Lithia Motors Inc (LAD) 2014 Q4 法說會逐字稿

Greetings and welcome to the Lithia Motors fourth quarter 2014 Earnings Conference Call. (Operator Instructions)

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

Thanks and good morning. Welcome to Lithia Motors 2014 earnings conference call. Before we begin the Company wants to know that this conference call includes forward-looking statements.

Forward-looking statements are not guarantees of future performance. And, our actual results of operations, financial condition, and liquidity, and development of the industries in which we operate, may differ materially from those made and are suggested by the forward-looking statements in this call. Examples of forward-looking statements include statements regarding expected operating profit, projections for our first quarter in 2015 performance, projected EBITDA, expected increases in our annual revenues related 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 to place undue reliance on forward-looking statements. We undertake no duty to update our forward-looking statements, including our earnings outlook, which are made as of the date of this release.

During this call, we may discuss certain non-GAAP items. Such as, adjusted net income and diluted earnings per share from continuing operations, adjusted SG&A as a percentage of revenues and gross profit and adjusted pre-tax margin.

Non-GAAP measures do not have definitions in our 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 disclosure, provide a meaningful presentation of our results from core business operations because they exclude items not related to core business, and improve the period-to-period comparability of our results from core business operations.

These presentations should not be considered alternative to GAAP measures. And, a full reconciliation of the non-GAAP items is provided in the financial tables for today's press release.

We also posted an updated investor presentation on our website, www.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 the questions. And, I'm available in my office after the call for any follow-ups you may have. Now, with that, I'll turn the call over to Bryan.

Good morning and thank you for joining us. Earlier today, we reported fourth-quarter adjusted net income from continuing operations of $37.5 million compared to $25.7 million a year ago. We earned $1.42 per share in the fourth quarter compared to $0.98 per share last year for an increase of 45%.

Our revenue was approximately $1.8 billion in the fourth quarter, a 75% increase over the prior year. From this point forward, all comparisons will be on a same-store basis. For the third quarter in a row, we saw double-digit increases in all four business lines as total sales increased 14%.

In the quarter, new vehicle revenues increased 12%. Our new vehicle average selling prices increased 2%. Unit sales increased 9% which, was higher than the national average of 7. Domestic units increased 12%. Import increased 7%. And, luxury units were up 9%.

Retail used vehicle revenues increased 16% in the quarter. Our retail used vehicle average selling price increased 5% as late model used vehicles continued to make up a greater percentage of the overall vehicle sales mix. We retailed 10% more used units over the prior year resulting in a used-to-new ratio of 0.8 to 1. In the quarter, certified units grew 17%. Core units increased 12%. And finally, value auto units, or vehicles over 80,000 miles, increased 1%.

Consistent with our third-quarter results, our used vehicle gross margins fell approximately 130 basis points from the prior year. Despite this, our store personnel have adjusted nicely, lowering selling expenses and maintaining their volume focus, to produce higher operating profits.

We sold a monthly average of 56 used vehicles per store, up from 53 units in the fourth quarter of 2013 and 48 units in the fourth quarter of 2012. We continue to focus on procuring core product and target 75 used units per month in each location. We believe that the increased availability of used cars presents a continued opportunity for our stores to increase unit sales in the future. This remains a top priority for our personnel in 2015 and beyond.

Gross profit for -- per new vehicle retailed was $2260 compared to $2306 in the fourth quarter of 2014 a decrease of $46 per unit. Gross profit per used vehicle retailed was $2429 compared to $2557 in the fourth quarter of 2013, a decrease of $128 per unit. Our F&I per vehicle was $1214 compared to $1168 last year, or, an increase of $46 per vehicle.

Of the vehicles we sold in the quarter, we arranged financing on 72% sold a service contract of 43%, and, sold a lifetime oil product on 35%. Our penetration rates were roughly flat when compared to last year.

In the fourth quarter, the blended overall gross profit per unit was $3565, compared to $3597 last year, or a decrease of only $32 or approximately 1%.

As we have previously discussed, our store personnel monitored gross profit per retail vehicle, and in aggregate, to evaluate and drive their performance. Growing overall vehicle sales volumes, nearly 10%, while lowering total gross per transaction 1%, is a trade-off we believe is worth making. Our overall gross profit generated through vehicle sales increased $9.4 million over the prior year. This increased volume provides greater trade-in and service opportunities and, establishes new customer relationships which give us a chance to complete the customer buying cycle by selling them another vehicle in the future.

Our service, body, and parts revenue increased a record 12% over the fourth quarter of 2013. This was on top of last year's 8% increase over the fourth quarter of 2012. Customer pay work increased 9% which is the 22nd consecutive quarter of improvement. Warrantee sales increased 32% which is the ninth consecutive quarter of improvement. Wholesale parts increased 7% and body shop increased 9%.

Providing affordable and convenient experiences with each customer, driven by service department personnel who listen and respond rapidly, remains the key to our success going forward. Our total gross margin was 15.1% compared to 15.6% in the same period last year. The decrease in gross margin was primarily due to used vehicles we discussed earlier.

Including DCH as of December 31st, new vehicle inventories were at a day's supply of 62 a decrease of 12 days from a year ago. Used vehicle inventories were at a day's supply of 53 or a decrease of ten days from a year ago.

