Lithia Motors Inc (LAD) 2006 Q4 法說會逐字稿

Good evening. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lithia Motors fourth quarter and full year 2006 earnings conference call. [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 may begin your conference.

Thank you, Steve. 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 fourth quarter and year end earnings press release and in the company's filings with the SEC. Now, I would like to thank you for joining us for our fourth 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 thank you, everyone, for joining us today. As you've seen for the full year 2006 total sales increased 11% and total gross profit increased 10%. In what we consider to be a difficult retail environment.

Total revenues actually reached a record level for the company of nearly $3.2 billion. The revenue increase was driven by increases in both same store sales and revenues from acquisitions in the past 12 months. In the fourth quarter, total revenues grew by 12% and total gross profit increased by 9%. These results were also driven by a combination of same store sales growth and revenues added through acquisitions. In the fourth quarter, we continue to see the weak retail sales environment that we had experienced in the first nine months of the year. Regardless, we were still able to push positive same store sales growth in all business lines, except in the used car business in the last quarter.

We were also successful in our efforts to work down new vehicle inventories. Some of the best news in this conference call. Our new vehicle day supply at the end of December was more than 30 days below the December 2005 level and eight days below our average levels for that time of year and also we're adding that end of January, our day supply of new vehicle inventory dropped another 11 days, which has positioned us very well in terms of inventory positioning for the rest of the year. While total revenues were up, full year and fourth quarter earnings, as you saw, were down year over year due to a combination of factors. First, we had the accounting changes for equity compensation under FASB 123R and a change year over year in derivative instruments in the hedging activities under FASB 133. The total impact of these changes actually was $0.29 to full year earnings and $0.06 to fourth quarter earnings. You can see more detail on these accounting changes in our press release today and in the company's previous filings. We think it is important that someone track that because it was an unusual hedge accounting issue we had to deal with.

In our third quarter press release, we provided annual guidance for 2006 of $1.95 to $1.99 from continuing operations. The restatement for hedging activities under FAS 133 had the effect of reducing annual earnings by $0.05. So, when you add this $0.05 to the $1.91 that reported today, we did make about $1.96 per share which was within the guidance range that we provided at the end of October. Other factors that impacted full year and fourth quarter earnings were higher inventory flowing costs resulting from higher inventory levels and higher interest rates. We also had lower retail gross profit margins due to poor inventory mix, having taken bank cars early in the year. L2 start-up costs also contributed to the higher costs and the increased costs resulting from company-wide operational initiatives that we have been implementing throughout the year.

For the fourth quarter then, net income from continuing operations was $6.6 million, and earnings per share from those operations were $0.32 . This includes the effect of accounting for the equity-based compensation under FASB 123R and the effective accounting for derivative instruments and hedging activities under FAS 133. Comparable earnings with last year would have been about $0.36. I refer you to the financials of today's press release where we have broken out the impact so you can all understand the accounting changes. In the fourth quarter, we continued with our strategy to aggressively pursue market share and, as a result, fourth quarter new vehicle same store sales were up 6.6%. Full year new vehicle same-store sales were up almost 5%. This demonstrates our ability to take market share in a difficult retail environment. Even with domestic brands.

This volume approach has a number of benefits. It helps create a larger customer base which improves the chance for future sales. It helps ensure growth in the more profitable parts and service businesses and it improves our relationship with our manufacturer partners. New vehicle same store unit sales for the quarter increased by 7.3%. This compares to an industry that had a decline in retail sales in excess of 6%. Lithia's domestic same store unit sales increased by over 10%, actually 10.5%. Domestic industry sales, including fleet, increased just over 1% for the quarter. Lithia's same store unit sales for General Motors increased 35% versus a 0.9% gain for the industry statistics for G.M. Our Chrysler unit sales were up 4% versus a very small, almost flat for Chrysler in the industry, and Lithia's Ford sales were the only one that we had a decline greater than the industry decline. Toyota sales for Lithia increased 20% versus a 13% increase for the industry.

The numbers I gave demonstrate the fact that we are able to hold our own or increase the market share of any of our major brands with our Lithia sales process in our unique markets. I want to reiterate a very important point, which is that market share is determined by the strength of the retailer and not just the brand mix. I pulled some independent county data from the state of Idaho just as an example and to demonstrate this point. Ford has a 9% market share in Bannock County as compared to a high in Idaho of 21% market share in Canyon County. In Ada County, Toyota has a 12% market share versus 26% in Kootenai County. Chevrolet has an 8% market share in Ada County as compared to a 16% in Canyon County.

What makes for these wide variations in market share from county to county? We think it is the retailer. You cannot extrapolate national numbers to come up with a retailer's performance for each of the markets they serve. A strong retailer can take market share in any given market with any one of the major brands. As I mentioned, new vehicle same store sales increased 6.6% and same store units increased 7.3%. The difference was $186 price decline in the same store per unit average sales price for the quarter. For the year, same store sales increased 4.8% and units increased 5.5%. Again, about $187 decline in the average price. For the quarter, total used vehicle same store sales declined 7.4% and same store units declined by 8.5%. Which was the opposite. Prices increasing by $156 per unit.

The decline is not an alarming thing for us given our focus on new units during the quarter and not used vehicle sales, as we still had a lot of 2006 models that we needed to clear out. For the year, total used vehicle same store sales were up 0.6% and same store units were down 3.2% with average prices up almost $500, $478. On a combined basis, new and used vehicle same store sales for the quarter increased 1.8% and units declined 1.4%. Full year combined sales new and used, were up 3.4% and combined units were up almost 1%.

Related finance and insurance same store sales for the quarter increased 3.4% and for the year increased 5.1%. Our F & I model continues to demonstrate its reliable source of revenue and income for our company. Our service and parts businesses continue to do well and for the quarter, same store sales increased 3.6%. This was on top of a very good growth at 3.7% in the fourth quarter last year. Same store warranty sales in the fourth quarter were actually down 2.3%, but were up against a 4.2% comp last year. Going up.

