Lithia Motors Inc (LAD) 2013 Q2 法說會逐字稿

Greetings and welcome to the Lithia Motors second-quarter 2013 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 for this conference, Mr. John North. Thank you, Mr. North. You may begin.

Thanks and good morning. Welcome to Lithia Motors' second-quarter 2013 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, liquidity, and development of the industries in which we operate may differ materially from those made and/or suggested by the forward-looking statements 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, 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 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 improve the period-to-period comparability of our results from non-core -- from core business operations.

These presentations should not be considered an alternative to GAAP measures. A full reconciliation of these non-GAAP items is provided in the financial tables in today's press release. We have also posted an updated investor presentation on our website, LithiaInvestorRelations.com, highlighting our second-quarter results.

Presenting the call today are Bryan DeBoer, President and CEO; Chris Holzshu, Senior Vice President and CFO; and Sid DeBoer, Executive Chairman. At the end of our prepared remarks, we will open the call to questions. And I am also available in my office after the call for any follow-up questions.

It is now my pleasure to turn the call over to Bryan.

Thank you, John. Good morning.

Today, we reported second-quarter adjusted net income from continuing operations of $27.4 million, compared to $19.4 million a year ago. We earned $1.05 per share in the second quarter, compared to $0.74 per share last year, for an increase of 42%.

All comparisons from this point forward will be on a same-store basis, unless otherwise noted.

In the second quarter, total sales were up 17%, reflecting increases in all business lines. New vehicle sales increased 19%. On a unit basis, we sold approximately 16,200 new vehicles, an increase of 2,200 units, or 16%, which was above the national average of 9%.

Our domestic sales increased 14%, compared to 10% nationally. Our import sales were up 20%, compared to 7% nationally, and our luxury sales were up 16%, compared to 6% nationally.

Retail used vehicle sales increased 19% in the quarter. We sold approximately 13,500 retail used vehicles, resulting in a used-to-new ratio of 0.8 to 1. We sold a monthly average of 54 used vehicles per store, up from 47 units in 2012. We continue to target selling an average of 75 used vehicles per store.

Our performance improved in all three used vehicle categories in the second quarter. Certified pre-owned continued the momentum from the first quarter, growing 39%. Core product, or vehicles three to seven years old, increased 8% in the quarter. Finally, value autos, or vehicles over 80,000 miles, increased 30% in the second quarter.

For the last few quarters, we have pointed out our ability to increase core vehicle sales. This remains our biggest unrealized opportunity across the Company. The recovery in new vehicle sales, coupled with increasing numbers of lease returns, have eased supply within certified pre-owned inventories. Also, the growth in new and used vehicle sales has been a key source of value auto sales.

However, core product is the hardest inventory to source and procure, especially due to the drop in vehicle production in 2009, 2010, and 2011, which reduced the pool of available vehicles in this category. Our store leaders continue to emphasize the importance of strengthening this area of the business and will work to improve our results in the future.

Our F&I per vehicle was $1,098 per unit. Of the 29,700 vehicles we sold in the quarter, we arranged financing on 73%, sold a service contract on 42%, and sold a lifetime oil product of 37%. Our penetration rates in the service contract and lifetime oil sales increased 150 and 120 basis points, respectively.

Our service, body, and parts sales increased 7% over the second quarter of 2012, on top of last year's 7% increase over the second quarter of 2011. Customer pay work increased 5%, which is the 16th consecutive quarter of improvement. Warranty was strong in the quarter, growing 19%. This is the third consecutive quarter where we have seen an increase in warranty work. Wholesale parts increased 6% and body shop increased 3%.

Despite the growth that we have experienced over the last two years in this business line, our stores still have capacity within their service departments to handle additional work. Our stall utilization rate was under 50% in the quarter, without contemplating the ability to extend our work hours or shifts.

Our gross profit per new vehicle retailed was $2,257, compared to $2,403 in the second quarter of 2012, for a decrease of $146 per unit. Import margins decreased 120 basis points, domestic margins decreased 20 basis points, and luxury fell 80 basis points.

Gross profit per used vehicle retailed was $2,757, compared to $2,659 in the second quarter of 2012, for an increase of $88 per unit.

Our stores continue to push a volume-based strategy that has resulted in lower gross profit per new vehicle sold. As we have previously discussed, the decline in margin from the prior year reduced gross profit by $3.3 million, but the increase in new vehicle sales added $6.3 million in gross profit, for a net increase of $3 million. Additionally, increasing the number of units we sell provides more opportunities for additional extended warranties and maintenance plans, generates more trade-ins to drive our used car business, and increases units and operations that would return for future service work.

In the quarter, our stores increased gross profit 14% over the prior year. Driving incremental gross profit dollars into the organization allows us to leverage our scale and gain efficiencies in operations.

