Lithia Motors Inc (LAD) 2014 Q3 法說會逐字稿

Greetings, and welcome to the Lithia Motors' Third Quarter 2014 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John North, Vice President of Finance for Lithia Motors. Thank you, sir, you may begin.

Thanks and good morning. Welcome to Lithia Motors' third quarter 2014 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 forward-looking statements in this conference call. Examples of forward-looking statements include statements regarding expected operating results; projections for our fourth quarter 2015 performance; expected increases in our annual revenues related to acquisitions; anticipated availability from our unfinanced operating real estate; and anticipated levels of future capital expenditures. 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 we may discuss certain non-GAAP items such as adjusted net income and diluted earnings per share from continuing operations, adjusted SG&A as a percentage of revenues and gross profit and adjusted pretax margin. Non-GAAP measures do not have definitions under GAAP and may be defined differently 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 core business operations. These presentations should not be considered alternative to GAAP measures. A full reconciliation 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 third quarter results.

On the call today are Bryan DeBoer, President and CEO; Chris Holzshu, Senior Vice President and CFO. At the end of our prepared remarks, we will open the call to questions. I am also available in my office after the call for any follow-up questions that you may have. Now I will turn the call over to Bryan.

Thank you for joining us. Earlier today we reported third quarter adjusted net income from continuing operations of $34.9 million compared to $29.6 million a year ago. We earned $1.32 per share in the third quarter compared to $1.13 per share last year, for an increase of 17%. Our revenue was approximately $1.3 billion in the third quarter, an increase of 21% over the prior year. From this point forward, all comparisons will be on a same-store basis.

For the second quarter in a row we saw double-digit increases in all four business lines. Total sales increased 12% and SAAR was $16.7 million in the third quarter, the best quarterly results since 2006. In the quarter, new vehicle revenues increased 11%. Our new vehicle average selling prices increased 4%. Unit sales increased 7%, which was slightly lower than the national average of 9%. Domestic unit sales increased 7%, import sales were up 5%, and luxury unit sales were up 13%. Retail used vehicle revenues increased 13% in the quarter. Our retail used vehicle average selling price increased 7%. We retailed 6% more used units over the prior year resulting in an used-to-new ratio of 0.9-to-1. In the quarter, certified units grew 17%. Core units increased 3%, and, finally, value auto units, vehicles over 80,000 miles, increased 5%.

As we announced earlier this month, while used vehicle retail revenue was up 13% in the quarter, some of our stores reduced retail prices in order to respond to weakening wholesale vehicle prices in order to clear out extra inventory before the fall. As a result, margins fell 160 basis points from the prior year. We sold a monthly average of 55 used vehicles per store, up from 52 units in the third quarter of 2013, and 46 units in the third quarter of 2012. We continue to focus on procuring core product and selling 75 used vehicles per store per month. We believe that both the increased availability and softening of the used vehicle values present an opportunity for our stores to increase unit sales in the future.

Our F&I per vehicle was $1,202 compared to $1,105 last year, or an increase of $97 per vehicle. Of the vehicles we sold in the quarter, we arranged financing on 72%, sold a service contract on 43%, and sold lifetime oil products on 36%. Our penetration rates in service contract sales increased 100 basis points. Our service, body and parts revenue increased a record 13% over the third quarter of 2013. This was on top of last year's 6% increase over the third quarter of 2012.

Customer pay work increased 10%, which is the twenty-first conservative quarter of improvement. Warranty sales improved 27%, which is the eighth conservative quarter of improvement. Wholesale parts increased 9%, and body shop increased 15%. Providing affordable and convenient experiences with each customer driven by service department personnel who listen and respond to our customers' wishes will be the key to our success going forward.

Gross profit per new vehicle retailed was $2,242 compared to $2,131 in the third quarter of 2013, or an increase of $111 per unit. Gross profit per used vehicle retailed was $2,537 compared to $2,687 in the third quarter of 2013, a decrease of $150 per unit. In the third quarter, the blended overall gross profit per unit was $3,593 a unit compared to $3,514 last year, or an increase of $79. As we have previously discussed, our store personnel monitored overall gross profit for retailed vehicle sale to evaluate and drive their performance.

Our total gross margin was 15.3%, down slightly compared to 15.5% in the same period last year. The decrease in total gross margin was primarily due to the used vehicle issue we discussed earlier. As of September 30, new vehicle inventories were at a day supply of 72, a decrease of four days from a year ago. Used vehicle inventories were at a day supply of 54. No change from a year ago.