More importantly, our customer pay business was up 7.2%. This is the number we're seriously tracking. And that was the number for the quarter. Same store gross profit grew by 3.7%. For the year now, same store service and parts sales increased 5.3% with same store warranty work increasing only 1.7% on top of 5.7% growth last year. Our customer pay business increased about 7% for the year. Same store gross profit in the parts and service business grew by 6.4% for the year. Finally, total same store sales were up 2.1% while total same store gross profit was down 0.9% for the quarter. For the year, same store sales were up 3.7% and same store gross profit was up 2.1%. I'll be available for questions following the comments from the others and we'll be able to add any color or any thoughts that you would like to hear from us today. I would now like to turn things over to Dick Heimann, who will comment further on our sales, our brand mix and the inventory position. Dick?

Good afternoon, everybody. Thanks as always for your interest and support.

First, I would like to comment briefly on the continued positive trends we're seeing in the parts and service business. As Sid mentioned, full year 2006 parts and service same store sales were up 5.3%. More importantly, our same store customer pay business was up over 7%. This is the critical number that we really focus on in the parts and service business. We have been consistent in growth in this business year after year for the last three straight years. Lithia's strategy of pushing same store sales and increasing units and operation is really benefiting our parts and service business and will continue to do so in the years to come.

Moving on, it is hard to believe we now have operations in 15 states. The states of North Dakota and Iowa added in the second half of last year. Our same store sales, broken down by state for the fourth quarter, was Texas is now number one with 17%, Oregon was 16, California, 14, Washington, 13 and Idaho and Alaska with 8%, Colorado, 7%, Montana, 6%, Nevada, 6%. Nebraska, 3%. South Dakota, 2% and New Mexico with 1%. On an annual basis, Oregon is still our largest contributor to sales with Texas and California close behind. I'll now list the states in order of increased same store sales performance. They are New Mexico, South Dakota, Texas, Alaska, Montana and Idaho. Followed by Oregon, Washington, Nevada, California, Colorado, and finally, Nebraska.

We believe our California sales are suffering as a result of declining real estate market. Both New Mexico and Texas had double digit gains on top of double digit gains in the fourth quarter of last year. South Dakota, Alaska and Montana also sought double digit gains, however, they had easier comparisons from the fourth quarter of last year. Our new vehicle mix by manufacturer as a percentage of total new vehicle units for the quarter was 40% Chrysler Dodge Jeep, 19% General Motors Saturn, 13%, Toyota Scion, 7% Ford Lincoln Mercury. 5% Honda. 4% for BMW. 3% each for Hyundai, Nissan and Subaru. 1% for Volkswagen Audi leaving approximately 2% of other brands for a total of 28 different brands.

From the third to the fourth quarter of the year, we saw a notable shift back toward trucks and SUVs. In the third quarter, 60% were trucks or SUVs compared to 68% in the fourth quarter. A lot of this is due to the heavy push we had to clear out the 2006 models in the fourth quarter. On a sales basis, 72% were truck SUV versus 68% last year in the fourth quarter. Now to inventories. You may recall that by the end of September, our day supply of new vehicles was 20 days above average levels for that time of year. But the absolute number of vehicle units was down substantially and on a dollar basis declined $230 million sequentially from the second quarter. We slowed the ordering of vehicle substantially in the third and fourth quarters by the year and by the end of the fourth quarter, we were able to gain -- to reduce our inventories by another $49 million. As Sid mentioned earlier, at the end of December, new vehicle day supply was more than 30 days below December of 2005 and eight days below average levels for that time of year.

Used vehicle inventories at the end of December were five days above our average levels for this time of year. They were, however, nearly six days lower sequentially from the end of the third quarter. We're now comfortable with the current levels. Lithia continues to generate industry-leading finance and insurance income. Our F & I per vehicle for the fourth quarter was $1,115 per vehicle. For the year, it was $1,094. And we had penetration rates for the financing of new and used vehicles of 77%. Service contracts of 42% and our own lifetime product of 39% in the fourth quarter.

Now, I would like to present Jeff DeBoer, our Chief Financial Officer who will provide you with more details on the financial results.

Thank you, Dick. Good afternoon, everyone. I would like to look at sales first. We posted record fourth quarter sales of $736 million. New vehicle sales increased 18%. Used was flat with last year. Finance and insurance increased 18%. Service, body and parts increased nearly 16%. New vehicle sales comprised approximately 58% of total sales versus 55% last year in the fourth quarter. For used vehicles, they were 26% this quarter compared to 29% last year. Parts and service represented the same 12% and finance and insurance also was flat at 4% of total sales, unchanged.

In the fourth quarter of this year, we see the shift toward more new vehicle sales as we focused on reducing inventories,as Sid mentioned. In the fourth quarter of last year, there was a shift away from new vehicles and toward used vehicle sales that was caused by the employee pricing programs that occurred earlier in that year. Accentuating the differences here. The contribution to gross profits by business lines this quarter was 26% new vehicles versus 25% last year. 18% used vehicles versus 21% last year. 34% service and parts versus 32% last year. And 21% F & I, the same as last year.

We tend to generally have a higher contribution from the parts and service business in the fourth and first quarters of the year. When vehicle sales are seasonably slower and this year, we also saw the contribution from higher service and parts margins. Fourth quarter total revenues increased by 12%. Total gross profit increased by 9%. Operating income, however, declined by 11% as we saw the impact of 14% higher SG&A expense. Which I'll give more detail on in a few minutes.

Now, I would like to go over the gross margins by business line. Gross margins first for new vehicles in the fourth quarter were 7.8%, 20 basis points lower than the fourth quarter of last year and 10 basis points above our third quarter new vehicle gross margins, so we did not see further margin deterioration this quarter. Full year new vehicle margins were 7.7%, a 30 basis point decline from last year. Retail used vehicle margins were 14.3% for the quarter. 120 basis points below last year. However, this was up against a record high fourth quarter comp of 15.7% gross margin last year. A level which we did not expect to continue. Our historical average gross margin for this business line in the fourth quarter is 13.6%, so the 14.3% is still higher than our average levels.

