Lithia Motors Inc (LAD) 2012 Q4 法說會逐字稿

Greetings, and welcome to the Lithia Motors fourth-quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions).

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John North. Thank you, sir. Please begin.

Thanks, and good morning. Welcome to Lithia Motors' fourth-quarter 2012 earnings conference call. Before we begin, the Company wants you to know that this conference call includes forward-looking statements. Forward-looking statements are not guarantees of future performance and our actual results of operations, financial condition and liquidity, and development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statement in this conference call. We urge you to carefully consider this information, and not place undue reliance on forward-looking statements. We undertake no duty to update our forward-looking statements including our earnings outlook, which are made as of the date of this release.

During this call, we may discuss certain non-GAAP items such as adjusted net income and diluted earnings per share from continuing operations, adjusted SG&A as a percentage of revenues and gross profit, and adjusted pretax margin. Non-GAAP measures do not have definitions under GAAP, and may be defined differently by and not comparable to similarly titled measures used by other companies. We caution you not to place undue reliance on such non-GAAP measures, but also to consider them with the most directly comparable GAAP measures. We believe the non-GAAP financial measures we present improve the transparency of our disclosures, provide a meaningful presentation of our results from core business operations. Because they exclude items not related to core business operations and other non-cash items and improve the trade-to-trade comparability of our results from core business operations. These presentations should not be considered an alternative to GAAP measures and a full reconciliation of these items are provided in the financial tables of today's press release.

We have also posted an updated investor presentation on our website, Lithia.com, highlighting our fourth-quarter results. Present on the call today are Bryan DeBoer, President and CEO, Chris Holzshu, Senior Vice President and Chief Financial Officer, and Sid DeBoer, Executive Chairman. At the end of our prepared remarks, we will open the call to questions. I am also available in my office after the call for any follow-up that you may have. It is now my pleasure to turn the call over to Bryan.

Thank you, John. Good morning. Today we reported record fourth-quarter adjusted income from continuing operations of $19.3 million compared to $12.7 million a year ago. We earned $0.74 per share in the fourth quarter compared to $0.48 per share last year, an increase of 54%. For the full year, adjusted income from continuing operations was $77.4 million or $2.96 per share compared to $52 million or $1.95 per share in 2011. This was also a record performance as we grew EPS by over 50% from the prior year. For the full year 2012, we grew total same-store revenues 23%. This was on top of same-store revenue increases of 22% in 2011 and 18% in 2010.

Most automotive analysts believe a multi-year recovery in auto sales remains ahead of us, and many of the western markets we do business in are still significantly below peak registration levels experienced in 2005 and 2006. Our store leaders continue to challenge their teams and remain driven to improve store performance in 2013 and beyond. All comparisons from this point forward will be presented on a same-store basis unless otherwise noted. In the fourth quarter, total sales were up 25% reflecting increases in all business lines. New vehicle sales increased 31%. On a unit basis, we sold approximately 14,200 new vehicles, an increase of 3,300 units or 30%, well above the national average of 10%. Our domestic sales increased 25% compared to 5% nationally, our import sales were up 41% compared to 14% nationally, and our luxury sales were up 24% compared to 18% nationally.

Used retail sales increased 20% in the quarter. We sold approximately 11,500 retail-used vehicles, resulting in the used-to-new ratio of 0.8 to 1. We sold a monthly average of 46 used vehicles per store in the seasonally lower fourth quarter of 2012, up from 40 used vehicles per store in 2011. We continue to target selling an average of 75 used vehicles per store. The key to our success in accomplishing this objective is to grow our core vehicle offerings, which increased 11% in the fourth quarter. In order to increase sales in this category of three to seven year old vehicles, we focus our stores to effectively source and procure inventory. This is an ongoing effort that will focus our attentions in 2013.

As we have more success in selling core vehicles, we will, in turn, generate more inventory in our value auto category through the trade-ins received on these sales. Success in core vehicles drives our performance in the rest of our used vehicle offerings. As new vehicle sales continue to recover, certified pre-owned vehicle sales continue to increase. This category grew 21% in the fourth quarter due primarily to normalization of late-model supply compared to the low levels experienced in the last several years. In the quarter, value autos or vehicles over 80,000 miles, performed well. This segment grew 38% year-over-year with a gross margin of 21%.

Our F&I per vehicle was $1,104 per unit. We arranged financing on 70% of the vehicles we sold. We sold 41% of the customers a service contract and 34% of our customers a lifetime oil product. Our service body and parts sales increased over 8% in the fourth quarter. Wholesale parts and body shops showed increases of 6% and 14%. Customer pay work increased 7%, which is the fourteenth consecutive quarter of same-store sales improvement. Warranty had a strong performance for the quarter, growing 11%.

Our gross profit per new vehicle retailed was $2,399 compared to $2,577 in the fourth quarter of 2011, a decrease of $178 per unit. Gross profit per used vehicle retailed was $2,465 compared to $2,334 in the fourth quarter of 2011, an increase of $131 per unit. We continue to grow unit sales volume, which allows us to take additional vehicles in on trade, provide financing, sell extended warranties and maintenance items, and increase units in operations that return for future service work. Additionally, our stores are focused on total gross profit dollars generated in each department, not just gross profit per unit, while increasing market share for new and used vehicle sales. Our gross profit on the same-store basis increased 21% over the prior year. Driving incremental gross profit dollars into the organization allows us to leverage our scale and gain efficiencies in operations. Much of this is due to effective cost control, which Chris will discuss in more detail in a few minutes. In the quarter, our overall gross margin was 15.8% compared to 16.2% in the same period last year. Increases in new and retail used vehicles sales outpaced our other business lines and explains the majority of the decline in overall margin.