We believe near-term SAAR is likely to provide low to mid-single digit growth. We have considerable opportunity within our existing stores to improve results. Increasing our new vehicle market share selling 75 used units per store per month, capturing the increasing units in operations returning into our service department, cost control, productivity gains and other corporate synergies all remain as opportunities.

Additionally, acquisitions will continue to be an important part of our future growth story. To that end, we completed the largest transaction in automotive retail history earlier this month with the purchase of DCH. The combination brings two strategies for growth -- exclusive domestic and import franchises in midsize rural markets and exclusive luxury franchises in metropolitan markets for Lithia, and further expansion within mega markets across all brands for DCH. This more than doubles the potential acquisition targets available to both of us.

Over the past 24 months we have opened or acquired 17 stores in the traditional Lithia operational strategy. In total, we purchased 44 stores, which contributed approximately $3 billion in estimated revenue since 2012.

Finally, less than two years ago we introduced three strategic milestones for growth made up of same-store sales growth, disciplined cost management and throughput, combined with acquisitions. Each milestone targeted increases in our earnings per share by $1 for $4, $5 and $6 earnings targets. This was expected to be accomplished in a three- to nine-year time period. We reached the first milestone of $4 earnings per share in 2013, and believe the second milestone of $5 per share should be achieved in 2015. The recovery and new vehicle SAAR combined with DCH and the other acquisitions we have yet completed provide a clear path to achieving milestone 3 at the shorter end of our time expectations. As we continue to optimize our existing and new stores operations, we look forward to sharing further details on earnings and growth beyond milestone 3. With that, I will turn the call over to Chris, our CFO.

Thank you, Bryan. At September 30, excluding vehicle floor plan financing, we had $273 million in debt, of which $237 million is mortgage financing and $30 million was outstanding on our used vehicle financing facility. We completed approximately $70 million in mortgage financing in the third quarter in preparation for the DCH acquisition, and anticipate closing another $130 million before the end of the year. We have no mortgages maturing until 2016.

On October 1, we invested approximately $670 million to acquire inventory assets and intangibles to complete the DCH acquisition. After asset-backed financing, we estimate a net equity investment of approximately $280 million. As of today we have approximately $122 million in cash and available credit, as well as unfinanced real estate that could provide another $148 million in the next 60 to 90 days, for a total liquidity of $270 million. These figures are all based off our recently expanded syndicated credit facility, which was upsized to $1.7 billion as of October 1.

We have no high yield bonds or convertible notes outstanding. We are in compliance with our debt covenants. Our net debt to EBITDA after the DCH acquisition is estimated to be approximately 2.2 times, still below our target of less than 3 times.

Our free cash flow, as outlined in our investor presentation, was $20 million for the third quarter of 2014. Capital expenditures, which reduced this free cash flow were $19 million for the quarter. For the full year 2014, we estimate free cash flow will be $88 million. We estimate that combined with the DCH organization will produce $135 million in free cash flow in 2015, providing significant capital to reduce our leverage or to deploy for acquisitions, share repurchases, dividends or internal investment.

We took advantage of the recent market volatility to repurchase stock when the share price fell below our predetermined target prices. Since July 1, we have repurchased 161,000 shares at an average price of $69. Our current authorization of 1.5 million shares remains in place for opportunistic repurchases, if available. However, we will continue to maintain our strict ROE thresholds required before we commit to deploy any more capital.

As Bryan previously discussed, we grew overall same-store sales 12% in the quarter due primarily to used margin compression. Our overall gross profit grew slightly less. As a result, our third quarter adjusted SG&A as a percentage of gross profit increased 50 basis points to 66.1%. However, our SG&A to gross is still the lowest in the sector. Throughput, or the percentage of each additional gross profit dollar over the prior year we retained after selling cost and adjusted to reflect same store comparisons was 38%. We continue to target incremental throughput of 50% in the future. As we integrate the DCH acquisition into our operations, we will go back to targeting our combined SG&A into gross profit in the low 70% range. However, our operational team will be working diligently in the short to medium term to return to industry-leading performance.

We have been closely monitoring the credit approvals within our customer base as we believe it is one of the main drivers of continued recovery in auto sales. Of the vehicles we financed in the second quarter, 11% were to subprime customers, consistent with the second quarter of 2013. We continue to focus on growing this area as we are below the national average penetration for subprime at 20%. More importantly, 16% of subprime customers who apply for credit were approved by third-party lenders, a 340 basis point increase from the third quarter of last year. While this was a significant improvement on a year-over-year comparison, a 16% approval rating still means over 8 out of every 10 subprime customers are declined for credit.