The 14.3% gross margin we achieved in the fourth quarter is the third highest margin we've seen in the fourth quarter as a public company and way above industry levels. Gross profit per unit was $2,365. This is the second highest gross profit per unit level we've seen in the fourth quarter. Full year used retail gross margins were 14.9%, a 70 basis point decline over last year, but the second highest level we've seen for the full year. In the fourth quarter, Lithia had a wholesale used margin of 1.4% versus 1.1% last year, and a gross profit per unit of $87 versus $69 per unit in the fourth quarter of 2005 and pricing increased $158. We have now seen three and a half years of wholesale gross profits. Full year wholesale margins are down 30 basis points to 2.4%. Gross profit per unit has declined $11 to $149 and pricing has increased $252.

The parts and service business gross margin for the quarter was 48.1% as compared to 47.9% in the same period last year. Our historical average gross margin in this business line for the fourth quarter is 46.8%, demonstrating the fact that we have made good gains over time. This is the second highest parts and service gross margin achieved by the company for the fourth quarter. For the full year, parts and service gross margins were up 70 basis points to 48.5%. This also is a record level for the company. For the quarter, our total gross margin decreased by 60 basis points to 17.1%. As a result of the declines in the retail new and used vehicle businesses which I've described.

SG&A as a percentage of gross profit went up 370 basis points for the quarter to 78.2%. Approximately 70 basis points over the increase, however, is due to the increased compensation expense resulting from the implementation of FAS 123R. We also had an unusual item from a worker's compensation claim, whereby 2006 SG&A expense was charged $1 million for a claim stemming from a 2004 incident. This increased SG&A as a percentage of gross profit for the quarter by 80 basis points, and impacted diluted earnings by about $0.03 for the quarter. For the year, SG&A expense as a percentage of gross profit increased by 280 basis points to 75.5%.

60 basis points is from the implementation of FAS 123-R as a point of comparison, this level is still 20 basis points below our 2004 level. The other increases to SG&A were mostly due to higher investments in personnel, systems and training for our centralization efforts in future projects. The largest cost items on the store level, sales compensation, advertising and rent on a combined basis were flat as a percentage of gross profit year over year. While we held the line on operational costs at the store on a combined basis, we did experience an increase in electric and natural gas rates with an impact of approximately $0.04 a share for the year. As a result of the higher SG&A in the quarter, our operating margin was 3.1%, 80 basis points less than the fourth quarter last year. Our annual operating margin came in at 3.6%, 60 basis points lower than last year.

Now we'll look at the debt and capital side of the business. For the quarter, our total flooring and other interest expense as a percentage of revenues was 1.8%. As compared to 1.3% last year. This increase is due to both higher inventories from acquisitions in the year 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 rate interest rate swaps. With average remaining terms of one to two years and an average fixed base rate of 3.7%. Including all fixed rate debt obligations and hedges, approximately 49% of our total debt has fixed rates at the end of December. For the quarter, we had an increase in flooring expense of approximately $2.9 million with the majority of the increase due to higher rates. Other interest expense increased by $1.6 million. The combined impact to earnings from these higher interest costs was approximately $0.13 for the quarter. One of the largest factors to the decline in earnings for this quarter.

Including swaps, our average annual interest rate increased by 90 basis points year over year to 5.8%. By comparison, market rates went up nearly 170 basis points for the same period. Our year over year interest rates have risen steadily for the last two years and now with some stabilization, they should start to level off over the next couple of quarters and floor plan interest costs should stop increasing as a result of higher rates in the year ahead. Finally, earnings per share from continuing operations, excluding the effect of the accounting changes, were $0.36 per fully diluted share, as compared to $0.54 in the same period last year. We saw the impact of the previously-mentioned higher interest expense, declining vehicle margins and the increased cost related to our 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 for the full year 2006, with no one item representing more than $0.01 to $0.02 in annual earnings per share. As mentioned in our press release, they will continue to be factors impacting our full year 2007 performance, as well. On the other hand, we expect that the accounting changes that impacted 2006 earnings will not be apparent this year.

Looking at the balance sheet, we had $27 million in cash and approximately $56 million in contracts and transit for a total of $83 million at the end of the year. Our long-term debt excluding used vehicle flooring is largely composed of debt from the convertible offering, real estate and seller notes and was $297 million. The breakdown of this $297 million of debt is $156 million in mortgages, $85 million in convertible bonds, $48 million on our working capital line of credit and approximately $8 million of other debt. Our long-term debt to total cap ratio excluding used vehicle flooring and real estate is 22%. A very low level. Our goodwill as a percent of total assets is now 19%. Shareholder equity rose by 7% to $493 million. Lithia's book value per basic share is now $25.32.

Our guidance for the full year 2007 is unchanged. At $1.90 to $2.10 per share. A number of key items will impact 2007 earnings. These have remained unchanged from what we announced in our third quarter 2006 press release and conference call. However, I will go over them again here briefly for you. First, company health and benefit plan costs will be increasing, lowering earnings by $0.10 to $012 per share. We'll also see a continued impact from our operational projects and initiatives which I previously described. Long-term, we expect these projects will markedly improve sales and enhance the customer experience. Bryan will be giving much more details on these in the next section.

We also expect this year that we will continue to fight the headwinds of declining domestic sales nationally. With our initiatives, we were able to hold our own over the last year. We hope to continue that this year. Longer term, we believe that the restructurings now underway at the domestic manufacturers along with changes in mix and product improvements will help us in the future. Also this year, we will have start-up costs from our independent used vehicle retail outlets. Start-up costs for this initiative will impact earnings by approximately $0.10 per share. That concludes the financial summary. I'll now turn things over to Bryan. Go ahead.

