Lithia Motors Inc (LAD) 2006 Q3 法說會逐字稿

Good evening. My name is Mary, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lithia Motors third quarter 2006 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS]. Thank you. It is now my pleasure to turn the floor over to your host Dan Retzlaff, Director of Investor Relations. Sir, you main begin your conference.

Thank you, Mary, and good afternoon to everyone.

To 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 our third quarter earnings press release and in the Company's filings with the SEC. Now I'd like to thank you for joining us for our third quarter 2006 earnings conference call. I have with me today Sid DeBoer, the Chairman and CEO of Lithia; Dick Heimann, our President of Corporate Affairs; Bryan DeBoer, our President and Chief Operating Officer; and Jeff DeBoer our Chief Financial Officer. At the end of their remarks, we will open the call to questions.

And now, it is my pleasure to turn the call over to Lithia's Chairman and CEO, Sid DeBoer.

Thank you, Dan, and thanks, everyone, for joining us today.

I'd first like to comment on the acquisition that we completed just yesterday of a BMW and Mercedes-Benz store in Des Moines, Iowa, a city of around 200,000 and market of larger than that. Combined, the stores have annualized revenues of about 65 million. We like the community of Des Moines which is a market that just fits well within our strategy. Also a week ago, and you may have seen our press release on this, by acquired a BMW store and a Porsche store in Seaside, California, one of the more affluent areas in California. With the acquisition of these two stores, we have reached an exciting milestone for Lithia, as you've seen, 100 stores in 10 years. It really doesn't seem like that long ago when we got started on this journey as a public company. And I can tell you that I am as excited and invigorated about what we are doing today as I was 10 years ago. And 10 years ago, I predicted that we would have 100 stores by this time, and we have accomplished that goal. Now I believe we can grow to 350 stores within the next 10 years. I also honestly believe that the progress that we have made over the next 10 years -- that the progress that we will make over the next 10 years will be as exciting as or probably even better than what has taken place over the past 10 years. We have learned a lot.

Now to the third quarter. As you saw, total sales did increase 3% and total gross profit increased 4% in what was a difficult environment. Total revenues actually reached a record level for the Company. The revenue increase was primarily driven by increases from acquisitions in the past 12 months and continuing improvement in our parts and services business. In the third quarter, we saw 3 months that were at best -- interference. Are we okay. Are we still on?

Yes, you are, sir.

Okay. Thank you. In the third quarter we saw three months that were at best fair, essentially a continuation of what we saw in the second quarter of the year. We have now not seen a stand out strong month for the past 6 months. And these are the months that normally comprise the seasonally best and strongest selling periods of the year. In addition, we face difficult comparisons with a very strong third quarter, particularly for us last year, having the domestic franchises that were affected by that effective employee pricing program and other incentives that were out at that time.

While total revenues were up, third quarter earnings were down year-over-year due to a number of factors. The aforementioned weak sales environment caused by higher fuel costs and the lower consumer confidence. The combination of high inventory levels and higher interest rates, the inability to sell some of our Dodge light duty pickup trucks, and increased costs resulting from Company-wide operational initiatives. As a result, earlier in the month, we prereleased our third quarter earnings and revised downward our full-year 2006 guidance. For the third quarter, then, net income from continuing operations was 12.8 million and earnings per share from continuing operation was $0.60. This includes the effect of accounting for equity based compensation, the options, under FAS123-R, which had the effect of decreasing reported earnings by $0.03. Comparable earnings with last year would have been $0.63.

In the first half of the year, we had a strategy to aggressively pursue market share, which continued throughout the third quarter. Year-to-date, new vehicle same store sales are up 3.1 versus 3.3% growth last year in the same period. Third quarter new vehicle same store sales were actually down, but this was against a very tough comparison last year of a 9.3% growth. Selling volume and driving same store sales growth is still a critical element in our long-term plan, as it does improve our relationship with our manufacturer partners and ultimately ensures our ability to purchase stores. By creating a larger customer base, it also improves the chance for future sales, and it helps ensure growth in the more profitable parts and services business. And we have seen those benefits even in the third quarter and the year-to-date this year. New vehicle same store unit sales for the quarter declined by 6.1%, slightly better than the industry at 6.2 and an industry retail unit decline of 11% for the quarter. Lithia's domestic same store units declined by 10.8 while the industry recorded a decline of 13.6, even though that decline included a large number of fleet sales, which was larger than the year before.

Our import same store unit sales increased 5.7% compared to the 3.7 reported by them. So you can see that our operating model continues to allow us to outpace industry numbers. The difference in the new vehicle same store sales decline of 5.8 and the same store unit decline of 6.1 was due to a $71 increase in the same store per unit average sales price for the quarter. Last year in the third quarter, we saw a pricing decline by over $800 per unit as we pushed for more volume on top of strong incentive programs and the mix shifted to lower priced cars. This year in the third quarter, the manufacturers held more firmly on prices and the slight price increase is a result of that. Even with the discounting programs we had in place for the quarter and the shift in demand towards cars and more fuel efficient vehicles, there still was a small price increase of $71.

For the quarter, total used vehicle same store sales declined 1%; same store units declined by 4.3%. Average same store retail price was increased by $407. We did, again, face difficult comparisons of a 10.2% growth in sales and 7.4 unit growth in the third quarter of last year. Year-to-date, total used vehicle same store sales are up 2.7% and same store units are just slightly down 2%. Retail gross profit per unit is up $39. On a combined basis, new and used vehicle same store sales for the quarter declined 4.4 and units declined 5.2. Year-to-date combined sales are up 2.9 and combined units are up 0.8. Related finance and insurance same store sales declined 2.6 against a comp of 8.5% growth last year in the same period. Year-to-date, F&I same store has grown by almost 5%, 4.8.

Our service and parts business was up again this quarter with same store sales increasing 3.6%. This was on top of the 4.9 growth last year in this quarter. Same store warranty sales in the third quarter were up 2.6%. Interestingly, domestic brand warranty work did finally increase again by 3.1%. While import warranty work -- on the import brands increased by 1.7 for the quarter. Same store gross profit in parts and service business grew 6.5% for the quarter, as many of our initiatives have improved that gross margin and is up 7.2% year-to-date. Finally, total same store sales were down 3.5%; total same store gross profit was also down the same percentage for that -- for the third quarter. This is against a backdrop of a 9.1% sales gain, a 7% gross profit gain last year in the same quarter. Year-to-date, total same store sales are up 3.3% and same store gross profit is up 2.5%.

For the third quarter of '06, Lithia announced a dividend of $0.14 per share. Investors can refer to our press release for record and payment dates. Our dividend has doubled over the last three years. We initiated a quarterly dividend of $0.07 per share in 2003. This continues to be a good means for Lithia to return capital to shareholders. And we believe it also increases our exposure to a broader base of shareholders. The Company currently has a million share repurchase program in place. Prior to the beginning of 2006, 60,231 shares had been purchased. In the past few months, the Company has purchased another almost 200,000 shares, 196,600 shares, leaving 743,000 shares still available in our purchase program. At current levels, we believe that share repurchases are a good use of the Company's capital.