On a GAAP basis, our overall gross margin was 15.8%, compared to 16.3% in the same period last year. Increases in new and retail used vehicle sales continue to outpace 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 purchase stores, 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 markets and exclusive luxury franchises in metropolitan markets.

Last month, we purchased three stores in Salem, Oregon, with estimated annual revenues of $110 million. This brings total new locations added in 2013 to four, including the MINI store we added in Anchorage, Alaska, earlier this year.

We remain focused on achieving the three milestones for long-term growth laid out in 2012, which doubles our sales in three to nine years. Each milestone grows our topline revenue by 25%, through a 10% to 15% increase in same-store sales and a 10% to 15% growth through acquisitions. We believe that we are on track to achieve the first milestone in 2013, on the shorter side of the one- to three-year timeframe we have targeted for each objective.

As always, this growth is dependent on the success in attracting and developing departmental and store leadership and sufficient acquisition opportunities that meet our investment hurdle rates.

With that, I will turn the call over to Chris, our CFO.

Thank you, Bryan.

Our record markets still remained depressed in terms of vehicle sales compared to national results and have not recovered off of historical levels. Using 2006 USR of 16.6 million units as a base, if 2013 full-year USR comes in at 15.3 million units, approximately 8% growth remains to return to the 2006 level.

However, our markets within Washington, Oregon, California, Idaho, Nevada, and New Mexico, which represent over 50% of our revenue, trail this national recovery. Based off registration data through April of this year, these markets would need to recover an additional 22% to return to their pre-recession levels. While some of our other markets have already recovered to 2006 levels, it is apparent there is still recovery ahead in many of the markets we operate in.

Of the vehicles we financed in the second quarter, 11% were to subprime customers, consistent with the second quarter of 2012. The absolute number of contracts originated for subprime customers increased 13% year over year, slightly lower than the total number of customers financed, which was up 16%. We believe that subprime credit availability is improving. The increase in the number of subprime customers we finance in the future will increase as employment recovers in our communities and lenders continue to loosen lending criteria.

We continue to focus on leveraging our expense structure off of an increasing revenue base. In the quarter, adjusted SG&A as a percentage of gross profit was 66%, a reduction of 330 basis points from the second quarter of 2012. Throughput, or the percentage of each additional gross profit dollar over the prior year we retain after selling costs and adjusted to reflect same-store comparisons, was 57%.

We emphasized prudent cost control around the two largest areas of SG&A expense, personnel and advertising, which comprise 76% of the total in the quarter. We improved leverage on our personnel expense, lowering it as a percentage of overall gross profit by 130 basis points from 45.5% to 44.2%.

We continue to invest in reaching our customers to drive traffic to our stores. In the quarter, we increased our advertising spend as a percentage of gross profit by 30 basis points from 5.8% to 6.1%.

Additionally, as we increase sales volumes across our store base, we gain more leverage on our facility costs. This quarter, we achieved additional leverage on the fixed expense base, lowering it by 100 basis points to 6.3%. We prefer to own our property as it allows for greater flexibility and lower ownership costs over time, and estimate we own over 80% of our real estate on a valuation basis.

As sales increase, we believe SG&A as a percentage of gross profit can remain in the upper 60% range. We continue to use incremental throughput as a way to measure our cost control effort, and our target of 50% remains unchanged.

At the end of the quarter, we had $20 million in cash and $91 million available on our credit facility. Currently, $164 million of our operating real estate is unfinanced. These assets could provide up to an additional $123 million of liquidity in 60 to 90 days. This brings our total liquidity to $234 million, and we remain comfortable with our overall level of available capital.

At June 30, excluding new vehicle floor plan financing, we had $301 million in debt, of which $168 million is for mortgage financing. We have no mortgages maturing until 2016. We have no high-yield bonds or convertible notes outstanding. We were in compliance with all our debt covenants at the end of the quarter.

Given recent volatility with interest rates, I wanted to discuss our exposure to a rising rate environment. Nearly 80% of our mortgage debt is fixed. We hedged $25 million of floor plan expense, as several of our interest rate swaps expired earlier this year. Our last remaining swap matures in 2016, and we do not currently plan on entering into any new swaps.

We estimate for each full percentage point increase in LIBOR that our annual pretax interest expense would increase by approximately $6 million. This assumes no change in inventory days supply or incremental sales.

As of June 30, new vehicle inventories were at 598 million, or a days supply of 76 days, an increase of two days from a year ago. Our new inventory levels remain somewhat elevated due to the platform changeover of certain truck models. Used vehicle inventories were at 154 million, or a days supply of 51 days. This is one day lower than our days supply level a year ago.

Our free cash flow, as outlined in our investor presentation, was $15 million for the second quarter of 2013. Capital expenditures, which reduced this free cash flow figure, were $16 million for the quarter. We estimate our 2013 CapEx will be approximately $55 million. This budget is based on new facilities, facility improvements and remodels, strategically exercising purchase options on leased facilities, and other business development opportunities. Based on this CapEx estimate and our full-year guidance, our 2013 free cash flow is estimated to be $81 million.