Thank you, Jeff. Thank you, everyone who is listening out there this afternoon. I would like to start by updating you on our acquisitions activity. In 2006, Lithia completed the acquisition of 13 stores with approximately $470 million in annualized revenue. This represents over 16% growth on our 2005 total revenues of $2.85 billion. We also have two stores in discontinued operations with annualized revenues of $49 million in total, so net additions for the year were $421 million in revenues. The acquisition pipeline remains strong for 2007 as we will continue with our consistent acquisition growth while we focus on diversifying our brand mix.

Now, I would like to provide you with an update on how the company is strategically positioning itself operationally for the future. We are currently in the process of repositioning the way we do business by focusing and capitalizing on two key drivers. And those are our customers and our employees. We know from past experience and current research that these two components are essential to a highly-competitive and profitable future. This is not just about any specific initiative or process change but it is a grander scale change of the culture of our company as a whole. Foresight, a cohesive and long-term executive team, a drive for continuous improvement and common language have been and will remain keys to our success at Lithia Motors. In the past, we have done the hard work of developing the underlying infrastructure and preparing our culture for a new customer-focused model. Our entire management team is firmly committed and focused on radically improving customer service at our stores and developing our employees.

Now that the key components and initiatives necessary to complete these changes are well-established, we are positioned to bring them all together into a stronger, more competitive and more easily replicable model. Lithia Support Services is the managing body that supports, develops and delivers our common language to the Lithia stores. The charter of Support Services is to relieve store employees from unproductive functions that detract from their attentions of growing their customer base and staff. We have previously discussed many of these initiatives that simplify and remove functions such as HR issues, legal training, cash management, inventory management, auditing and accounting, staffing, facility issues, recruitment, expense control and more. By doing this, our store leaders can then focus on what they do best and that's developing their teams and their staff. To support this, we are developing our operational leaders by continuing to implement and ingrain sound, human development practices into our culture.

We know that long-term, we can only be as good as our people are so we continue to focus on applicant tracking, performance management and individual development plans so that our employees are exceptionally supported and empowered throughout the organization. At the store level, our customer-centered processes are coming together nicely. In the past, we have talked about some of these initiatives and Jeff mentioned them earlier in the call. So, I won't review them again right now. But what is important now is that we are or will be revamping all customer processes in the new, used, parts and service businesses in the future. What will emerge is a new customer-driven model that will specifically speak to our customer's needs and the ability of our employees to increase their success. Once achieved, we'll be able to truly leverage and grow the value of the Lithia brand with one message based on customer experience, word of mouth advertising which will, in turn, make for a more cost-effective, more profitable and more successful model to grow with.

We are extremely excited about the changes that we're implementing throughout Lithia. Now is the time to do the hard work of changing the way that vehicles are sold and serviced while keeping our focus on driving for current profits. Our mission is and has been to be the preferred provider of cars and trucks and related services in North America. We can only achieve that goal by simplifying and creating a more customer centric sales process and by growing strong, dedicated employees.

That concludes the presentation portion of this conference call. And I thank you all for joining us. We would now like to open the floor up to questions. Steve, could you open the call up?

Certainly. [OPERATOR INSTRUCTIONS]. Your first question comes from Paul Swinand of Stephens, Inc. Sir, you may proceed.

Good afternoon, guys. I'm on the call for Rick Nelson who's out today.

All right.

Hi, Paul.

First as usual.

We get there early. Question on the acquisition climate. We've heard from some of the other dealers that maybe pricing is a little more rational. I know you guys are often in different markets. But would you say that, your outlook or the climate is looking a little improved in 2007 versus 2006?

We haven't seen a big declines. It seems pretty stable and the pricing seems stable as it has over the past two or three years.

And then you mentioned your brand mix and that we did notice that you acquired some -- just one or two luxury dealers there at the end of the year. Is the pricing that you're seeing in the markets that are Lithia-type markets, is it much more for the luxury brands or how does that fit into your capital disciplines?

Obviously on luxuries, they do cost more in terms of what we have to pay for them on ROI targets but it still -- I mean they're priced the same as they've been over the last number of years. We're fortunate that in the smaller markets we still don't have a lot of competition but obviously the imports and the luxuries still command better prices.

There is some acceleration still with the Lexus stores, they're probably the most expensive stores in the world. They have not softened at all. In fact, they're asking even more.

Ok. Thank you for that. And just a little housekeeping on some of the expenses that you laid out as part of the guidance. Is the timing of all of those pretty equal throughout the year? Or some of the cost more start-up with L2 and it should be loaded more into the beginning of the year?

The initiatives are going on from last year. Those were still definitely heavily weighted in the beginning of the year and if anything lightening up toward the end but the L2 on the converse is not really started until the middle of the year then it ramps up toward the end of the year. You have some offsetting factors there.

They're probably pretty even because of that.

Ok. Fair enough. And then sort of -- almost a philosophical question about, you mentioned that as you gain market share, you're seeing a rise in service and parts. Do you have any metrics or data that you could point to on units and operation and then is there an expected value of service and parts per vehicle? And where I'm going with that is I'm wondering if some of the market share gains you've made in 2006 are not really what's driving your business today but will maybe drive it tomorrow.

There's really a good case for that market share issue and believe it or not, we finally have at least one of our manufacturers providing us with a units in operation and an actual penetration based on our real data and setting objectives much like they do on the sales side for the vehicle sales and I think it is a model we need to duplicate throughout our organization to try to fully identify where we are and where the improvements can be made in terms of market share. We are expanding both the tire parts of the business, the accessory sales parts of the business and those things that we think a customer can get done in a very quick manner like the oil changes and all of the adjacent products that we have in there. Later this year, we'll be talking more about our assured service program and how that's working because we are integrating some new processes throughout our service departments that will enhance customer sales over the next years, I don't like to say quarters because all of these things take time but we have the kind of organization that can actually integrate and make changes as we see fit to do them. It does still take time, however. Each store has to be done and trained and changed one at a time.