I would now like to turn things over to Dick Heimann, my long-term partner in this adventure we're on, and who would like to comment further on our sales, brand mix, and the inventory positions. Dick?

Thank you, Sid. Welcome, everybody, to this afternoon call.

First I'd like to comment briefly on the positive trends we're seeing in the parts and service business. As Sid mentioned, year-to-date parts and service same store sales are up 5.4%. Lithia's strategy last year and in the first part of this year of pushing same store sales and increasing units in operation, I believe is benefiting our parts and service biz this year and will continue to do so in the years to come. I've always believed that a customer we can service today greatly increases our chance of being able to service that customer and his friends and relatives in the future and sell them more vehicles on an ongoing basis.

Now, let's look at our operations. We currently have operations in 15 states, with the states of North Dakota and Iowa added in the last month. Our same store sales broken down by state now stands at Oregon with 17%, Texas and California both with 15%, Washington 13, Idaho 9, Alaska with 8, Colorado 7%, Montana 6, Nevada 5, Nebraska and South Dakota and -- with 2%, and New Mexico with 1%. The states in the order of increased same store sales performance are New Mexico, Texas, and Idaho. These perform the best. This mirrors the second quarter results. And then we have Montana, Oregon, Washington, California, South Dakota, Alaska, Nevada, Colorado, and finally Nebraska. The states of New Mexico, Texas, and Idaho all experienced double digit gains in same store sales, even with the difficult comparisons from last year. In addition, Oregon, Alaska, and Nevada were up against difficult double digit growth in the third quarter of last year, as well. Our new vehicle mix by manufacturer as a percentage of total new vehicle units for the quarter was 41% Chrysler-Dodge-Jeep, 19% GM-Saturn, 12 Toyota-Scion, 7% Ford-Lincoln-Mercury, 5% Honda, 4% Hyundai, 3% each Nissan and Subaru, 2% BMW, 2% Volkswagen-Audi, leaving approximately 2% other brands, for a total of 25 different brands. We have continued to see a notable shift in unit sales from trucks and SUVs to smaller vehicles. 60% were truck SUVs in the third quarter this year versus 68% last year, a substantial change due to higher gasoline prices and shifting customer tastes. On a dollar sales basis, 69% were truck SUV versus 73% last year in the third quarter.

Let's look at inventories. You may recall that in the first and second quarter, we received additional incentives from our largest manufacturer partner for taking and selling extra vehicles with the plan to sell any excess inventories into our strongest third quarter selling period. As Sid mentioned earlier, we ended up having three average months in the quarter without a strong month to help us work down our new vehicle inventory position. By the end of September, the absolute number of vehicle units in inventory was down substantially. And on a dollar basis, new vehicle inventories were down $230 million sequentially from the second quarter. The day supply, however, was the same due to the slower selling rate in the quarter. We slowed our ordering vehicles in the third quarter and have been working to sell down our new vehicle inventory to normalized levels.

Used vehicle inventories at the end of September were 5 days above our average levels for this time of year. But only 1 day below where we were last year at the end of September. The average price went up by $721, however, gross profit per retail unit declined by $100. Lithia, however, continues to generate industry leading finance and insurance income. Our F&I per vehicle for the third quarter was $1105, an increase of $49 over the same period last year. We had penetration rates for the financing of new and used vehicles of 75%, service contracts of 42%, and our lifetime oil product of 39% in the third quarter. All are about the same or slightly better than last year.

Now, I'll have Jeff DeBoer, our CFO, provide you with some more detail on the financial results.

Thank you, Dick. And hello, everyone.

Starting with revenues of 880 million, we break that into the different businesses. New -- actually, new vehicle sales increased 1%. Used vehicle sales increased 6%. Finance and insurance sales increased 5%, and service body and parts sales increased nearly 12%. New vehicle sales comprised approximately 58% of total sales versus 59% last year in the third quarter. Used vehicles were 27%, up from 26% last year. Parts and service 10% versus 9% last year, and finance and insurance was the same at 4% of total sales. By contribution of gross profit, new cars contributed 27% compared to 28% last year. Used vehicles were 19%, down from 21% last year; 31% came from service and parts versus 28% last year, going up. And F&I stayed the same at 23% contribution. The decline in used vehicle margins and higher parts and service margins was apparent this quarter in these numbers. While third quarter total revenues increased by 3%, total gross profit also increased by 4%. Operating income, however, declined by 14% as we saw the impact of 11% higher SG&A expense.

I'll now go over the gross margins by business line. Starting with new vehicles. 7.7% was the same as the third quarter last year and 40 basis points above our second quarter new vehicle gross margins. So we did not see further margin deterioration this quarter. Our historical average gross margins for this business line, however, in the third quarter is 8.4% so we are below our historical averages. Year-to-date, new vehicle margins are at 7.6%, a 30 basis point decline over last year. Retail used vehicle margins were 14.5%, 130 basis points below last year. However, this was up against a very difficult comp of 15.8% in the third quarter of last year, a level which we did not expect to continue. Our historical average gross margin for the used business in the second quarter is 13.8%. So the 14.5% is still relatively high level. We have to go all the way back to the third quarter of 1996 -- let's move on.

Gross profit per unit was $2,348 in the used business. This is the second highest gross per unit we have seen in the third quarter. Year-to-date, used retail gross margins were 15.2%, 50 basis point decline over last year. In the third quarter, Lithia had a wholesale used margin of 0.9% versus 1.7% last year. Gross profit per unit was $56 versus $93 per unit in the third quarter of 2005. And pricing increased $390. We have now seen 13 straight quarters of wholesale gross profits. Year-to-date, wholesale margins are down 40 basis points to 2.8%. Gross profits per unit has declined $20 to $168 and pricing has increased $274.

Parts and service gross margin for the third quarter was 49.8% as compared to 48.1% in the same period last year, 170 basis point increase. Our historical average gross margin in this business for the third -- for the second quarter is 47.2%. So the 49.8%, nearly 50%, is much higher than our historical levels. This is the highest -- in fact, this is the highest parts and service gross margin achieved by the Company in the third quarter. We saw gross margin gains in both service and parts -- in both the service and parts businesses this quarter. Year-to-date, parts and service gross margins are up 100 basis points to 49.7%. Again, a record level for the Company. For the quarter, our total gross margin increased by 30 basis points to 16.7% as a result of the gains in the parts and service business. However, SG&A as a percentage of gross profit went up by 430 basis points for the quarter to 74.1%. Approximately 50 basis points of the increase is due to the increased compensation expense resulting from the implementation of FASB123 R. Additionally this was up against an improvement of 130 basis points in the prior year on solid same store sales increases.

