Lithia Motors Inc (LAD) 2015 Q3 法說會逐字稿

Greetings and welcome to the Lithia Motors third-quarter 2015 earnings conference call.

(Operator Instructions)

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

Thanks and good morning. Welcome to Lithia Motors third-quarter 2015 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 condition, liquidity and development of the auto industry and markets in which we operate may differ materially from those made and/or suggested by the forward-looking statements on this call.

Examples of forward-looking statements include statements regarding expected operating results, projections for our 2015 and 2016 performance, expected increases in our annual revenues related to acquisitions or open points, anticipated availability from our own finance operating real estate, and anticipated level 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 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 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 financials measures we present improve the transparency of our disclosures, provide a meaningful presentation of our results from core business operations because they excluded 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 third quarter results.

On the call today are Bryan DeBoer, President and CEO; Chris Holzshu, Senior Vice President and CFO; and Sid DeBoer, 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 followup you may have.

At this time, I'd like to turn the call over to Bryan.

Thanks, John. Good morning and thank you for joining us today.

Earlier, we reported third quarter adjusted net income of $53.6 million compared to $34.9 million a year ago, for an increase of 54%. We earned $2.03 per share in the third quarter compared to $1.32 per share last year, up 54%. Our revenue was over $2 billion in the third quarter, a 61% increase.

From this point forward, all comparisons will be on a same-store basis. Total sales increased 12% as all four business lines increased double digits. New vehicle SAAR was $17.8 million in the quarter, the highest national result since 2005. In the quarter, new vehicle revenues increased 11%, new vehicle average selling prices increased 2%. Unit sales increased 10%, which was higher than the national average of 6%.

Domestic units increased 15% compared to 8% nationally, import increased 5% compared to 5% nationally, and luxury units increased 6% compared to 7% nationally. Gross profit per new vehicle retailed was $2185 compared to $2231 in the third quarter of 2014, a decrease of $46. Leasing penetration improved on a same-store basis, up 33% from the prior-year period. Our store personnel continues to focus on accelerating new vehicle purchase cycle while improving the supply of future used vehicle inventory and increasing customer retention.

Retail used vehicles increased 13% in the quarter. Our retail used vehicle average selling price increased 3% as certified vehicle growth continued to outpace other categories. We retailed 10% more used units over the prior period, resulting in a used to new ratio of 0.83 to 1. In the quarter, certified units grew 19%, core units increased 8%, and value auto units increased 5%. Our used vehicle gross margins declined 10 basis points due to higher average selling prices.

Gross profit per unit was $2546 compared to $2489 last year, for an increase of $57. On a 12-month rolling average, we sold 61 used vehicles per store up from 55 units in the comparable period last year. Our goal to retail 75 used units per store still provides considerable upside in the future. We continue to grow used vehicle sales as inventory supply increases in the marketplace. Additionally our stores continue to recruit and develop used vehicle managers with the ability to source, recondition, and merchandise used inventories.

Our F&I per vehicle was $1274 compared to $1203 last year, or an increase of $71 per unit. Of the vehicles we sold in the quarter, we arranged financing on 74%, sold a service contract on 44%, and sold a lifetime oil product of 36%. Our penetration rates and profitability improved in all three categories over last year.

In the third quarter, the blended overall gross profit per unit was $3638 compared to $3565 last year, an increase of $73 per unit. This was complemented by an increase of 10% in unit volumes. As we have previously discussed, our store personnel monitor total gross profit generated rather than the margin percentage to evaluate and drive their performance.

Our service body and parts revenue increased 10% over the third quarter of 2014. Customer pay work increased 8%, warranty 25%, wholesale parts increased 4%, and body shop increased 4%. Our total gross margin was 15.3%, unchanged from the same period last year. As of September 30, consolidated new vehicle inventories were at a day's supply of 64, a decrease of eight days from a year ago. Used vehicle inventories were at a day's supply of 54, the same as a year ago.

We completed three acquisitions in the third quarter, Missoula Ford and Great Falls Subaru Hyundai GMC in Montana and the only Acura store in Honolulu, Hawaii. The fourth quarter is off to a good start with the acquisition of Concorde Chrysler Jeep Dodge Ram and Fiat in California. Thus far, in 2015 we have purchased or opened six locations with estimated annual revenues of approximately $220 million.

The acquisition market remains very active with a significant number of stores for sale. With Lithia targeting exclusive markets and DCH pursuing a metropolitan market strategy, we have identified more than 2600 stores nationwide as candidates. We remain confident that we will find accretive purchases in the near term to increase our portfolio and continue to grow earnings.

We remain optimistic that pent-up demand stemming from the past seven years of new vehicle SAAR performing below averages will be realized over the next few years. This opportunity will drive growth in all four business lines, complementing the push for market share gains and greater earnings by our store leadership. This improved optimism coupled with strong performance in the first nine months of the year has allowed us to increase our outlook for 2015. Chris will be providing more detail to follow.