Our store leaders continue to live our values of continuous improvement by finding new and innovative ways to grow their business and capture unrealized opportunities. However, we still see considerable opportunity within our existing store base to improve results. Increasing our new vehicle market share, selling the 75 used vehicles per store in each location, capturing increasing units, and operations returning into our service departments, controlling costs, improving productivity, and realizing other corporate synergies, all remain as opportunities.

Additionally, acquisitions will continue to be an important part of our future growth story. Over the past two years, we purchased 45 stores which in total, contribute approximately $3 billion in estimated revenues and, nearly doubled our revenue base.

The DCH integration is going well. The combination of Lithia and DCH has established our Company as a nationwide retailer. And, our combined results in the first quarter are a foundation for our continued growth in the future.

Our similar values, allowing employees to be entrepreneurial, while exceeding our customers' expectations, have allowed us to cross-pollinate best practices quickly and effectively. We held business meetings in every DCH location to meet the general managers and their teams.

During these meetings, we listened and challenged each other to capture identified opportunities in 2015. Through the first three months of the combination, DCH is performing ahead of expectations we established together. I anticipate a long and successful relationship with our two companies as we continue to learn and grow together.

Finally, less than two years ago, we introduced three strategic milestones for growth. The key to achieving these milestones are the combination of our internal focus on same-store sales growth, disciplined cost management and throughput, and the external focus on acquisitions to gain scale. Built off our 2012 base of $3 per share, each milestone targeted increasing our earnings by $1.00 for $4.00, $5.00, and $6.00 targets. This was expected to be accomplished in a three- to nine-year time period.

We reached the first milestone of $4.00 earnings per share in 2013. And, now also achieved the second milestone of $5.00 earnings per share in 2014. The third milestone of $6.00 per share is squarely in our sights in 2015 given that this is now the midpoint of our annual outlook, which, Chris will discuss in more detail shortly. Additionally, we are now comfortable in establishing a fourth milestone of $7.00 per share. Which, we anticipate achieving within one to three years after completing milestone three.

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

Thank you, Bryan. As previously announced, on October 1st, we acquired the DCH Auto Group. After this transaction, and other general activity related to our existing operations, we ended the year at $641 million in debt, excluding new vehicle floorplan financing. Of this debt, $334 million is mortgage financing, $134 million was outstanding on our used vehicle financing facility, and $135 million was outstanding on our revolving lines of credit.

At December 31, 2014, we had approximately $100 million in cash and available credit. As well as unfinanced real estate that could provide another $110 million in 60 to 90 days for total liquidity of $210 million. Since year end, we have completed another $25 million in mortgage financing. And, are targeting an incremental $40 million to $50 million in mortgage financing in the next 60 to 90 days to increase our working capital and take advantage of the current rate environment to lock in long-term financing.

We have been strategically extending our mortgage maturities and we currently have no mortgages maturing until 2016. Despite the increase in our leverage, as a result of the recent acquisition, our net debt to projected EBITDA is approximately 2.0 times. Still within our targeted range.

At the end of the fourth quarter, we were in compliance with our debt covenants other than our current ratio which came in at 1.16 to 1, slightly under 1.2 to 1. Our bank group has agreed to reduce the covenant to 1.1 to 1 for all future periods and granted us a waiver for the covenant, as of December 31, 2014. I'd like to thank all our banking captive finance companies for their support.

Our free cash flow, as outlined in our investor presentation, was $17 million for the fourth quarter of 2014. Capital expenditures, which reduced this free cash flow figure, were $32 million for the quarter. For the full year 2014, free cash flow was $87 million. We estimate generating over $100 million in free cash flow in 2015 providing significant capital to reduce our leverage or to (deboy) for acquisitions, internal investments, dividends, or share repurchases.

Our capital strategy is unchanged. Our first choice for capital deployment remains to grow through acquisitions and internal investment. But, regardless of category, all investment decisions are measured against strict ROE metrics and will be solid long-term investments for Lithia's future.

As Bryan previously discussed, we grew overall same-store sales 14% in the quarter. Due primarily to used margin compression, our overall gross profit grew slightly less at 10%. Our fourth-quarter Lithia same-store adjusted SG&A as a percentage of gross profit, improved 100 basis points to 67.2%. Including DCH, and on a consolidated basis, our SG&A as a percentage of gross profit was 70.3%.

Our operational team will be working diligently in the short- to medium-term to return to industry-leading performance. Throughput, or the percentage of each additional gross profit dollar over the prior year, we retained after selling costs and adjusted to reflect same-store sales comparisons was 42%. We continue to target incremental throughput in a range of 45% to 50% in the future.

As Bryan mentioned earlier, we achieved our second milestone of $5.00 earnings per share in 2014. We see a clear path to achieving the third milestone of $6.00 earnings per share. As such, we have updated our guidance as follows. We expect first quarter 2015 earnings per share of $1.18 to $1.21. And full-year 2015 earnings per share of $5.95 to $6.05. 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'd now like to open the call to questions. Operator?

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

(Operator Instructions)

Jamie Albertine, Stifel.

Great, thanks, and good morning, gentlemen, for taking the question.

Hi, Jamie.