The other increase to SG&A were due to higher investments in personnel, systems, and training for our centralization efforts and future projects. The next three largest cost items, sales compensation, rent, and advertising, were all flat or down as a percentage of gross profit year-over-year. So we continue to do a good job of holding the line on operational costs of the stores. As a result of the higher SG&A in the quarter, our operating margin of 3.8% was 70 basis points less than the third quarter of last year.

I'll now discuss the debt and capital side of the business. For the quarter, the total of flooring and other interest expense as a percentage of revenue was 1.6% as compared to 1% last year. The increase is due to both higher inventories and higher interest rates. That said, we have substantially minimized the impact of higher rates by fixing a significant amount of our flooring debt with interest rate swaps. We have outstanding 175 million in low, fixed interest rate interest swaps with average remaining terms of 2 to 3 years. Including all fixed rate debt obligations and hedges, approximately 48% of our total debt had fixed rates at the end of September. For the quarter, we had an average -- we had an increase in flooring expense of approximately $4.5 million. Approximately half of the increase was due to higher rates and half was due to higher inventories. The year-over-year third quarter increase or difference in flooring interest expense amounted to approximately $0.12 in earnings per share for the quarter. And this includes -- excludes inventories that were added from acquisitions in the prior year.

Including swaps, our average interest rate increased by 80 basis points year-over-year to 5.7%. On average, market rates went up nearly 190 basis points for the same period, so we increased substantially less than what the market did, which demonstrates the positive effect of our hedging strategies. Interest rates have risen steadily for the last two years and with interest rates now steady, floor plan interest costs should stop increasing in the year ahead.

Finally, earnings per share from continuing operations, as Sid mentioned, were 7 -- $0.63 per fully diluted share as compared to $0.85 in the same period last year. This is a decline of about 26% as the bottom line number was impacted by a number of items we've discussed. Obviously, as was mentioned earlier, we were up against comparisons to a very strong third quarter last year. But there were a combination of other factors that impacted earnings for the quarter. The previously mentioned higher interest expense corresponding to increased inventories and higher rates had the greatest impact to earnings. This quarter and in the first half of the year, we have also had increased costs related to various long-term operational initiatives. These initiatives include Office Automation, Lithia Store Management System, Human Development Systems , our Assured Used Vehicle Program, and our independent used vehicle program. These costs were apparent in higher SG&A expense with an impact to earnings of $0.07 to $0.08 per share for the full year. And no -- with no one item representing more than $0.01 to $0.02 in annual earnings per share. They will be factors impacting our fourth quarter and full-year 2007 performance, as well. And I will discuss the impact to 2007 earnings in a bit.

Now looking at the balance sheet, we had about 41 million in cash, 49 million in contracts and transits, for a total of 90 million at the end of the quarter. Our long-term debt, excluding used vehicle flooring, is largely composed of debt from the convertible offering, real estate mortgages and seller notes, and was $250 million. The break down of this debt is 161 million in real estate mortgages, 85 million for the convert, and approximately 8 million of other debt. Our long-term debt to total cap ratio, excluding real estate, continues to decline to 16%. We have a very highly unlevered balance sheet. Our goodwill as a percentage of total assets is now 18%. Shareholders equity rose by 7% to 491 million from 460 million at the end of 2005. Lithia's book value per basic share is now $25.20. Our price to book ratio as of the close of the market yesterday was 1 times.

Looking at free cash flow, net income from continuing operations plus depreciation and amortization for the first 9 months of the year was 47.8 million, non-financeable CapEx was 21.2 million, dividends paid were 7.4, so we have free cash flow of approximately 19.2 million in the first 9 months. Our total non-financeable CapEx expectations for the remainder of the year will bring our total to between 25 and $30 million. For next year, our total non-financeable CapEx expectations, including the independent used car store business, are expected in the range of 30 to $35 million.

As a final note, the lower tax rate for the third quarter reflects the release of tax reserves that were deemed no longer relevant. Our tax rate in the fourth quarter and for the full-year 2007 should return to the more normal levels of 39 to 39.5%. Our guidance for the full-year 2006 remains in range of $1.95 to $1.99. For the full-year 2007, we are giving guidance of $1.90 to $2.10 per share. For the full year 2007, we are giving guidance for a flat year as a number of key items are material to the year ahead. Company health and benefit plan costs will be increasing, negatively impacting earnings by $0.10 to $0.12 per share. We will also continue with our special operational projects and initiatives mentioned before, but including Office Automation, the Store Management System, the Human Development Systems , our Assured Used Vehicle Program. Long-term we expect all of these projects to reduce the Company's SG&A expense and allow the stores to focus more on customers, which will help drive long-term sales growth. They're all things that are very important for the culture of Lithia Motors to be a leading auto retailer. We also expect that in the coming year our domestic product mix will continue negatively impact earnings; however, we believe that the restructuring now underway at the domestic manufacturers, along with changes in mix and product improvements will help us in the future. In 2007, we are excited about the start-up of our first independent used vehicle retail outlet. Start-up costs for this initiative will impact earnings by approximately $0.10 per share next year. Once established, we expect that each independent used vehicle store will reach monthly operational profitability within 12 months of opening.

That concludes the financial summary, and I'll now turn things over to Bryan, our President. Go ahead.

Thank you, Jeff. And thank you to everyone that's listening in out there this afternoon.

I'd like to first update you on our acquisitions this quarter and so far this year. In August, we acquired a small Chrysler-Jeep-Dodge store in Ukiah, California, and then followed that with stores in October where we acquired 6 more stores with a good mix of high line import and domestic brands with approximately $230 million in annualized revenues. As Sid mentioned earlier, our recent acquisition of high line stores is a good step towards our continuing brand diversification efforts. Brand diversification is important to our on going strategy, and the high line and import stores that we acquired over the last months will help us achieve this. Lithia has now completed the acquisition of 11 stores with approximately $390 million in annualized revenues in 2006, with -- which continues to prove the stability of our growth model.

Now, I would like to provide you with an update on our current operational initiatives and where we stand on each. We are continuing with the rollout of our new sales process. The key of this new process is that our showrooms will have interactive personal computers tied to the Lithia Store Management System that we've discussed in previous conference calls. We have completed the implementation and rollout of these systems throughout California and Oregon. And by the end of the year, we'll have them completed in Nevada, Idaho, and Montana. We expect to have the system in place in all of our stores by the end of the first quarter of next year. We are receiving wonderful positive feedback from our customers and our employees who feel more empowered and truly appreciate the time savings and simplification in the stores where this has been implemented. Our work on centralizing operational functions that supports services continues to move forward, as well. These centralization efforts are targeting new and used vehicle inventory control and procurement, internet lead follow-up, service and sales follow-up, and certain back office administrative functions. These areas are being redeveloped to improve future performance, streamline store operations, and importantly, reduce costs.

