Lithia Motors Inc (LAD) 2008 Q4 法說會逐字稿

Good afternoon. My name is Lynn and I'll be your conference operator today. At this time, I would like to welcome everyone to the Lithia Motors year-end and fourth quarter 2008 earnings 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 session.

(Operator Instructions). Thank you.

Mr. Dan Werthaiser-Kent, Manager of Investor Relations, you may begin your conference.

Thank you, Lynn. Good morning, everyone, good afternoon, and welcome to Lithia Motors fourth quarter 2008 conference call. The Company, before we begin, wants you to know that this conference call includes forward-looking statements. These statements are necessarily subject to risks and uncertainties, and actual results could differ materially through certain risk factors. These risk factors are included in the Company's filings with the SEC.

And additionally, certain non-GAAP financial figures as defined by SEC regulations may also be discussed on this call. The Company provides reconciliation tables in filings with the SEC in order to compare those results to GAAP. On the call today, we have Sid DeBoer, Chairman and CEO of Lithia, Bryan DeBoer, our President and Chief Financial Officer, and Jeff DeBoer, our Chief Financial Officer. At the end of their remarks, we will open the call to questions. And with that, I'll turn the call over to Sid DeBoer. Sid?

Thank you, Dan. And thank you, everyone, for joining us. Good afternoon, or good morning wherever you are.

As you know, our fourth quarter net loss from continuing operations was $419,000 or $0.02 per share. This is compared to the prior year net loss from those same operations continuing of $409,000 or $0.02 per share. Because we had to restate last year's numbers, putting [disc ops] into those numbers so they were very comparable. And this was achieved and I hope you all realize that we had a lot less business and still made or lost the same amount in the two years. Despite the negative retail environment, Lithia showed marked improvement performance compared to the same period last year based on continuing ops.

In the fourth quarter, the Company realized a pretax benefit from early retirement of its convertible bonds of $3.6 million or $0.08 per share after tax. After adjusting for this item as shown in the financial tables on our press release, the net loss from continuing operations for the 2008 fourth quarter was $2 million or $0.10 per share. Consolidated net loss was $4.2 million or $0.21 after inclusion of a $0.09 per share operating loss and $0.10 per share of impairment on discontinued operations for the fourth quarter of '08.

After adjusting for impairment charges and other one-time items, net income from continuing operations for the full year 2008 was a profit of $3 million or $0.15 per diluted share. We outperformed our internal projections largely by cutting costs, right sizing our business to match the reduced sales volumes. This allowed us to report similar operating results over the same quarter last year, despite a markedly worse macro economy.

When we had our last earnings call in October, our economy has just entered into a credit market panic prompted by the collapse of Lehman Brothers which left the banking system reeling. We felt its impact almost overnight as financing options were really constrained and consumer confidence took a big hit. The already diminished $13.5 million saw a runrate plunged down further to a $10.5 million runrate within days.

Though consumer financing from GMAC and Chrysler Financial declined temporarily during the latter part of the quarter particularly, we were still able to find retail loans with other financial institutions, especially smaller community credit unions and selected banks that we have long-term relationships with. We still were able to arrange financing on 73% of the vehicles sold during the quarter. In the fourth quarter, our new car sales were off by 39% while total and used vehicle retail sales, new and used declined by approximately 50% according to [CNW] numbers. That's the research firm in [Vandon], Oregon.

It is important to point out a major flaw in [SAR] numbers. They are still a mix of fleet and retail. For instance, total reported Chrysler sales for one month in the quarter were down 55% while their retail sales were only off 35% as their fleet was down a whopping 81%. So we look hard at the retail number and have built our business model on succeeding at very low retail sales numbers going forward.

Lithia has responded then to these dramatic changes in the market with cost reductions that brought expenses in line with the softening sales, making December almost a breakeven month. Additionally, our marketing efforts are really beginning to bear more fruit. January's customer traffic was up approximately 11% across the Company over December; in contrast to what we hear about other nationally provided data. And our unit sales for January were higher actually than in December. Internet visits were still one of the highest since August of last year. And e-mail leads continue to grow with [their acts up] over 48% in January from December.