Hey, Paul --

Yes?

When we've done studies on trying to determine what the ratio is of initial gross when you sell the vehicle and then when you service it in the future, we've usually come up with about a one-to-one ratio. So, if you make $2500 on the front end of the deal, you usually typically through the person's life cycle make about $2500 on the back end.

Over what time period would that be?

Well, the average turn is three and a half to four years. So, it is a pretty easy recapture that you can definitely make a case for why you need to continue to push our volumes on the front end of the business.

Chrysler's metric on the units and operation, they're using seven years for the count that they weigh and measure us against and they find that it tails off pretty much after that that we don't get a lot of service business out of the older than seven year product.

Ok. Thank you. That was very helpful.

Sure, Paul.

Your next question comes from Matt Nemer of Thomas Weisel.

Good afternoon, everyone.

Hi, Matt.

Quick question on -- first question is on L2. I'm wondering if you have any update on the timing of that. And then also, if you can give us any more color on the number of stores where you've implemented a few of the other projects that you're working on such as Assured Used. Can you give us sort of a number that it's installed at versus the total base or something along those lines?

On L2, it is still targeted to open our first store in the middle of the year. We're obviously staffing up at a corporate level to be able to support more stores than that. In terms of Assured Used and some of the other initiatives, most of those things are on track as we have been over the last number of quarters. And we continue to integrate each of those initiatives into that one core model that I talked about earlier about trying to bring those together so the store has all of the functionality that we're really trying to bring to them, to really put them back in the driver's seat on growing their customers and their employees.

Ok. So, the goal is basically to get each store implement all of these in a store, one store at a time rather than kind of doing them separately.

Well, we have rolled out initiatives independently throughout all stores to really set a foundation, to be able to roll out the whole model at some stage. So, the foundations are there in many of the stores obviously with office automation and those things, we'll have an accelerated roll-out schedule and plans on how we do that soon.

A lot of times, Matt, it is done regionally where we have four or five stores in a region or a certain state that gets done at one time. It is not one by one. It is done region by region, sort of.

Got it. Then another question probably for Bryan.

Yes?

Was there a change in the compensation structure for sales people in terms of new versus used vehicles or how did you incent the sales staff to work through the new inventory as opposed to the used?

There wasn't a compensation change for the sales staff. Now, obviously at the sales manager levels, general manager levels, department leaders, there is an incentive to reduce your new vehicle inventories because their pay plans are affected by flooring costs so that's probably the single biggest driver. Now, they could have also adjusted some maybe stair step programs or waiting on specific cars to tailor those a little more toward the new vehicles to help that.

Matt, a big piece of the pay that is used to move is funded by the manufacturer partners. For instance, Chrysler just announced now closing out the last of the '06s, they're paying every salesman $200. And they're giving the sales manager a 20% override so he's getting $40 for every '06 that goes out. So, we also, have our own bonus plans based on units we need to sell and focused on but it is usually a flat fee. When you're clearing out inventories with cash as it is, most of the sales people are getting a flat fee for selling the car both from us and from the manufacturer so it is not a change. That's historically how it has been. We will, as time goes on, move more toward a flat pay system for all sales people.

Got it. And then just a couple of housekeeping items. On discontinued ops, which has been relatively rare for you guys, can you comment on where and what brands that might have impacted?

I won't tell you which stores but it is domestic and metro markets.

Ok. Then lastly, Jeff, is there any way to quantify what normal workers comp is on a quarterly basis?

We're on our retro program so it is very difficult and the claims come in over a time period of two to three years and it is very hard to predict. It reduces our cost by having it that way, but we have swings in that that are not going to be controllable and that's just the way that we have it set up unfortunately.

The other negative on that work comp piece, we've had it historically is all of those things tend to happen in the fourth quarter. Because that's when they finalize all of this stuff and they bring it to you and so we try to figure out every quarter exactly what we think the cost will be for the year but at the end of the year, we might have a year where we set up too much and we have to bring some back in and we might have a year where we don't have enough set up like this year. Actually had the opposite last year. We put some money into the fourth quarter and made the fourth quarter look better because we had a really good work comp experience. You're forecasting to an extent there. It's a very difficult one. It is the same as being self-insured. But we have an underlying policy that insurance company runs. It is Liberty Mutual Nationwide. They do a hell of a job with it but they lost a lawsuit on the $1 million one and no one anticipated it would be that much. So, the guy won the lawsuit and he got a horrendous amount. I don't want to give you the details of it but it obviously angers you that our society would allow it but this guy is really not hurt.

What I'm getting at is the underlying worker's comp excluding the $1 million, is it about -- was that running at a normal level year over year?

There's no acceleration. In fact, our experience overall has been better. We're getting lower and lower rates as it goes out. So, there's not an acceleration on the cost. We're managing that very well.

Got it. Thanks, guys.

Sure, Matt.

your next question comes from Scott Stember of Sidoti.

Are you calling from home, Scott?

No, wish I was.

We worry about you guys on this late call.

We do what we have to do here. Can you just -- going back to the used car side, the 120 basis point decline in gross margin, besides the tough comparisons that you guys were discussing, are there any underlying trends we should focus on?

The important thing there is the margins as I mentioned in 2005 and the fourth quarter were unusually high. We had an opportunity to take in very attractive trade-ins and after employee pricing and that made those margins look just incredibly unrepeatably high. During employee pricing, we were very successful in getting attractive vehicles that had much higher gross margins because people traded things in that they never would have because of the opportunity. And so that was never going to happen again and unless we have -- don't say never. Maybe we'll have employee pricing again but that was solely a result of the employee pricing and the opportunity for us to take in very attractive inventory with very high margins and that's it.