Hi. Very quickly, just a housekeeping item on the margins that you reported for the fourth quarter. This is the first time I get to see DCH flow through the model. So can you talk about a little bit about how that degradation, at least sequentially, versus where you've been running? How much of that is contributed from DCH relative to your core business? That's the first question.

And then, from a much higher level, talking about from a capital allocation standpoint. Now, I want to ask about your return targets. How do you relate your expected IRR for different capital deployment initiatives? And then, ultimately, it seems like you said M&A is the best use of capital for the last six years. And continue to be focused on M&A.

So why is that so important for your business model going forward is really the second follow-up. Thanks.

Hey, Jamie. Good morning. This is Chris. I think to answer your first question on the margin degradation. I think the easiest way to look at that is looking at the same-store performance in relation to the overall performance in the press release. And definitely, it's down.

But, as you know in the urban markets, I think, more competitive environment. There's more of a volume approach to the selling model. And in return, they're going to see a little bit lower margins. But, all in all, we're going to continue to stay focused on gross profit dollars that generate the used-car trade, the F&I work, and business into the service drive. The second question.

IRR; I can take that real quick. This is Bryan, Jamie. On capital allocation. We're staying focused that internal investment acquisitions are our primary use of capital. However, we do balance, depending on stock disconnections or those types of things when it comes to share buybacks. And, of course, we'd like to maintain stable dividends.

Also, on acquisitions. I don't know how deep you want me to talk about that. But that is one of our primary uses. Basically because it perpetuates through, hopefully, eternity. And it can continue to build capital for the organization. The market continues to be fairly robust. We're still actively pursuing candidates and believe that our future looks bright in that arena as well.

That's fantastic. And I appreciate the color there. I mean, is it fair to say you, sort of, reached a point as you've grown over time that centralization efforts, they can only draw so much or drive so much leverage? It really becomes about adding volume, I would argue.

And so, the best way, the fastest way to do that, I would imagine, is M&A. And then quickly, I guess, from a multiples standpoint. What are you seeing in the market right now in terms of seller expectations for takeout multiples? Thanks.

Jamie, this is Chris. As far as leverage is concerned, we continue to look at each one of our stores individually to identify the opportunities. And several of the acquisitions that we brought online over the last two to three years, as well as some of our existing stores, still have opportunities to improve our leverage, bring down the SG&A to gross. And we continue to work on those.

But you're exactly right. I mean, bringing on a company the size of DCH into the organization and being able to identify additional gross opportunities that bring down the SG&A number, as far as leverage is concerned, is something that we're very focused on. But I think our focus is more on generating additional gross opportunities. And less about cost cutting initiatives in the field and I think that's a very important distinction for us.

Jamie, in terms of sellers' expectations on acquisitions, I think it's fair to say that prices are up. I think the activity and the number of buyers is up as well. I do believe that we've been pretty good about keeping our head down and focused on specific acquisitions. And I believe those specific acquisitions aren't really targeted by other groups or other companies.

So I really believe that the prices that we've paid in the past; that we can stay disciplined at those five- to six-year payback to be able to recapture our investment as we always have. So we really look at it, that it's really about that building the relationship for a period of time of up to decades at times, to really be there at the right time when a seller chooses to make that lifetime decision.

That's very helpful; thanks again. Congratulations on a solid fourth quarter and good luck in 2015.

Thanks, Jamie.

Steve Dyer, Craig-Hallum.

Good morning, guys. Nice quarter.

Thanks, Steve.

Thanks, Steve.

Wondering, maybe, if you could give a little color on what you're seeing in the energy markets, be it Texas or elsewhere, given the steep drop in oil?

You bet. This is Bryan, Steve. In Q4, I think what we really saw was a mix shift from new vehicles to used vehicles. The oil states performed slightly lower than the rest of our states in Q4.

If you want a little more color of what's happening in January, Alaska was up 28% year over year in total revenues. North Dakota, which is a highly based energy state, even though we're in the Eastern part of the state, was up 4%. And Texas was up about 3%, which was a little bit behind things. So --

Great.

It still seems strong though. I mean, we're still very pleased. It's a robust economy. There's no question about it. And if there's one thing we could say that's an opportunity is some of those pump jacks are now not running, which means that those technicians that are fixing the broken ones are coming back into our Company and able to now fix the cars that are in service, which, we all know that the throughput in service and parts is a much higher rate than what it is in new vehicle and used vehicle sales. So we think that there's a little bit of a ying and yang benefit here.

And that's a good segue. Parts and services was obviously extremely strong in the quarter. Is there anything specific you can point to that's driving that? There's obviously been a lot of recall activity. But, I think, you guys are pretty much far and away best performers in the group. What are you seeing specifically that's working?

Rick, it's Bryan again. Or Steve, sorry about that. I mean, it's primarily driven solely off of units and operations. And despite us being up 12% in aggregate in fixed operations. Yes, it's driven off warranty and it's driven off customer pay.

But primarily still, we have probably half of our stores that are considerably below that 12% level and that hasn't reinvented themselves to be able to attract our consumers back to our stores and be able to meet their needs when it comes to a cost proposition or a time proposition. And I keep saying that and saying that again.