The acquisition market is active, and we are optimistic that we can generate acquisition growth, in addition to the organic growth we are forecasting in 2013. It is important to note that over 90% of the dealerships in the United States are still privately owned, and that long-term consolidation remains in front of us. We seek exclusive domestic and import franchises in mid-sized rural markets and exclusive luxury franchises in metropolitan markets. In October, we acquired a Toyota store in Missoula, Montana, which -- with estimated annual revenues of $45 million. We also sold a Chrysler Jeep Dodge store and Hyundai store near Seattle, Washington in the fourth quarter. Our guidance has been updated to reflect these changes.

As we look ahead to 2013, I wanted to share with you some important milestones that we have developed as a road map for the future. Last year, we laid out three sequential milestones, each milestone grows our top-line revenue by 25% through a 10% to 15% increase in same-store sales and 10% to 15% growth through acquisitions. We believe that we can accomplish each of the 25% growth milestones in a one to three year timeframe to almost double our current revenue within a total timeline of three to nine years. These milestones are primarily dependent upon our success in continuing to develop additional talent in our stores and sufficient acquisition opportunities that meet our investment hurdle rates. When this revenue increase is coupled with the operating leverage in our model, the incremental EPS growth that is generated has the potential to drive significant increases in net income and EPS. We are excited by the challenge to reach each of these objectives, and look forward to updating you on our progress in future quarters. With that, I'll turn the call over to Chris, our CFO.

Thank you, Bryan. As we have discussed for several quarters, an important driver of recovery in auto sales is the expansion of consumer credit, particularly for lower-tiered customers. Lenders are committed to increasing their portfolio of automotive loans and are loosening their lending criteria to accomplish this objective. Of the vehicles we finance in the fourth quarter, 13% were to sub-prime customers, consistent with fourth quarter of 2011. The absolute number of contracts originated for sub-prime customers increased 26% year-over-year. We anticipate continued improvement in sub-prime credit trends as we look ahead to 2013. Over our entire customer base, the average credit score in the third quarter was 729.

As Bryan mentioned, we have challenged our store leadership to increase the absolute number of gross profit dollars produced. We also challenged them to retain as many of these dollars as possible through prudent cost control around the two largest areas of SG&A, personnel and advertising expense, which comprise 74% of the total for the full year of 2012. We accomplish effective expense management through consolidated information systems and a standardized reporting structure that allows Management at all levels to quickly see opportunities for improvement. For the full year, we reduced personal expense as a percentage of overall gross profit by 2% from 47% to 45%. In addition, we aggressively invest marketing dollars when prudent to increase individual lines of business. As a result, our advertising spend as a percentage of gross profit increased on a year-over-year basis. Our full-year same-store sales increased 23%, validating the investment we made to increase customer traffic.

In the quarter, SG&A as percentage of gross profit was 70%. Throughput or the percentage of each additional gross profit dollar over the prior year we retain after selling cost, adjusted to reflect same-store comparisons, was 53%. For the full year, SG&A as a percentage of gross profit was 69.4%, a record low. We have targeted SG&A as a percentage of gross profit below 70% on a full-year basis for several years, and have achieved this objective. Looking to the future, we believe SG&A as a percentage of gross profit will be in the high 60% range as sales increase. We continue to use incremental throughput as a way to measure our cost control efforts, and our target of 50% remains unchanged. Through the incremental throughput we maintain in 2012, and reduced interest cost and income tax expense, we have generated an adjusted net margin of 2.3% for the full year of 2012. This is an increase of 30 basis points over 2011 when our adjusted net margin was 2%.

During the fourth quarter, we increased the capacity on our syndicated credit facility by $150 million to $800 million in total availability. The facility allocates $575 million to new vehicle floor plan financing, $80 million to used vehicle floor plan financing and $145 million to our revolving line of credit and matures in April 2017. At the end of the quarter, we had $43 million in cash, $120 million available on our credit facilities, which brings our immediate liquidity to $163 million. Currently, $102 million of our operating real estate is unfinanced. These assets could provide up to an additional $77 million of liquidity in 60 to 90 days. This brings our total liquidity to $240 million and we remain comfortable with our overall level of available capital.

At December 31, excluding floor plan, we had $295 million total debt, of which $193 million is mortgage financing. In the quarter, we refinanced $17 million of mortgages, extending the maturities and fixing the interest rates. We also retired $1 million in higher-rate mortgage debt. As of today, 67% of our mortgages enjoy fixed rates and we have no mortgages maturing until 2016. Finally, we were in compliance with debt covenants at the end of the quarter.

Our free cash flow, as outlined in our investor presentation, was $34 million for the full year of 2012. Capital expenditures, which reduced this free cash flow figure, or $65 million for the full year of 2012. We estimate our 2013 CapEx will be approximately $55 million. This budget is based on new facilities, facility improvements in remodels, strategically exercising purchase options on lease facilities and other business development opportunities. We focus on the prudent allocation of capital, and believe a balanced strategy of acquisitions, internal investment, dividends and share repurchases is appropriate. Our first choice for capital deployment remains to grow through acquisitions and our internal investments. Regardless of category, all investment decisions are measured against strict ROE metrics and will be solid long term investments for Lithia's future.

In the fourth quarter, repurchased 25,000 shares at an average price of $31.98, and we have approximately 1.9 million shares remaining under our current repurchase authorization, and will look for opportunities to acquire our stock when appropriate. As of December 31, new vehicle inventories were at $563 million, or a day supply of 76 days, an increase of 14 days from a year ago. Our new inventory levels remain somewhat elevated as we ordered in advance of the build-out of certain truck models prior to the manufacture planned platform changes when production is halted and a normal supply of vehicles is not available. Used vehicle inventories were at $131 million or a day supply of 56 days; this is four days higher than our day supply level a year ago. We have increased our guidance for the first quarter of 2013 to $0.69 to $0.71 per share, and a full year 2013 guidance of $3.25 to $3.35 per share. For additional assumptions related to our earnings guidance, I refer you to today's press release at Lithia.com. This concludes our prepared remarks and we'd now like to open it for questions. Operator?