Now, let's move on to our used car business where we have a couple of initiatives going on. We have completed our initial rollout of our used vehicle first look technology and related process improvements in all of our stores. The first look technology provides a trade analyzer with the most up-to-date information from all the key used vehicle valuation sources. The inventory management center provides aging information and functionality used to hold stores accountable for developing a marketing strategy for each vehicle in stock. The purchasing center function helps create stocking plans to assist our procurement specialists and stores to secure additional high demand used vehicles. This leads to more proactive demand-driven, instead of supply-driven, models. The redistribution center will also assist us in positioning our inventories within the Lithia Dealer Group and outside our organization as needed to maximize sales. These are just some of the functions that we expect will improve our used vehicle operations within the coming periods.

The initial rollout of our Assured Used Vehicle Program in our 11 pilot stores in Tri-Cities, Abilene, and Reno is now completed and being refined for full rollout. The Lithia Assured vehicle sales process is about selling vehicles at a low haggle price, very similar to our promo pricing strategy on our new vehicles. The used program is designed to streamline customer transactions while offering unprecedented peace of mind to the Lithia used vehicle purchasers. Assured prices reflect current market values without the typical dealer markup that allows for heavy negotiations. In other words, a Lithia customer is quickly given a competitive price without hassles. Lithia Assured also provides a 60-day, 3,000-mile, if it breaks we fix it at no cost limited warranty on all used vehicles. Each vehicle receives a rigorous 160-point inspection, extensive detailing and reconditioning, and a vehicle history report. In addition, the Assured program allows all customers to return the vehicle within 3 days or 500 miles of purchase. The customer can exit the deal and receive their trade-in back at no cost to the customer and with no questions asked. This program is intended to create a compelling marketable brand, a simpler and more satisfactory customer buying experience, and generate long-term benefits to Lithia through word-of-mouth referrals and repeat business.

Our first independent used car outlet will be operating by the second quarter of 2007. We have developed industry-leading customer focused processes, intelligent customer center, and interactive IT systems, used vehicle procurement and inventory management systems. All of which leverage Lithia's common language approach to operations and process. In time, our independent used vehicle model will greatly enhance our growth opportunities and will be in addition to our current projections under the existing new car franchise model. As Jeff discussed earlier, we are and will have start-up costs related to these initiatives. We believe that these investments, however, are extremely important in developing a superior operating model and a strong and competitive company for our future. We are very excited about each of these initiatives and will continue to make them part of Lithia common language as we benefit from greater employee and customer retention, improved productivity, and a lower cost, higher performance model.

That concludes the presentation portion of our conference call today. I'd like to thank all of you for joining us. And now we'd like to open up the floor to questions.

[OPERATOR INSTRUCTIONS] Rick Nelson, Stephens.

Thank you, and good afternoon, and Happy Halloween.

Yes, Rick. The phone and the Business Wire thing was late and the phone didn't work, and we thought the spooks were at work today.

All right. Sid, one of your peers cited a correlation between the housing market and truck sales. Wondering if you think that is valid and what's happening to the housing market and the secondary markets that you're located in, I guess relative to some of the bigger markets?

I think that it may be hitting bigger markets harder. I'd like to say I knew more about that, Rick, but I've seen no trends that anyone's identified for me to indicate that, and I have a limited view of that, obviously. I mean, I'm only live here in Medford and Ashland, and housing here is still going on. The guys are still busy, the contractors have not stopped buying cars. But the people that were speculating on land and buying lots all -- in all the markets we're in, that's over. They're not doing that right now. Those lots are all sitting empty and not projected to be built on speck houses. So until this over supply leaks it way out, it ultimately could impact some of that commercial truck market, which never been real heavy for us. Most of the trucks we sell are way of light vehicles and a lot of those trucks, as you know, in that truck count are SUVs. And you saw the shift in the price level down so that you could see that we're selling now the little Caliber or something else that's called an SUV or the Jeep Compass or something else that really isn't a truck. So there's a lot of that mixing going on. I'd love to see statistics that said trucks and those type of things that are passenger vehicles would quit be calling trucks because they've substituted for passenger cars almost entirely in many of the markets we're in.

Are you seeing anything on the incentive front -- the OEMs to help you get out from underneath? Anything better here in the fourth quarter than what we saw in the third?

Well, we certainly saw an increase in incentives by largely Chrysler. And we've seen some from Ford and GM, as well. And Toyota, believe it or not, is upping the incentives on the Tundra and Sequoia. So all of those heavier vehicles are where the money's at. And we haven't seen a marked impact. So far October was not a great month. So hopefully we'll see some [surgence] from that. We had 2000 ups yesterday and sold almost 400 and that was one of the better days of the month.

And then on the acquisition front, I'd say the last couple announcements have been high line imports and -- is that part of the strategy now going forward that you'll favor those over the domestic brands?

We've expanded -- Bryan, why don't you answer that because that's really your field. I mean, what's your answer for -- what are we doing? We actually -- we raised our future ROI targets on imports and luxuries to allow us to purchase a little bit more aggressively on those areas, which was -- which allowed us to be able to buy those couple of stores. So we're -- we obviously have modified that a touch. But we still plan on also buying the domestics that we have typically bought in the past. So, yes, Rick, I mean, we've modified our ability to purchase those by lowering the return on investment on the current store. Looking to growth in the future, particularly when we can see that. And both of these stores were in markets that are like the markets we're looking for. And a little below the radar of the other people that have driven the prices up on those high-demand luxury stores.

Thank you.

We're getting an interference. Are we okay, operator?

Yes, sir, you're still on the line.

Okay. Thank you.

Okay.

That was the end of his questions. Go ahead, next.

Hello?

Matt Nemer, Thomas Weisel Partners.

Good afternoon, guys.

Hi, Matt.

The first question is on the used vehicle gross profit. That came in a little bit lower than what we were looking for. I was just wondering what changed there?

Well, we're probably changing our mix of what we have in stock. And we've suffered some gross margin erosion in getting rid of some of the vehicles that don't have the high demand they had three months ago. A large part of that, Matt, was last year in the third quarter, the gross margins were really high at 15.8%. With employee pricing, we took in a lot of good trade-ins at really good prices and those margins were probably unusually high. We didn't expect to do those type of levels. So it wasn't really unexpected the margins in the third quarter. Those two factors. There's a mix shift going on in used as well as new.

Got it. Okay. Fair enough. Turning to the SG&A gross profit ratio, can you help me understand the different pieces there? It sounds like the long-term initiatives, if they're approximately $0.02 a quarter should be about 50 basis points. Options should be about 70. So I'm trying to understand what the remaining 300 plus basis points are. Your gross profit was up, so I'm assuming that it's more of an expense issue than a profit issue?