We focus on the prudent allocation of capital and believe a balanced strategy of acquisitions, internal investment, dividends, and share repurchase is appropriate. Our first choice for capital deployment remains to grow through acquisition and internal investment. Regardless of category, all investment decisions are measured against strict ROE metrics and will be solid long-term investments for Lithia's future.

We are providing guidance for the third quarter of 2013 of $1.06 to $1.08 per share, and raising our full-year 2013 guidance to $3.80 to $3.85 per share. For additional assumptions related to our earnings guidance, I would refer you to today's press release at LithiaInvestorRelations.com.

This concludes our prepared remarks. We would now like to open the call to questions. Operator?

(Operator Instructions). Ravi Shanker, Morgan Stanley.

So you said that one of the areas you guys can probably do a little bit better is in the late model used sales. What are the steps or what levers do you think you can pull there, and what kind of ultimate goals or targets do you have to get that -- to get the sales up there?

Ravi, this is Bryan. The biggest area of opportunity is the three- to seven-year-old vehicles, which we call core vehicles, which are driven primarily off of procurement of vehicles.

So the biggest thing that we work on when we are in the stores, and our general managers and used vehicle managers are focused on, is opening up the five basic channels of how do you procure cars -- make sure that we are paying enough to our customers when we take them in on trade, obviously; working with auctions to be able to procure and whether it's online or in the lanes; working with other dealers; working with wholesalers; and then buying cars off the street. And I think we have wonderful reporting that allows us to look deeply into where we procure cars and where we divest cars to make sure that each and every store has those channels open.

Is it more of a training thing or a process thing?

I believe it is more of a training. It is DNA in your people that understand and are accepting of the risk that it takes to go and find cars.

Because as a new car dealer, it is very easy to get into the mode that trade-ins are the easiest thing, and you don't necessarily have to pay full market value because you, to some extent, have a captive customer. So you get lax in terms of what you have to really do to be able to buy cars, and I think that mentality and that DNA is rebuilding in our organization. And we are challenging our teams each and every day to be able to accept a little more risk to go deeper into the market and find the right cars that sell quickly.

Understood. On SG&A, I think you said in the past that you'd be looking to settle in the mid-60s eventually. You are already there at this point. So do you think you can do better and get into the low 60s or do you think you are going to be pretty stable at these levels?

Hey, Ravi, this is Chris. I think the mid-60s is an objective that we would like to achieve for the full year before we kind of start committing to something lower than that.

We are doing the things that are necessary to continue to drive down our leverage with people, with facility costs. Obviously the opportunity that we have in advertising, which, as a percentage of SG&A, went up, but when you are seeing same-store sales comps of 19%, I think that is a trade-off that we are willing to make.

So I think at this point in time, we are going to stay committed on the high 60s, but there is nothing that right now we don't believe we can get down below mid-60s longer term.

So then, just finally, are you seeing any signs of the acquisitions market opening up a little bit or valuations coming down a little bit?

Ravi, this is Bryan again. The acquisition market, there is a flood of deals out there, but again, like you mentioned, they are a little pricey. But the good thing is there is enough deals that they are starting to come into reality, and the longer time goes on, the more we are able to come to agreements with our sellers.

So we are pretty confident that the pipeline is full enough that a lot of those deals will come to be.

Very good. Thank you very much.

Thanks, Ravi.

Simeon Gutman, Credit Suisse.

Thanks. Good morning. First on gross profit per vehicle, the comment made about trading a little bit of volume for margin, which makes sense, and I think the business overall is doing really well, especially if you look at the used side. But I am curious about down the road, what type of precedent this sets for gross profit per vehicle. Because if you look over time, it doesn't look like within each class of vehicle they go back up.

And so, how do you think about that? Do we have precedent for gross profit per vehicle even going up over time after a period of compression? And down the road, when we eventually level out in SAR and some of your markets come back, does that mean that the gross profit just keeps moderating from that point on?

Simeon, this is Bryan. I think the way that we look at the operations in the vehicle department is primarily based off total growth and our ability to gain productivity and throughput in that department.

And what we find, and I think we will see that in a recovering market or even in a stable market as well, is that deal average, to some extent, drives some of that. And you are seeing margin degeneration in the new vehicle side, but it is offset by the benefit in F&I, in used vehicles, and obviously service and parts.

In fact, our deal average, if you look deeper into the financials, was $3,621 this year and it was $3,598. That includes both new and used. So we were up $23, and as long as we can control our expenses at that, it's a win-win situation and we are able to maintain that plus-50% throughput, which is really what we are striving for.