Thank you. We will now be conducting the question-and-answer session.

(Operator Instructions).

One moment, please, while we poll for questions. Thank you.

Our first question is from the line of Steve Dyer of Craig-Hallum. Please proceed with your question.

Thank you. Good morning, guys, and congratulations on more good results.

Morning, Steve.

Question on the new margins. They're at 7% or lower than anything I think I've seen, looking back here a couple of years. Was there anything -- and that's not specific to you, it seems like the other dealers saying similar things. Was that anything anomalous in the quarter, just in terms of promotional activity before year-end? Or is that just more of a new level here?

Steve, this is Bryan. Thanks for the question.

We don't see anything really different than what we typically see in the fourth quarter. You're usually more aggressive to clear out inventories at the end of the year, and it's pretty typical as it's normally been.

Okay. And then inventory levels overall -- it sounds like the implication being GM ahead of the K2 launch. Is that a pretty comfortable level, et cetera, that you guys have in inventory right now?

Yes, Steve, if you recall, we beefed up on inventory about three months ago at the end of the last quarter, and it was primarily in the Chevy half-tons, as well as the Dodge three-quarter-tons. If you recall, Chevy was -- their plants were down for, I believe, 5.5 months; so I think that those moves were a good decision. We are starting to see that inventory in Q1 start to clear out and move a little bit quicker; and we are starting to see some of the margins and stuff start to stabilize, which is what we were expecting.

Okay, and then a question on the acquisition environment. What are you seeing out there right now? Pricing, availability of different dealerships, relative to expectations?

Great, great question.

Because we actually -- we thought that there would be a little bit of a flurry at the end of last year; and it never really happened because prices seemed to be adjusted upwards, because they thought that they could at that time, because they thought that there was going to be a frenzy to some extent. However, I will say this -- after the start of the year, it's probably the most active acquisition environment that we have seen since we've been public.

However, a lot of the deals are priced, again, at higher numbers. Many of the sellers maybe even adjusted for the 5% or 8.8% increases that came through taxes. But we still believe because of the quantities there's probably an oversupply of deals. We'll be able to buy them at our pretty stringent ROE thresholds; it just may take us a little longer than what we expected. But it's very active.

Okay, great. I'll hop back in the queue. Thanks.

All right. Thanks, Steve.

Thank you. Our next question is coming from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Thanks. Good morning, everyone.

Can you talk about your SAR expectation for 2013, as well as the SAR in your particular markets? Because your geographic footprint is so different?

Yes. Hey, Ravi, this is Chris Holzshu.

I think that, generally speaking, from a SAR perspective, based on the feedback that we get nationally, we expect SAR to be between $15 million and $15.5 million in 2013. And as we've stated, our goal is to always outperform what happens in our markets. And as you know, each market in the US performs differently. And as we have stated, we have a lot of markets that are performing well below the recovery that we've seen at the national level; and we feel like that's an opportunity for us going forward to continue to see upside, especially in our Western state markets.

And do you see those markets catching up in 2013? Or do you think it takes longer than that]?

No, I think when you look at what we guided, we expect new car sales to be up about 12% in 2013. So generally speaking, SAR should be up around 5%. We want to outperform the market at 5%; so it's really hard to predict when those markets are going to pop, but right now we've baked in at 12% improvement in sales. And if the markets recover quicker, unemployment recovers faster, then we will see an improvement above our current guidance.

Ravi, this is Bryan again.

One additional quick thought -- we believe that we could have up to three years of these type of improvements before we actually see the full recovery in many of those markets.

Got it. (inaudible) -- out of there.

Can you comment on Chrysler performance in the quarter? I mean, what is the market reception like with products right now? And also, at their last earnings call, Chrysler announced that they were delaying a number of new products by a year or two, including the next Ram. So I was wondering what you thought of that? If you look at the combination of delays in products, as well as the expanded product range, do you think that's a net neutral for you?

Ravi, this is Bryan again.

We're pretty confident with the pipeline of vehicles coming from Chrysler. They did discuss a few push-backs, but right now, we're sitting pretty nicely with new products; we think that can carry us for the next few years. If you recall, our domestic sales were up 27%; Chris will give you the specific numbers. National was only up 5%; so in our markets -- in regional-sized markets -- the domestic sales, we're able to still take market share because of that impact with trucks and SUVs.

Chris, you want to give him the specifics on Chrysler?

Yes, you bet, Ravi.

When you look at the actual performance, our domestic sales in the quarter were up 27%, as Bryan said; import was up 43%; and our luxury brand was up 26%. So our domestic franchise actually didn't keep pace with our overall improvement in new car sales -- not that they didn't have a great quarter, but we saw some great performance in Toyota, which was up 46%; BMW, which was up 32%; Honda was up 48%; Subaru up 65%. And we've got a lot of successes in other franchises that we could talk about. Chrysler, specifically, was up 35% in the quarter.

Very good. And lastly, when you talk about the potential to double revenues in the next three to nine years, can you remind us again what the big moving parts are there? And is there going to be a ramp or is it going to be a steady trajectory to get to that point?

This is Bryan again, Ravi.

We believe that it can be pretty steady. The key components are basically broken down into three milestones; each milestone is broken into two different parts. One is organic growth, which we believe we can grow at a 10% to 15% over each milestone. If you look at what our current earnings are, we're saying that we will be up somewhere in the 8% to 9% in total revenues. That's a blend between new, used, and fixed operations, obviously, right?

The other part of the milestone is external, which means acquisitions; we believe we can find 10% to 15% acquisition growth. Now obviously, a typical acquisition may take between 12 and 24 months to get it ramped up to a typical Lithia-type of performance, so there is a little bit of lag on that part of the formula on each milestone. And those three milestones then compound to -- well, if you add them together, it's 75%. It's about 83%, almost double our current size, if we compound them.

