Lithia Motors Inc (LAD) 2013 Q4 法說會逐字稿

Greetings and welcome to the Lithia Motors fourth-quarter 2013 earnings conference call.

(Operator instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. John North, Vice President of Finance for Lithia Motors. Thank you, sir, you may now begin.

Thanks and good morning. Welcome to Lithia Motors fourth-quarter 2013 earnings conference call. Before we begin, the Company wants you to know this conference call includes forward-looking statements.

Forward-looking statements are not guarantees of future performance and our actual results of operations, financial conditions and liquidity and development of the industries in which we operate, may differ materially from those made in 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 the call, I 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 pre-tax 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 include items not related to core business operations and improve the period-to-period comparability of our results 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 of today's press release. We have also posted an updated investor presentation on our website lithiainvestorrelations.com, highlighting our fourth-quarter results.

On 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. I'm also available in my office after the call for any follow-up you may have. It is now my pleasure to turn the call over to Bryan.

Thank you, John. Today we reported fourth-quarter adjusted net income from continuing operations of $25.7 million, compared to $19.3 million a year ago. We earned $0.98 per share in the fourth quarter, compared to $0.74 per share last year, or an increase of 32%, a record fourth-quarter result.

For the full year, adjusted income from continuing operations was $105 million or $3.99 per share, compared to $77 million or $2.96 per share in 2012. This was also a record performance, as we grew EPS by 35% from the prior year.

Our revenue exceeded $1 billion in the fourth quarter and $4 billion for the full year. This is the highest annual revenue in our history, and an increase of 21% over the prior year.

For the full year 2013, we grew same-store revenues 15%. This was on top of same-store revenue increases of 23% in 2012, 22% in 2011, and 18% in 2010. From this point forward, all comparisons will be on a same-store basis.

In the fourth quarter, total sales were up 11%, reflecting increases in all business lines. New vehicle sales increased 11%. On a unit basis we sold over 16,000 new vehicles, an increase of 1,300 units or 9%, which was above the national average of 6%.

Our domestic sales increased 4% compared to 8% nationally. Our import sales were up 12% compared to 4% nationally, and our luxury sales were up 20% compared to 9% nationally.

Retail used vehicle sales increased 16% in the quarter, compared to a national increase of 4%. We sold approximately 13,100 retail used vehicles, resulting in a used-to-new ratio of 0.8 to 1.

We sold a monthly average of 53 used vehicles per store, up from 48 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 fourth quarter. On a unit basis, certified pre-owneds grew 26%, core product or vehicles three to seven years old increased 4% and finally, value autos or vehicles over 80,000 miles increased 12%.

Our F&I per vehicle was $1,174 per unit compared to $1,096 per unit last year. Of the 29,200 vehicles we sold in the quarter, we arranged financing on 72%, sold a service contract on 43%, and sold a lifetime oil product on 37%. Our penetration rates in service contracts and lifetime oil sales increased 240 and 340 basis points, respectively.

Our service body and parts sales increased 8% over the fourth quarter of 2012. This was on top of last year's 8% increase over the fourth quarter of 2011.

Customer pay work increased 7%, which is the 18th consecutive quarter of improvement. Warranty sales increased 16%, which was also the fifth consecutive quarter improvement.

Wholesale parts increased 9% and body shop decreased 2%. Gross profit per new vehicle retailed was $2,325 compared to $2,397 in the fourth quarter of 2012, or a decrease of $72 per unit. Gross profit per used vehicle retailed was $2,570, compared to $2,445 in the fourth quarter of 2012, an increase of $125 per unit.

However, as we have previously discussed, our store personnel evaluate overall gross profit per retail vehicle sale to evaluate their own individual performance. To calculate this, we add total gross profit on new and retail used vehicles, plus F&I profit and wholesale profit, and divide it by total new and retail used units sold.

In the fourth quarter, the blended overall gross profit per unit was $3,621, compared to $3,540 last year, or an increase of $81. For the full year our blended overall gross profit per unit was $3,581 compared to $3,550 last year or an increase of $31.

Our store leaders are maintaining gross profit on a blended transaction basis. And while there has been a shift in the allocation of gross profit by business line within the vehicle sales departments, the overall result is higher.

Our overall gross margin was 15.5%, down slightly compared to 15.6% in the same period last year. Increases in vehicle sales continued to outpace our growth in service, body and parts revenue, and this mix shift explains the decline in overall margin.

As of December 31, new vehicle inventories were at $657 million or a days' supply of 74 days, a decrease of two days from a year ago. Used vehicle inventories were $168 million or a days' supply of 63 days. This is 7 days higher than our days' supply last year.

We remain focused on achieving the three milestones for long-term growth that we laid out in 2012, which doubles our size in three to nine years. I am pleased to announce that we achieved our first milestone by surpassing $4 in consolidated earnings per share this year.

We anticipate achieving our second milestone of approximately $5 per share, and our third milestone of approximately $6 per share over the next several years. However the next two milestone achievements will be driven more off acquisitions than organic growth.