We are also introducing our fifth milestone of $8 a share in earnings to supplement our remaining milestone of $6 and $7. As always, we anticipate achieving these milestones in a one- to three-year time frame.

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

Thank you, Bryan.

At September 30, 2015, we had approximately $196 million in cash and available credit, as well as unfinanced real estate that could provide another $108 million in 60 to 90 days for an estimated total liquidity of $304 million. What at the end of the third quarter we were in compliance with all our debt covenants.

During the quarter, we completed $16 million in mortgage financing. We will continue to selectively mortgage properties to provide additional flexibility and to take advantage of the current rate environment. Our free cash flow, as outlined in our investor presentation, was $58 million for the third quarter of 2015. Capital expenditures, which reduce this free cash flow figure, were $14 million for the quarter. We estimate generating over $160 million in free cash flow in 2015 providing significant capital for internal and external investment.

Our annualized net debt to EBITDA is approximately 1.7 times, reduced by over half a turn from year end, demonstrating the impact that strong financial performance has on our balance sheet. As a result, we have ample liquidity when necessary to complete larger acquisitions.

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 investment. But regardless of category, all investment decisions are measured against strict ROE metrics to generate solid long-term returns.

Our third-quarter adjusted SG&A as a percentage of gross profit on a same-store basis was 64.3%, a decrease of 160 basis points over the third quarter of last year. Throughput, or the percentage of each additional gross profit dollar over the prior year we retain after selling cost and adjusted to reflect same-store comparisons, was 49%. We continue to target incremental throughput in the range of 45% to 50% in the future.

On a consolidated basis, including the effect of recent acquisitions, our adjusted SG&A as a percentage of gross profit was 66%. On a sequential basis, this reduction was 60 basis points from our consolidated 66.6% result in the last quarter. As we continue to integrate the DCH acquisition into our operations, we will target a full-year consolidated SG&A to gross profit in the mid-60% range.

As previously announced, we entered into a transition agreement with Sid DeBoer, reflecting his changing role with the Company. Effective January 1, we will cease paying him like an employee, including any performance-based compensation arrangement. This agreement results in a $1.5 million annual reduction from his previous compensation package, or approximately $0.04 per year. We reported an the accrual of approximately $18 million in the quarter to reflect the discounted value of the arrangement. We have isolated the impact of this as a non-core item and removed it from our pro forma results.

Based on the results in the third quarter, we have increased our 2015 guidance as follows. We expect fourth quarter 2015 earnings-per-share of $1.61 to $1.65 and full-year 2015 earnings-per-share of $6.89 to $6.93 per share. We also expect first quarter 2016 earnings-per-share of $1.46 to $1.50 and full-year 2016 earnings of $7.15 to $7.35 per share, and setting these estimates we would remind you that our approach to guidance remains unchanged. We generate a bottoms up model using current store performance in current market conditions to derive overall Company performance estimates that have a high probability of success.

In 2016, we are expecting modest improvements in sales rates and similar trends in recent execution at our stores. Our guidance does not include the impact of future acquisitions. However, given the robust activity in the marketplace we anticipate acquisitions will play an increasingly important part of our future growth plan. This is reflected in the $8 milestone that Bryan introduced earlier in the call.

For additional assumptions related to our earnings guidance, please refer today's press release at the lithiainvestiorrelations.com. This concludes our prepared remarks.

We'd now like to open the call to questions. Operator.

(Operator Instructions)

Michael Montani with Evercore ISI.

Good morning. Thanks for taking the question. I wanted to ask first a question for Sid and for Bryan really which was looking at residual values, and the Manheim Index has shown quite a bit of resilience. I've been getting a lot of questions about if and when that's going to roll over and what that portends about demand, and I guess having the benefit of some experience would be interested to hear management's view on sustainability of residuals, the impact a CPO would have in this cycle where maybe it wasn't in place to the same extent in 2000 and 2002?

Hi, Mike. This is Bryan. Maybe to start, thank you for picking up coverage as well. We're glad to have you on board. If we look at residual values and we look at what we believe will be future trends, what we're starting to see initially is that there are starting to be increased supplies in used vehicles, so off-lease vehicles are becoming more prevalent, which would give indication that values may soften a little bit as supply begins to loosen. And I think those trends may continue as the SAAR rates continue to climb as well.

This is Sid. I would confer with Bryan there -- I concur. It's pretty much -- this is kind of a stable position we're in now. There's no extremes.

Okay, great. And if I could just follow up. One area that was impressive was the total gross on a same-store basis was actually up on the front end. I noticed that on a reported basis though it was not and I guess the question I have is what specific initiatives have you found have been successful at core Lithia that you can transpose and put into practice both at DCH and some of the other acquired stores, in particular on the F&I side and also on the used vehicle side to make sure that as you cycle DCH in some of these larger deals that the total can grow in addition to the same store?