That makes sense. Thank you very much.

Great, Ravi.

Our next question is from the line of Rick Nelson of Stephens and Company. Please proceed with your question.

Thank you. Good morning, and congratulations.

Hello, Rick.

Interested if you hit your earnings targets for 2013, where you see the free cash flow? And what sort of revenues do you think that would support via acquisition?

Yes, Rick, this is Chris.

On a free cash flow basis, in 2013, if we hit these numbers and also follow through with the CapEx that we lined out, we expect to be between $55 million and $60 million in free cash flow. And as far as acquisition growth off that number -- Bryan, I think you can answer that better, but I think it's $300 million to $700 million in revenue.

Right.

Just depending on the store, the franchise and the location.

And if you could comment on the pipeline, I guess I'm most interested in what you're seeing in the Eastern markets. I know you've got some new relationships with brokers there and --

That's a great question.

If you look back at that $300 million to $700 million, Rick -- real quick to finish up on the other question -- this is Bryan again. That is about double the rate that we need to grow at to reach each of our milestones, if you noticed, right? So we can use capital for other things if we choose to.

Now, in terms of the Eastern markets -- like we've mentioned before, we have strong activity with brokers; we spent some time in NADA with people and dealers that we weren't familiar with in the past, and had some good appointments at NADA. We believe that something in the next six months or so should occur in the East, because it is fertile for us because we've never really spent a lot of time there.

Now, I will say this. The East is obviously a growth opportunity, but the West, we're by no means saturated. I mean, we're only in about one-third of the markets that we want to be in, in the West; so I think you will see some Western markets that may even come in prior to that.

I got you. Thanks for that color.

Also interested in what you're seeing in terms of sales trends in early 2013?

We're right on target; it's definitely looking nice. Like the $15 million to $15.5 million SAR is going to take shape nicely; and we'll be able to put a lot of it to the bottom line in 2013.

So these payroll taxes don't appear to be having impact?

They have a slight impact, but with a SAR recovery of 7%, 8%, you're able to offset them. And obviously, our efforts in 50% throughput in reducing those SG&As, and looking for new opportunities and ways to find efficiencies and higher productivities in our teams -- I think that they can absorb those increases.

Got you. Thanks a lot and good luck.

Thanks, Rick.

Thanks, Rick.

Thank you. Our next question comes from the line of Simeon Gutman of Credit Suisse. Please proceed with your question.

Thanks, good morning. It's Simeon, and congratulations on the quarter and the year.

My first question is regarding throughput and efficiency. You have been closer among industry leading for awhile, and this quarter was no exception. And thinking about how you get better, do you think there's going to be more improvement coming from some of the best stores -- which I guess can only get marginally better -- or are you seeing it from some of the underperforming or lower-performing stores? And are you actually seeing that progress today?

Hey, Simeon, this is Chris. Good question.

I think it's a mix of both. When you look at the improvement that we saw in overall SG&A to gross on a year-over-year basis, a big piece of that came from our personnel cost. And the focus that we've had in making sure that any incremental add that we have in personnel is driven by the productivity that we see. And there's no new tools that we're trying to implement; this isn't a new strategy for us; this is the same strategy that we had back in 2007, 2008, 2009.

As we went through the recession, we used these tools to identify how many people we needed to minimize in each of our locations, and as we recover in each store, they're using the same tools to determine when it's safe to add back people. And I think that's key; and I think it's kind of a foundational tool that we have in our business that has allowed us to continue to leverage costs. So I think we're going to continue to see that opportunity there.

The other big improvement that we saw in a year-over-year basis was just our basic facility costs. As you know, dealerships carry a lot of real estate, and leveraging those costs is critical as we continue to recover and improve sales. There's no change in the number of times we turn on the lights; there's no change in, really, other than general increases that you see in property taxes. And so we saw about 100 basis-point improvement year over year in our overall facility cost that also led to that leverage. And all I can say is we expect that to continue. We are focused on that 50% throughput number on a same-store basis; and we're confident we can continue to deliver that over the long haul.

Simeon, this is Bryan.

I have one quick thing to add that will help you with your model. At a 10% top-line growth and 50% throughput, which is each of the milestones that we spoke to, correct? It's an approximate reduction in SG&A of approximately 200 basis points.

Got it.

So if you take the whole network of dealers, of locations -- as everything improves, I guess the threshold for what's underperforming probably changes as well. But do you find that the mix of stores that are below whatever threshold they should be earning -- is that decreasing, where maybe it's one-third of stores, or it is maybe 20% or 15% of stores today?

Yes, I mean -- this is Bryan again.

We have something called managing by thirds; but those buckets of thirds in the thresholds for performance have changed dramatically. I mean, I would say our bottom one-third of storage used to be, three or four years ago, more like what a middle-performing store was acceptable. Our bar of performance is increasing all over the place, and I think whether it's SG&A or whether it's top-line sales efficiency numbers, what we see is, there's a dramatic variance between top performance and bottom performance.

An example is -- we have stores in SG&A that are in the mid-50 percentile range. We also have stores that are in the high-80 percentile range, maybe even low-90 percentile range in certain quarters and months. So it's definitely variability; and I think that ability to manage each one of those thirds to improve each of them is our ability, and why we will be able to accomplish that 50% overall throughput, which will eventually continue to reduce SG&A.

Okay, and then a follow-up on gross margin. I think the full year came in about 7.3, the guidance midpoint just a tad beneath that. Is that more a reflection of the inflation that's expected on the ASP side? Or what is the embedded view on the pure gross profit dollar per vehicle within that margin outlook?

Simeon, this is Chris.

I think the key to look at there is twofold. One, our revenue growth up 31%; it's obvious that our stores are pushing for volume, which is something that we really believe in. I mean, we want new vehicle sales to grow so we get incremental opportunities with used vehicle trades; we get the opportunity in F&I; we develop relationships with customers that then funnel back into the service drive long term. And so the margin that we're seeing right now, we guided that it's sustainable into 2013. We're not concerned about it, especially when you look at the growth rates that we have seen in vehicle sales.