Scott, there's -- we're not alarmed by any change there. We're certainly in the historic rage. We built our business model around that, between 13% and 15%. It will swing a little bit based on the pricing. Remarkably, to replace what we sold in the quarter, we're having to pay $3,000 or $4,000 more, the market has accelerated on the used vehicle values for SUVs. So, that's beyond me how that could be true but it is. We're standing at the auction. There's either a shortage of them or the demand has increased because the prices have shot up on the wholesale level on all of the stuff that was soft in the fourth quarter. So, interesting dynamics. The used car business is fluid but we're very good at managing that and we do, as you know, have very high gross margins overall in that section. We don't look to improve those. We want to increase volume.

All right. Back to new car side on Chrysler Dodge Jeeps since it is such a big piece of your business. Could you talk about some of the beyond '06 cleanouts, anything you would expect for newer '07 models and in general, your expectations with some of the product that you're seeing coming out for 2007?

I'm not going to comment any about whether the Germans might sell or whatever but right now, the management group there, Tom LaSorda and Mike Manley and Steve Landry, I've got one common voice. They're out there really working hard. They've got the plans on what incentives will be out through March already, and we all kind of know it's a better program than it's been in the last three years, so they're really working hard on being dealer friendly and getting inventories down, and putting the incentives where they make sense. I'm excited about it actually. There is a chance we'll have a decent year with Chrysler, better than we had in the past. And the new products are selling really well. The four door Jeep Wrangler, are you still there?

Yes, I am.

We had somebody stumble on a cord here.

I'm still here.

Chrysler right now is in as good a spot as we've had them in the last three years.

Ok. And lastly, Jeff, if we wanted to adjust our models for the hedge accounting issue for the fourth quarter of both years, what was the dollar amount for the fourth quarter of last year and this year and which line item should we adjust?

It is in the press release if you look at the bottom line there. It was a $0.01 hit this year and $0.02 gain last year. So, $0.03 swing year to year.

Which was the line item that we should adjust if we wanted to?

It is not done on a line item. It is done down in the shares.

Oh, in the shares, ok.

After net income.

Ok.

Just an override.

We showed more income in '05 than we would have had without the adjustment and we had less this year. And that's all just based on the value of those swaps.

Got you. Thanks a lot, guys.

Yep. Thanks, Scott.

Your next question comes from Rich Kwas of Wachovia.

Hi, good afternoon, guys.

Hi, nice to hear you.

Question, did you buy stock during the quarter?

I don't believe we ended up with any.

Ok. Do you still have what, approximately 800,000 shares remaining under the authorization? Is that right?

Yes, it is in that range.

Yes. Ok. And then on the Chrysler inventory, how do you compare versus their 18% model year '06 at the end of January?

Pretty close to the same.

Ok.

I'm not exactly sure. We're doing it day by day. There's nothing alarming there. We've got a lot of PT Cruisers and that was intentional. Because they have $3500 now dealer cash on them and they're way cheaper than the '07s and they're great buys, and we're using them to hit BPAs.

Then on the used market with the SUVs, SUVs have increased here over the last few months in terms of sales. What is -- what's being traded for the used SUVs? What's being brought in?

Mostly another SUV.

Ok. So you're not losing any of that potential inventory. People are not initially moving up to trucks away from cars.

We get quite a few minivans traded on SUVs because that's the deal. If you were raised in a family that had a minivan, you swore you would never buy one and so you still need something that will haul the three kids and their friends so you go buy an SUV and that's kind of the wave that is still there. I think the minivan segment may come back a lot. I know Chrysler's '08 minivan is a home run. They've got great new seating and the whole change of shape, what not. It will be easily the most dominant minivan.

Ok. All righty. Thanks so much.

Your next question comes from Rex Henderson of Raymond James.

Good afternoon. Thanks for taking my question. First of all, just a housekeeping issue. A unit same store sales for retail used, did you give that number or did I miss it?

For the quarter, Rex?

Yep, for the quarter.

It is 9,227.

What was the same store unit change?

Let's see. Last year, it was 9,815. Units. So that's a 6% decline.

6% decline in units.

Correct.

We sold a lot of people new '06s instead of a used car.

I'm sure you did. Second question goes to acquisitions. Do you have any -- a budget or a target for acquisition revenues, numbers of acquisitions or dollars spent on acquisitions in a typical year and for '07?

Yes, we have an objective between 10% and 15% but no one's held to that objective. We want to average that year in, year out. So, that's baked in and the cash flow and we know the amount we pay relative to that. We know how much cash it takes. It is all baked in.

10% to 12% of revenue, Rex. Our base revenue.

And then we'll have a net selling next year. We'll have a couple of stores sell so you've got to net it out against the sale.

Ok.

That's why the 10% to 12% works pretty well.

Ok. Secondly, on -- you mention the four door Jeep Wrangler as a car that is actually moving pretty well from Chrysler. Are there any other Chryslers that are doing well since so much of your business is in Chrysler, anything that's really moving right now in that?

We're seeing some light with a new Sebring and good movement on the Aspen, maybe people that would have bought a Durango and the Caliber is doing well. The new Jeep Liberty will be really good. The Grand Cherokee with diesel. That's going to be a home run. I mean there are spots, pieces of this thing that will keep working for Chrysler, particularly. But better than that, Chevrolet, the new Silverado truck is a home run. And now we've got a GMC, the new Acadia, in the Saturn line, the Aurora, we're selling almost all of those. And the new outlook. That's an exciting vehicle and a good line-up. New Scions in the Toyota store will be real popular.

Not a lot of gross in those but we sell a lot of accessories and we're building customer base and the new Tundra, I think when it faces off with the new Chevrolet, the Chevrolet may end up being ranked above it. They've done a hell of a job with that General Motors product. Toyota has a great truck. It will sell the production out. It will cost everyone a few units here and there but I think overall, there may be people that trade the smaller trucks in on the new Tundra.