Most analysts are predicting a $16 million to $16.5 million SAAR in 2014. This would represent an increase of approximately 5% over 2013.

The acquisition market is as active as I have ever seen, and there are a number of potential transactions in play at any given week or month. We continue to seek exclusive domestic and import franchises in mid-sized rural markets, and exclusive luxury franchises in metropolitan markets.

In the fourth quarter, we purchased an underserved import franchise in a metropolitan area. We believe acquisitions like this will become more important in future periods as we accelerate our acquisition cadence.

During the fourth quarter we purchased a total of three stores in California, Diablo Subaru, Lodi Toyota and Stockton Nissan Kia. For the full year of 2013 we acquired seven stores, which represents $273 million in estimated annual revenues.

2014 is also off to a strong start as we purchased our first store in Hawaii in January, Island Honda, and purchased a VW store in Northern California to expand our presence in the Stockton market. These two stores add approximately $50 million in estimated annual revenue. With that, I will turn the call over to Chris, our CFO.

Thank you, Bryan. As it relates to cost control and getting leverage on our expense structure, adjusted SG&A as a percentage of gross profit was 68.2%, a reduction of 200 basis points from the fourth quarter of 2012. This improvement was primarily related to a reduction in personnel expense of 50 basis points and reducing our facility cost 30 basis points.

Throughput, or the percentage of each additional gross profit dollar over the prior year we retain after showing cost and adjusted to reflect same-store comparison, was 55%. For the full year SG&A as a percentage of gross profit was 67.2%, a decrease of 220 basis points and a record low.

As sales increase, we believe SG&A as a percentage of gross profit can remain in the mid to 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.

Through the lower SG&A expense levels we achieved in 2013, and reduced interest costs and income tax expense, we have generated an adjusted net margin of 2.6% for the full year of 2013. This is an increase of 30 basis points over 2012, when our adjusted net margin was 2.3% and represents a record result.

As we previously announced during the fourth quarter, we renegotiated our syndicated credit facility, expanding it by $200 million to $1 billion in total availability, extending the duration to 2018 and lowering the interest rate. At the end of the quarter we had $24 million in cash and $160 million available on our credit facility.

Currently $181 million of our operating real estate is unfinanced. These assets could provide up to an additional $136 million of available liquidity in 60 to 90 days. This brings our total liquidity to $320 million and we remain comfortable with our overall level of available capital.

At December 31, excluding new vehicle floor plan financing, we had $253 million in debt, of which $165 million is 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.

Our free cash flow, as outlined in our investor presentation, was $12 million for the fourth quarter of 2013. Capital expenditures, which reduce this free cash flow figure, were $16 million for the quarter. For the full year, our free cash flow is $93 million, and our capital expenditures were $50 million.

We estimate our 2014 CapEx will be $84 million. This budget is based on $17 million in lease buyouts, $19 million in new or remodeled facilities as a result of prior acquisitions, $5 million for open points granted by the manufacturer, and $44 million related to facility improvements and other business development opportunities. Based on this CapEx estimate and our full year guidance, our 2014 free cash flow is estimated to be $72 million.

Our capital strategy is unchanged as we balance acquisitions, internal investment, dividends and share repurchases. Our first choice for capital deployment remains to grow through acquisitions and 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.

For the last few years we have discussed the impact of sub-prime credit availability on our vehicle sales rates. We believe that sub-prime customers in our markets are still not experiencing credit availability as they were prior to the recession of 2008 and 2009.

Of the vehicles we financed in the fourth quarter, 11% were to sub-prime customers, slightly higher than the fourth quarter of 2012, but below the national penetration numbers of 20%. Given our rural market and domestic brand exposure, we believe our customer base is more dependent on sub-prime financing than the broader national trend.

We anticipate our normalized volume of sub-prime customers should be approximately 20% of the overall mix of financing, and believe there is room for improvement in this area in the future. Specifically, in our western markets, registration levels for new vehicles remain approximately 12% below 2006 levels, through October of 2013, the most recent data available.

While the market recovery may not be linear, we believe this indicates market expansion that will come to fruition over the next few years. We are contemplating a market recovery of 4% to 6% in our 2014 guidance, which we updated to $0.92 to $0.94 per share for the first quarter of 2014, and $4.30 to $4.40 per share for the full year of 2014.

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)

Steve Dyer, Craig-Hallum Capital Group.

Good morning, guys. Congrats on another good quarter. I'll ask the obligatory weather question. You guys are probably a lot better situated than most, but was there any impact that you saw, or anticipate seeing, in Q1 from the weather?

Thanks for the question, Steve, this is Bryan. We did have some weather, primarily in the Northwest and a little bit in our Midwest stores. We don't have a lot of presence in the Midwest, so it wasn't too impacting there.

We did have four days in the Northwest that was a little bit tough with snow on the ground in about 22 stores. And it vapor locked things for about, I would say, three or four days. It appears though, that we have recaptured most of that, and there were some pent-up sales over the last seven to ten days. It looks like we are back on track.