Okay, makes sense. Thanks, guys.

Our next question is from the line of James Albertine with Stifel Nicholas. Please proceed with your question.

Great, thanks for taking my question, and congratulations on another great quarter.

I wanted just to ask a higher-level question, dovetailing off of a prior question that was asked -- with respect to your markets underperforming, the broader US trajectory on SAR. Again, you got great sales performance on your new and used vehicle side; but also, I think it's worth noting again that your customer pay business, I think outperformed the rest of your peer group -- at least among the publics this quarter. So we're all grappling between discretionary and non-discretionary, demand and looking at different publics to try and extrapolate what's going on. What are you seeing in terms of driving new vehicle sales, but also driving the increase in customer pay work that you cited earlier?

Jamie, this is Bryan.

I think that what we're seeing that may be a little different is, our markets are definitely more depressed than much of the country. And our markets typically are not built off of the same type of disposable incomes that metropolitan areas are. So small dollars make big impacts pretty quickly in our size markets. So as our local SARs recover, we get to see the effects of that in a much more dramatic way; and I think the fact that our customer pay was up 7% -- which was a good number; we've had similar numbers to that -- but also, we're starting to see that our warranty was up.

We had our first quarter that our warranty was up 11% year over year. That's a huge difference for us, which means that our UIOs have finally stabilized and are trending back the right direction. Which is also good indications of what's coming next, which is additional customer pay -- because they spend their warranty dollars first, right; and then they eventually move more into heavy customer pay as their warranties start to deteriorate.

I think we're pleased, and because of that incremental change in the disposable incomes within our smaller, lower-income markets, as well as depressed markets, the small, incremental changes that are occurring make big changes to us and our service and parts wings. And I think eventually, it starts to bleed into our new vehicle and used vehicle wings, which we still haven't seen all of that take shape yet.

All right, I appreciate the additional color and detail there.

And looking at your slides, I think that's what you're alluding to -- the 41% mix of six-plus year-old vehicles, up from 36% last year. Is there a similar mix or breakdown that you can provide on the used retail side? The quality ABC or ABC-tier vehicles, as you see it?

Sure, we have that. So our mix on core vehicles -- which is our biggest segment, and that's what we really drive -- was 58% of our mix; and that's that three- to seven-year-old vehicle. And we say why -- we always look at that as our ability to differentiate ourselves from the competition, because that is all about finding the right cars and going in mining the cars that we've talked to before; and it often generates the trade-in for certified. Our certified was about 25% of our mix, and then our -- excuse me -- our value auto was about 17% of our mix, and our certified was 25% of our mix, which is a one- to three-year-old vehicle. The value auto is the trade that comes off the core product, excuse me.

The 58% core product -- it relates to what last year, same quarter?

Let's see here. Do we have that, Chris?

13% revenue growth on a year-over-year basis.

Okay, great. (multiple speakers).

That's all I needed.

Perfect, and then last question, just a housekeeping item -- the advertising expense increase year over year -- I apologize if I missed it in the prepared remarks.

That's okay.

I just wanted to understand what was going on behind there; and then I'll get back in queue. Thanks.

Advertising is one of our three major items in SG&A, obviously, right? We are seeing growth in advertising; it's not growing at the same rate as our top-line sales, so we are seeing a little bit of leverage. We still believe that as we get market saturation, which we are a long ways away from, that we are going to be able to retain some of those advertising costs. So it grew as well, but it didn't grow at the same rate as what our top-line sales grew at.

Great, thanks again, guys, and best of luck in the year ahead.

Thanks, Jamie.

Thanks, Jamie.

Our next question is coming from the line of Brett Hoselton of KeyBanc Capital Markets. Please proceed with your question.

Good morning, gentlemen.

Brett.

Good morning, Brett.

Let's see here -- acquisitions, maybe start off with that one. In 2011, you did $250 million; 2012, you did $260 million. You're talking about 10% to 15% of revenue, which seems to put you in that $325 million to $500 million?

Yes.

And so as I kind of look at all that, I'm thinking -- it seems reasonable to expect that you would be able to get in that $250 million to $500 million worth of acquisitions each year over the next two to three years. Is that unreasonable? How would you respond to that?

Brett, this is Bryan.

Hello, Bryan.

Yes, you nailed the numbers. We need to grow at a little bit bigger than we have the last couple of years.

Our previous history has shown that we've been able to grow at that $500 million, $600 million range; but remember, our ROE thresholds are extremely steep, okay? And we're not modifying those, which means we have to find a bigger pawn; that's why we're moving into the East, because we don't want to relax our ROE thresholds to find the right acquisitions. More importantly than that, the Lithia model is all about small to medium-sized markets, right? Now, in luxury, we will go into metropolitan areas; but we want franchise exclusivity, which means we have to expand our wings.

We think that, that $325 million to $500 million is very doable; and I think more importantly than that, we don't want to get acquisitions ahead of our ability to grow people. However, we currently are growing people at a rapid enough rate, we can fill all three of the milestones at the current trends that we're having in terms of growing our people. And I think there's a fine line between getting ahead of your people and then finding ROE; because even if the acquisition pipeline seemed to come through and we were able to do $700 million, $800 million, would we do that? It would be difficult if we didn't procure some of the teams that were in those stores, and I think that's the delineation.

If we find stores in the East that have good people and we're able to relate with and integrate into our team, it makes it a lot easier to grow at a faster rate, okay? But we're building the model that, no matter what happens with the existing people, our people can populate stores if necessary to be able to grow at that $325 million to $500 million.

Brett, this is Sid.