Now, I would say in a stabilized market, where you are not aggressively going after market share, you're really protecting market share, to some extent, in that environment I believe that as long as product is rejuvenating, meaning that they are continuing to find new safety, new sustainability, new efficiencies in cars, then you should be able to still maintain or grow margin, even in a stabilized market.

Okay. And then on stair-steps, because it was mentioned by a competitor or peer company, would you characterize the environment as very different year over year where you just -- you had a lot of stair-step in the market the year before, a little bit easier numbers to achieve, and then this year-- or even progressively, it's just going to keep getting harder because the manufacturers see that the volumes are good, that the dealers are doing well, and therefore there doesn't -- the thresholds to achieve could just be ratcheted up over time.

Simeon, it's Bryan again. We are not that concerned about stair-step programs. There's only a few manufacturers that really do them.

No matter what happens with stair-steps, they have to set goals that are realistic and are played by all dealers. So as long as we are able to perform at a higher level than our competitors, stair-steps are good for us. And we are not really that concerned about it. What it does is continue to focus us on improvements, which is really how our people are built in our organization. So we are pretty comfortable with it.

Okay. And then, last question on parts and service, the gross margins have been improving now for a couple quarters. Can you talk about the drivers there?

Yes. I think the biggest driver there is the ability to get new faces through the door and retain customers a longer period of time is improving in our stores.

I don't want to sit here and pound our chests because I still believe that many of our stores are not to the level of satisfaction or listening to our customers to be able to achieve greatness in those departments. But most of the drivers are coming through -- again, good cycle times, meeting our customers' needs by having value-priced items, as well as good OEM parts, and, most importantly, getting them in and out of the doors as quickly as we possibly can. And I think the better our people are listening to our customers and then meeting those specific needs, the better we seem to do.

And I think a 7% topline in our 16th, I believe -- was it 16 consecutive quarters? -- of customer pay growth, now our units and operations is starting to come back that's kind of troughed out. We are excited to be able to pull those levers of how to really meet our new customers' demand.

So would you said that the margin per service -- oil changes, tires, whatever -- that is basically constant, it's just your ability to drive either penetration or just more older cars even in that system (multiple speakers)

Simeon, maybe to be a little more specific, it's primarily warranty and parts mix shift that has helped that as well. Now the topline growth, obviously, is going to come from the things I talk about.

Okay. Thanks. And good quarter.

Thanks, Simeon.

Rick Nelson, Stephens.

Thanks. Good morning. And congrats on a nice quarter.

Hi, Rick. Thanks.

In the service and parts, we saw a big jump. And warranty this quarter is up. Recall activity driving that?

It was primarily recall activity in BMW. And Honda a little bit as well.

Got you. And do you think that sort of growth, Bryan, can be sustained? Or was it more of a Q2 issue?

I think pushing into those double-digit numbers is probably a little bit of an anomaly. But I do think believe that the recall activity is growing. It seems like the national transportation board is continuing to find new opportunities for us to service our cars and get our customers back.

So we still look at that as a very likely positive number. I don't know that it can sustain at those types of numbers again.

Yes. Hey, Rick. This is Chris. I think just to add onto that, the one benefit that we have as a tailwind right now is that a lot of manufacturers are moving towards the maintenance plan that comes with the new vehicle purchase. So right now, BMW and Toyota are big on their two first -- including the service -- Toyota two years and BMW, what was it?

Four.

Four years. GM just announced that they are also going to offer a two-year maintenance plan as well on all their 2014s. So that's going to be a real benefit for us on the warranty side.

But more importantly, just getting that customer retention back into our store and continuing that customer lifecycle throughout that ownership period. So that's something that we are looking forward to as well.

Got you. Bryan, wondering if you can update us on the acquisition opportunity you are seeing in the eastern states. I know you are working with brokers in that part of the country.

Absolutely. If you recall on previous, we've discussed that we are really looking for a group with some talented people or opportunities that have really high ROEs for us.

Both of those things need to be met, so we are still continuing out there. We believe that we will still find something, but obviously, it's a little easier if our people are close by, like the Salem acquisition or even a couple others that we kind of have in the hopper right now, where we have people ready to go or we know the existing market a little bit better or the existing people within the store where it makes it a little easier to integrate.

So again, if we are looking at the East, we need to have, obviously, the ability to find and attract some people that have some of the same DNA of what we really look for, which is that personal ownership and, more importantly than that, continuous improvement.

Got you. And if I could ask you, too, about the CFPB and if you are seeing any impact to date from the lenders (multiple speakers)

Yes. Hey, Rick. This is Chris. So year to date, we have actually had one lender in our entire portfolio that did, I think, 10 deals for us year to date that actually went from a reserve method to a flat method.