Perfect. A lot of strength out of service, body and parts in the quarter. And particularly, given that weather wouldn't have driven a lot of that, what do you attribute that to? Is that just more uptake of a lot of the pre-selling of the lifetime oil, et cetera? Or is there something else driving it?

This is Bryan again, Steve. I really believe that it's primarily driven by that units-in-operation bubble that's just now starting to come into our service department. And really our ability in our service lanes to respond to our customers' needs and provide them the value, the timing, and the benefits that they are really looking for, that our competitors really have been able to provide in the past.

But now with the ability to sell multiple products, to be able to put our service and parts departments more in the forefront of the dealership, where it is more convenient for customers to come in, get in and out and providing transportation. We really believe that we are poised well to be able to capture a lot higher percentage of our customers of this new book of business in the future.

Got it. Okay. Last question for me and I'll hop back in the queue. You have historically talked about the SAAR and your footprint trailing the national average here, since the downturn anyway. Have you seen that gap closed at all? Or how does that lay out right now?

We have seen it close. We have about 52% of our stores that we would qualify as being our western markets that still have about 11% or 12% depressed markets over what their peaks were in 2005, 2006.

The other 48% of the country has really recovered. We even see markets like Texas or Montana, where they are beyond the peaks that they were at. Now fortunately, they are still growing.

They probably don't have the potential to grow the same as the 52% in the west. But yes, a lot of that has been recaptured. I think when we look forward, it is going to be a little heavier lifting on our part. We are going to have to conquest market share rather than to really sit back and let the market grow and give it to us.

Steve, this is Chris. Just to add on to that, when we talked in our prepared remarks a little bit about the sub-prime customer and how it affects our customers out in the West, we still see that opportunity. We ran some numbers by state to figure out what percentage of our overall sub-prime business in each of those states is still available for recovery.

If you look at Oregon. Oregon, 6% of our customers are actually sub-prime. California it is 10%, Washington it is about 3%. We know that the recovery that Bryan is talking about on registrations is going to come in those markets.

The inverse of that is a market like Texas, which is really up way above pre-recession levels. They have had a lot of good things happening out there in the economies, unemployment is low and the sub-prime consumer that we have out there is closer to the national average of 20%. We look for good things to happen for us out west as jobs recover and customers get back on their feet.

Great, very helpful. I'll hop back in the queue. Thanks, guys.

Rick Nelson, Stephens.

Good morning, this is Joe Edelstein on for Rick. You indicated that the acquisition pace is accelerating. We have also seen you substantially increase the size of the credit facility in the quarter.

I'm curious if you could comment, what sort of debt-to-cap levels are you comfortable operating the business with, given where we are in the ongoing auto sales cycle?

Yes. This is Chris, Joe. I think just to answer that, I'd go back to what our acquisition model looks like. We are looking to have a return of 20% per year cash on cash. And from a debt-load perspective, we fully finance our floor plan. We get mortgage financing on any facilities we buy.

Right now our debt to EBITDA is 1.6% as a Company. It is the lowest in the space. We are very comfortable with our capital position today. We don't feel like, unless things change dramatically, that that is going to move much. I think that answers your question.

It does, thanks. As you mentioned, you have got some pretty high hurdle rates as you look at deals. I was hoping you could just comment, describe the types of franchises you are looking for.

Would you say you are in the market for fixer-uppers or primarily looking for some high-quality franchises that perhaps the owners are just simply looking to exit because of lack of succession plans?

Hi Joe, this is Bryan. When we look at acquisitions, because our hurdle rates are so high, we typically are able to buy average performing stores. We are not typically able to buy the high performers.

Fortunately, though, there are a lot of dealerships out there that are average performers. And in our model, we really need them to perform at about half of what their potential is for us to be able to buy them at that 3 to 5 times EBITDA number or that 20% return that Chris spoke to. And right now, it appears that this last two years of a lot of deals really fitting in our size market, that things are loosening up at a much faster rate than we expected.

We did four acquisitions last quarter. We've done two so far this year, which we believe are high-quality franchises in single-point markets that have the ability to increase fairly substantially. They are also in western markets, if you noticed. Many of those markets are even depressed more than that average of 12% like our core stores.

In fact, in the Hawaii market they are still depressed over 30%. In the Stockton market, they are depressed in the mid-20 percentile range.

So when you are able to buy earnings at half the potential today, and there is a potential of top-line growth of 20%, 30% on top of it, and now you calculated in some throughput calculation, you have the potential to have pretty attractive returns. Those are going to be really difficult not to say yes to.

Thanks for the details there. If I may just ask one more question? I would like to ask about the inventory levels. First, could you just break down what the supply looks like across the different categories, volume imports, premium, and domestic brands?

And then, as a follow-up to that, are you seeing inventory starting to build at any of your local market competitors? And what gives you the comfort that we won't see more gross margin compression in 2014?

Sure. We ended the quarter with a little bit lighter days' supply on total new vehicles than last year. And on used vehicles we ended a little bit higher.