Matt, there's two components to that. The amount of gross was substantially less. So that obviously impacts because your SG&A doesn't immediately change as gross comes down. It takes a little longer. So some of that's certainly there. And I think that's the majority of it. In reality it was such a big month last year. We'd never been below 70%. And we were last year. But it was because we had such a big quarter. And gross profits were huge in dollar amounts. And so that makes that number -- it can vary like that based on how much gross we have, too. Because it's not just the cost, it's also the gross that determines that number, so gross is down. Expenses were not down. If you look over a 2 to 3 year basis, we're actually still higher. So what Sid said is accurate.

Okay. And then on your current inventory, can you comment on the mix between '06 and '07 model year?

I don't think we have that specifically. We stock up heavily on some models that have the higher incentives, like the PT Cruisers. We got a lot of those because they've got 30,000 bucks on those right now. And they only have 500 on the '07. So we don't think there's an issue there relative to what we have to sell. I mean, we're going to work our way out of the '06s, but they're preferred inventory right now and they have the higher incentives on them. So I don't -- I can't give you an exact number. It's obviously changing every day now because the '07s are beginning to trickle in. But we ordered very few '07s and we had a lot of '06s, obviously.

Which is how we've done it in the past, too.

That was what we did last year as well.

Is it fair to say that your '06 -- you're a little bit richer on '06s than even in the last few years?

Probably not. Probably not, Matt. I mean, we didn't get the big clear out. So, yes, maybe a small amount, but nothing alarming, particularly since we cut back a lot more on '07 orders than we did in the past on the new model orders.

Okay. And then just moving on to '07 guidance. Can you help us understand. It's hard to understand why that would be flat year-over-year. If you go back three or four years, you were earning about $2 with 30 fewer stores. So I was just wondering if floor plan is relatively flat in '07 and you've got 30 more stores than you had in 2002, can you help us explain why the earnings aren't materially higher?

Matt, we've debated a lot internally whether we'd give any guidance anymore for an annual basis. And we hope it's better than that, obviously, but we think that's a safe number and we don't see an impact -- I mean, an improving sales environment next year. We don't know what's going to happen. And we have a feeling that what's taken place this summer and what we're seeing even in October is going to continue. So if that's true, we won't have those sales increases that we would normally see. And I -- I hope we're wrong. But that's the guidance we gave, and I think we just have to let it be at that. You guys'll have to make your own decisions on what you think we'll do. But, I mean, that's all we're willing to say at this point. We didn't want to take away guidance completely and we gave you some clues as to a couple higher expensive things that we're going to have that we didn't have this year, the health care costs and the actual store openings and the losses in those stores as we open those [L2] outlets. It takes us a while before those are going to be profitable. They'll cost us something. But we try to give you those numbers so you'd have something to work with.

It sounds like your philosophy regarding earnings growth is that the long-term projects are probably more important and that you're not necessarily balancing, one or two year earnings with investments. You prefer to front load the investments. Is that kind of the basic philosophy?

Bryan's got some comments on that.

Matt, I think probably the, a simple approach to it is if we look back a couple years ago, our brand mix has also affected us. If we look at Chrysler or General Motors or Ford, three years ago they had approximately 30% more sales volume. Well, obviously our costs are somewhat fixed and somewhat variable. The variable things we're bringing down, and obviously our initiatives are driving those variable expenses down so we can be the lowest cost provider in spite of a manufacturer declining, okay? But that's a big portion of that, as well as we're fighting a little bit of a power curve on our manufacturer mix for the current time, and as Jeff said, hopefully their restructuring will get them back in the game on building the product and being competitive. So -- And, Matt, you're not wrong, though.

I mean, we definitely are going to invest in what makes this Company great in the long-term. And that is a higher priority than anything in the short-term. When we know something has to be done, we're going to do it. And I think that's critical that people understand it and accept that about our Company because we've learned this over the last ten years that you can't worry as much about short term performance as you have to worry about what's going to make a difference. And the way we see our future, these things we're doing are completely necessary. And we're way ahead of everyone else in the industry in doing them and maybe we're paying a short-term price for that, but it's worth it. I am a firm believer that what we're doing will make us a world class retailer in auto retail.

Got it. Fair enough. Thank you.

Thanks, Matt.

Scott Stember, Sidoti.

Good afternoon, guys.

Hi, Scott.

Hi, Scott.

Can you maybe talk about inventory just a little bit more? Obviously, you saw a very big increase year-over-year in flooring costs. Where do you stand now? Obviously, Dodge and Chrysler have had some issues with putting some units into channel. Have you seen any abatement on that front? And what can we look for just in general terms as far as a direction with floor plan costs on your books?

Scott, for your information, I mean, if anything, we've gotten a little more religious about inventory levels and we're going to really be shooting for a much lower inventory level long-term in this Company. We do believe we have the infrastructure to do that and I don't believe any manufacturer incentive is going to take us off of that at this point because we tested that last year. And I wouldn't say it was a failure at all because we don't know what would have happened if we didn't taken the cars. You can always second guess yourself, but I -- in reality, we probably sold a lot more cars than we would have if we hadn't taken them. So that could have been as good a positive as a negative. But long-term we believe it's more healthy for our Company -- and I'm not worried about the rest of the industry because it's really up to us how many cars we carry -- that we can effectively turn the inventories at a much higher level and hold ourselves down so that cost drops over time and I don't think that that's going to be a wavering on our part. And the domestics are definitely harder. When you get into big truck lines with three-quarter tons and what not, you can't do it on a 60-day supply, but there's a whole lot of units you can do it on a 30-day supply because they're not very unique. You can certainly do that with PT Cruisers and you can do that with Calibers and you can do that with Compasses and Jeep Wrangler 4-doors, and you can have a 10 day supply of some of those. So that average better get closer and closer to what the industry calls 60-day supply instead of what traditionally has been more like a 90-day supply in most of the inventories. You know those blind numbers that people use for a day supply are all over the board, and we have our own formula which looks forward and used as a 90-day tracking and has a whole bunch of formulas in it. But that's why we only give the change in the day supply so you guys can have a handle on it. The biggest component in day supply is your rate of travel and if your rate of travel slows down and you have the same inventory, your day supply goes up. And that's really what took place in the third quarter. We didn't get the travel to show a lower day supply than we had at the end of June, but we had a $230 million decrease in the amount of vehicles in stock. So I think overall the initiatives we put in place to get inventories under control and take a stiffer discipline on that with our domestic partners is in place. I mean, I used that one example in the last press conference we had that we had -- that Chrysler wanted us to take 3100 cars. In that last program, and we took 50, and that's the kind of thing that's happening. We're only going to take what we can turn.

Did you give that figure on the -- earlier in the call about a -- number of days higher than last year?