Lithia service and parts business and used sales business outperformed the new vehicle sales businesses. Though new and used vehicle same store sales were down 39% on new and 17% respectively on used, our service and parts sales remained relatively stable with only a slight decline of just 1.7%. Because of the overall mix shift of revenue to this higher margin business, service and parts, we saw our gross margin improve to over 19% compared to the historic level of around 16%, 17%.

Our new vehicle margins also increased to 8.4% in the fourth quarter. Our focus on gross profit at the sales level and enhanced manufacturing incentives contributed to this increase. Used vehicle margins are also finally beginning to stabilize and came in at 11.5% for the quarter and were trending up as the quarter ended with a 12.9% used vehicle margin in December.

We are pleased to report that we are in full compliance with our debt covenants. Our bank group is committed to continue working with Lithia as we have made progress paying off two-third of our outstanding debt to them over the past year. It's important to point out that our executive management group forfeited our earned bonus for the second year in a row. We still feel this is a prudent financial decision until our results show further improvement which we are confident of occurring in this year we're in currently. As we discussed last quarter, our Company's senior management team has experienced several prior recessions. Our history shows that you must adhere to cost reduction discipline, reducing debt, and focusing on satisfying customers. We can then emerge a much stronger company in tough times do make more muscle.

With that, I will turn the call over to Bryan, our President and Chief Operating Officer, to provide you with some more operational details. Bryan, before we forget, again I want to personally thank all the team members at Lithia who might be listening and all of our investors who have stood with us through these tough times, knowing that we are making the progress necessary to be again one of the best retailers in America of automobiles. Thanks, Sid. And again, welcome everyone. Let me get right to our cost reduction efforts which have begin our primary focus began in 2008. First, we have quickly brought variable costs in line with sales volumes. In addition, we have reduced expenses consistent with the sale or closure of multiple stores.

Lithia has also focused on fixed cost reductions. On our last conference call, we outlined approximately $33 million in total annualized fixed cost reductions. This number was up from our original goal that we set of $18 million in June of last year. With our dedicated teams, we have reached annualized cost reductions now totaling $43 million.

During 2008, only $15 million of the annualized $43 million are shown in our numbers. The greatest progress we have made has been in the areas of personnel, rent and vendor contract renegotiations. We have been able to preserve the positive sales environment and to mitigate adverse reactions to our cost reductions. It's very critical; it's difficult to do both. Analyzing each individual store has been instrumental to these achievements. This strategy continues to gain traction as we see store leadership, finding new ways of doing more with less time and time again. It's great to see that.

Now to our right sizing plans that we initiated back in June of last year as well. On our last call, we updated you with information on our 31 stores that we had selected for divestiture. This list is made up of stores that do not meet our return on investment criteria. We sold four more stores in the fourth quarter as well as in -- so far in 2009, we have divested another four stores; two of which were Chrysler, one Hyundai store, and our historically Toyota store in an over dealered market in California. This brings our divested total to 17 stores. Despite the difficult economic environment, there is still healthy demand for these dealerships from private dealers wanting to add to their local presence in our markets. With that, I'll turn things over to Jeff, our CFO, to provide you with the financial analysis information. Thanks, Bryan. Let's start with our current mix of states continuing operations. We have 11 states in continuing operations now, and this is all detailed in the press release. Even with our recent divestitures which Brian outlined, we remain regionally diversified. Texas continues to be the only state with over 25% of sales.

The states that held up the best this quarter were, in order, Alaska, Iowa, and Idaho. The four states in our same store mix showed the biggest (inaudible) were in Oregon, Nebraska, Washington, and Texas. Our domestic import mix for the quarter on a continuing operations unit basis was 53% domestic and 47% import; in contrast to the third quarter when it was 55%, 45%. We continue to make progress on our diversification efforts.