Since then, the inventories in use have come back into line over the last 45 days or so. So we are just a touch higher than we typically are in use.

Now, to get into a little more detail on new. Our domestic days' supply is about 90 days. Our imports, 54 and our luxuries about 64-days' supply.

And that is, again, this is typically the peak levels of inventories within the year. As January and February and then obviously March, which is a typically robust month, they start to lean things out and balance inventories heading into the spring and summer months.

I would like to add something. This is Sid DeBoer. Historically, when there is an oversupply in vehicles, the manufacturers ramp up incentives. And our gross margin in the past did not deteriorate because of an over-inventory supply.

We are not the manufacturer. Their costs go up when there is too much inventory but as a retailer, we benefit from increased incentives.

Sounds great. Thanks for taking my questions.

Bret Jordan, BB&T Capital Markets.

Couple quick questions. In one of them, did you comment earlier in prepared remarks that you were going to be focusing more on traditional non-luxury franchises in metropolitan markets?

No. We did purchase a Subaru store in the Bay Area, it is actually in Walnut Creek, which was a pilot, but we believe it is an underserved import in that market and have a very good track record with Subaru. We thought it was a good chance and the return was extremely high.

If we are able to do some of those things, it sure opens up some additional opportunities in the future. But, no, our core strategy is not to grow with non-luxury franchises in metropolitan areas.

Okay great.

This is Sid again. Subaru is like a luxury in many ways, because it is an over-dealer. It really makes sense for us in some opportunities and we have a great partnership with them.

Okay, yes, I understand that. I misheard, I thought you were buying Honda dealers in Atlanta.

No, absolutely not. Good clarification, Bret.

All right. And then one question on sub-prime. Are you seeing much sequential change?

You talk about sub-prime penetration of 11% versus the national average. Are things changing on a more recent basis in any of your markets that give you visibility toward getting towards the national average?

Hey, Brett, this is Chris. I'd say, yes, we are up a little bit. Year over year, I think we said our sub-prime penetration was up about 10%, from 10% of our portfolio to 11%.

Obviously, not where we want to see it long-term. Our registrations are in a similar format, our registrations in the West have improved a little bit. But we really believe there is some fundamental changes that have to happen out here to see big job growth. Then increased sales and increased sub-prime consumers getting financing.

We are anticipating that is going to happen in the next two to three years. It's baked into our guidance to some extent.

Okay, and then one last question, it's sort of a rounding error. You said collision was down 2%. Is that driven by the drought conditions on the West that you have just had less precipitation out there? Is there anything changing in the collision space that would be a headwind?

Brett, this is Bryan. I think it is a combination of the drought conditions in the West. But I think more importantly than that, we had two of our large body shops that we had personnel issues with. It is our fault, we'll get it back.

Okay, great. Thank you very much.

Brett Hoselton, KeyBanc Capital Markets.

Want to start off, just looking at slide 26. I was looking at the acquisition revenue growth and the milestones down at the bottom. It is 0.4 and I'm thinking that, I just want to make sure. What that seems to suggest is that you are targeting about $400 million in acquisition revenue in 2014. Am I correct in that understanding?

Yes, hey, Brett, this is Chris. No, what that is, is that's the acquisitions that we completed in 2013 and early 2014, with Hawaii, that are rolling in throughout the year. So we forecast out those stores and they are rolling forward into 2014. We never bake any anticipated acquisitions into our guidance.

Okay, good. That is what I thought.

One additional thing as well, you have to remember that acquisitions do have a 12- to maybe even 24-month lag when it comes to earnings. So those milestones will always lag. We'll need to ramp up acquisitions a little ahead of what those targets are so they correspond with the internal growth.

As I look at slide 25, I look at the analyzed revenue, $250 million in 2011, $265 million in 2012 and $273 million in 2013. Taking a step back, thinking about your comments, it seems like that pace is probably a likely pace in 2014. I know you are not necessarily baking that into your guidance. That is not necessarily a formal expectation per se. It doesn't sound like things are slowing down. Is that a fair characterization?

This is Bryan again, Brett. I think that that pace is sustainable in 2014. We do currently have four deals under contract, as well as another two open points, one of which will open in the next four weeks, the other opening in Q4. And it seems that there is a robust pipeline to be able to sustain that upper $200 million number.

Then talking and thinking about your used vehicle, your guidance on the used vehicle side, you are looking at same-store growth of around 8%. So as I think about your target of going to 75 units per store, you are currently at 53, that is about a 42% increase.

I'm not sure what time frame you are thinking about, but if it were over a four-year time frame, that would be 10% per year. If it would be over a three-year time frame, even more, like 10% to 15% growth per year which is obviously above the 8% expectation that you have in your guidance.

My question is, is your guidance potentially conservative, and there is potentially some upside? Or are you expecting some sort of an acceleration as you move into year two and year three?

Brett, this is Bryan again. We really believe -- there's two major factors when you look at our ability to get to the 75 units. One, is our people and talent within the stores, which still has lots of opportunity.

