for the customer and salesperson satisfaction in terms of their job performance go up. And they can both focus with the customer on choosing just the right product.

We have put together a strong operating model that we will continue to improve and develop as we grow. We've also built a strong team of employees that are well-prepared to lead us into the future. On the scale of one to ten we're still just a seven, we can only improve from here. We continue to see this as a real opportunity in this sector, to be the operator that executes a common language, common platform growth plan for the long-term.

That concludes the presentation portion of the conference well. I'd like to thank you all for joining us. We would now like to open the floor to your questions.

(OPERATOR INSTRUCTIONS). Rick Nelson, Stephens.

Sid, one of your public peers was talking about the pull forward -- potential pull forward here of the strong sales in June and July. How do you see that taking up the rest of the year?

Rick, we look forward and are balancing our inventories for the seasonally slower second half of the third quarter and -- I mean really the September month and then obviously seasonality plays a big role now in our numbers as we moved into some of these markets in the North. But we are not seeing pull ahead as much as we are seeing, again, this substitution for the used vehicles sales. We still think that that's -- the aggregate market is not being over extended. So we're planning on balancing our inventories around.

Our inventory strategy has really helped us and it's going to help us tremendously in the third quarter. We're not going to run out of the key products. We really stepped up at the right time knowing that this kind of thing would probably take place this year. So strategically I think we made a good call and I think that we're not really borrowing ahead as much as we're getting used car business up into the new car field which is fine with us at this point.

Do you alter your promo pricing strategy or do you with this one price selling on new cars?

Our employee price becomes the promo price, so it makes it much simpler actually -- it's easy to define.

Does it lose any of its effectiveness? Everybody is doing promo pricing?

I think what happens, Rick, is the low-ball advertiser and some of these mass sellers like Dave Smith Andy Landers group in the Midwest are not now having this perceived advantage on price that actually never really existed. But since employee pricing is pretty much a uniform pricing method that is the most you can charge a customer for the car, there are some people discounting even from that, but it's pretty hard to discount very much from it. So I think it's changed the dynamic and brings us an additional benefit. I'm asking the manufacturers to continue these programs so I hope that we've set a new standard and that really there was a major change in the way cars will be retailed at the new car because of this new method of pricing.

It actually sets a maximum price you can charge a customer and takes away the advantage from these people that appear to be discounting -- usually really price leader advertising and some things that we just can't do in an incredible (ph) environment that we've created.

Additionally once a customer comes into the dealership; our salespeople are very in tune to really having a reduced level of negotiations. So really now with the employee pricing we're having to really negotiate on trade-ins which is how they did it on promo pricing and it's very simplified. And it's different than setting a customer up when they come in and preparing them for a big long winded negotiation. So our people are well-prepared and they're accepting this very well and we hope it leads to a more standardized pricing (technical difficulty).

You sort of segued into it. On the used car side do you see the competition now heating up for those used car trade-ins?

Well, Rick, I still think that we're borrowing away from that late model used car purchaser and we're not seeing same-store sales growth that we should see considering all the initiatives and the methods we're using to improve used car sales. We're seeing margin improvement -- I think that has to do largely with how we manage our inventories and how we're pricing the cars. But reality is that total aggregate car demand -- and I still think people need to try to measure that -- is not accelerating, it's probably a substitution again and we get 17 million shares we get a million less used cars sold.

So I don't think the aggregate number is borrowing ahead and I think we're just in a very stable environment where people are choosing to buy a new car instead of a used one at this time. We never saw a real fall during the GM program at our Chrysler Ford stores, it was incremental business. And now we're seeing from the employee pricing thing -- actually Ford is drawing the biggest improvement sales volume so far this month which is interesting. It might reflect on their advertising. I think the Ford strategy on advertising may be the strongest, the Ford family thing really sets well and attracts people and their truckline is a very strong productline. So I think having it priced at a very reasonable price without negotiation is really helping that productline in this month. So there's a little more color than maybe you wanted.