Hey, just to weigh in -- historically, we do find that we don't necessarily make it in one year and then another year. I mean, we'll get one once in a while that is way above the average for the year; and you're going to see that happen, I'm quite confident. Bryan and the acquisition team are so focused on finding the right mix of people and the right mix of brands, and finding that return on investment on an analytical basis -- way better than we used to be in terms of acquisitions.

So we don't want targets that have a deadline, we want to just average those things out. And I'm quite confident this team is going to perform on the acquisition side, as well as and probably a lot better, even, than we did in the past.

Okay, thank you.

The F&I -- in third quarter, you were at $1,100 and in the fourth quarter you were essentially at $1,100; your target for 2013 is $1,100. But in the prior two years, you have seen an improvement in your F&I of about $45 in '11 and $58 per unit in '12. So you are averaging an improvement of about $50 per year. You're below your peers in terms of F&I per unit.

And so all of that seems to point to conservativism in your $1,100 target. Is there some reason to believe that you're not going to be able to continue to improve your F&I?

Hey, Brad, this is Chris.

When you look at our guiding philosophy, what we tend to do is line out the current trends that we see, and look forward with those trends. And we know we have a lot of opportunity in F&I in a lot of stores, just like Bryan talked about. When we look at SG&A in our bottom one-third stores, we have a number of stores that are underperforming in F&I.

So, yes, it's a focus area for us. We are doing a lot of things, looking at different products and services we can offer in F&I to improve that number. It's a goal of ours, but our guidance is based on what we're seeing right now, today.

The one caveat I would say, when you compare to our peer group, just keep in mind that the value auto segment, which does make up 18% of our used car sales, has very low F&I penetration. It's just a lower-priced vehicle, generally basic transportation; and the F&I per unit on that product is about half of what it is on our core product and our new-car sales. So it does bring our average down; and again, it's all about gross profit dollars. So we believe the gross profit that we make on the front end and the back end on the value auto products still brings incremental gross to us, but it does make our F&I number look a little small. But we have opportunity, and we're going to continue to focus on it.

Fair enough. Thank you very much, gentlemen -- and very nice quarter.

Thank you, Brett.

Thank you, Brett.

Thank you. Our next question is from the line of Scott Stember with Sidoti & Company. Please proceed with your question.

Good morning.

Good morning, Scott.

Hey, Scott.

Yes, most of my questions have been answered. But could you talk about, on the parts and service side, the pretty sharp jump that we saw in warranty. What you're driving at, and are these trends sustainable for the future?

This is Bryan, Scott.

We believe that they are sustainable, and I think the main drivers when it comes to warranty is your units and operation; and we definitely troughed out and are heading back up. This is, again, it's the first quarter that we were positive, we're up 11%. And remember, the days this year and last year were exactly the same, so there is no anomalies that can happen quarter over quarter. So we think it's sustainable; we think, if anything, it will grow at a continued rate.

Great; and going over to some of the new products that are out there -- the Ram 1500 with the eight-speed transmission and six-cylinder engine -- that has begun to sell. What are you guys seeing on that, and can you just comment on that?

It's an exciting product; I mean, we're glad to have it. Consumers seem to be excited about it. It's definitely a little bit of a niche, but it gets the ability and gets the torque that's needed to be able to meet a lot of our customers' needs.

We think -- this is Sid, Scott.

We think there's lift, too, coming from that diesel in the half-ton; we're going to have the only ones for a while; and I don't know how many of those they can produce and (technical difficulty) -- that's going to be another winner.

Got you. That's all I have right now. Thank you.

Thank you, Scott.

Thanks, Scott.

Our next question is from the line of John Murphy with Bank of America. Please proceed with your question.

Good morning, guys. I just had a follow-up on this units in operation in the parts and service inflection. You know, you started year with 4%-plus; you finished with 8%-plus in the fourth quarter. You're talking about the units in operations really kind of turning a corner, which makes a lot of sense. But just curious -- your guidance is only for 5%-plus on parts and service. Is that purely conservatism in your outlook? Or is there something going on with units in operation we're kind of missing here?

Yes -- hey, John, it's Chris.

I will say, having a great quarter, up 11% in warranty was a big win for us. But after 14 quarters of negative comps, it's hard to bake that into what the full year is going to look like this early in 2013. So, yes, we believe there's opportunity for us, and the key is not only to continue to get those units in operation into warranty, but also retain the customer pay business. Which, as vehicles become more technologically advanced, they do make our locations a lot more appropriate for people to bring their vehicles to. And our belief is through -- just commodity sales, focusing on the service drive, new advertising that we're going to be able to not only retain the customer pay business, but also grow that warranty business with UIO.

Hey, just a little color, John. This is Bryan.

We did an evaluation on our service and parts departments a month or two ago. And what we saw was that our high performers had these huge retention rates on their units in operation and their customers; and it was reflected in their total gross profit within the stores. We had 60% of our stores that we felt had considerable opportunities, in the neighborhoods of 10%, 20%, 30% top-line growth, that they had the ability to attract and re-attract customers that they hadn't seen in the past.

So despite the fact that we're starting to see a 4% increase and then a 6% increase in overall service business, and now 8% -- we believe that there's still a lot more there despite the fact that the warranty has been a little weak. We're starting to see nice trends in all areas of the business.

John, this is Sid.

There's a lot more recall activity than there ever was, as well; which we benefit from immensely.

Yes, yes.

There's a real sensitivity to be sure you recall your cars. Toyota learned a real lesson, just doing them quietly. And then so that's driving volume on warranty, as well.

That's very helpful.

When you think about the attach rate of holding a consumer for a longer period of time, maybe up to seven, eight, nine years in this parts and service space, have you done any studies as to what's the proclivity or likelihood is that, that consumer then comes back to buy another used car or new car to you? Because holding onto the consumer, as you guys know, through the life cycle of ownership, whether it be new or used, is really the ultimate key to the model.

Just trying to understand if you hold onto them longer, what the greater propensity is for them to come back to your store to buy a newer used vehicle, or a new vehicle?