Ok. And do you think -- what's your sense of what's driving all of this -- all of the truck sales? Are consumers immune to the gas prices now? And if gas prices went back up, do you have any feel for what would happen in that business?

No more than you would. I think in reality that people need these vehicles. I just mentioned the family with the SUVs or the minivans. That's a big segment. They're not going to go away. They're safer to drive. They're getting the fuel economy up on them. The new Acadia and the new Outlook is a 20 mile per gallon rating. I think the city one is almost as high. They've done a really good job. So, you get a lot of that going on and people are ok. If we can keep the fuel, in the $3 range and not get it up to $4, $4, we would have an impact again.

Ok. All right. That's it for me. Thank you very much.

Thanks, Rex.

Your next question comes from Kelly Dougherty of Calyon Securities.

Good afternoon, guys.

Hi, Kelly.

How are you? I'm just wondering if you have any intermediate or longer term brand mix targets that you hope to lower your domestic exposure to and then maybe also whether you think you can benefit from any of this talk about just domestic distribution network rationalization, particularly given your Chrysler exposure.

We do have long-term targets we would love to achieve about a 50/50 mix. There may be a change in what you count as an import. What's going to sell ten years from now? Do you know?

I wish I did.

Well, that's what we have to forecast because we're building a long-term business plan and we think any one of the six major brands is going to succeed in one form or another and it will be a shifting sand. Political elements may play in and soften the impact of Asian cars for awhile. That happened once before in my career. They were under fixed obligations. They could only sell so many. I don't know where it all goes when you see Chrysler announcing laying off 13,000 people, is there politics to that?

Is there enough balance when they built plants all over the United States that assemble cars, we think it is really important that any given market we have that we're willing to buy actually we include Hyundai in that now. So, one of seven major brands. We'll take them on. Once we fill about a 30%, 40% market share in that market, we're not taking anymore. So, if a Toyota store came up, where we've got Dodge, Nissan and Chevrolet, we probably won't buy Toyota. Do you follow me? The brand mix is what we're concerned about in our own each individual market. That's why I gave those numbers on the Idaho markets because as a retailer and if we got the best retailing methods and great customer centric processes, brands can come and go a little and we can still be successful.

So, I really think that's the best long-term strategy on this rather than say that geez, everybody is going to drive a Toyota and everybody is going to work for Google because that seems to be the common thread now in our society. And we just know those kind of things aren't true. There will be a balance of products sold over time. We're including Nissan, Toyota, Honda, and Hyundai in the Asian mix and we're including in the domestic Chrysler, Ford and G.M. and G.M. is largely Chevrolet for us because we're mostly in a regional market. Then you can layer in the luxuries. We'll do all of the luxuries we can in the bigger markets. That's where we want them. It is harder to make a profit in a stand-alone luxury store in a small town.

So, those are -- Des Moines is about as small as you want to get to. We bought one in Seaside last year. And we will buy those when we can see the return on investment and there are some of those that underperform, too and our model really looks at underperforming stores and tries to find those and then buy them based on what we can do with them. Because that's building something for the future and helps our manufacture partners and builds our credibility not only with investors but with those manufacturer partners that can limit our growth if we don't succeed.

Kelly, on the second part of your question, the rationalization and distribution, the domestics, that's a metro market phenomenon as we focus on small markets where the rationalization does not impact them. Over 80% of our stores are single point small market stores and there's no impact there.

We won't drop those stores. None are closing.

So for Lithia, that's not an issue. More so -- I won't talk about it. For others that have metro domestic stores.

Most of them are cleaning those up, Kelly. You saw our discontinued ops. It is two domestic stores in metro markets that are underperforming and we're not going to fight the battle. They're for sale.

Ok, great. So, do you think it would be fair to characterize when you're looking at your acquisition activity that geography rather than brand is the number one criteria for you guys?

Yes, it really is something that we have focused on and our success rate proves it to be a really true thing. I've got investors that come up to me, stick to your knitting and keep buying in the regional markets. You've got a niche and we don't have to overpay for them and a lot of those are underperforming and our methods will bring them up to higher standards so that's still the biggest opportunity for Lithia.

Ok, great.

In the metro markets, import and luxury.

Right. We've got a great BMW store in Seattle. We're building a new facility for them right now. I mean that's a home run for us. We're going to continue to find those when we can find them. They are fully priced right now. We do not believe they're going to go higher.

Ok. Thanks for that. Then, can you just give us a little more detail on some of assumptions that lie behind the 2007 guidance, what you're thinking for the sales level for new and used vehicles and maybe where you expect incentives to go particularly on the truck side?

We generally don't provide anymore guidance than what's in the press release on the conference call. So, you'll have to take from what we've given.

The incentive side, I've talked a little about, I think this is going to be a year where very specific brand aware incentives are logically going to be continued to be placed. There is $6500 on be a '06 Suburban and there are still a lot of them out there for sale so General Motors can't say they're not incentivizing any more. I think we'll see where there is a sluggish market, we'll see lots of dollars. We'll plan on a closeout on the Chrysler minivans. They'll have four months where they don't build them and they're dropping the short wheelbase. Those kind of initiatives, we do on a corporate-wide basis.

I mentioned the PT Cruiser initiative. We bought '06s. We did that last year with Cobalts in Chevrolets. We saw an opportunity to get a lot of production and improve market share with that model and that car, and we were very successful with marketing it. We'll do that with some Ford products. We continue to try to find the niches where is we can take advantage of where we know the customer incentives will be and where there is some growth opportunities in the markets we're in to sell that product.

Ok, great. Then finally, I'm wondering what -- you mentioned earlier the Silverado and the Tundra. I'm wondering what you think that impact may have on the Dodge ram.

Well, Dodge will have to have higher incentives until they get their new truck out. That will drive and maintain their share. I don't see any decline in share for their truck volume. That's a great truck and it is way cheaper than everyone else's when they put the money on it and they'll keep the money on it.

All right. Thanks very much, guys.