As of the end of December, our new vehicle inventories were approximately 36 days higher than our five-year historical average day supply. Our efforts to have these numbers back in line by the end of the year were derailed in the fourth quarter, once the retail sales rate plummeted. We are committed to reducing new inventories by ordering fewer vehicles and selling through what we have in stock. So far in 2009, we have made good progress on this front with our average day supply at the end of February only 22 days of higher than our historical average.

Our day supply for used vehicles at the end of the quarter was nine days above our five-year historical average for December. There had been a marked uptrend in wholesale values during January and February that many of you may have heard about, particularly for trucks which are actually starting to be in short supply. Our F&I for vehicles for the fourth quarter was $1086 PPR which is $42 lower per vehicle than in the fourth quarter of 2007. We had penetration rates for the financing of vehicles of 73%, service contracts, 42%, lifetime oil products, 29%. These figures have held up pretty well given the challenges facing the consumer in today's economy.

Our service and parts business continues to be a stable process center for Lithia, as Sid outlined earlier. In a vehicle sales environment which was down 39% for new and 17% for used, our service and parts business continues to remain relatively stable, declining only 1.7%. For the full-year, service and parts were down only 0.3%. Our customers are still servicing their cars.

Margins on service and parts are up 120 basis points in the fourth quarter. Warranty work accounts for approximately 20% of the Company's same store service and parts sales. Domestic brand warranty work increased almost 10% for the quarter and import luxury warranty work declined by 1% in the quarter. Sales in the customer paid service and parts business which represents the remaining 80% of this business were down 3.2% for the quarter.

New vehicle margins, as Sid mentioned, were up 80 basis points from the fourth quarter of last year to 8.4%. If you look further at the detail, the margin on new cars as opposed to trucks was up 210 basis points to 9.9% from 7.8% last year in the fourth quarter. Truck and SUV margins came in at 7.5% in the quarter, showing the stabilization in margins. You might remember, this margin went down to 6.3% in the third quarter of last year so we are seeing stabilization in our margins.

Used vehicle margins were down 100 basis points from fourth quarter last year to 11.5%. Though lower than our historical average, this is a display of great progress from last quarter's margin which were down to below 10%. We are seeing improvements in used car margins as Sid again outlined earlier. Our overall gross margin increased from 16.7% to over 19%, a 240 basis point jump from the fourth quarter of 2007, largely due to improving vehicle margins and the relative mix shift to our higher margin service and parts business. This is an important aspect of the auto retail model that investors should never forget.

On the debt and capital side of our business, we had positive cash flows from operations in 2008, $85 million, due largely to inventory reductions and positive trends in our receivables. We anticipate the further cost cutting and inventory reduction measures, as well as an income tax benefit, will continue to increase our cash flows from operations despite the current economic environment. The Company raised approximately $100 million in 2008 from internal sources. This is from the sale of stores, financing of real estate and the sale of development properties, and excludes construction loan financing projects which are a direct offset.

Proceeds from these activities went towards reducing the line of credit from $184 million at the start of the year to approximately $86 million at the end of the fourth quarter. We have completed the early repurchase of half of our convertible bonds that would have been due in May of 2009. These bonds were purchased at a discount and as mentioned, our remaining convertible debt balance is approximately $42.5 million. The discount recognized by our buyback in 2008 was a pretax gain of $5.2 million for the year, $3.6million of which was in the fourth quarter. Thus far in 2009, we have raised an additional $20 million through four store sales that Bryan had described earlier, and the financing of real estate, and the sale of another development property.

For the quarter, the total of [flooring] and other interest expense as a percentage of revenue was 2.4% which is 70 basis points higher than last year. For the quarter, we had an increase in flooring expense of approximately $89,000. This increase is largely due to our interest rate swaps. This activity increased flooring expense by $1.8 million. LIBOR interest rates being lower than last year contributed $1.7 million to to decrease and volumes had a positive impact of $28,000.

Including all fixed rate debt obligations and hedges, approximately 43% of our total debt is now at fixed rates. Including swaps, our average annual interest rate on all debt is 5.3%. Our long-term debt to total cap ratio, excluding real estate, is down to 29%.