John, there's two points there. This is Bryan again.

What we do know is that our ability to increase the speed and improve the value of the customer's experience within our service lanes has increased the average car that comes into our lane by just over a year. I think it's about 14, 15 months.

We weren't in those businesses pre-recessionary times, so we're definitely going to be able to keep those customers for a longer period. The conversion rate to used vehicles or new vehicle sales happens at all different times through the life cycle; and I would agree 100% with what you said, that the propensity for them, when you have the ability to see them more often and to develop relationships, you then have the ability to convert them. I don't have specifics with us on what those conversion rates are, but I got to think that it's part of why our core product sales are improving in used; and why our new vehicle sales continue to take greater market share.

Got you.

And then one question on the financing. You said that your terms were sort of easing in general, but you did mention that you had 13% penetration in sub-prime in the fourth quarter of '12, which was equal to fourth quarter of '11. So I'm just curious what else you're seeing in the financing of your customers that it is actually really easing. And if that is coming from the captive finance subs, or you're seeing third-party lenders, as well, dive into the equation?

Yes, John, this is Chris.

I think it's a little bit of everything that you said. One, we're seeing more lenders that are entering into that sub-prime space again. They realize that there's a high return rate in loaning money to sub-prime customers, because your vehicle is what you tend to pay first before all your other bills. I don't think that was proven pre-recession; and so we're seeing a lot more entrants come in that market.

With that said, at 13%, we still feel like there's a lot of opportunity for that sub-prime business to recover. We think more normalized levels should be 18% to 20%, which mean that we have another lift in vehicle sales of 5% to 7%. So I think there's still opportunity there. We're going to continue to push to get as many lenders as we can into our stores in that space. But we're definitely seeing things move in the right direction.

I think the one comp that we didn't see -- that we looked at in Q4, was that our sub-prime growth was up 26% and our total sales growth was up 30%. So it didn't keep pace with what we saw new vehicle sales; but that was generally due to the strong fourth quarter we had with luxury brands and import brands. I don't think it's a big anomaly, but something that we want to continue to see recover in 2013.

Yes, that's a very high-class problem to have with having, up 30% and up 26%. (laughter)

Last question just on the Chrysler incentives. Obviously, there's a lot of scuttlebutt about stair-step programs in the last, really, two years; and it sounds like some of that has eased. I'm just curious what you're seeing from them specifically. Have those stair steps really eased? And what are they replacing it with? And are they still very aggressive in the market? I'm just trying to understand what they're doing on their incentive schemes now.

John, this is Bryan.

I mean, they are aggressive numbers, but it also keeps us focused on volume; and I think it's an important thing in retail that you are always trying to improve and living our value of continuous improvement. The numbers that they gave us for the first quarter were pretty steep. I mean, they had to be better than the previous year? Is that correct?

Better than the previous year; and something else to get to the highest level. And we were coming off some pretty strong years, but somehow we seemed to be able to find customers and be able to conquest sales from the other domestics and imports to be able to achieve this. We're challenged by them.

John, this is Sid again.

Hey, I'm on that National Dealer Council with Chrysler, so privy to their planning and what they are trying to do with those stair-step programs. And more than 93% of the dealers hit the big money in January; and they did pick up market share and they're willing to spend money to get market share.

I don't know if you heard Michael Jackson at the NADA Conference talk about somebody asking -- well, you know, stair-step things are really bad; NADA just got a big push on it. He said the problem is, they work. And so as a growing company that's taking market share, we can benefit from stair steps. A guy that's asleep and is not doing well, he gets hurt by it; so we want to be on the front of all of that. And I'm not going to be a voice and say they're great, but I think as a whole, Lithia benefits from stair-step programs.

And then maybe just one other follow-up to that stair-step question. It sounded like coming out of NADA, and some of the scuttlebutt around NADA, was that the stair step programs were not just being tied to -- or the dealer incentives were not necessarily being tied to just pure volumes; that there was also facility enhancement in CSI scores and other stuff that was a little bit less focused on volume and more focused on just becoming a better partner to Chrysler and the auto makers in general.

Is that something that you're seeing, that you're getting some more support if you are investing more in facilities?

John, this is Bryan again.

There's no question that over the last two years, manufacturers have tied some of their incentives to facility improvements. We are, as a company, pretty much through them even though we have allocated -- we're finishing up a few of the Chevrolet projects; we have a couple of small Chrysler projects; and there's a couple small manufacturers that are still coming down the pipe. But I think, ultimately what we like is a lot of scuttlebutt over stair-step incentives, because then they go back, and they're negative with their own dealerships and manufacturers change them.

And the fact that we're hitting most of our stair steps and planning on growing them and looking at it as positive opportunities to get more income, that we don't mind them being negative about it. But we think that they're okay for the industry. And like Sid said, they do work.

John, this is Sid again.

Chrysler has no incentive money related to CSI or store improvements. They killed all of that programs (multiple speakers) -- we lost revenue from that. I mean, that was a decent incentive program that they took away. So they're not going back to that, at least that's the plan currently. I happen to be on the subcommittee related to that, and they're not going to put money on it.

General Motors has something on their EBE program that does require you to improve your facilities, and you do earn money from that. So it's basically, though, a payback for the expense of improving the facility. So I don't think there's any trend that's going to be coming on stair steps except volume growth.

Great, that's very helpful. Thanks a lot, guys.

Thank you, John.

Thanks, John.

Our next question is from the line of Bret Jordan of BB&T Capital Markets. Please proceed with your question.

Good morning.

Most have been asked, but a couple, just sort of follow-up here on the service question. I think you had stated that your used car buyer is usually retained as a service customer for 14 to 15 months. Was that -- did I get that correctly?

No. Our -- what's happened -- this is Bryan, Bret.