And our teams are out there helping people see the opportunities that are afforded them with this huge units in operation increase. So, to us, 12% is just keeping pace with the units in operation growth. And that's assuming that we were really good before that and I don't think that's how we operate our stores.

And I think our store leaders and department leaders always look for opportunities. And they know that there's still considerable opportunities above and beyond. And this idea of double-digit growth in service and parts, I think we're just now starting to reach some type of equilibrium where we're dropping off a [10.7] and [12.2] SAAR, that it's starting to help us.

So I believe that this is going to continue and it feels really good to me. And I think our people out in the field are saying, you know what, it's people-based. How do we attract our consumers in a better way? And I think we'll see this continue.

Got it. Last one for me. I think as it relates to DCH, it seems like there's a lot more in the way of synergies there. Low-hanging fruit, I guess, if you will than, maybe, you guys even anticipated going into it. Can you comment a little bit on that? And how that plays out throughout 2015? Any color there would be great.

Absolutely. Steve, Bryan again. When it comes to how we looked at DCH, let's talk pre-acquisition first, or pre-combination. We really looked at that we were going to get some of the benefit, about half of the benefits coming from synergies in the first two years. And the other half coming from operational improvements, whether it's cost management or whether it's gross improvements coming in the next three to five years.

We're very pleased how DCH has really welcomed change management and the idea and the challenge to respond to managing cost. So when we look back at what we talked about four or five months ago, we really look at the synergies in terms of corporate synergies. We have everything fairly well-completed in that arena, even though, we originally talked about a two-year time scale. Now we'll realize those and some contracts have to wind down. And there's still negotiations on some things.

But we're on a clear pathway on that; to accomplish that. In fact, there may even be a little more than what we expected. George and his team back in New Jersey have done a wonderful job at that and are way more proactive than expected. When it comes to the operational side of things, the stores in DCH are quick responders and quick movers. They've responded as well. They've established forecasts. They're working towards those forecasts.

The Western stores are doing phenomenal. The Eastern stores have been hit with a little bit of weather. But we really believe that they're taking action as well and finding those cost savings opportunities as well as those margin improvement opportunities and are really responding nicely.

So I really look at the change from then to now is we're very pleased with what we purchased and the combination and how it's going. And I think that there's likely more opportunities on the operational side than we originally expected.

Yes, Steve, this is Chris. Just to add a little more color on that. SG&A to gross for DCH is in the high 70%s. As you know, Lithia has been running in the mid-to-high 60%s.

And so, transitioning that opportunity in gross into leveraging cost as a joint organization is something that we're very focused on. And then, when they're generating $75 million a quarter in gross, you can just see the opportunity that's going to come in over the next 12, 24, 36 months.

Great. Very helpful. Thanks again, guys.

Thanks, Steve.

Scott Stember, Sidoti and Company.

Good morning and thanks for taking my questions.

You bet.

Can you maybe talk about, within your core Lithia markets, the smaller niche markets? I know that, over time since the recession, you've seen a nice catchup effect there. And, it seems as if maybe that was plateauing a little bit? Can you, maybe, talk about where that stands right now within those markets and the additional opportunity?

Sure, Scott. This is Bryan. Let's see here. On our registration levels, it's actually very similar what we've been reporting in the past.

Where the Texas, the Montana; those energy-based states are still considerably above where their pre-recessionary numbers were. Oregon is still 5% recessed. Nevada down 10%. Idaho down 10% still. Hawaii down 5%. California's actually flat now, which it was a little bit recessed. Even though, I believe, the Central Valleys are still 5% to 10% recessed.

Okay, got you. And on the parts and service angle. Obviously, you guys have been putting up fantastic numbers on that side, now that we have DCH in the mix.

Can you, maybe, just flesh out a little bit the strength that was contributed there? Whether it be customer pay, warranty? Maybe just give us a little bit of a flavor of where the strength in parts and service for DCH is coming?

Yes, sure we can, Scott. This is Bryan again. In terms of the Lithia side, on same-store basis on 12%, obviously, that's all Lithia, right? I would say though and reiterate that probably between 30% and 40% of the Lithia stores are at 2% to 3% increases. And, as warranty grows, it creates this anomaly that happens where you don't increase your customer pay, which means we're not reattracting those new units and operations that are out there. So we believe that there's still a lot of opportunity within our existing Lithia stores.

When we look at the DCH and what's occurring there, they actually are lagging year over year where the Lithia stores are. And I think George and his TVP team, as well as their general managers and service managers, are fairly aware that the units and operations growth that are afforded them provides a big opportunity to be able to expand their business. And I think until the combination of the two companies, that wasn't quite as known a number.

So we're starting to see the early stages of some stores really try to market and attract what I would call an expanded radius of consumers to be able to bring them into our stores for the first time or back of the stores and to really grow that business. Now, they're very good about expedience and price awareness, okay, which are the things that Lithia's really been focusing on because of the hypersensitivity in a competitive market.

However, I also believe that the idea of trend management and common measurements that Lithia and DCH combined together have brought to the party has been able to really highlight those opportunities and see where to pinpoint an attack on a marketing basis in specific stores and departments to be able to capture that opportunity. So I think they're actually seeing those opportunities. Even though they have the solutions already built to meet those needs, they just need to know when to drive it.

Got you. That's all I have. And thanks again for taking my questions.