Thanks, Kelly.

Your last question comes from Jonathan Steinmetz of Morgan Stanley.

Thanks. Good afternoon, everyone.

Hi, Jonathan. You're still there. It is after 6:00.

We try here, Sid. Just a few questions, maybe first for Bryan. I know there are a lot of elements to this but on a very simplistic level, can you describe for us with all of the initiatives what I would be seeing differently if I'm a customer in your store as you get through all of them. The biggest impact and what you think if I'm a salesperson in your store, the biggest impact is. I'm trying to clarify what difference it is going to make in the process that's sort of visible.

Good question. I can run through a lot of that. The biggest thing that you're going to notice is the time frame goes from 3.5 hours to 2 hours. That's through a lot of those car deal process type initiatives. Now, before the customer comes in, there is obviously guarantees that we're going to be providing that are not typical guarantees of people selling vehicles against us. So, we're going to add some customer centric guarantees that put our money really where our mouth is. So, that's something that they're most definitely going to see. Now, also, when they are interacting with the sales staff, the sales staff will be more value-oriented rather than price-oriented. Obviously we'll be competitive on price but our focus is going to be on our employees building value and relationships with a customer. So, we're going to take a lot of the price element out of those negotiations through a clean and organized easy to understand and simple process for the customer.

Just a follow-up on that, I'm just trying to understand from that perspective of value versus price, what is it the salesperson would be doing differently or is there a change in how the deal gets negotiated? From the customer's perspective?

Absolutely. In the pricing model, we're substantiating with facts why the vehicle is priced as the vehicle is priced. So, we're going to be using other vendors such as Kell Blue Book or Edmunds or other marketing conditions to justify where the market is on the vehicle we're selling. Additionally, on the trade-in, we're going to have a type of self-appraisal process that also uses facts for the customers to evaluate their values on their trades. So, that -- the trade-in value is probably one of the most confusing things in the transaction and we've really trained our customers over the years to expect more than their vehicles are worth. So, we're going to be working on both of those elements to be able to have a consultive process with the salesperson and the customer where it is fact-based and it is -- it is disciplined and set up ahead of time with the customer so they can see what they can expect throughout the process.

Jonathan, Bryan hasn't said the word negotiation-free and obviously that's our long-term goal. We are going to execute that in L2 and we're also going to be able to sell cars on the Internet in L2 and all of those processes will migrate over to L1. Those are really long-term initiatives that are hard to change the cultures of existing stores. Our assured used process we talked about. We've told you what those steps are. They are unique. We do give a full three-day refund on the car and there's no questions asked. We give you your trade-in back on those stores that are assured used car stores and we give the 60-day warranty which we've always given, but we always had a deductible and there were a bunch of hooks in it. If anything is wrong with it, we fix it, free, period. That's a whole new way of going about that. So, we're going to layer some of those things into the new car side as well. We don't want to get promising things before we can actually get them in the stores. We would rather be talking about these more when they're in the stores, Jonathan. Than with what we're going to do and so a lot of this stuff, we've designed it. We know how to do it. We've tested it but man, it takes time.

We got to all be patient enough. It will be so customer centric that people will choose us and prefer to buy an automobile here. And it will be different. It is not what goes on in the average store today. We're already -- we put a lot of frosting on what we do and so we're really good at what the normal store in the world does but when we make these changes, where salespeople basically can get away from the negotiations as much as possible and really deal with the customer based on what they need and find them the right car and work the transaction around what we've already set up for them where they can save money without making them haggle or get involved in those kind of things that take forever.

So, that's really part of speeding it all up and making it clean and friendly. I don't want to overpromise here because it takes time and I think we may have said a little too much about some of these things. Bryan is being very cautious. He's put together a whole management team, the average age is probably 35 years old. It is a group of people that know how the use the Internet and know what a customer is thinking like today. It is going to change how Lithia does business and I'm excited about having a whole new group of people running this company at the store level.

Sid mentioned the technology piece. That's very important. With ADP technology and things that we've developed, first look, we have tools now that allow to value things and communicate with our customers and track things we didn't have before. You can't underestimate the strength of good technology that we've added in the last couple of years. We're really just starting to use it. That's really what allows us to do a lot of this plus changing our mindset. It is really important.

I appreciate the call. Let me throw two quick ones in here that are hopefully a lot shorter. Did you give a number I may have missed on the warranty business same store in the quarter?

Yes, we did.

We did.

A little over 2%.

I think it was about 2.7% down.

Also, I think I ma may have missed, what was the G.M. number that you were up. I thought it was very high.

35%.

Which vehicles were behind it if it was as high as I thought it was.

35% same store sales.

That's what I thought I heard. What was the cause of that?

It was across the board. A lot of these marketing strategies that we put together on stocking correctly and we didn't have the inventory issues with G.M. to the extent we did with Chrysler. We weren't clearing out '06s. We were able to market around our strategies. A lot of things we're working out in terms of ordering inventory are playing out on the G.M. side and they've got great, strong products. There's new stuff that people really want.

A lot of Silverado and had you mentioned stocking up on Cobalts, was that part of this?

Bryan, on the cobalt, were we in that period or was that earlier in the year? I don't think a lot of that was in this quarter. It was mostly truck. We also stocked the classic '06 Chevy. It is a great buy. We were selling quite a few of those. That's a lot of the increase. Our company is really good at finding strategic models that we know they will incentivize heavily that we put in stock in enough volume when we can get them because they usually close them out and we did that last year with Neons. We're doing them with PT Cruisers. I think on the Chevy line, we did it with the Classic Truck.

Thank you very much.

Yes.

Anything else, Jonathan?

He went away. Steven?

Yes, sir, that was the last call for today. I'll turn the floor back over to Sid DeBoer for closing remarks.

Thank you all for listening, and we will be available for any other questions, both Jeff and Dan are available in the morning. Thanks, bye. Or later this afternoon.