Now I'd like to provide a breakdown of our non-flooring debt as of December 31, 2008. First of all, the convertible notes, $42.5 million, the line of credit, $86 million which today is down to $59 million, mortgages, $193 million of which $49 million is in liabilities held for sale. other debt of $22 million with $3 million in liabilities held for sale for a total of $344 million with $52 million in liabilities held for sale. Our nonfinancial CapEx for the full-year 2008 was $15.6 million. For 2009, our projected non-financable CapEx is between $5 million and $10 million dollars with further reductions expected. Consolidated free cash flow for 2008, defined as consolidated net income excluding noncash items plus depreciation and amortization and noncash stock based comp expense, minus non-financable CapEx, was a positive $2.6 million for 2008.

Our internal forecast for free cash flow in 2009, assuming a 10 to 11 million unit SAR, is between $20 million and $30 million of profit. That does not include any cash raised from the sale of stores or other assets, nor from the financing of assets. It's just our free cash flow on the same definition. Although SAR data is not entirely reliable as an indicator of retail sales, as Sid explained, it is still remains a benchmark for many in the industry. In order to address concerns over the SAR levels we may experience in the future, we feel it is necessary to point out that our internal projections show us able to breakeven below a 9 million unit SAR. These internal projections are based on the cost reduction levels we have attained and the margins we have been able to pull thus far in this recessionary environment.

Our current book value per share the $12.41 which does not include any appreciation of real estate value above our carrying value, nor does it include goodwill as it was all written up in the second quarter of 2008. Lithia has substantial positive tangible net worth. That concludes the presentation portion of the conference call and I'd like to open the floor to questions.

(Operator Instructions). We'll pause for a moment to compile the Q&A roster. Your first question comes from Rick Nelson of Stephens, Incorporated.

Thank you and good afternoon. Or good morning for you guys.

Hi, Rick.

Question for you on the expense cost of $43 million that you outlined. How much of that would you consider to be permanent expense reduction? And how much will come back with a natural improvement in the business? How much is variable?

100% of it is fixed and permanent. We did not count anything variable, such as interest rates or reductions in compensation of pay related to sales volume decreases or increases.

Got you. You had also mentioned that you were almost breakeven in December and the units have increased from there to December to January. Did you make comments about profitability in January?

We didn't in the call. But we indicated we would be profitable above a 9 million SAR and the industry hasn't been above that level so indications are good.

Okay. There's a lot of speculation out there about General Motors and Chrysler and potential for bankruptcy filings. I'm wondering how you think that would affect your business?

Yes, Rick. We've spent a lot of time analyzing that and there's actually a lot of good detail in the 10-K that will be filed today with a clean opinion. And it has good information that shows how Lithia will be able to withstand any such bankruptcy filing and be fine basically. Refer to that 10-K with a lot of good detail I think you'll find.

Thank you for that. Does it also discuss GMAC and Chrysler financial?

Yes. It includes the finance companies as well.

The strength in the used car business, I'm curious how sustainable do you thinks that is? And when does the consumer migrate back to the new car alternative, given the firming in prices on used cars?

Rick, I think that the used car business is here to stay for a period of time. We're seeing that our futures are really dictated about where we can get cars because everyone is starting to be able to sell down their inventory and then it's replacement. We spent a lot of time over the last 12 to 18 months looking at procurement opportunities that really went on a hiatus because we didn't have any reason to go get more used cars. Fortunately, our stores understand how to get those vehicles and we see that as a growth opportunity again in the future.

What is the used to new ratio -- do you think is in store for year ahead?

We've been tracking well above one to one, more used than new. That's been the trend. Right, Bryan? Yes. For both the first months, we're at 1.2 to one, used to new so about 20% more used vehicle sales than new vehicle sales. Rick, as you know, the dollar amount of gross profit per unit is about the same on new and use. The gross margin is normally higher on used. We're just laying in that flexible business state where we go with where the consumer is going. And we're going to keep inventories real low in both areas so that we can respond as it shifts back to new. We'll just take advantage of that and we'll get more trade-ins in then, and we'll have to manage that of course.