Rick, maybe also on the trade-in side when we're taking used vehicles in, what we're finding in our markets -- and remember, we're small medium-sized markets typically -- so we're not competing with other -- of the same make. We're finding that a lot of dealers in other makes, it may come from being undercapitalized, but they're really trying to push the amount of trade-in value down with the customers which is allowing them -- it's making us more competitive because we're able to take those trades in and with our used car wholesaling we're able to dispose of those vehicles as necessary. So some of those people are getting very tentative it seems like so it's making us more aggressive I believe.

Thank you for that. A question about the guidance. You beat the second quarter by it looks like $0.04 or $0.05 versus the midpoint of your prior guidance. And the full year guidance has gone up $0.02 at the midpoint. Is there something you see in the business or is it just hard to be conservative?

Well, you know us, Rick, we do tend to be conservative and we think there may be some possibly in the fourth quarter, some pull forward seasonality more than anything. We've added most of our stores in the northern states as well. So we're just being conservative there. There's nothing particular that we're pointing to.

We raised the low end quite a bit.

Very good, thank you.

Gerry Marks, Raymond James.

Three questions. First of all, in the first quarter your EPS grew about 30%, this quarter it was more like 14%, yet nothing really seemed to change. How come we kind of decelerated in the second quarter?

A really bad quarter the year before.

We had a bad first quarter the year before, Gerry.

That's fair. The second question was you guys had about 12% topline growth with 3% comps -- and if I'm doing the math right it looks like 17% more franchises this year versus last year. So if I add the comps plus the number of franchises I come up with 20% and only get 12% in topline revenue growth. What's the differential? Is it just in terms of the makeup of the stores that you are or acquiring are a lot smaller or something?

I think you just hit it on that, Gerry, it's smaller stores. Do the store count, Gerry, and don't go by franchise count. (multiple speakers) store count you have to pay attention to what the revenues are. We added franchises to existing stores that didn't add much in volume, Chrysler to the store in Eugene and Concord we added Chrysler and Jeep. And the franchise count -- we still have the same number of stores and even when we add those it doesn't create an additional store. I paid very little attention to that franchise count; I think it's much better to focus on store count.

That's fair. Last question, if I look at your inventory levels, they were up about 9%, you had about 12% softline growth which means pretty much matched it -- it was a little bit less. But the (indiscernible) inventory levels were down about 10% year-over-year which is just your inventories are probably similar to what they were about this time last year.

It just seems -- I don't want you to give away any competitive advantage, but you guys somehow had a crystal ball to, okay, be stocked up pretty well this year during the summer months with pretty good stocking of inventory levels and probably selling into them during down inventories right when everybody else is scrambling to try to get inventories. And what is it in terms of your system that is allowing you to do that so effectively?

Well, you know we use a seasonality index and forecast our days supply based on seasonality and I don't know that others have done that. This is the fourth year in a row that's happened and it seems to make sense that you want your inventories in July and August because these manufacturers get hungry and they really push these '05 models or the model that's going to become obsolete. And it just makes more sense for us to stock up.

We're ordering pretty light on '06 and we've stocked up heavy for '05 and we'll balance it coming into November. I think it strategically just makes the most sense and we've proven it now -- this'll be the fourth year and I think it's something we'll probably continue to do unless some dynamic changes in the industry.

So it's something in your model that adjusts for the strength in the summer months. Is it using like the BA (ph) data or --?

It's based on a forward average on the seasonality -- forward rolling 90-day average and we understand we believe that having inventory is important to getting higher sales and we don't think it is good necessarily at certain times of the year to have low inventory. I know a lot of companies target like a real low-level and all the time they think they're doing but I'm not sure that is the right approach.

Thank you.

Scott Stember, Sidoti & Co.

Could you talk about if there was any impact whatsoever on the gross margin from GM sales?