Our service customers -- because we now sell windshield wipers, we sell value parts, which are less expensive than certain OEMs, and we provide a broader offering of services -- our average service customer is retained in our service department for 14 to 15 months longer than it was pre-recession.

Okay. How long are you retaining your used-car buyer as a service customer, assuming his vehicle is off warranty and he's opting between you and independent pricers. How sticky is that business in customer pay?

Let me try and answer that differently. When you look at our F&I performance, both for new and used vehicles, we have penetration rates on our service contract sales and our lifetime oil program -- which is a prepaid maintenance program over the ownership cycle of the vehicle -- about blended average of about 40%. That's a very important product for us to keep customers coming back into our service drives during the ownership cycle. And we have proven that, whether you attach one or both of those products to the vehicle sale, that you're going to see those customers several times throughout the ownership life cycle.

So the exact number is hard to give you, but I can tell you that we're focused on making sure that up front on the vehicle sale, we push products that help us retain customers on the service drive. Because we know that when they're in the service drive getting their vehicles repaired, that they're probably out on the lot looking at new vehicles, and that's very important to us.

Brett, this is Bryan again.

It's fair to say, also, when you have -- this is now our third year in a row of 20% approximate top-line growth. Those are big numbers, and our ability to retain customers is such an extremely higher rate of what it used to be. The 8% that we had in same-store sales growth and service and parts, we believe, is the start of this ability to attract and retain; and I think, your question on used vehicles and our ability to attach them into service and parts, I think it primarily is brand-dependent

Obviously, if you're selling a certified car, you're selling a late model or a mid-year, three- to seven-year-old of the same product you sell new, you're going to keep that customer at a 50%, 60% rate. Which is very similar to what it would be on new, right? But when it comes to op products, if you're a domestic store and you have imports, we can keep 20% to 30% of those with the right type of presentation initially with the customer. Introductions into the service lanes, what we call service walk-throughs, and the ability to get to know and start that relationship by providing this lifetime oil type of thing.

And remember, we have exclusive franchises in most of our markets, right? That ability on those products means that we're the only place, when you're doing your maintenance, within a 40, 50 mile radius; and people don't drive that far to typically spend $100, $200, $300 on maintenance.

Okay, great, and then one last question.

I think you said your average credit score is 729 on the quarter. How does that compare to, say, a pre-recession credit score? It seems like credit is freeing up here; but just put it in perspective.

Yes, I think that's still a little bit higher. As we focus on continuing to try and get the sub-prime customer back into our stores, you're going to see that number come down. I don't think it's drastically different; I think the swing in credit scores pre-recession has been 50 points; so I'm more interested in looking at each segment individually and looking at the opportunities. And I can tell you that the sub-prime customer is still an opportunity for us today.

Great, thanks a lot.

Our next question comes from the line of David Whiston of Morningstar. Please proceed with your question.

Good morning, guys.

Hey, David.

Just two questions, one on value autos and one on trucks. On value autos -- I think, Bryan, you said gross margin was 21%; and can you just remind me what it was a couple years ago when that program started? I remember it being lower back then.

No, that's similar. It's typically an $8,000, $9,000, $10,000 car, so you make your typical $2,000, right? And then you get to the 20% to 25% gross margin. It's a great business.

Yes, definitely.

On the GM trucks -- I guess, one, can you share any feedback that you've been getting from consumers in terms of, are they really excited or really not excited about the 2014s? And then how would that sentiment impact your ability to draw down the 2013 inventory you have?

David, this is Bryan again.

I think as a retailer, no matter what the product is, our stores are excited about it and they're going to get consumers excited about it. But the truth be told, on the General Motors product, the consumers are excited about it; it's very muscular looking; they're responsive to it; the new interiors are incredible. It seems to be moving out the doors, and we're hearing things that are positive elements about that truck. So I think it's going to work out well, especially once we get some real volume in there.

Okay, thanks.

Our next question is from the line of Jordan Hymowitz of Philadelphia Financial. Please proceed with your question.

Hello guys; thanks for taking my question.

Jordan, welcome back.

Thank you. You mentioned the used to new ratio, which is always very good for you guys, and highlighted that again. A couple of the other retailers this quarter have kind of poo-pooed that ratio a little bit. Do you think that ratio is becoming less important? Or do you just think you're doing it better?

This is Bryan.

It's a relevant ratio. It is dependent a little bit on new car volume, and obviously, we were at 0.8 to 1, which is below our 1 to 1 expectation. But when you get spikes in new vehicles that are higher than your used vehicles, you're going to have anomalies in that. So more importantly to us, is our ability to get to that 75 units per site, okay? We sold about 46 in a -- excuse me -- low quarter, we were running at about mid-50s in the third quarter. So we believe that, that's a more important sign of our ability to capture market share, is just looking at a pure number of 75 units per site. And we think we can accomplish that in the near term.

Jordan, this is Sid.

In using that reference, it does demonstrate the opportunity. And I think that's why we want to measure it and track it, because we have stores that have the potential to do three used cars for every new, including the one Bryan used to run. So I just don't want to take a focus off of that huge opportunity to take share in the used car market. It doesn't cost us hardly any overhead. We get great leverage out of it. And so it's critical that this Company focus on it, never poo-poo it; because we're on our way to being better at used cars than we even are today.

But I guess -- to strengthen what you're saying, is that, even if the ratio is not where it is today because new car sales are spiking, that's the opportunity, because when new car sales stabilize at the higher level, then the used cars will catch up, and if you --

Absolutely.

-- and if the eye is taken off that ball, then it will never catch up.

You got it, Jordan. That's exactly right.

Jordan, this is Sid again.

It's really easy for a store manager to relax on the used-car side because he's doing really well on new and hitting store performance expectations. But he's missing something. And so we just keep hammering on it.

Okay, thank you.

Thanks, Jordan.

Thank you.

There are no further questions at this time. I would like to turn the floor back to Management for closing comments.

Thank you, everyone. We look forward to speaking again in April.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.