You bet, Scott.

Brett Hoselton, KeyBanc.

Good morning, Sid, Bryan, Chris, John.

Hey, Brett. How are you?

Good. First, just on the used-car issue. Should we consider that to be largely behind you at this point in time? Or is that going to potentially bleed over here into the first quarter of 2015 as well?

Brett, this is Bryan again.

Bryan.

I would say this. Our Lithia stores rallied pretty hard from the Q3 opportunities that were afforded us in Q4. And I think they've got it figured out that, even if margins remain a little bit below where they've historically been, they've now adjusted pricing. And they've adjusted compensation to accommodate those things.

If you notice, our day supplies are down pretty good. We're not in a position to panic anymore where it should regain margins. But, even if it doesn't, we believe it's a better model. I think if you recall, that $9.5 million in added gross that we got for a 1% reduction in overall deal average, we believe is an absolute trade-off that we should take every single time.

And despite the Q3 anomalies, I think it opened up some of our stores' eyes that they may be able to have a little of both. And, actually, make a lot more net because of it.

And switching gears, thinking about the DCH acquisition. Obviously, quite a sizable acquisition for your Company. Generally, when I think about an acquisition of that magnitude, there's some potential integration risks and some potential opportunities. And what I'm wondering is, can you possibly provide, maybe, the top one or two risks that you see? And the top one or two specific opportunities that you see?

Yes, sure, Brett. Bryan again. I think that the risk, the number one risk, which is most likely behind us, was this idea of a cultural shift from a volume-based organization to a balance of volume and net profit, which their people and their stores are responding very well to it.

When we looked at the corporate synergies, we thought that there was additional risk there as well. But we've now integrated our staff on the marketing side. We've integrated them on the legal side. We've integrated them on the F&I side. We've integrated them on the accounting side. Our corporate synergies, like I just mentioned, are fairly well done, okay?

The teams that are out in New Jersey are integrated and working well with Lithia. They're wonderful people that we believe are here for the long haul. George is leading that part of the organization in a way to really grow that into a growth entity for us as an organization. We're kind of at that stage now, that we're looking at what's next, despite it only being, what, 145, 150 days into the combination.

But, I mean, and that means we're looking at that 2.5 times additional opportunities of where can we go buy stores? What are the opportunities? Where are our people talent and where can they grow from? So I think the risks are really behind us in terms of that integration, which was probably the biggest uncertainty. And that shock when we talk about that volume model versus a volume profit model balance.

And then, as you think about the opportunities, I think most of us seem to lie on operational side. Can you cite which you think might be those top one or two specific opportunities or areas of opportunity for your Company?

Yes, Brett. This is Chris. I mean, I think one of the key things we were able to do very quickly was unify our reporting metrics that we use to really engage each store and identify the opportunities in each store. So now that we've done that and we're working to transition that information down into the field, it makes it very easy for us together to identify opportunities and the successes that we had.

And so, I think one of our opportunities is, now that we have the information in front of us, for us to continue to use that. Operationally, an area that I think is a focal point for both Lithia and DCH, it hasn't come up yet today on the call, is definitely our F&I performance. We lag the peer group right now in F&I. And, if you look at our same-store comps compared to our total comps, the Lithia number is lagging. Or the DCH number is lagging a little bit where Lithia is on F&I.

But, together what we've both done is lined out a path to take our F&I PVR from [1200] down to [1300]. And it's something that we're focused on and it's going to take some time. But it's an effort that we know is going to generate a lot of additional gross for the organization.

Brett, additionally DCH has been working on something that they call sales evolution. They've rolled out three stores and allowed those general managers to start to test the waters on what we would call a more transparent sales process and a more cost-efficient sales process. The initial intent was to capture a greater market share, while doing it with a lower delivery cost, meaning, that we could ultimately generate more net profit, okay?

The initial results on that are fairly good. The front end averages are up a considerable amount, a couple hundred dollars a car. In those initial three car -- three stores. We believe that that can be a model that some other stores may choose to use in the future. But we believe front-end deal average is also an opportunity. And then, along with that comes that ability to find the productivity benefit and the cost reductions to help bring the money to the bottom line.

And, Bryan, I know one of the areas that you've really done a nice job, and you continue to focus on, is actually over the long-term used cars. And I'm kind of wondering, metro dealerships tend to lag a little bit in terms of used cars, used-to-new ratios and so forth. But is that another opportunity for you at DCH specifically?

Absolutely. In fact, the biggest area of that was, I would say, 80% of their stores didn't play in what we call that value auto. In fact, only played in the upper end of the core products, typically. And I think they're quickly finding that those are fairly easy vehicles to keep on your lot. And don't take a lot of personnel costs to be able to keep them on your lot and sell those vehicles. So that's something that's taking hold fairly quickly.

You are correct that the used-to-new ratios are definitely lower in metropolitan stores. However, if you remember, our space constraints are fairly minimal; meaning, that most of our stores have the ability to grow their used car inventories whilst continuing to grow their new vehicle inventories, which we're pretty excited about.

And, if you recall, they own 72% of their facilities, which means that those space constraints are going to get tighter, okay? We control those assets, which is good.