I don't think we did, but we said it's about the same. Which was 20 days higher than normal levels. And that's all driven by rate of travel, because if we'd had the same rate of travel we had last year, our day supply would be down where day supply was last year. But we didn't have the rate of travel. But the inventories are falling back in line. All we need is to get the sales environment improving in some way. And hopefully we'll see that in November and December. December normally can be a pretty good month. November we usually have to make it through it. But usually the last week or so of that gets a pickup. But I've got this whole Lithia Store Management System that gives me the daily up-count at every store and get a total. And it's too much information, but -- because you don't sleep at night sometimes when you didn't have anybody come in to speak of.

Scott, in that conference call we also mentioned that we're down $230 million from the end of the second quarter of this year.

Yes, that's the number I was referring to.

Okay. All right. And this sell holds on the Dodge RAM pickups, has that been lifted so far this quarter?

It's lifted a truck at a time, Scott, as they can release parts to fix it. They also have a whole lot of units running around that people own that they need to get fixed. And it's a weird deal. It's nothing to do with anything instrumental to most people. If you put a child seat in the right seat on the Dodge light duty pickup, the seat belt doesn't hold properly. So they're changing the seat belts, but only if you put a child seat in it. So it's an overreaction in this litigious world we're in to a concern that became apparent. I guess they had -- I don't know that they even had a fatality, but somebody in testing discovered a problem. So they shut down the sale of them until we can replace the seat belts. So they're doing them one at a time. So we have enough now to sell those trucks. We had plenty of supply as it was. And so that as they -- now we've got enough there those customers come in, we have something that's been repaired we can sell and show.

Okay. And that's all I have for now. Thanks.

Thanks, Scott.

Thanks, Scott.

Rich Kwas, Wachovia Securities.

Hi, good afternoon, guys.

Hi, Rich.

Wanted to ask about -- Jeff, could you tell us what the health care cost increase was in '06 versus '05 since you pointed it out for '07 -- in the '07 guidance?

In '06 we held our health care costs basically flat. And we're paying the reaper a little bit, I guess, next year probably, but we had no increases this year in that area.

We redesigned the plan last year and changed to a different deductible and a bunch of changes so the people basically only had major medical and not much first dollar. We changed to a 50/50 plan, and the insurance company held the rate the same last year. Well, it didn't work out real well for the insurance company. They really didn't lower costs by what we changed. So they've raised us substantially. We did bid it, and we got good bids from everywhere, but they're all higher than what we're paying, so we're staying with what we've got, but we do have to pay the higher cost. It's kind of a two-year raise in one is what happened.

Okay. All right. And then, Sid, when you look at the inventory level where you are now, you've talked about getting out from underneath this by the end of the quarter. It sounds like there's going to be some residual going into the first quarter of next year. Could you give us some more color on that?

I don't anticipate that unless the sales rate here just continues to deteriorate, because the rate will determine that. I think our mix will be pretty good by the end of the year. I mean, we're doing a really good job of ordering only not what sells and as they go. And you can go down now and buy a new Dodge Durango for $25,000 that's loaded. It's got $7,000 rebate. Well, that's pretty attractive when you have to pay 24,000 for a Caliber right beside it and it'll haul 7 people. And so what if it burns a little more gas. I mean, it's the sales pitch, so I think they'll sell. And that's an example only. We got that across the board. I mean, you've got Chevys, Tahoes, and different vehicles that have the same issues.

Okay. And then the mix, have you seen a discernible shift back to trucks over the last 8 weeks or so? Or is it still shifting the other way?

Bryan?

We haven't -- we haven't seen the shift yet. We're assuming that it should happen again, but as gas prices went up, it took a little while for people to finally slow their habits on buying trucks. So we suspect it'll happen by the end of the year or towards the start of next year.

One of the indicators I watch on that is the used purchasing program that we have. We attend all the factory auctions where they sell those '06 models. And we've got a couple buyers that work full-time at that. And surprisingly, in October the price on those has increased substantially. So either there's a shortage or there is a -- some market force driving those to where they're more attractive than they were. Hopefully, that gives us some indication that there is a returning consumer. I mean, they can delay the purchase of some of those things, but they're still very popular. I mean, you still have a family, or you want a safe rig to drive, you're not going to buy a little car.

Okay. And then final question is what's your approach to divestitures now, given that you're mainly Detroit three? Are you looking at taking a fresher look at the portfolio and seeing stores maybe that are not worth your time at this juncture, or how you looking at that?

We constantly evaluate that, Rich, with the Board and internally. Since going public, we've sold off 5 stores of 105, I guess that we bought. So about 5% or so we've sold off as a practice. And we continue to maintain that discipline. It's only when a store is not hitting our investment hurdles and we don't see a fix for it. It's been that way for a long time. We have very few stores like that. It's one or two only. Very few stores that would actually qualify for that.

They probably will be domestic, though.

Yes.

All right. Thanks.

Thanks, Rich.

Matthew Fassler, Goldman Sachs.

Thanks a lot, good afternoon. My questions are focussed primarily on 2007. I guess my first one is when you back out your various investments that you're discussing, and health care and systems, and the used car initiative, what are your underlying assumptions about the core business? I guess both in terms of a sales assumption and also your ability to essentially recover some of the gross profit dollars that you lost in the middle of this year due to the inventory issues?

Well, as Sid mentioned, we don't see a lot of reasons to be optimistic about things improving in '07. I mean, we basically maintained things at these levels part and service business we have continuing to improve as it has, but the vehicle side, we're saying about the same so very little same store sales growth, margins about the same, real stable on all aspects.

Understood. And from an interest rate perspective, what kind of -- what kind of thought process drove the numbers?

We're always conservative there when we give guidance. And we have rates going up another 50 basis points next year built into our guidance.

So if they were to track flat, that would be clearly favorable to your thinking?

Yes, a few pennies, yes.

And then finally, on the used car. On the used car initiative as we're getting closer probably to seeing the product of your hard work, can you talk about, I guess the number of stores that this investment is driving initially, and then some preliminary thought process on pay back? In other words, when do you expect the initiative to potentially break even.

Like we've said in the conference call, the first prototype store is opening in the second quarter. We're going to evaluate the performance of that store during the year and talk further about further rollouts depending on that development. There's not a major rollout planned right now.

Got you. So the current costs are focussed around that one store rather than around an infrastructure that that would support --?

And some investments in infrastructure for more stores. We're obviously planning to more stores over time. We have to have people and systems and infrastructure in place. And that's going to be happening this year.

Okay. Thank you so much.

Yes.

Thanks, Matthew.

Matt Nemer, Thomas Weisel Partners.

Hey, guys. Just a few follow-ups. First, Sid, given that you've -- you're expecting a mediocre year next year, I was just wondering if there's any attempt to look at some of the variable expense lines that you can change, whether it be advertising or compensation, given the potential for a softer environment?