I think we had that -- we were down about 20 basis points for the quarter and a little more of that was in June but actually gross margin was down in May because volume wasn't that good either in May. We don't see a trend. We are pretty good at working, getting the trade-in at a reasonable cost and working finance and insurance to continue our overall margin including finance and insurance. We're not alarmed by it, we think increased volume is well worth the little bit of discount we might have in margin.

It is interesting, in June if you look at the deal average it was actually as high as it was in May and April, there was no change, the dollar amount. The average price did go up a little bit because people were using employee pricing to buy higher priced cars and that is the only reason the margin really went down. We were able to maintain our deal average on a dollar basis even in June.

We do manage from a dollar per unit of gross profit, not a percentage on our store level. Everybody has targets based on so many dollars per unit retailed and that we actually held to our numbers from the prior months in June. So again, Jeff reiterated, it was largely they were buying a little more expensive that caused the reduction in percentage but in dollar amounts we held would much the same gross average.

Scott, on a side note as well, the Chrysler program actually has two percentage points higher margin than the General Motors program had so that should actually maintain those margins in Chrysler very well which is obviously our biggest manufacturer.

Our margin is determined by the fee they send us after selling it for the employee price, so it is a set amount.

That answered my next question. Thank you. Can you talk about related to the dilution from the convertible, the add back in interest expense for this quarter and last year? It looks like it was around $400,000?

I don't have that number right in front of me. Can we get back with you on that, Scott?

Yes, that would be fine. The $0.07 dilution, I notice that is going up from the $0.04 from this previous quarter can you just explain if there is anything behind that?

Nothing in particular, no.

Could be a little bit of rounding and that is a bigger quarter, we do more business then.

Okay. That is all I have for now. Thank you very much.

John Tomlinson, Prudential Equity Group.

A couple questions. First, congratulations on the quarter. Secondly, can you give a little bit more detail on maybe the substitution effect that you're seeing on the late model? Do you have any kind of numbers of where you see maybe the one- to six-year-old vehicles being down after the employee discount programs went into effect?

It would probably be only the one- and two-year-old vehicles that would be impacted and we don't have good data. We know that we've stopped buying program vehicles at the auction for stores that have the opportunity yet to sell more new cars and that's a shift that takes place internally. Because we can't -- we've got to get numbers at those stores that perform at a level that the manufacturers aren't as comfortable with.

So we've done that, not that that's going to change the big dynamic of our whole company but those kinds of things add up. But the numbers we get are from Bandon (ph) -- what's his name? (multiple speakers), he and Art Spinella. And I think his research is as good as anybody has got on the used vehicle volume and it does show decreases.

Okay. The other question I had for you was -- you talked about fixed pricing for the industry. Have you seen anything at your Toyota stores or anything along those lines that would indicate maybe the import brands considering this strategy as well?

Well, if it works as well as it does for the domestics I'm sure you'll see them copy it. I don't think they're immune from reacting. They don't have -- if the price is reasonably cheaper and it's easier to buy a car at a domestic store than an import store, the domestics are going to gain share if the imports don't respond. Our import stores use promo pricing largely which is very much like an employee price; it's a lower price than retail and we pretty much market that way. But this is substantially lower than that because it's subsidized by the manufacturer.

So, I'm not sure if I can read the tea leaves on that. I think you'll see maybe Honda go to it first if anybody would. You know, they're not doing quite as well on sales as Toyota. It's just hard to tell.

And then just one final question on the service and parts comparison. You mentioned you were up against a 3.5% comp the year before. Are you having any issues there in terms of capacity or having trouble with getting the right technicians or is that an opportunity going forward?

A lot of others are talking about expanding capacity and how many new stalls they're installing. And technically if you factored that into your same-store sales do you really have increases when you're increasing square footage provided for that? We don't dwell on that a lot. Our way of increasing sales and capacity is to expand the hours of operation and not to add overhead by adding a bunch of stalls.