The second is supply. And as these 14 million and 15 million SAARs start to become three- to seven-year-old vehicles, it starts to loosen up the supply of those vehicles. Right now our three- to seven-year-old vehicles have a blend of a 10/8 SAAR to a 14 SAAR. It makes it difficult to get those cars.

So yes, I believe that even though we are expecting an 8% increase in the coming year, it will accelerate for us to be able to achieve that 75 units within the coming couple of years. I think there is some compounding effect in that number as well.

Hi, Brett, Chris. Just to add on to that. When you contemplate your guidance for full year 2014, keep in mind that one of the things that we are dealing with is this idea of mix shift where our certified units were up 26% in the quarter, but the gross profit margin on those is 10%.

While we guide an 8% increase in sales, we are thinking more normalized on that core product, which is over 50% of our business. Our margins are more normalized at the 14.5% to 14.7% range. If you are going to push an increase above that that comes from certified units, then you've got to contemplate the impact that's going to have on overall margins which, in the end, what we're really looking for is gross profit dollars in the stores.

Yes, that leads to my final question which is, if I calculate the gross profit per unit, using the methodology that you used, that new-used F&I combined, I'm in that mid-$3,000 range which is where you have been for the past two years. As you think about that number going forward, is there any reason to believe that it is going to shift materially, in your mind?

Brett, yes, this is Chris again. I think in the quarter, our same-store deal average was $3,621, so a little bit higher than $3,500. But going back, our philosophy on setting guidance, what we look at is what our current performance is.

While we know we have opportunity in areas in really all aspects of the business, we are focused on improving that number but we don't bake that into our guidance. We look at what our normalized run rate is on margins and really gross profit dollar per unit. And that is what we bake into the guidance that we have.

I'm not necessarily looking for the upside, Chris. I guess what I was simply asking was, I know that over the past few quarters you have talked about, let's say, maybe taking a little bit shorter deal on the new car side because it generates a lot of revenue and gross profit per unit in the parts and service and used cars and so on and so forth.

I'm just looking, thinking about your overall, is there any reason to believe that that's potentially going to deteriorate as we move over the next year or two, by any significant amount? Is that your expectation? Or is it, look, we just think we are going to stay steady-state here?

Brett, this is Bryan again. There is some validation. If we look at our guidance and we are saying we want to grow 8%, we are willing to sacrifice some margin to be able to capture additional market share.

The 8% growth rate, I think the world is really predicting about a 4% to 5% growth rate which means we have to conquest 3% to 4% from our competitors within our local markets.

That may mean at times, that we need to sacrifice a little bit of front-end margin. However, we really believe that the F&I growth, and if you notice we were up $80 a unit, is a way that is not marketable visibly to all of our customers.

We can make that money whether or not we advertise it or not. That is a residual effect of selling the new or used car at the same margin or possibly even slightly lower margin. But I think, as Chris stated, that is $3,621. We believe we can grow that slightly.

We have been showing that over the last number of quarters and really believe that there is demand there and there is supply to be able to support that. I think as incentives increase or decrease as well, what we really see is it helps spurring possibly lower pricing to consumers.

And at times, there's anomalies that don't match up with local markets. And you are then able to capture margin again without having to push it in marketing dollars or additional costs.

Thank you very much, gentlemen, doing a great job.

Ravi Shanker, Morgan Stanley.

Apologies for bringing up the 2014 guidance again, but the one number that you guys don't give us in the guidance is the SG&A to gross. So can we just talk about what we can expect there for 2014? Especially because if we put in your revenue and gross margin assumptions, it points to something pretty punitive on the SG&A line to get to your full-year EPS guidance.

Hey, Ravi, it's Chris. A couple of points on that. First, obviously we are going to continue to focus on that idea of incremental throughput. As sales start to moderate a little bit, the incremental gross that we are getting, I think, becomes a little less important. What we need to focus on is really net profit retention.

When you look at our overall SG&A to gross by store, it is a really fat bell curve. We have stores that are in the mid-50%s and we then have stores that are in the high 80%s.

So what we need to do is work on those stores in the high 80%s and bring them closer down to the average. And we should do exactly what we said, which is continue to generate leverage in that 65% to 70% range.

I will say that one of the opportunities that we have is, we have $450 million in acquisition revenue coming in, in the year. The integration of those tends to take 12 to 24 months to get them back to that average number.

So that is going to be a focal point for us and that is going to put a little strain on SG&A as well as a couple of things, like Affordable Care Act, that took $0.04 or $0.05 out of our personnel costs just by the number of participants that jumped on our plan. And a few other things that we are doing to enhance some our benefits for employees, that is going to roll through this year.

But all in all, Ravi, we know we have opportunity. We are going to continue to bring that SG&A number down and focus on it as a Company.

Ravi, one additional thing if you recall, and I think we've talked about this in the past. We originally discussed that each of our milestones of one to three years, if we are able to accomplish those top-line numbers, it has an effect on SG&A of about 200 basis point reduction on each of those milestones. So you may be able to extrapolate some things that way as well.