The other thing that we believe is a big opportunity that's spun off of this idea of more used-car volume is the idea of detail departments, which Lithia runs detail departments in all of its stores. So we have now, I believe, two stores that are piloting what we call detail departments, which is another way to improve reconditioning. Despite it being eliminated, it's still something that's passed along to consumer cost. And is not -- it doesn't have any costs associated with it. So it's bottom-line profit that's generated fairly quickly.

And then, switching to the acquisition outlook. As I think about your acquisitions in the past, I kind of tended to think about it as driving mid-single-digit revenue gross; 4%, 5%, 6% or something along those lines. Obviously, DCH is accelerating that. As you, kind of, look forward, obviously, the law of large numbers, you now have a $7 billion entity.

So how do I think about that revenue growth rate and your expectations there with regards to acquisitions specifically? I mean, is it still reasonable to think that you can drive that mid-single-digit revenue growth rate? Or should we kind of curtail that somewhat, given that you've got a much larger revenue base at this point in time?

Yes, I hear what you're asking. So we don't specifically give -- we don't really have any quotas, per se, of how many acquisitions we do. We do believe that there's enough headroom in the market to be able to continue in that mid-single-digit range. We also believed, with the opening of this idea, that now we have 2.5 times the opportunities in metropolitan areas because of the combination of DCH. That provides some additional opportunities.

And, I think, maybe, to round that out for you, if we look at the idea that we just introduced a milestone [four], which is $7.00 a share. We believe that we need to do somewhere in the 12 to 15 additional stores, on top of the DCH stores, to be able to achieve that $7.00 EPS milestone.

Very helpful. Very helpful, gentlemen. Thank you very much. Great quarter.

Thanks, Brett.

Elizabeth Suzuki, Bank of America Merrill Lynch.

Good morning, guys. Your outlook for 2015 has gone up pretty meaningfully. In the fourth quarter EPS beat the midpoint of your outlook by 20%. But you didn't revise your first quarter outlook at all. So should we assume that some of your 1Q 2015 outlook is pretty conservative? Or are there other factors that have been developed -- that have developed that make that [118] to [121] range still look realistic?

Yes, Elizabeth. This is Chris. I think two things. We continue to guide the same way we've done it consistently for the last five-plus years, which is look at the store performance that we're currently seeing, make some assumptions on what's happening in our markets and roll that forward. And that's where the raise for, really, 2015 came from.

In Q1 specifically, the issue that we ran into had to do with vacation accrual for the DCH teams. We didn't realize that all of their employees actually vested vacation on January 1st. So we take a huge hit in the quarter for vacation, which, at the traditional Lithia stores, comes in over the year. So it was more of the timing of an accounting adjustment, which I think was around $0.06, $0.07, and that's why you didn't see a meaningful lift in Q1.

Okay, that's really helpful. And regarding your digital strategy. It seems like a lot of your peers are placing more emphasis on this and trying to engage with the consumer online through Smartphone apps, et cetera. So what's Lithia doing along these lines? And how does that kind of strategy translate into your unique market?

You bet, Elizabeth. This is Bryan. When we look at our opportunities from what we would call living room to showroom, a lot of the reason for a combination with DCH was we really believed that the technology that they developed around their sales evolution was something that had a lot of meaning to us, despite us having partnerships with vendors like ELEADS or CDK, ADP.

We've grown those things. But it's not able to be able to adapt as quickly to changing consumer demands as what we believed that Al Amari and his teams back in New Jersey have done. So, we really look at it as a two-pronged approach. One is, this very flexible model the DCH has brought that we'll hopefully be bringing into some of the Lithia stores, as well as the, maybe, a little bit more stable models of the CDK and ELEADS, that we're, kind of, used to.

But they're not as transparent when it comes to in your living room. Whereas, the DCH model is something that you can sit in your living room, you can be on an iPad or so on and so on and work through a sales transaction. And then come into our showrooms and have that same experience on iPads with our sales personnel and our sales management staff and quickly complete an automotive vehicle purchase.

So, we're pretty excited at what's happening there and they did it in a fairly cost-efficient way to be able to accomplish a lot of transparency in the consumer's mind.

Great. Thanks very much.

You bet.

Rick Nelson, Stephens.

Thanks. Good morning. I would like to follow up DCH and the accretion guidance that you provided coming in to this here is $0.70. What your thoughts are now? An, how much of that $0.30 raise in guidance for 2015 at the midpoint related to DCH?

Hey, Rick, this is Chris. One of the things that's getting really difficult for us to do very quickly is just identify the additional leverage that we're gaining from either Lithia or the DCH team. And that comes because working together as a combined management team, when we add an employee, let's say, in our corporate headquarters, and, let's say the payroll department, was that a DCH add or was that a Lithia add?

And so, what we're finding is that the synergies that we're getting are really benefiting both sides of the organization. But, yes, coming out of the expectations that we laid out for DCH last year, there's a large piece of the incremental lift that we're seeing in our guidance in 2015 related to what Bryan said was a smooth integration with DCH.

Okay, got you. And I think you had pointed out DCH generates about $75 million per quarter in gross profit?

Yes, that's correct. I mean, if you just look at the revenue base and apply an average gross profit margin, Rick, it should be somewhere around $75 million.

Okay. And the SG&A you said for DCH was high 70%s?

That's correct.