So that's our long-term forecast is to continue to expand. We'd like to get to a point where our service departments are open 24 hours a day and I'll see that before I retire.

And do you have any kind of utilization rates in your base; do you track that at all?

Yes, absolutely. We track all of that. We don't tell what it is and we don't share that publicly, but it's tracked at every level at every store by every service manager and it's also tracked on a productivity basis by a mechanic and his stall utilization. Bryan has got some data on that.

It's just over 50% utilization rate.

So there is some upside there. So you're not capacity constrained really on the service department?

Our best store is Seattle BMW and it utilizes about 108% on a technical base because it's a very efficient shop where they're flagging -- they're able to do work quicker than the flag times.

And there are two shifts there that run 13 hours a day six days a week.

Yes, it's pretty amazing.

And we are going to have to build a new store for them in Seattle and we're working on that because we're capacity constrained there.

I know it's kind of early on looking out into maybe the fourth quarter, but is there anything that you see -- any kind of -- I know you kind of touched on it -- but payback in the industry or anything that you're kind of worried about at this point in time?

Nothing beyond the 90 days we need to forecast. We're looking out right now 90 days from now determining how we will react and we still see a strong market through that period. The wintertime for Lithia is always a time that's a concern because we've got a large presence in those northern states and it is effecting -- I mean it affects our volume in those months.

So we think our seasonality forecast for days supply, we use a forward-looking 90-day sales forecast to determine our current days supply because basically that's what you've got. The cars you've got are going to service you for the next 90-days and you've got to plan and seasonality adjustments can vary 20% almost between the highs and the lows so it's pretty significant.

Especially the fourth quarter, that's the one quarter I would ask everyone to look at because that's the quarter when this business slows down. And we plan for that, but that's normal, it's to be expected. I don't want you to be surprised.

Thanks again, guys, and congratulations.

Peter Sirus (ph), Perella Capital.

Good afternoon. Sid, I was talking to the CEO of one of your competitors and the guy said to me, he said Sid is my hero, he said. He said the guy is just a dictator who makes that company run like -- I forget what his exact words were, but the point was that you were a dictator. And I can hear -- and frankly I'm surprised that you don't have these guys working 24 hours a day now. As a shareholder I would like to see Jeff and Bryan out there in the service bays at 3 in the morning.

But having said that, in your discussion you talk a lot about the systems that you put in and I'm curious whether the systems that you put in are especially applicable to beating the competition in these small markets or if you think down the line they're going to give you a competitive advantage in bigger markets as well?

Thanks for the compliment. I don't think I earned that and I'm certainly not a dictator. I work through process internally as well and encourage everyone to create these things that we've done and there's a whole team of people that believe in what we're doing even more strongly than I do. But in answering your questions, (technical difficulty). Peter, I'm sorry, we lost the connection there for a second. In the Metro markets we're developing a metro strategy that includes those things necessary to be as successful as we are in regional markets in Metro markets.

And we've got several stores that we're testing new processes including different marketing budgets and different ways of paying salespeople and different ways to inventory. And we think long-term we'll develop a metro market strategy particularly with import brands which aren't as over dealered in those markets and I don't think that's going to be an issue for Lithia long-term. I mean, we have to be able to run in the metros as well.

Let me ask the question differently. It sounds to me that you're -- I believe you're much more process oriented than your competitors in that your stores, besides the fact that they all have the same name, that you spend much more time putting your management systems in than do your competitors. You have much more uniformity than they do and I'm wondering how much of a competitive advantage that is down the road, that's what I'm wondering.

Where the competitive advantage will come in on that, Peter, won't be in terms of better performance necessarily than a real top entrepreneurial operator could do, but it will mean lower personnel costs, lower operating costs because our processes will carry more average people to success. And we believe that a process driven retailer in this sector is ultimately going to have a huge cost advantage and a marketing strategy that will be more flexible and developed because it can be executed by a whole group of people on a consistent basis and it's measurable, it's auditable, it's trainable.