Yes, complete -- through this year we've done that very aggressively. We mentioned every call this year that we've been able to reduce advertising costs, reduce compensation costs as a percentage of gross profit consistently throughout the year. We'll continue that next year, so that's definitely something we're going to continue. And we've been successful at it this year, actually.

In reality, most of it is percentage driven, so it does trail itself. But we do have initiatives internally. Looking at all of our expenses and we need to continue to look at that. It's real easy for corporations to grow a whole staff of people and you begin to wonder sometimes if in fact that investment has really given us any return. So that's an examination that's going on all the way through with every training, every kind of -- we have a huge amount of travel costs. We're trying to find some ways to get that down. And we're spending enormous amounts of money on moving people around for training and bringing them to central headquarters and bringing them into central places that do parts, service, F&I, there's all kinds of things like that going on in the Company, so there hopefully is some room to improve those things. I mean, I'm not going to give up on it, but I don't want to short circuit anything that helps us develop future business, nor anything that might help us develop our growth plan both for L1 and L2. The L2 question, I mean it certainly is real. We had it earlier and I'm more optimistic about that than Jeff was willing to say, obviously. It's been my initiative to start with and now it's become that of the Company, so we think there's great potential there and this isn't just a test. It's more than that. I mean, we're pretty convinced it'll work. But it will take time. If you rolled out one this next year and then did three the next year and then did six the next year. At some point the whole aggregate will be profitable. I don't -- and we'll give that business plan when we talk about it probably in June of next year, after we've demonstrated one store.

And actually -- in your release it says that you're excited about the start-up of -- you use outlets in the plural. And I'm just wondering if there might be more than one location open in '07?

Oh, we have a whole business plan laid out, Matt, so clearly that's part of our plan.

We know we're safe with the one in '07, and we'll let you know if we can get another one open or not before that.

Okay. And then last -- last question related to the recent luxury store acquisitions, just curious if you've used a broker for those deals and if there were multiple bids or if you were the sole bidder.

We were the sole bidders on both acquisitions and there was brokers in both of them.

Which is normal for all of our acquisitions.

Okay. Thanks so much.

Thanks, Matt.

Kelly Dougherty, Calyon.

Hi. I'm just wondering for you can talk about the valuation differential between the recent Chrysler acquisition you made and then these luxury brands ones you guys recently announced? Hello?

I'm sorry, we had an interruption there. Yes, there's -- we obviously pay more. We have a higher hurdle for a luxury store than we do for a domestic store. So -- but they met our criteria.

Can you give us the new ROI targets for the domestics versus the non-domestics?

Well, the long term ROI targets are the same.

Okay.

So it's just that in the short-term we've had to adjust them because we think all these stores can improve that we just purchased in the luxury field. So they initially won't have the return that we would love them to have, but they will long-term.

So how about the differential on the short-term?

Kelly, on the short-term, we cut the ROI targets in half on imports and luxuries to 7.5%. They're 15% on the domestic franchises still.

But that'll --

-- Able to increase our competitiveness on buying things even though neither of these acquisitions we were in a bid process.

Okay. Thanks. And you're primarily focussed on these luxury or import brands in the metro markets not in the typical rural markets where you guys normally buy your domestic dealerships?

No, we're focusing on our typical dealerships which are small to medium sized markets where there's a limited number of that franchise. So if you look at the Seaside one, which is Monterey, Carmel County, that is the only BMW and Porsche store in that area. So that's our typical model, okay, on those type of things. Des Moines, those are the only ones in those states.

Hey, just so you know, though, in Helena, Montana, there's not going to be any luxury store purchases because that's too small. They don't even have stores there. You know what I'm saying? So that kind of sorts itself out.

Yes, [inaudible].

Mostly mid and metro. We would do metro with luxury if, in fact, we could find one at a competitive price, but that's where the prices have been pushed up. So these middle-sized markets like Des Moines, like Seaside, those are ideal for us to expand our import and our luxury brands.

Great. Thanks. On the previous call, you mentioned about increasing your new vehicle volumes, how it strengthens relationships with the OEMs which I completely understand, and how it ensures your ability to make acquisitions. I'm just wondering if there were any particular OEMs that may have pushed back, or if you guys are just trying to be proactive as you go out and try to make non-domestic acquisitions?

I've given the answer standard on that. And we don't exactly always say who can buy and who we can't. But it goes, it's like a shifting sand. There is our manufacturers who don't want public companies to buy stores at all and they resist it. And I think it's obvious that's probably Ford. And they probably need public companies as bad as anyone. And we're certainly working with them, and if all the public companies were like us, they would let them buy them. But they've had issues where many of their stores are being sold off and they were high-performing stores and now they're not selling well. And so they don't have a good experience with public companies generically, they have good experience with Lithia. So -- I was just using that as an example. But overall, obviously, we have a great relationship with Daimler. We're -- we've got good relationships with General Motors and Toyota and Honda and Nissan and -- but if you don't sell what you need to sell and you don't get the numbers, they will cut you off. And they don't pull any bones about that. They don't care if they like you. I mean, it's pretty much a rigid set of rules because their problem is they can't favor anyone, they have to stick with a standard. And if you fall below. So it's dangerous buying underperforming stores if they don't perform pretty quickly. So we've got to really be careful with it. And sales increases are critical to our ability to continue to buy and we know that. We're being -- looking forward as much as anything as -- more than just curing problems.

Great. You also mentioned on the last call that there were two or three OEMs that have actually asked you to acquire their stores. Can you tell us which ones they are?

I just assume not go there, obviously, Chrysler has. That's our major supplier.

Are you guys looking to make more Chrysler acquisitions, or you're kind of comfortable with the exposure you have to them already?

Well, honestly I'm not afraid of exposure with them. So when we can find a store that meets our criteria -- and we're pretty fussy. I mean, we look at ten of them and finally find one. But when it's in a Des Moines, Iowa, and when it's in a Grand Forks and it's a single point store that we know we can make money with, we're going to buy it.

And we're sticking to our 15% hurdle, as Bryan mentioned. I mean, there's very little risk in a store like that.

We probably aren't going to stretch out and go into metro markets with Chrysler stores, but we will definitely will stick to our knittings on what we've proven to be successes at.

Yes. We're really avoiding with domestics the metro markets. They're highly competitive and right now that's who's taking the hit.

Thanks a lot.

Thanks, Kelly.

Alex Yaggy, Morgan Stanley.

Yes. Thank you. I wanted to go back to the 2007 guidance and try to make sure I understand this correctly. You're calling for $1.90 to $2.10, and included with that is a $0.10 to $0.12 hit from healthcare costs, roughly $0.10 from your used car initiatives. And are you still looking for -- maybe it's $0.08 to $0.10 from your other investments in the SG&A? Is that correct, as well?