Understood. It sounds like there's certainly some dry powder there. Also want to talk about F&I per unit, which seems to be ticking up pretty nicely both last quarter and this quarter. What are you doing there to drive that? Is that something that we can potentially extrapolate over time?

Ravi, this is Chris. We definitely know we have opportunity. If you look at our slide deck where we show our F&I per unit compared to our peer group, we definitely fall on the wrong side of that chart.

We are doing a number of things right now to enhance that, a lot based on product. If you look at our product penetration, both in our service contracts and our lifetime oil plan, we are up 200 basis points year over year in penetration there. A lot of that is just making sure that we have the right product with the right deductibles, for the right term that we offer our customers at the right price.

We have been piloting some things in different stores, and changing some things around that give our F&I team, we think, a better product to sell. And we did just raise our guidance, I think in F&I from $1,100 to $1,125. Obviously we'd like to keep bumping that number up throughout 2014.

The other piece of that is just the demand we are seeing for finance contracts. Our penetration on finances is up again 200 basis points year over year, but the demand for our contracts is high. People want an asset-backed loan that has proven to provide a high return. Incrementally, both on a flat reserve program and a participation program, we are seeing more profit come out of those deals.

Understood. Lastly, I'd love to get your thoughts on the Diesel Ram 1500. There has been some reports that the initial demand has been pretty strong. Is that something you think is going to be pretty popular in your regions? Or do you think it is more of a niche product?

This is Sid, Ravi. It sounds like that they are going to have a capacity constraint, so it should help gross margins on that vehicle. I know there were 8,000 orders immediately. I don't know how many they can actually make.

But it is a great rig, great gas mileage. And Dodge and Ram continue to win awards with that truck. It's got a lot of momentum.

Great. Thanks, Sid.

John Murphy, Bank of America Merrill Lynch.

Good morning, guys. I just had a couple of follow-up questions. First on the guidance, it does look like you guys just alluded to that you are being reasonably conservative on 2014 on the flow-through.

Our numbers are indicating you are looking at about a 35% flow-through and you are targeting more like 50%. Is this really just conservatism? Or are there really a lot of costs that are coming in for the acquisition integrations?

Yes, John, this is Chris. Our target of 50% is on a same-store basis. The acquisitions definitely drain that down because their first dollar flow-through is equal to their SG&A to gross.

So that's, I think, what you see in the quarter. Our same-store throughput was 55%. But if you just looked at it on the financials, it was about 45%. It has a pretty big impact overall. The more acquisitions we do, the more strain it is going to put on that number.

Again, what we're focused on is really that net profit margin. We feel like there is opportunity there to continue to generate leverage in a lot of our existing stores, as well as new acquisitions. We are going to continue to drive our profit margins up and increase our leverage.

John, this is Sid. Those gross margins on the stores as they come in, the SG&A is 85%, 90% on most of them, because they are under-performing stores. They hurt us to start with in terms of the aggregate. We'll try to get those so they improve quickly then hopefully they'll generate growth in their same-store number a year from now.

I guess the worse they are when you get them, the better you can make them and the bigger the delta and the cheaper the deal, right?

That's the first year, you're right.

That's the deal, John. You got it.

That is the game plan. Second question, when you look at these weather events that you guys have had in the industry, have faced. Isn't it typical that the sales are just delayed and you see a pretty big catch-up one, two or three months after? Is that the standard pattern?

Absolutely. This is Bryan. I think you get the catch-up within the first couple weeks. Maybe there is a lag into a month period of time but really all of ours happened in this quarter. We don't really see that it is going to be impactful.

Got you. Then just on the last question, who do you guys sell the L2 assets to in Denver or do you still hold the land and some of the buildings there?

We have actually divested all four of the L2 properties. I don't recall who it was in Loveland. Did we sell it to Moreland? We sold it to Doug Moreland.

He put a Hyundai day store in there. This is Sid.

Okay, got you. Awesome. Thank you very much, guys.

James Albertine, Stifel.

Good morning and congratulations as well on a solid quarter and year. I wanted to follow-up, if I could, on a question that was asked earlier as it relates to the ramp in used. Just so I understand it, some of your markets, given the late, maybe harder hit during the recession, late entry into the SAAR recovery on the new side. Does that follow through with respect to the longer-tailed ramp on used? Or is there something, maybe a nuance about the markets, where used is a little flatter than perhaps in some of the bigger metropolitan areas of the country?

Jamie, this is Bryan. The used perform almost in synchronicity with the new performance. So if the new is depressed it is very likely the used are. We don't see huge anomalies there.

Okay, great. If I could extend that maybe argument, the sort of late entry of your markets in the new recovery, to parts and service, it stands to reason I guess that warranty is now starting to ramp. And perhaps you have a longer-tailed growth rate from a customer pay perspective, perhaps a higher margin part of your parts and service business. What are your thoughts there?