We continue to carefully monitor registration levels in our markets to gauge our progress in the economic recovery. While overall our markets are approximately 14% higher than in 2006, in our Western markets, registration levels remain 7% below 2006 levels through July of 2014, the most recent data available. We believe this indicates market expansion that will come to fruition over the next few years.

Earlier this month we introduced our 2015 earnings outlook. Our guidance philosophy remains unchanged. We utilized a bottoms-up forecast considering both current market conditions and current store performance to determine our financial results within a high probability of success. We also did not make any assumptions related to potential synergies or operational improvements that may result from the DCH acquisition.

Our guidance for the fourth quarter 2014 is $1.17 to $1.19 per share, and full year 2014 is $4.86 to $4.88 per share. Our guidance for the first quarter 2015 is $1.18 to $1.21, and full year 2015 is $5.60 to $5.80. For additional assumptions related to our earnings guidance, I 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?

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Rick Nelson with Stephens. Please proceed with your question.

I wanted to ask you about DCH. You have obviously been through the due diligence. You've owned it now for a few weeks. What have you learned in terms of the opportunities to improve that operation? And also if you could provide some color on the multiple that you paid for it.

Great, Rick. This is Bryan. I think most importantly, we spent the last, almost half a year with the DCH leadership team. So, really, the transition on October 1 was very smooth. We spent really the last 120 days preparing for that transition, and I think most importantly to remember, it is a combination of two organizations. However, we really believe that our opportunity is to build upon their success and continue to expand their market share and their offerings to their consumers. So, all in all, very smooth transition. We are excited about their team and we are excited to see the results continue to grow.

I would say that in terms of the actual acquisition, there are a few points that we can elaborate on. In relationship to what our previously announced hurdle rates are on acquisitions, we have a, what, a 75% to 100% return on equity over a five-year period. We ended upon the low end of that range. When we look at our EBITDA ratios, we were really on the high end or right around five times. When we look at revenues we were only around 12% of revenue, which is on the very low end of what we pay for acquisitions. And I think even more importantly than that, if you look, and I think Chris mentioned this, our liquidity dollar amounts, we had about $282 million of liquidity before the acquisition. And after the acquisition, because of the asset base of DCH as well as a little bit of an expansion in the working capital line, we still have $270 million of liquidity, so we've got lots of dry powder to continue to grow if the opportunities arise.

Also Chris mentioned that our leverage ratio went from 1.8 pre-acquisition to 2.2, and our comfort level is up to almost 3. So, we are very excited about the combination of the two organizations, and I think the idea of sharing best practices and now having the ability to grow in not only our exclusive sized markets but now into large metropolitan areas really provides a lot of upsize in the future.

Thanks for that color, Bryan. Also, I'd like to ask you about the used inventory levels. You mentioned 4Q, do you think the challenge was one time in nature and we're back to business as usual?

Yes. I mean, the stores that had some issues in regards to inventory levels and then pulled through it, we think most of it is behind us. What we still don't know is whether the market continues to soften, but we are obviously on our toes in most of our stores ready to respond as need be. I think we ended the quarter at a 55-day supply, which was about the same as last year.

Long term, I really believe that when you look at used vehicles, there is a very fine line between having the right cars and the wrong cars, meaning when you're trying to expand your used car retail unit sales, you try things. You're not as experienced at knowing what cars specifically sell. So, when you have a glut of trade-ins come off of new vehicle sales or they become more available on the used vehicle wholesale or auction areas, it is easy to take the path of least resistance and buy newer cars, later model conquest cars that are really, let's call it a sucker's bet. Because it's easy to buy, it looks good, it's going to go through the shop easy, so on and son on, but those are cars that quickly are damaged when the market weakens, and they are pretty readily available at competitors. So, there is still some training there in some of the stores, but we really look towards that 75 unit goal and believe that that is still in our near future, near mid-term future.

Great. Thanks a lot and good luck.

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

This is actually David Kelly in for Bret this morning. Thanks for taking my questions. I just had a quick question on the used buckets and the performance from a unit standpoint. I think you mentioned CPO was up 17% and core and value were in the maybe mid-single digit range. Could you talk about what you are seeing in the delta between those three buckets, why CPO has been so strong, and what is happening in the core and value markets from an industry standpoint?