But there is a shortage now of particularly used trucks, and the prices are back and it's helping to sell new ultimately. Those things counter balance over time. The model does move back and forth and it needs to, and that's the flexibility of that business model that Jeff spoke about. Between parts and service and used cars, we are able to easily react to these recessions and get profitability back, regardless of the macro economics that have occurred. Certainly, none of us saw this of an extreme of a drop.

We were really do well coming out of the third quarter with 13.5 million SAR rate and then get hit with a drop of another 30%, 40%. Pretty tough to respond to, but we're there already again. Unless things get worse, we're tightened down. We're going to keep hunkering in. If new car sales come back, we'll take advantage of that. If the used car sales are still strong, we'll keep inventories lean and be able to respond to the demand that's there. One example, Rick, I think to point out is how dramatic the swings were from last spring and summer of valuations. Sid happens to have a [rare picking] the used -- odd jobs around the house. And he tried to sell it last year and got a price on it, and it was $13,000 wholesale book. He sold it -- what last month for around $20,000 for wholesale and I think they sold it to a customer for $24,000 or $25,000 even. In two days. It went down to $13,000 last summer, and right away, it's back to above $20,000.

The margins are obviously [terming in use]. Are the unit sales also -- are you seeing growth there?

What's happening -- we're seeing stabilization in our unit sales. The most important happening is that our average cost per vehicle sold on the used car side has dropped in the $2000 to $2500 per unit neighborhood. We're around a $14,000 average cost of used vehicles sold, which is a huge reduction year-over-year which obviously helps you in terms of cash because it's a lower cost inventory. But it also helps increase your margins over the long-term as well.

What about the benign opportunity in used compared to new, Bryan?

It continues. Some of the older cars are becoming a little bit more difficult to finance. But for some reason, they're still back filling the better finance companies that continue to come into play. Our national presence allows us to pinpoint those fairly quickly and then get the additional stores signed up across the organization and communicate where there's pockets of financability.

In general, how much are the new car sales decline do you think is attributable to a lack of credit and how much of it do you think is consumer fundamentals, employment and confidence, that sort of thing?

It's probably shifted. It was more the credit side for the first part of the quarter, and then it's solid. Credit has actually improved some. And now, we have the economics and people losing their jobs and worried about that. We're getting a tradeoff right now, Rick. It's both ways. That's a discussion we could all talk about. I'm not an economist beyond the training I had when I was in college. The numbers show, Chrysler Financial and GMAC , right back up in the top 500. They're active again. That's good to see. That's been in the last two months, that shifted

Are you optimistic about how, Sid, further falling the credit markets?

I think Bernanke last night was phenomenal. I think he said the right things, and we have to get the banking system solid. I'm concerned that they don't let them sell paper for credit below that AAA level. That credit market is still seized up.

They need to let that slip down to AA and some of the people that aren't quite perfect with that so our lenders can sell their paper into that secondary market again. It's freeing up, Rick. The banking system itself was in much worse shape than anybody knew. Bernanke and his crew, along with Paulson and now Geitner, are all responding in ways that didn't happen in the 1930s. And it's a great thing to see, knowing the history of our economics and this nation. Hopefully, mankind has learned how to mitigate these risks and do the right things at these times. And I believe we are.

Thank you and good luck.

Thanks, Rick. Thank you, Rick.

Your next question comes from Rex Henderson from Raymond James.

Good morning, and thanks for taking the call. I wanted to ask -- first of all, start on the debt covenants. I was doing my own calculation of your fixed coverage ratio and it improved very slightly. My calculation improved very slightly from the third quarter, but still pretty close. I was wondering where you stand on your fixed coverage ratio?

As we said in our press release, we're in compliance with all of covenants, comfortably. Actually -- the actual levels will be included with the 10-K that is being filed today. You'll have very good details about how much room there is. There is comfortable room on all our covenants for compliance. Like we said, our banker has been very willing to work with us on any necessary changes, given that we've made so much progress in paying them down.