Okay. And Lithia SG&A in the high 60%s. Curious how long you think it would take or if it's even possible to close that gap?

There's no doubt that we want to become industry leading again, Rick. And that 70.2%, we have a runway here in front of us now to get back to, so let's start in the high 60%s. DCH knows the opportunities are there.

They know that the first thing to do is generate additional gross in the area that they can with new cars, used cars, F&I and service. And then, from there, we'll start talking about cost control and pay plans and advertising, which make up about 75% of our SG&A. So, definitely opportunities on the table. And we're going to work through those over the next 36 months.

Great. Thanks a lot and good luck.

Thanks, Rick.

Bret Jordan, BB&T.

Hey, good morning. Quick question on the service side of the business. And as you're cross-selling the warranty volumes on this historic recall against customer pay, do you have a feeling for what percentage of the business comes in for warranty that you can sell customer pay service on?

Bret, this is Bryan. I really believe that it's probably in the neighborhood of 50% of the consumers that come in. Many of them are just typical customers that are always coming into our service departments.

And, if you recall, our retention rate in service is in the high 50%s, low 60 percentile range. So, if you make that assumption, those are typically not people that you're going to be getting additional upsells on. So that remaining 40%, 50% is what you can upsell and hopefully generate a new relationship with.

Okay, and then a follow-up. You'd covered some of the spread on the F&I between DCH and Lithia. What is the least penetration? As compared to the two, I'd imagine DCH is significantly higher. And does the higher lease penetration limit what you could do in F&I because people aren't willing to spend some incremental dollars when they're not actually owning the car?

Wow, Bret, that's a great realization. That is actually the single biggest benefit that Lithia is learning from DCH is how do you get to 40%, 41%, 42% lease penetration on new vehicles, which is a huge benefit when you look at the cycle of a consumer. And how you generate a trade-in that's a built-in certified car is something that we've really missed in the past, other than in our highline stores at Lithia. So our Lithia stores are really starting to grasp onto this idea and look into the opportunities that are afforded them when it comes to leasing.

Yes, there may be a little bit of degradation in margin and slightly in F&I. But it is so minimal for the benefits that you gain out of a higher lease penetration that we believe that it's a big opportunity. Lithia, on a side note, is in the mid-to-high single digits, which most of it comes from a highline product.

So there's a large opportunity in our mainstream franchises, such as Honda, Toyota, Chevrolet, Chrysler, and Ford that we really believe can help expand our market share and not just replace other deals, but more expand those transactions.

Yes, Bret, this is Chris. The one thing I'd add to that is that when you look at some of the DCH stores that have high lease penetration and that are doing F&I, PVR in the [1200,1300,1400] range.

I mean, it opens our eyes to the opportunities that we have. Not just in the DCH stores, but also, in our existing Lithia footprint. And it's evident by what our public peer group is doing in F&I and high lease markets, that there's still opportunity there and we're focused in on that.

Okay, great. Thank you.

Good question, thanks.

Paresh Jain, Morgan Stanley.

Good morning, everyone. I had a question about the $7 EPS target. So it seems like you guys are on track to almost double your EPS in three years in 2015. And, originally, your time window was three to nine years to achieve that. And, clearly, it's coming in at the low end of that.

And now, you have the $7.00 target following the $6.00 in three to -- in one to three years. And it seems like acquisitions have some way to go. So, if we were to assume that these acquisition targets can be met in one to one-and-a-half years rather than three years, are there any liquidity or management bandwidth constraints that prevent you from getting there?

This is Bryan again. When we look at the $7.00 EPS and we look at where we came from at $3.00, it's easy to think that it's a big hurdle. But I think we have multiple things in place that allow us to see the vision on the $7.00. And like I reiterated once before -- like I said once before, the idea that we still need 15 acquisitions to get that done.

We need an environment where SAAR starts to push above $16.5 million pretty consistently. We need DCH to fully integrate together and realize their benefits to accomplish that. So we really look at it as achievable. But we also look at it as a long ways from where we've come. So we have to re-inspire our people and help them stay humble to see the opportunities in front of them.

Understood. And then, a follow-up on the F&I. You talked about leasing debt. But, when we look at the current $100 gap versus peers, what are the main buckets that explain that gap?

Yes, hey, this is Chris. I think the biggest thing that we're looking into is where we generate the majority of our F&I profit after the finance reserve is definitely service contracts in gap. And I think those are some opportunities that we have to improve. One thing that makes Lithia unique is that we have a fixed pricing model in all of our F&I offices. So we don't negotiate pricing on F&I products, which is -- puts us on the right side of compliance, I think, with the CFPB.

But, at the same time, we may lose a little bit of F&I revenue that, if we're not competitive in the market on what we can ask for the products and services that we sell. So, we're experimenting with some new things; we're trying some new things. We're adjusting pricing in a few areas and that's the core of our focal for 2015.

Understood. Thank you, guys.

Thank you.

Bill Armstrong, CL King and Associates.

Good morning, guys. So, it looks like inventories were well under control, both going into the quarter and coming out. I was just wondering if you could review on the same-store basis gross profit per unit?

Both new and used were down year over year. What was driving that trend in the quarter? And what are we looking at, maybe, going forward?