Jamie, Bryan again. You are right. You are absolutely correct. We are right now starting to grow that 5- to 7-year UIO. We have been saying for a couple of years that we're really at the bottom. Really, we only have a couple of years dropping off that are good, but now we are adding on better years.

I think there is a lot of upside in service and parts. I think the early indications on warranty are the same thing that's occurring. And I think, I don't like to promote the National Transportation Board, but it sure seems like the idea of recalls is becoming more and more prevalent, which fortunately helps us as new car dealers and warranty sites.

Some OEMs call recalls, it's a semantic argument about recalls, I have been told. If you remotely diagnose, apparently it is not a recall.

Yes. (laughter).

Well, that is very helpful. Then the last, and this is a very high-level question. I just wanted to get any color we could on what you are seeing in terms of customers' need for vehicles.

Is it still something, as you would characterize it, that tends to be more of a discretionary purchase in nature? Meaning fuel economy-driven or taking advantage of credit markets? Or are you starting to see, quite frankly, the average age of the vehicles and neglected vehicle fleet start to break down and underpin more of a need-based purchase intent, if you will?

Jamie, Bryan. You could probably correlate it exactly with our Texas, our energy-based states. I believe in the energy-based states there is a element of, it is not so much a need-based market any more. There is enough disposable incomes in those markets. The market's recovered well enough that those are truly, they are buying vehicles for the fun of it, rather than for work vehicles.

I would relate that back to the West where the West truly is, I believe, still buying vehicles of need that helps get them to work or helps them perform in their jobs that they are currently in. And I think that will continue. I think the western markets will act more like they did seven, eight years ago, pre-recession, once that recovery of that additional 12% is captured again.

Jamie, this is Chris. If you look on page 20 of our slide deck, we show what the age of the service vehicles look like. If you look back in 2009, the six-plus year bucket was about 30%. In 2013 that is 40%.

So that goes in lock step with what Bryan is saying, is that there's a lot of customers that are holding on to their vehicles longer. We are seeing them in the service drive. But over time, we anticipate that will shift.

Jamie, this is Sid. One of the biggest things that you left off the list, because all of those things are impacting consumer demand for new vehicles, is the innovation that is taking place in technology and features and safety. There is a lot of reasons to buy a new vehicle. I mean, you wouldn't want to drive around in a 12-year-old vehicle with no airbags any more.

No, especially if I'm driving. (laughter) No, I appreciate it. Gentlemen, thanks again, as always, and good luck in the year ahead.

Scott Stember, Sidoti & Company.

Scott?

Hello?

Mr. Stember, your line is live.

Hello? Can you hear me now?

Sure.

Sorry about that. Faulty headset. Just wanted to ask a question about the parts and service. You had very strong growth in the customer pay and warranty, yet the overall blended margin was off about 50 basis points. Were there any special promotions, the tires higher, or something used to drive volume in there? Could you just explain that?

Yes, I think the biggest shift that you see, Scott, is warranty. When warranty is up, 17%, 16%, that's going to drive your overall margins down just a little bit. Our highest margin business is customer pay, so it is just a mix shift issue.

Okay, got you. Next question, a bigger picture kind of question. You have talked about managing the business in thirds and trying to bring the bottom two-thirds from total operational performance up to the top third. Referring to, from an expense standpoint, can you talk about what the opportunity there is going forward?

Have we plucked a lot of that low-hanging fruit already or is there still a nice opportunity to bring some of the bottom-performing stores up?

Scott this is Bryan. This is what we do probably two-thirds of our days, is discuss growth opportunities within our stores and our current talent, to be able to challenge them to do better. And I think it is funny, we look back five to seven years ago, and we had these thirds. They were really poor-performing in the bottom third.

Now they are not horribly performing, but we still have opportunities to grow our customer base within our stores. I think it really boils back down to helping our stores find opportunities to become better aware of their customers' needs, and to proactively respond to that.

No matter how good or bad we are, there is always a large portion of our stores that don't have the responsiveness that's necessary to become a top third dealer in our eyes. I think that ability and that trust we've built with the stores allows us to challenge them to find new opportunities without them being defensive and really shutting down and proving that there is no more opportunities. What we want to do is open their minds up and help them see the opportunities.

Believe it or not, there is a ton of low-hanging fruit still. We really believe, and I think as you look at SG&A and throughput and those type of things, without that low-hanging fruit and those under-performing stores still out there, it would be very difficult to continue to have through-put of 53%, 55% and reduce SG&A beyond the 67.2. Those are difficult things without sloppy stores. And I think those will come into the play and it is a continual battle of growing our teams and replacing our people if necessary.

Scott, this is Sid. One of the things that's really remarkable is when you look at our improvement, a lot of the lift comes from the stores that are in the upper third. They don't want to stop.

There is continuous improvement in a culture in this Company and it is just great to see that. So it does move the mark. It is going to get harder and harder to move from the lower third to the top third. Hopefully the whole boat is going up.