I don't think there's any choice that if you're going to be a public retailer and try to have a nationwide organization -- and that's what we're going to do -- you've got to have processes that drive your business plans and we're going to be that kind of a company. There is nobody in the retail industry, besides the car business, that depends on entrepreneurial operators to create the sales volume for them or the success because we aren't able to retain and keep those people. They want to make $1 million a year and we have costs that are in line with what competitive retail establishments have over time.

So a process driven company is right where this thing is going and we're going to be the leader in that, we know that and we think it's a huge advantage we already have. I gave ourselves a seven in terms of really doing well on a scale of one to ten because I think that our processes still need to be improved and incorporated and at even higher levels and we can get down to the nitty details of exactly how almost everything takes place for a customer at our stores. And we're just excited about that and I'm so pleased that it's possible in our Company.

Is there any way to quantify at least even in your own mind how much difference over the long-term these kind of processes could mean in terms of profits as a percent of sales or something?

I want to make sure that we're on the right track here because I think what you're asking specifically is our processes today, will they work in metro markets. And really I think we need to go back to how we develop our processes. It's a learning experience even though we all do things the same and we work from the exact same playbook like we mentioned earlier, we are very dynamic in changing those processes. When we change those, however, to attack the competition or to stay competitive we all do it the same and that's really what we're saying with common language and we think that those processes are always the most current and relevant for the markets that we're in.

Your comments on more competitive markets and metro markets, we're definitely going down two pathways and we believe that they will join somewhere down the road. As our small markets become more and more competitive in what they're doing we're learning. Well, as these metro markets, we obviously need to possibly jump ahead further and it may expand our growth opportunities.

Peter, on your question about how much margin improvement over time. I mean, our goal would be to make 5% on sales instead of the 3.9 and we think that's achievable over time. One of the things we're doing, we keep layering in new stores and obviously they don't perform very well for a while particularly when we take them apart now when we buy them; we're willing to sacrifice current performance on those new stores to get them in line of doing things our way. So when you add 15% to 20% to your base each year, that always impacts your current performance. But there's more room.

You see the leverage at AutoNation as demonstrated in terms of size, too. As we get bigger there's some leverage we can get out of that. And then if you layer that in these operational efficiencies of having common practices and lower raw costs -- long-term in order to deliver automobiles to people you're going to have to be the most efficient supplier. There is no if about that and we're going to be that, somehow.

Thank you very much, guys. I appreciate it.

Jonathan Steinmetz, Morgan Stanley.

It's actually Soei (ph) in for Jonathan. I might have missed this, but could you give us a bit more color on the SG&A leverage in the quarter? Was there anything special this quarter versus last?

Improvements in gross margin drive that as well as cost-cutting which we continue to find avenues to save in many areas as we grow particularly. So I think those two elements really drive that percentage of gross profit that expenses represent. Our goal there is to get that down 70% and I don't know how soon or fast, but it's a result, it's not something you can set a standard for and then execute.

It's really across the board, Soei. It's dedicated efforts at every store, every department, every vendor, everything that we do. We're just trying to lower our costs and become more efficient and it results in -- as well as the margin improvements that Sid mentioned, it's a combination. And we'll continue to do that.

How are you guys doing without Mr. Drewski (ph)?

We're going to miss him a lot actually.

Be sure to give him my best.

Of course. And then for the service and body revenues, could you talk a little bit about that as well in terms of its being down while everything was up? Is there quite a bit of improvement?

The service and parts was actually up on a same-store basis, not as much as the other businesses -- maybe that's what you're referring do. But for us in terms of progress I think we are making good progress in service and parts. And we have a lot of initiatives and programs there that we think will continue to help us there.