But I think what we are seeing as the CFPB and the lenders are digging into the transaction, they realized that the benefit that the dealer provides as an intermediary in the transaction is both good for the lender and it's good for the customer. And so, I think what we are seeing is just reinforcing the value that we provide both sides of the equation. And the feedback that I'm getting, especially from our preferred lenders, which do about 75% of our deals, is they don't anticipate any changes coming down the pipeline.

I also just want to point out that when you look at the percentage of our deals that actually pay off reserve, it's only about 50% of our transactions. So half our transactions are already on a flat fee basis, and so that remaining 50%, the rate spread that we hold is about 75 bps overall, between both the flat and the reserve. So I think it's 175 bps for the reserve transactions. And we don't anticipate seeing a big change in that moving forward, at this point in time.

Sounds good. Thanks a lot and good luck.

Thanks, Rick.

John Murphy, Bank of America.

Good morning. This is Elizabeth Lane, on for John. On F&I, you have been grossing about $1,100 per vehicle for the last few quarters, and some of your peers are grossing around $1,200 or even up to $1,300. Is there room for improvement on that F&I per vehicle, or is the lower gross a function of your customer mix or other fundamental differences between Lithia and other public dealers?

Elizabeth, this is Chris. I'd say, yes, there is definitely opportunity. I mean, like all the business lines that we have, we continue to focus our attention on the bottom-third performers.

But I think one of the anomalies that we are seeing is as we continue to increase our penetration on our value auto sales, they bring a lower PBR and F&I than our mainline product. And so, yes, there is opportunity, but I think some of the push that we have had in some of the segments of the business have also helped us lag our peers a little bit. But it is a focus area for us and we are going to continue to work on it.

Okay. That makes sense. Thanks very much.

Scott Stemper, Sidoti & Company.

Good morning.

Hi, Scott.

Could you guys maybe just talk about units in operation? I know you touched that you are starting to see a stabilization there and maybe a little bit of a jump. Can you maybe talk about how much of that possibly is leading to increased volume for warranty or for customer pay business, and what the outlook there would be for next year?

Yes, Scott, this is Bryan. I think when you look at units in operations, we look at it in a couple different ways that can drive business.

Obviously, the most obvious and what we really focus on is, what does it do to our service and parts regular customers, the retention rate of what we are able to continue with our customers? And I think that's what really troughed out late last year. It is starting to build again, so we are going to get some natural attrition in customer pay and warranty work from that.

The other big driver is, as we spoke to a little bit, is it provides those certified vehicles where our UIOs are starting to grow, so that two-, three-year-old vehicles now are not -- are coming off those troughs as a -- what was it? A $10.8 million SAR? So those years are now -- that $10.8 million a year SAR is now sitting at what we call the core used vehicles, which is making it harder to find those cars, but as we move into a $12 million SAR year and that moves into the core bucket, that helps us a lot.

Now, obviously, units in operations is key, but I think we are starting to find is that even though we are gaining some exposure in units in operations, the biggest thing that we are gaining is these new areas of business that we never played in, which is really value auto, as well as commodity service and parts business, are segments that we never did really pre-recessionary. And now, when the market comes back, we get the benefits of all those things and that's going to come through in that unit in operation impact.

Scott, just to point you -- this is Chris. Just to point you to slide 20 in our investor presentation, we do show the average number of vehicles serviced per month, and that is up about 5% year over year.

So the key for us is to continue not only to see those units in operation from the increase in sales come into warranty, but, as Bryan pointed out, retain those older vehicles, that six years and older bucket as well. And I think what we need to continue to monitor is that we just get more vehicles into our shops into the future. And that's where we are focused.

Got you. And on the body shop side, we saw a little bit of a slowdown here in the second quarter from previous growth rates. Is that weather related or anything else going on there?

It is slightly weather related.

I think the primary reason is we had a body shop manager in one of our larger shops in Texas that ended up opening up his own body shop, and that shop went down about 30%. And it made a big impact and brought the whole average down. So we have rebuilt that shop, got a new leader in place, and it is starting to help.

Okay. Got you. And just last question, maybe you can just anecdotally talk about what you guys are seeing on the new and used front in July so far?

Looks on track.

Got you. That's all I got. Thank you.

Thanks, Scott.

Brett Hoselton, KeyBanc.

I was wondering about used cars. And so, you are doing 54 per dealer today. You've got a target of 75. You've talked about some of the things that you are trying to implement. I guess my question is if you were to say, here are the one or two major things that we are looking to change to get to that 75 unit target, what would those be?

And then, secondly, do you have any sense as to the timeframe to achieve that target? Is that kind of a five-year target, one-year target? I mean, any thoughts as to the timeframe.

Yes. Brett, this is Bryan. We haven't really set a date, but we would look out a couple years and be able to do that.

The single biggest driver is getting people in the store that understand that. We probably still have over half our stores with teams in place that, one, either built their business off of new vehicles and have focused on gaining market share in new. And they have tendencies to forget about used.