Okay. On the parts and service business, you said that customer pay was down a bit. Can you give me some color on what the trends in that business are and why you think it was down? And why was warranty up so much?

Customer pay was down about 3% with the total being down about 2%. Warranty for domestic was up. We're certainly seeing consumer weakness. It's nothing like on the vehicle purchase side. Rex, the traffic coming into the store is down somewhat. When we actually have a customer there, the amount that they spend, believe it or not, is very similar to what it's been over the previous couple of years. We did see a little bit of hit in our traffic. However, our same store sales on an aggregate was down 1.7% in fixed operation which I believe is outperforming the market pretty considerably.

Okay. How about the warranty business? Why did that occur and is it sustainable? Will it continue for a couple quarters? Or is that just a one quarter phenomenon?

Domestic brands the last few years have been positive on warranty work. Imports have been negative. That's really just a continuation of the trends from the last few years. I don't think that's related to the economy or anything. It's more recalls and different things. Rick, as you know, our warranty business is only 20% of the total. And you can see that the drop in customer labor of 3% and an overall drop of 2%, the warranty increases marginally. I don't know if you could track why or how. There may have been a recall in one brand that created a bunch of claims or something on that order. We don't have -- We have a theory operationally. We believe that warranty is like prepaid maintenance. People and consumers are looking for ways that they don't have to pay for certain things. And a lot of times they might have deferred that. Even though it's under warranty, they don't think about it.

Now they're thinking about every possible dollar. We're actually trying to get into the consumers' minds that way by doing owner loyalty programs or mailers, as well as all of our past work. If a consumer comes in -- has some problems, we're getting back to them quicker. And that's how we're really able to stabilize that only 1.7% same store sales drop.

I would think that with the new vehicle sales down as much as they are, with some lag, probably a year or so, that warranty number starts to moderate over time. Is that fair?

That probably is a fair assumption that units and operations will be lower. And at some time point, they would stabilize.

How long is that lag? A year? 18 months before you start to see the lag between sales and warranty work?

I don't know, Rex. With the lifetime warranty now on Chrysler of seven years and General Motors, 100,000 miles, it all depends on the dependability of their vehicles and how far often we have to fix them. I don't think you can forecast a big drop in warranty sales that's going to impact anything in our numbers in terms of service and parts, same store sales growth because our customer labor will continue to grow. It's definitely a couple of years.

You said that 73% of vehicles sold were financed. Can you give me a basis of comparison? What was it a year ago or a couple of years ago when credit was easier?

It's generally in the 75% to 78% range. 5% maybe subprime and things may have dropped out.

Do you think you're losing sales on that? Or is it just still? Or has that stopped being the case in the last couple of months?

Rex, in October, November, we definitely believe we were losing sales, even back to September. The biggest impact there was the value of the person's trade-in. Their equity in the trade was so difficult to finance on top of that. Now their value on the trade-in over the last 90 days has come back about 8%, I believe is what [Contos] has said. It's helping us get deals financed again. We think we're through the worst of that.

Very good. Thank you for your time.

Your next question comes from [Chris Paul with Canelle Capital].

Thank you. A follow-up on capital structure. It sounded like the Company paid down the credit line a little bit more during the first quarter of 2009. Were any convertible notes purchased in 2009 to date? And maybe you could review the tradeoffs on the notes versus the credit line paydown. Finally, is the Company constrained in any way from further repurchases on the notes?

We raised $20 million further in the first quarter and paid down our credit line which is all that our credit agreements allow us to do at the current time.

Understood.

It's the highest cost debt we have, too.

Thank you.

Was there something else, Chris?

No, that's it. Thanks.

Okay. Thank you.

At this time, there are no further questions.

Thank you all for attending our conference call and paying attention to our company. And we certainly are. This is our life and we're going to continue to improve it, and fight these recessionary trends that we're in and find solutions as we've been doing for the last year. We look for a lot less stressful year and we look for progress as we're going forward. Thank you for your attendance.

This concludes today's conference. You may now disconnect.