In the past we've had warranty declines that have held us back a little bit and that can be an issue at times because we can't control the recall pace of especially domestic makers. So that's been a struggle for us in the past. That's not as bad now, so hopefully we can do even better in that area when that's not a drag on our service and parts business.

Our domestic brands won't grow parts and service businesses like these luxury car brands will and that's a given in the industry. Luxury owners tend to spend more on service and parts and the quality of the domestics continues to improve and that not just reflected in warranty repairs, it is also reflected in customer labor repairs and service contract repairs. Our service contract repairs are actually much lower than they were a year ago which indicates that some of that quality is even coming through on those domestic brands. And we can't make cars break to gain volume so we've got to manage what we've got and increase the opportunities to sell service to customers that they need, expanding the tire business and expanding our quick lube business and working on all those areas.

If we have capacity constraints in service it's around our ability to do the quick lube because we're selling that lifetime oil change and most of our stores are flooded with oil change business and that's not very profitable to just change the oil. We're trying to develop some new standards and ways to get those people to spend more money than just having their oil changed and I think we're making progress on that. But I hope to see some real leaks in that as we develop some strategies.

It may even include free rental car if you have your oil changed and then you need repairs right away and you allow us to do it that day we may let you have a rental car so you can go home and come back the next day and pick it up because it seems to be one of the biggest issues. When people come in for an oil change they don't have the time to let us do the 30,000 mile service or to do the break job they need or do the other things they need.

We're also putting in a company credit card that we haven't talked a lot about, but that's going to help our service and parts business as well. It's a private-label credit card that allows customers to actually get repairs done that they couldn't afford right now but they can afford it over a 90 to 60 -- six-month basis and that will help parts and service business we believe long-term as we roll that out.

We're doing -- our customer parts and service businesses were both higher than the service and parts same-store sales number. So the only negative really was the service contract declines that we're seeing from improving quality on domestic cars which is similar to the warranty issue I mentioned. So that's really an issue that's beyond our control.

This is Jonathan, I'm back on. Just philosophically on the one price and the idea if we do migrate to one price, can you just discuss your viewpoint over time once things reach an equilibrium? Does that represent an environment where margins go down and you have to generate more volume to pick that back up or reduce your SG&A or do you think that margins could actually stay stable or go up in that kind of environment?

Probably not go up, Jonathan, and margins will always be under pressure on the new car side. Our opportunities to make money in this business are largely on the used car and the parts and service business. That's the piece the auto dealer owns and it's ours to lose and ours to develop as well. So that new car margin is going to be set largely by pricing matrixes like this and it probably won't increase. I mean 8% may be the high and 7 may be the low, but it's somewhere in those ranges. It won't be dramatic a shirt. And we're excited about it; we think it gives us a competitive advantage over time. Process driven companies that don't have the capability to haggle successfully, they need to give value on a straight sale method will an advantage in that type of pricing.

I mean, we've demonstrated that with our Saturn stores. At our Saturn stores everyone pays the same price and that's a huge strategic advantage in terms of cost reduction because you don't need people that sell cars that have to be negotiators. You can just pretty much find the car the customer wants and sell them on the benefits and features and the price is not a negotiated item. I think it helps us immensely over time. I'm encouraging the manufacturers to set a maximum price if they can get away with it. I'm not sure it's legal, I don't know, they've done it.

I think for forward-looking retailers like Lithia it's actually a positive, Jonathan. It's the retailers that aren't willing to accept the change that will actually be hurt by it. And we will not be hurt by it, it will actually help our business (multiple speakers).

Would you have to reduce SG&A cost? If it's a less complicated transaction and all that can you get a salesperson who effectively accepts less commission per car and maybe makes it up by selling more cars? Do you have that opportunity or is it too competitive to do that?