Well, we purposely didn't give any number on that because we're hoping some of that begins to pay off next year. And it's potentially for $0.04 or $0.05, but we're not sure exactly. It's very difficult to track that because it's a core part of our Company and we're always going to be adding new initiatives that hopefully will help us long-term. So -- and some of them we'll drop that didn't pay off. So, I mean, there's a -- it's a shifting sand. So we purposely didn't give a number to that. But remember, that $0.06 to $0.08 last year included some L2, which -- and we've broken that into that $0.10 for L2. The independent used car.

Okay. And what is your assumption for interest rates? Are you assuming that those remain flat from current levels?

We said we're anticipating [stage] during the year another half a point up.

You're anticipating a 50 basis point increase at some point through the year?

Right.

[First] quarter and third quarter, I think we bult them in.

The run away fed.

Okay. So I mean, and your sales assumptions, which you didn't put in print, you're saying you're just generally being cautious.

Certainly, we don't see an uptick in the economy at this point. And remember, our viewpoint's 90 days, but we're going to base projections on what we're doing -- or what see happening in the next 90 days.

We hope that ends up being conservative. But at this point we don't see any factors that would lead us to do it any differently.

Okay. And looking forward from that, the $0.10 to $0.12 from healthcare, should that just go back to a normal -- I don't know how you want to look at it but maybe $0.05 increase every year because you -- just that's what health care does?

Yes, I think that's probably reasonable. I think we paid two years in one.

Okay.

Probably $0.04 to $0.05, yes.

And you also mentioned inventory how you'd like to be running with lower inventories. Have you put a dollar figure on how much inventory you believe you can take out on a go-forward basis?

It's a tough one, because the business increases than the dollar amount doesn't mean anything. But in the environment we're in, we took 230 million out and that's looking at a future sales rate through this fourth quarter shows still a fairly high day supply. But that dollar amount we currently have could serve us well next year.

Okay. And then finally, you're -- you have bought back some stock. How aggressive do you think you're going to be over the next several months with your stock basically trading at book value?

Well, we have to follow the guidelines and the rules of how much we can purchase every day. But we have that program in place, and we have purchased 190 -- almost 200,000 -- almost 200,000 shares in the past few months. So we'll continue with that program.

There really are a lot of restrictions. You can only buy a certain percentage of the daily average volume, and you can't buy on an uptick and down tick. And Morgan Stanley manages that for us, Alex, and I guess that's where you work, but it's a different group, obviously. But -- and we just have to follow the rules.

Can't be in the first 30 minutes, the last 30 minutes --

And if you do a block trade, you can't trade in the market. And so it's got -- there's a -- millions of rules. We're learning, obviously, and we're getting better at it.

Okay. But you remain in the market?

Yes.

Okay. Thank you.

Yes.

Thanks, Alex.

Jerry Marks, AutoRetailStocks.com.

Good evening.

Hey, Jerry.

Just to clarify a couple things, the 7.5%, 15% ROI as well as the $0.10 to $0.12 that you guys are quoting for L2 and health care, all of that's on an after tax basis?

The $0.10 to $0.12 is on an after tax basis, yes. ROI is also on after tax.

Yes, they are all, Jerry.

Yes.

Okay. So from a cost standpoint with L2, we're talking about, I guess it would be 2.2 million after tax, so 3 million pretax. Is a lot of that going to come in the first half because you're going to -- I assume you're probably going to have several hundred vehicles that you stock in inventory. Is this how we should kind of think of it to lump it into the first half of '07?

Not at all. Obviously the health care is spread throughout the year. But the L2 will -- actually the losses start as we open it. So a lot of those, it's just ramping. So I think it's pretty much through the year. We are predicting that within 12 months of each store opening, it will be profitable. That store will. And we're hoping that's sooner than that, but that's the way our forecast model works now.

Right. And like I said, I don't want to get to detailed, but it sounds like if you're going to open it in June or July, you'll have to start stocking the lot, maybe, in April or May because you don't just all of a sudden wake up with 2 or 300 vehicles on the lot, right?

And they're reconditioning cars and getting ready to --

But that isn't expense. I mean, you've got some of that, but that isn't going to -- I mean, an expense really happens when you open. You start advertising and you start with personnel costs and all the operational things that go on. Until sales ramp up to cover that and you build some service and parts business behind it, you're not going to have the profits you have in the plan in the later months.

Now, in terms of your -- the last question I have is in terms of your used gross margins, they were down 50 basis points. It seems with all of these initiatives that -- and all of your other peers have been showing pretty encouraging used results. Is there something that happened with maybe the centralization of used where something kind of hiccupped in your process that you had to learn from? Or is it something related to your markets?

We talked about that already, Jerry. You may have missed the answer. But the used last year were unusually high because of the trade-ins that we took in on employee pricing at our domestic stores that we had very good margins on. Unusually high, we never expected to be able to maintain those levels in normal conditions. And also the used market was weak -- continued to be weak this quarter with valuations falling. So it was a more market-related issue.

And related to initiatives, no, we don't see any hiccups in those. Actually, the Assured -- it's only in 13 of our stores so far. The first look is starting to take hold and we're starting to see those -- the effects of that now.

Hey, Jerry, we're -- we still are way above everyone else in terms of used vehicle gross margin. So if they improve, that's great. I'm hoping that they can get to our numbers over time and there -- the potential is certainly there, and we think we can improve ours, but we're going to be investing in that. And when you're changing to culture. Like for instance, that price changing from having a negotiated transaction to trying to get to as close as we can to one price, I mean, that's a difficult thing to do in a cultural thing. That's why we're rolling those out slowly because we've got to educate, teach, train, because these guys don't know how to tell a customer that's the only price we're going to give you. Those things are going on.

The big things we've got to keep in mind there are the benefits are referral customers that we'll get from those satisfied customers and then multiple repeat customers, which will show in our -- in our new car sales, used car sales eventually, but will definitely show in the service and parts department immediately.

Okay. I understand. And I guess I heard you guys say in terms of the tougher comparisons, but I think your peers had tougher comps as well, with the employee discount, so I guess the big difference is because you guys have a greater mix of domestic brands that had those employee discounts?

We got a lot more out of that last quarter last year -- that third quarter last year than others did, and that comparison's tougher for us because that's what fell this quarter is that very brands that we shined with last year.

And if we look at, if we look at our strong improvements, it's in the import lines and the luxury lines as -- as they have. So we're seeing the big push, we just, unfortunately, have a little bit more domestic exposure.

Got you. Okay. Thanks.

Yes, Jerry. Thank you. Enjoy your articles every day. Keep it up.

[OPERATOR INSTRUCTIONS]. Gentlemen, there appear to be no more questions at this time.

Happy Halloween, everyone, and we look forward to continued success and thank you for being investors and those who follow us. Good evening.

Thank you.

Everyone, this concludes tonight's conference call, you may now disconnect. Have a wonderful day.