Bill, this is Bryan. The drive on both new and used declines is primarily that we believe that volume is a better model than higher gross. So we were down the $30-some in aggregated deal average. So we made some of it up in F&I, if you recall.

But, we believe that $9.5 million that we made in additional gross is going to generate downstream business over the next three to five years in service. And then, possibly, used car trades and all the other things, that it's a big benefit. Chris, did you have something to add? Okay.

Bill, this is Sid. Just, I think, focus on gross margins is a mistake, in the sector the focus should be on total gross generated. And those goals have to be part of every piece of our organization.

Lithia's values are on this decentralized model where store leadership makes such a huge difference. And we think that these people, particularly the DCH group, have a lot of opportunity yet. One may realize that corporate isn't going to tell them how to do this. They reach out. They find solutions individually with each brand, each market and each a different way.

And we avoid major investments as well in restructuring or in making everybody off of a common playbook. I mean, none of that's going to go on at Lithia. I mean, we are an organization that believes that the store manager, the store leadership and the total gross generated, is the goal.

That makes sense. Thank you very much.

Thanks, Bill.

David Whiston, Morninstar.

Thanks, good morning. I wanted to go back to leasing first. Traditionally, I believe, Automotive News, in a recent story on you guys, was saying that (inaudible) lease, that your rural customers don't like to lease. And I was -- can you just talk about the mindset of that? Because I would think at the end of the day, isn't it about a low monthly payment wherever you live?

David, Bryan. I think that the mindset of the consumer may be established from the mindset of our teams and our stores. (Laughter) The more that we get out there -- and we were in Washington and Northern Oregon last week visiting 14 stores. And what I heard time and time again were arguments.

But, then when you looked underlying what those arguments are, that a consumer is not used to leasing; it's not typical. And when we were able to show them competitors around us that had two or three times the lease penetration rates and we're able to ask them, how do they actually, what we call, desk a deal on a lease? And find out that their technology doesn't even have the ability to do leasing very easily, where you can compare it and show them the benefits compared to a purchase, and show them laid up to each other, so they can see the benefits, that it is actually less expensive many times.

Because, if you recall, many manufacturers subsidize their lease products at a higher rate than what they do their purchase or their cash products. And the reason is, is because they know they have better control of the customer in three years and it's more likely that they will buy another car.

In fact, the numbers that Toyota and Honda have both given us is there's a retention rate on buying a new car again, which is around 40% for a non-leasing customer. It goes up to 60% or 50% better retention rates for leasing that vehicle. So they're willing to pay $500 to $700 to $1000 more to do that. So we're helping open up our Lithia stores' eyes. And the good thing is, many of the stores, especially the highlines, they already get it. They know this.

But our other mainstream franchises, we're having to open up their eyes to the idea that leasing is a better value for our consumers. And, despite them possibly being adverse to some extent in small regional markets where, maybe, disposable incomes are a little bit less, that's even more reason that they should be able to lease. Because, ultimately, the monthly investment is about 10% to 20% less than what it is on a financed purchase.

Well, that's very helpful. And how long do think it's going to take us on the Lithia side of your stores for that -- not only -- it sounds like the message is already nesting, sinking in. But how long will it take to actually change the execution and operations in the store?

Yes, I really believe, like I said, it's a mindset. So, when we look at -- remember, we talked so much about how do we get to 75 units per store in used cars, right? Well, we're at 57 or so, right?

It's really a -- you have to have your people in the store believing, which means you have to challenge them and point out the opportunities. And then, hopefully, follow up and provide them with solutions so they can take the baby steps to continue to build off their base of business without losing everything. Otherwise, they could end up leasing cars to consumers that really want to finance and actually may be lowering their gross because of it because, they're trying to push a percentage rather than the overall gross that Sid spoke to, which is ultimately what drives net profit.

So, we're always pretty delicate and make sure it's their idea in the stores rather than our idea. So we really plant the seeds and then hopefully they'll take up the watering and the fertilizing and those type of things to really grow that ability to lease vehicles. So it can take some time.

It's really just a mindset change? You don't need to do a lot of IT dollars spending to do this, right?

No, in terms of the IT dollars spending, Advantis, who the product is that the DCH stores are using, so some of the Lithia stores may turn to them because it's a very cohesive transparent system for the consumer.

But also, we have ELEADS and we have CDK, which is ADP, that have solutions as well. It's a couple hundred dollars a month if we choose to add it in our ELEADS stores, on to our existing CRM system. So it's a low-cost adventure to be able to add the technology components if the store may or may not have it.

And just one quick question on used-to-new ratio. Longer term, can that get back to 0.8% or even 1 to 1?

I believe that in the Lithia stores, that the idea of a greater than 1 to 1, used to new, is totally doable. But remember, within the next, what, three quarters, the DCH stores will be rolling into same-store sales. So the DCH stores will help us get closer to the 75 units per store, which, we'll probably end up raising that target at some point because of that. But, it also hurts us when it comes to the new-to-used ratio.

Okay. Thanks very much.

Thanks, Dave.

Thanks, Dave.

Thank you. That is all the time we have for questions. I would like to turn the floor back over to Management for any additional or closing remarks.

Thank you, everyone, for joining us today. And we look forward to updating you again in April on Q1. Goodbye.

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