David, this is Bryan again. That is insightful because, really, the certified vehicles are up 17%. What really is happening is there is a loosening in that late model product, which means the availability. And as I mentioned to Rick, when it is easy to get those vehicles, it is easy to buy them, and what happens is you start to use up dollars on certified or late model conquests rather than core product or even value auto. And I think that is what happens when supply loosens, and I think what we will see as it begins to mellow out a little bit, it will be a little easier for stores to go back and find the correct core product, and we should see that start to grow again at a more typical rate.

All right, great. Thank you. And then just to switch gears quickly looking at parts and service. Can you maybe just talk about or provide some color on maybe the recall impact on the warranty business and what we are seeing in customer pay and potential attachment into the customer pay segment going forward?

Absolutely. This is Bryan again and then Chris can maybe talk about the F&I question on warranty as well. I really believe that we are just starting to see the tip of the iceberg when we look at our service department overall business, and what we really now have is this blend of being able to keep customers for a longer period of time. We are starting to stretch out now 8, 9, 10 years with certain customers, but your units in operations now is starting to be your bulk of the business, so that 3- to 5-year-old vehicle is now also starting to grow. Now, that comes through a focused effort over the past few years of improving our service drive, putting them front and center in the dealership, as well as really helping our frontline people understand how to listen to our consumers and quickly respond to their needs many times even before they even know what they are asking for. So, I think our ability to capture that, and I think that expansion, I think we ended up the quarter at 13%, which is our highest same-store sales quarter, I believe in our history. And I think a lot of that is coming from customer pay, which is where it needs to come from, because that's the heavy lifting where dollars speak louder than in the warranty business that is really paid for by the manufacturer.

Now, I would also talk to you about the warranty business, because obviously it is up at a dramatic amount, almost 27% for the quarter, which is coming off of a lot of the recalls that happened really in the spring of this year. We still haven't seen the Takata recalls on the airbags. Those are starting to come into the service departments, and a lot of those domestic recalls and import recalls that we had from spring still were not all pushed through the service departments back then but now are starting to trickle in. So, parts are starting to loosen up. The people that weren't quite as concerned about it now are still coming into the dealerships, and we really see that as continued strength.

As it relates to the F&I products specifically, one of the important products that we sell in our finance departments is the service contract. Our penetration rate overall for the service contract is at 43%, which is actually up 100 basis points in penetration year-over-year. And that product is critical when it comes to especially that core and value auto product, which makes up almost 71% of our used vehicle sales. Because it not only retains warranty customers but it also ensures that those vehicles that are off warranty are coming back under the service drive as well and it is something that we continue to focus on along with our lifetime oil product, which we have a penetration rate of 36% overall [and] 33% on used vehicles. So, both those products combined really support the efforts that we get from the OEM in getting that service retention back into the service drive.

All right, great. I appreciate the color and thanks for taking my questions.

Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Good morning, guys. This is (inaudible) in for Ravi. A couple of questions, one on F&I. You highlight on slide 12 how F&I per vehicle is $90 lower than your peer average. Assuming transaction prices are flat, can you provide more specific as to how you can close that gap and any color on what peer averages are for service penetration and lifetime oil contract penetrations?

This is Chris. I think the biggest driver of that is really the mix that we have between new and used vehicles. Our new vehicle F&I per unit is about $1,400 a unit, and our used vehicle is about $1,000 a unit, so just given our ratio, our used-to-new ratio at almost 1-to-1, I think that is one of the most obvious opportunities that creates the differentiation between our peer group. That is not to say that we don't have a lot of opportunity given that a lot of our peers are running at $1,400, $1,350 a copy. We realize that there is additional opportunity and I don't think it comes from additional penetration. I think it is just trying to find the right pricing in the right mix of products to offer in each one of our stores. And as we continue to try new things, offer different products in different stores, we are seeing that take hold and feel like that is really what is responsible for the success that we are seeing and the growth that we are seeing in F&I PVR.

You asked about penetration rates or finance penetration with 72%, our service contract penetration rate was 43%. Again, like Chris said, a little higher on new vehicles at 45%, and our lifetime oil penetration is 36%.

Got it. On DCH, one of you peers has been actually disposing of stores in New York and is also looking at New Jersey citing high cost to run business and perhaps competition as well. Just wanted to get your thoughts on how different it is for the DCH stores in that region and if having scale makes it any better?

This is Bryan again. So, I don't believe there is any intent to dispose of any stores, and I think when you look at the New Jersey market or southern New York market, it is obviously highly competitive. We are very fortunate that the DCH brand that they built in New Jersey and New York has high customer belief and adhesion to the dealerships. The products that they sell, Honda being the number one product in the tri-state area, seems to be well received. Their stores are top stores within that area and their personnel have been there a long time.