No, it's very much an opportunity. If you look at the cost of salespeople at CarMax, that's a no haggle environment and they've lowered the cost of selling an automobile particularly on the negotiation side with your high price negotiating general sales managers in that type of position don't become as critical. And those guys make 150,000 to 200,000 a year some of them. And so if you can replace that job with somebody at 70,000 or 80,000 that's a huge cut over time. So I think it's an advantage for us. I'd love to have a no haggle environment in all our stores and this may encourage us to begin to experiment more with it.

(multiple speakers) to have that then the compensation is less for that type of personnel?

Absolutely.

Okay.

I think the thing you'll find too, Jonathan, is that there are many salespeople coming into the business thinking they can do it, find out they really don't enjoy the negotiating part of it and nice good solid people leave the business. So I think we'll retain a lot more of those people then, have less turnover where turnover is very expensive for our dealerships.

Jonathan, this is Bryan. Let's clarify this for our salespeople out there listening in, okay? I think what's going to happen -- Sid and Dick are both correct -- there will be a reduction in the percentage that you pay salespeople because the experience will be lower; however, the productivity of that salesperson should increase dramatically. We've been doing studies on the productivity of our current salespeople and we're pushing up below 50% productivity time.

So what will happen is you'll have salespeople rather than selling ten cars per person will sell 20 cars per person. So their actual pay may actually go up as a whole. However, your commission and your SG&A cost for that will be driven down substantially. There's also advantages in advertising as well and you can actually predict things more easily because you're not as dependent on the expertise and negotiation and determining all your expenses.

Thank you very much.

(OPERATOR INSTRUCTIONS). Alan Seymour (ph), Columbia Management.

Alan, where are you located?

I'm actually in Hartford, Connecticut.

That used to be an Oregon company.

Well, yes. We were part of the Shawmut acquisition by Fleet and Fleet also bought Columbia and what they've done is they've basically put Fleet, which also bought Steinrow (ph) and all the Liberty guys altogether under the Columbia name. So there still is some operation actually in Portland, but it's all -- a lot of it's in New York and Boston.

Good. Go ahead on your question.

My question is can you give me a sense of the number of stores that still aren't what we'll call up to snuff on the margin side? It seems to me that you still have a long way to go to kind of -- obviously, as you say, you bring in and I think historically have bought underperforming stores and kind of brought them up -- where are we in that process I guess? Can you give me some sense of that?

I think you could say that there's 20% of our stores at any given time right now that have opportunities, let's say, to improve dramatically. Our initiatives both from the get go in terms of acquisitions and those that may, for whatever reason, not have done as well in our integration process, we try to identify and work on fixing those and if we can't we dispose of them. I think we've disposed of five or six stores since we've gone public. And I think we have -- there was a little bit of -- 1 penny on a discontinued operation right now and I think that was a store we already sold. It was in Broken Arrow, Omaha -- I mean in Oklahoma which is part of Tulsa.

We should've known by the name, Broken Arrow.

Alan, this is Jeff. We did just come through a pretty serious recession and so I would say that 20% number is actually probably low right now looking at where the stores were before the recession and how they're gradually getting better but they're not near the levels that they should be. So I think it's even higher today. I think the 20% is a good number anytime because of where (multiple speakers).

Because of the acquisition, yes. But you still have some way to go in terms of improving the store performance.

We have stores that actually lose money. There's still a couple. At any given time there always seems to be something.

There are lots of stores still that used to make 2% to 3% pretax that are making a percent and there's no reason why they shouldn't be and they're not yet, so.

The middle two quartiles, the middle 50% are definitely -- still have lots of room for opportunity.

The hardest store for us to deal with is the store that was run by some really good entrepreneurial operator and then we come in with all our processes and replace him with processes and it takes time for that group of people to begin to execute around that framework without that dynamic leader there. That's the real issue in this whole sector, can you run these things with processes and more average people? And we know we can, but it does take time.

Okay, great. Thanks very much.

There appear to be no further questions at this time.

Very good. Thank you all for listening and I'm sorry this was no long but hopefully it was helpful to all of you and thanks for being a part of our company. Talk to you later.

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