The second really being back to that procurement. They are not confident in buying the cars and they really believe that if they have to pay a higher amount for a car, rather than take it in on trade, that they can't take the margin and they won't be able to accomplish their goals. And that mind block -- when you pay people the majority off of net profit, they are very nervous about wholesale losses and the downstream effect of buying a car that is more expensive than their trade-in and the effects of the wholesale loss, okay? And that mindset takes time to be able to build.

And if you recall, back in 2004, 2005, 2006, we took a lot of the expertise in our used vehicles out of our Company and we were centralizing used vehicles. We did some things that damaged that DNA and I think we are still feeling that.

What we know is that the facilities, the locations, and the abilities within those stores have the abilities to get to that 75 used cars in today's market. So that's even without a recovery of another 10%, 15%, 20% to be able to accomplish that.

So I think that driver in getting through to those -- to our individuals and convincing them that they need to be a little more risk acceptant is the biggest road barrier that we have, and we are out there every day helping them understand and changing how our policies are to hopefully help open their eyes up to be a little bit riskier on buying used vehicles.

When you think about the changes associated with that risk acceptance, are those changes potentially in compensation or are they changes just in terms of stated performance standards, acceptable losses, those types of things?

Yes. I think you are touching on a couple different things and I think you are right. It's not always just one thing.

The compensation probably isn't the biggest driver because if it was, they would be doing it because they would be increasing their pay. They don't get that. They believe that by buying more used cars, it's going to cost them money. They fundamentally don't understand how you pay $1,000 more than a trade-in to go buy a car, when ultimately their pricing may be off the market. They are actually pricing cars more than what they take them in on trade, rather than what true market is. They maybe have sales people that aren't selling the full value. They may have competitors within the market that are affecting things. There's all kinds of different things that come into that play, and each of those needs to move in synchronicity to be able to accomplish that.

And that's why it's not as easy as going and changing compensation plans, looking at your merchandising on the lot, and just going and buying cars. When you buy the cars, you have to make sure that your customers understand now that you are stocking another level of car. You have to make sure that your salespeople have the ability to sell those cars. And probably most importantly, your management staff has to believe in the cars they are buying and buy the right cars.

And I think that's what we find a lot of times is when we go into stores, we say, why don't you try a Subaru Outback? Why don't you try a Chevy extra cab pickup? So on and so on. And they say, well, we have tried that. And then we go look at the numbers and the vehicle that they actually tried, and we find out that it's a late-model vehicle of two or three years old and it may be a $26,000 late-model Chevrolet pickup, and they need to try a $15,000 Chevrolet pickup and it will sell quickly.

And they are making the job on their customer and their sales people so hard by buying the wrong car. And that's why I say this is an expertise. It's not something that you can quickly go in and change. In fact, when we look back at how I operated my used car lot, it took us two or three years to get to that 3-to-1 used-to-new ratio that we were selling. And it came through confidence of your sales staff, consumers, lot merchandising, pricing, and a whole bunch of different factors.

Chris, wanted to talk about throughput -- gross profit throughput. Your target at 50%, if we were to kind of extend that on into infinitum, that would suggest that your 66% SG&A as a percentage of gross profit could eventually go down to 50%, let's say. But that's probably unrealistic. I guess my question is, what are the natural impediments that will start to, let's say, prevent you from maybe bringing that 66% down even lower?

Yes, Brett. So let me first start with the 50% SG&A to gross comment. Really, we could never get to an SG&A to gross of 50%, just because of the fixed costs that we have in the stores. So what our goal is is for each incremental gross profit dollar that we are generating today, to bring that 50% down to EBITDA. And that is something that we are going to continue to sustain.

The opportunity that we have is just each individual store. I mean, we have stores right now that are doing SG&A to gross in the low 60s. But we also have stores that are doing SG&A to gross in the 80s. And our job is to continue to focus on those stores in the 80s and the high 70s, the mid-70s, and work with them to identify where those opportunities are, and, more importantly, have them work on those opportunities.

And I think that's the success that we are seeing, is that this isn't really a corporate initiative that's driven by four or five people at our headquarters. It's the understanding of our stores. It's indoctrinated into our culture that people are going to continue to figure out ways to get leverage in their facilities and with their people and with their advertising, and by doing that, we can continue to drive that number down. But it takes a lot of effort and a lot of time.

Brett, one additional piece of information. We talked in the script about the milestones. We have disclosed in the past that each level of the milestones reduces our SG&A percentage by 200 basis points. And we started at just around -- just a little bit under 70% and we are on track to accomplish that. So that can give you some insight into where we believe we can drive leverage in throughput.

Brett, this is Sid. Just to add color from historically watching expense ratios, and the volume that is produced is a trade-off that you are going to make. There is some bottom that you cut expenses and you lose volume. I mean, you've got to find that balance.