I think it is also important to restate that in the DCH transaction, their real estate and their locations being in good locations, solid locations, typically on interstates or expressways are also owned, okay? 75% plus of their facilities are owned, much what like Lithia is, which adds for stability of locations without having to be transient, to some extent, in those locations.

This is Chris. The thing I would add to that is just like we do on the Lithia side of the fence, we go through each store and we evaluate each store individually. We look at the opportunities in each location and make sure that the return that we are going to get out of each store is sufficient. And we are very excited about the opportunities in each one of the DCH locations. I know George Liang and TY both see the same opportunities and we anticipate that the store footprint that we have is perfect.

Thanks for the color, guys.

(Operator Instructions) Our next question comes from the line of John Murphy with Merrill Lynch. Please proceed with your question.

Good morning. This is Liz Suzuki on for John. Looking at the same-store performance in used retail, your average selling price went up by almost $1,200 per vehicle, but you gross profit for vehicle declined by about $150. So, some combination of the used vehicle acquisition cost, reconditioning or transportation would have had to have gone up by over $1,300 a vehicle. So, can you talk about just what happened and whether there was something going on where you had to acquire used vehicle inventory through more expensive channels, or if that was just a conscious decision to move up into the late model side?

This is Bryan. I think you hit on what I was discussing earlier, was this idea of what really relaxed in terms of supply was the ability to find one- to three-year-old vehicles. And, again, those conquest vehicles that aren't what you sell new are the easiest cars to find. While we are trying to push the expansion of conquest vehicles, but it is more in the three- to eight-year-old vehicles, which didn't loosen up in supply. So, I think that the combination is we bought a lot of higher dollar cars of off brand, and then you have the competitive pressures of selling against a certified car that may have incentives on financing or extended warranties that are included in the price or, most importantly, knowledgeable salespeople that you are competing against in selling those products. And ultimately you increase your average cost per unit but you don't make any more money doing it, and I think that is what you are seeing in that bucket.

That is not typical, though, in all of our stores. It is when those stores haven't been through that experience of learning to expand their business with the right cars. And, like I said, it's a very fine line between a three-year-old vehicle and a five-year-old vehicle and what the equipment is on that car, or the colors of that car, the mileage or something like that, to find the right price inflection point between a new car and now a used car.

Great, thanks. And just given what happened with used vehicle ASPs and what you mentioned in terms of the growth in CPO, which I imagine would continue to take more used vehicle market shares off lease volume comes back and more late model units are available, do you think it is fair to say that used vehicle ASPs should remain somewhat elevated given that mix shift for like the longer period of time?

I think that is fair to say, Liz.

Okay, thanks very much.

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

Yes, good morning. Going back to recall repair, does the labor get reimbursed by the factory at cost for you guys or the same rates that we charge consumers?

David, this is Bryan. Thanks for the question. We get reimbursed at warranty rates, just like we do on all breakages.

Okay. And on the Nissan deal near Fresno and Clovis, you talked more about how the Central Valley in California hasn't recovered yet. Is that market an exception or is that market still struggling? I was just surprised to see more exposure there.

The Nissan deal in Clovis, we have the Nissan store in Fresno as well, so that was a clustering strategy to really control the Nissan brand within that 1.1 million person market. The Central Valley is still depressed somewhat. I believe the actual number is somewhere around the low double digits, so we still believe that it was an opportune time to get that additional pop and not pay for it.

Okay, and last question. I know you don't have a lot of Ford exposure, but I was just curious what percent of your technicians are going to be ready to repair the Illuminated F-150 by early next year?

They will all be ready.

Okay, that's all I had. Thanks.

Our next question comes from the line of Irina Hodakovsky with KeyBanc. Please proceed with your question.

I only had a question for you on the subprime. You mentioned that you have remained below the national average. If you can speak to what you think are the drivers of that and what are the opportunities you see coming your way that could bring you up to the national average?

Irina, this is Chris. As we stated, our subprime business is about 11% of our overall finance business and the national average on that is much higher. We think the real opportunity that we have is in the depressed market that we lay out in our slide deck. It is really unemployment based. So, while credit is available for customers who have a job and have income, I think that the opportunity that remains is for those customers that are still unemployed. And several of our rural and midsized market still have high unemployment and I think as that recovers you will continue to see that number climb.

Thank you.

We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Thank you for joining us, everyone, today. We look forward to giving you further updates in February.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thanks for your participation and have a wonderful day.