Got you. Just last question on the Jeep product, the new Cherokee. Could you talk about how that's doing within your markets?

This is Bryan. It seems like it is right on track. Sid, do you have anything else on that?

It is a home run, the vehicle is. There is actually a little bit of a supply constraint. We are hoping they get more lift out of the Dart too. That's a very great car and as the Avenger goes away, that has to fill that bucket. It is an exciting new product, the Cherokee. Some people grumble about the look, but overall it's brought us a whole new customer.

Got you. That's all I have. Thank you, guys.

Bill Armstrong, CL King & Associates.

Good morning, gentlemen. Just going back to sub-prime, there is a lot of financing available, obviously, for sub-prime car buyers throughout the industry. I was wondering if you are seeing any trends on that score? Either maybe more availability or less that may be changing the competitive dynamic, either making it more difficult or perhaps easier, for you to increase your penetration in sub-prime?

Yes, Bill, this is Chris. Just going back to what we touched on earlier, our western markets still have opportunity. We believe it is related to jobs, unemployment in a lot of our markets is still high.

As customers get jobs, especially in the lower credit tier, they have the ability to get financing. So the banks are there, but the customer profile needs to change in a lot of our markets in order to improve their options in getting financing. I think that is going to drive the market recovery that we've talked about in California, Idaho, Nevada, Oregon, Washington.

Right, but do you see other competing dealers getting more aggressive and trying to capture share with those sub-prime consumers and maybe making things a little bit tougher for you guys?

Bill, this is Bryan. I think the big thing here is who captures the share is who has the car. Once the market comes back and the consumers have the ability to buy a car, or get financed even as a sub-prime customer, it's about finding the car. Always remember that we are at the top of the food chain.

We have that three generations of used cars. First generation is a certified. Second generation is a core product. Third generation is a value auto, which is the most attractive car to that sub-prime customer.

The way we get those is to sell more core product because they come in on trade. I think if we look at the competitive environment and who is going to capture those vehicles, it's who can sell the most of those core products or the upstream used vehicles sales that take those in on trade and have the ability to obviously recondition them and get them to the front line safely.

Got it. Thanks a lot.

David Whiston, Morningstar.

On the used vehicles, I wanted to follow up with an article in Automotive News recently that talked about how many dealers buy pre-packaged software to manage their used inventory but you guys do it in-house. I was just curious what benefits you get from your software that is unique.

David, this is Bryan. We actually partner with a company called FirstLook in most of our stores. We allow our stores to do different things with their used car management software. But there is an underlying basis that is similar across our stores, so we are able to transfer vehicles or do our internal auctions and prepare those things.

We do have some internal IT solutions when it comes to the auction sites, or DMV and trading of those vehicles. But outside of that, we use outside items as well. I think the biggest thing of what they do is they give you a history of what either you sold within your stores, or what the market sold and try to help guide you as to what you should sell, if you take it in on trade and it's the wrong vehicle.

But more importantly, what should you be looking at to go buy, and where are the margins within those vehicles, and how does that relate to consumer demand in pricing in terms of what is out there competitively on the internet.

Helpful detail. Thanks. Staying on used, do you guys procure inventory at all from rental fleets?

Absolutely.

Okay. And are you at, given your rural market focus away from larger airports, does that put you at any kind of disadvantage on costs or availability?

Not really. The only disadvantage is time to front line. We probably have an extra two or three days. Most of our stores are within 300 miles, which is typically a day commute on transport.

I would say this, there is no monetary difference other than that additional transportation, because we are able to buy those cars at auction or we are able to buy them in bulk because of our size and distribute them throughout our stores to keep it competitive. So monetarily, to a consumer, I don't think there is really much delta there.

Okay. We talked earlier in the call about Chrysler doing so well with things like Jeep. That momentum has been going on for a long time. I would really be interested in what is your opinion on what are they doing well?

This is Bryan. I think they keep their head down and focus on what matters. They are building good product. They are providing us with fairly lucrative incentives, sometimes they are a little beyond our reach, I would say.

But it keeps us focused that volume is what drives the rest of the profitability within the dealership. I think because of that, our Chrysler stores are fairly profitable and fairly lucrative earnings-wise. They seem to keep it simple and don't over-complicate what the formula is on automotive retail.

Okay. And just two quick ones for Chris. In your prepared remarks you mentioned sub-prime back in 2006 and I missed that percentage. Do you have that handy?

Yes, we feel like it was close to 20%.

Close to 20%? Okay. With acquisitions driving a lot of growth going forward, do you think you are going to be carrying a balance on your revolver throughout the year, going forward?

I think when you look, they were going to generate over $100 million in free cash flow. We could probably buy most of the acquisitions that we need from that. However, if Bryan puts a big deal together, we are definitely prepared from a balance sheet perspective. So I would say no.

Okay, thanks.

Thank you, ladies and gentlemen. We have reached the end of our question-and-answer session. I would now like to turn the floor back over to management for any concluding comments.

Thank you. We look forward to updating you again after the first quarter.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.