And in a static market historically, anything under 70% was terrific in the private dealer world. So this growth gives us this leverage as we grow from where we are. And if we can continue to take market share with volume improvements, even without the market improving, then we can continue to drive it lower. But in a static market, anything under 70% is terrific. And if you get too low, you may miss volume.

Yes, Brett, just to add onto that. I mean, our goal when we go in and talk to our stores is not about cost cutting. It's about cost optimization.

And whether it is increasing our advertising or increasing our headcount in certain positions, you need to manage that based on the factors that are impacting each store. And so, we don't look at this as a cost-cutting measure. We look at it as cost optimization, and I think that's what's going to help us drive those numbers down long term.

Okay. And then, finally, on the capital allocation front, you stated that your preference would be acquisitions and so forth. But obviously in the past, you have done some share repurchase. Kind of at what point, if the deal market maybe isn't necessarily as robust, at what point do you start to look at your capital and say, you know what? Let's look at allocating some more capital to share repurchase because the acquisitions just aren't available.

Yes, hey, Brett. Chris again. We have a 10b5-1 in place all the time that when we see a dislocation in our stock price or we see the opportunity to step in and buy shares that we feel like are attractive, just like an acquisition, we will do that. And so, we don't have any stated goals or objectives, but there is nothing that's going to prevent us from stepping in and buying our stock back into the future.

Thank you very much, gentlemen.

Bret Jordan, BB&T Capital Markets.

Good morning. A couple quick questions, and one, I guess, I'd like to look at new vehicle margins. Did any regions or particular product lines change from a promotional level much in the quarter? Have trucks become more promotional, or is it still sort of [midline] import that are leading the charge?

No. It's pretty static, still. Not a lot of changes. There is no anomalies happening in any region.

Okay. And then, I guess if you look at the service and the commodity parts and service, ex the warranty, which the independents don't compete in, if you look regionally, how do your numbers stack up against regional growth? Are you seeing yourself gaining share with mid single-digit growth?

Brett, this is Bryan. I think when we look at commodity and the ability to track and retain a customer longer, we are really talking about the Jiffy Lubes, not the warranteed.

So it's more what do we do for batteries; what we do for oil changes, timing belt, brakes, that simple service that keeps us front and center in the customer's mind and repetitive.

What we are seeing in terms of our markets is we are running at about 10% better retention rates than the industry. And that's information given to us by our manufacturers, and it's called units in operation retention rates. So we typically run in the mid to high 50% range, where the industry is more in the 45% to 50% range.

Okay. And how do you see yourself in collision? I guess the collision was up three. Do you have a feeling for what your general regional collision market looked like?

I think it still looks positive. And like I mentioned, that one Texas market, we went down in that one shop and it took a pretty big cut out of our department, but we are rebuilding that.

We had have had 16 consecutive quarters of positive comps in body shop sales, despite it only being three this quarter.

I got it. All right. Thank you.

James Albertine, Stifel Nicolaus.

Great. Thanks for taking the question, and good morning, guys. If I could just kind of follow up on a line of thought here that seems to -- was in your prepared comments and also in the Q&A. Lots of opportunities to go, notwithstanding the tremendous gross profit throughput that you had in the quarter. When you are thinking about organic leverage opportunities -- so you are obviously, as an organization, a much more efficient operator, presumably, than a small independent mom-and-pop. So from an organic perspective, how would you prioritize the ability to drive more leverage, number one?

And then, number two, when you are looking at deals, where are the stark contrasts that you are seeing from a mom-and-pop perspective? Where are they just not executing, and therefore when you bolt on a deal, day one, how much lift can you potentially get from the M&A perspective? Thanks.

Jamie, why don't I take the first part of the question and Bryan can talk about the acquisitions?

I mean, our opportunity, when you just look at our SG&A composition, is really in that personnel and advertising bucket. That makes up about 90% of our controllable SG&A, and we are going to continue to work on that with our stores and find opportunities there into the future. And I'd say that if, where's the opportunity going forward, if we have another 20% growth rate in overall sales, I think that you could see another 200 bps or so in reduction there.

As far as acquisitions, Bryan, why don't you take that one?

Sure. I think the biggest thing between the mom-and-pop that we buy and our selves is -- typically it's easy to get comfortable when you make $500,000 or $1 million. It's a pretty good living, right? Is that their sales volumes are typically not to the levels that we would see.

A lot of times they are not as risk acceptant, again, on used vehicles. In fact, a Missoula deal that we had, they had hardly any used vehicles in stock. In fact, they didn't even stock Toyota pickups because they had a Ford store that they stocked Ford pickups. So there is some mind blocks that you can quickly get into.

Staffing levels is typically a big issue, too. There is usually somewhere between 10% and 15% of additional staff that hasn't reached their productivity or hasn't been expected to, and there is a comfortableness of, whether it's friends or whether it's longevity within the stores, that we are able to accelerate and help succession planning occur a little bit quicker.

There are some economies of scale that we gain from the ma-and-pa. We do typically have a little bit lower interest rates. Some of our benefit expenses are slightly lower. And we have a little bit of centralization that can help things, primarily within the office functions. Outside of that, it really comes through building a belief within the stores that the sales teams and the service teams can find more customer base.

Great. I appreciate all the detail. And if I could ask a quick follow-up as it relates to your service business. I think, if I am reading through your slides correctly, there is still some deferral of maintenance, I think, broadly speaking, going on. Again, I'm not focusing as much on the warranty or the recon or the body shop side of the world, really more on the customer pay side. Can you just walk us through what you are seeing there and what the impetus is from adding on incremental work, as it would seem?

Yes, Jamie, Chris. I think if you go back and look at that slide 20 again, it shows our service trend. The average sale per RO has gone from about $340 in 2009 to about $250 in 2013, and I think part of that is our focus on commodities is obviously going to drive our pricing down.

But I also think the recovery in the economy is going to continue to help that. There is still a lot of deferred maintenance out there, and as our markets recover, I think customers are going to feel like they have funds to spend on some of that deferred maintenance that's needed on vehicles. And hopefully, we will see that trend that we've seen over the last five years start to improve again.

Jamie, two other little tidbits of information. The average age of vehicles in the US today is 10.4 years. In 2006, it was 7.6 years, which takes your average a long ways into this six years plus, and I think it's why we focus so dearly on how do we retain that customer past its warranty period and into its second or third ownership cycle.

And I think as we begin to sell more used cars, it's critical that we even try to retain those customers.

Very helpful, as always, guys. Thanks and good luck in the next quarter.

Greg Palm, Craig-Hallum Capital Group.

Hey, guys. It is Greg on for Steve. Congrats on the good quarter.

Hi, Greg.

You have touched on it a little bit, but just want to dig into the new vehicle gross margins a bit more. New guidance reflects 6.7% at the midpoint, which I think is down from 7% from previous guidance. Obviously, weakness is kind of being offset by strength in F&I and parts and service downstream.

But I guess, where do you see that metric going in the longer term? I mean, is this high six level kind of a good level to think about over the next few years?

Greg, this is Bryan. I think when we look at our business, the gross profit margin has nothing to do with how we operate our store.

Our people on the front line aren't looking at a car and saying, it's $30,000 and I need to get 7% so I need to make $2,100. That's not how they think.

They think about what do they need to do to meet their demand with their consumers and how do we maximize each investment. And when you look at margin pressures, the biggest thing is, am I going to take market share and what are the impacts of the entire vehicle department?

And that's why we really highlighted that fact that our deal average is up $23, and I think the implications of that, whether new margins go down or not as we grow to that 75 used vehicles, even if we lose new vehicle margin, you're basically paying to be able to get that trade-in to be able to push your used cars up. And then, obviously, the residual effect of that is three, four, five years down the road in the service and parts department.

So we are not really that concerned whether margins are at 6.8% or whether they go to 6.5% or 6.3%. And I think you'll see that as long as we are maintaining throughput, as long as our used vehicle sales are growing, then it's a good trade-off for the organization and for our investors.

Greg, this is Sid. One thing that people don't realize is on a trade-in, we assign a purchase price. We don't write a check, and that determines the gross margin on the new car.

If we brought in used cars at a higher price, which Bryan has talked about, because we are stealing them in some senses, we buy them below what we would have to pay at an auction, and that gives us a little higher used car margin, but reality is it shorts the new car margin.

So you look at combined new and used car margin, that's the best number to look at. Because that will tell you whether we are really improving or sliding.

You know, I've spoken publicly that five years from now, we need a business model that makes a lot of money at a 5% margin on new car. And I'm still in that camp. I think a lot of factors drive it. A new car is a commodity and that's the reality.

We've just got to be better at it and quicker and more friendly for customers, and we've got to sell a car to everybody and we need to reach out from every market we're in to get out 200, 250, 300 miles and capture share from other dealers. And that's the reality of what we have to do as a business. And we are confident that's going to happen.

And ultimately, the operating margin effective -- what Sid talks about, it's a win-win for the dealer body, too, because the throughput and the impact of used cars are huge. Now we are obviously not striving to get to 5%, but if it happens, I think you'll be very pleased with what happens on the bottom line.

Remember, it's a result, the margin is. It's not a goal. It's just what happens based on what we had to do to sell everybody a car that came in the door.

Okay. That's very helpful. Thanks and keep up the good work, guys.

Thanks.

There are no further questions at this time. I will turn it back to management for closing remarks. Thank you.

Thank you for joining us, everyone. We look forward to talking to you in a couple months.

Thank you. This concludes today's conference. All parties may disconnect. Have a wonderful day.