Mike, good catch because you're accurate. Next quarter, DCH will begin to roll into same-store sales as well, but for now it's still showing independently. We were up I think $73 in total gross and I think what we're talking a lot with the DCH team who's really making wonderful strides and be able to generate bottom line profit, but they're starting to get that it's about total gross and total volume and it's not individual per unit numbers. And I think because of that they're able to control their expenses in relationship to a total number a lot better.

So -- and I think something I'm sure we'll get asked on is our SG&A percentages. When we look at what we're trying to accomplish with DCH, their teams are doing wonderfully. I think it was a year ago, maybe a little over a year ago that we introduced the DCH included in our guidance and what we had forecasted for their SG&A and at the time they were in the mid-80% range, which was vastly higher than most of the public group as a whole. Well, when we look at today, they've been able to reduce their expenses through synergies as well as through corporate staff but the stores are starting to get it as well. For the quarter, they were at 71% SG&A, which is the middle of the pack of our public peer group which is just wonderful considering that they are in competitive metro markets, and year-to-date they are at 73% and I think they can see a pathway to get into that even lower 70 percentile or maybe even in the high 60 percentile.

That's great color. Thank you and good luck.

You bet, Mike.

Paresh Jain with Morgan Stanley.

Good morning, everyone. Bryan, let me start off with a question for you. You stated in the press release and mentioned in the call as well that you anticipate further transactions in the near-term. What does that pipeline mix look like in the near-term? More of these single store smaller dealer groups that we've seen this year or is there a healthy mix of more sizable deals?

Thanks for your question. I think what we're seeing is that there is a ton of opportunities so we're able to be selective on not only large groups but on our individual groups. So far this year we've done six acquisitions or open points. We really believe that the pipeline is full and that was maybe a little bit slower than what we would expect in the future, and I think it's because there is such a vast array of selection.

When we look at whether or not they're going to be [stable diet] the one or two type of stores, I think we will have a balance of those. We have our fingers into most deals. There's recently been two larger deals announced of which we were involved with both of those on the initial offerings and chose really not to do that for a number of different reasons. And I think when we look forward you're going to see us continue to grow because now both Lithia and the DCH division have people growing with the ability to take on new opportunities.

Understood. And, Chris, a question for you on the $8 EPS milestone. And please correct me if I'm wrong but you introduced the $7 milestone in February of this year with a target of achieving it in the next one to three years and now within less than a year the $7 EPS is already on the horizon. What are the factors that accelerated that part to $7 and why shouldn't we expect some of those factors to help get to the $8 milestone sooner?

Paresh, this is Chris. Thanks for the question. I think the number one reason that we got to or are working well towards that $7 milestone so quickly was because of the DCH acquisition. I think that as we continue to assimilate acquisitions and continue to execute on a same-store basis, our intention is to accomplish those milestones as quickly as possible. The nice balance with the milestones and the external guidance that we provide is that it does include the acquisition footprint that we feel like is going to be the next phase in our growth and hopefully you can kind of see the correlation between the two.

What we look at right now is 2016 incremental market growth is probably going to be in the 3% to 5% range and so everything above that is going to come from additional execution and as we said, our guidance doesn't bake into that additional execution beyond what we're going to see in our current market. So, there's a balance between the two.

Got it. And lastly on F&I, can you share any more details on the Honda settlement with the CFPB? Do we have more clarity on what the additional fee beyond the 100, 125 BPS of spread could be?

Yes, this is Chris again. So, I think first off before we just get into Honda let me talk about the CFPB in general. One, the CFPB has made it very clear that the dealer plays a valuable role in the finance transaction, so this is not about eventually not making finance reserve. What it's about, it's about the disparate treatment with the consumer. And so what we're finding is not just Honda but a number of partner lenders both captive and non captive are looking at numerous strategies that they are approaching to satisfy the disparate treatment with the CFPB, but what we're finding is none of those really have a material impact in the overall finance reserve that we have.

This is Sid. I'm on the National Auto Dealers as a director from Oregon. I just spent three days with them in a meeting, the quarterly meeting, and most of the discussion was about this. They're working hard to find a solution that works that's revenue neutral for all of us, and it looks like they're making good progress.

That's good to hear. Thanks, guys.

Thank you.

Steve Dyer with Craig-Hallum.

Thanks. Good morning, guys. Bryan, that was impressive improvement on SG&A to gross at DCH. And, Chris, you threw out a mid-60s SG&A to gross I think, and I missed for what timeframe that was.

Yes, Steve. We're going to continue to focus on improving the SG&A by working on the initiatives not just at the DCH stores but at our Lithia stores that are still well above kind of where the Company averages today. If we break it out by state, we currently have about five states that are below the 60% range. We have about five states that are in the 60% to 70% range, and we have four state that are actually above the 70% range and these are a mixture of DCH stores and DCH locations as well as Lithia stores and Lithia locations. So, that mid-65% range we'd like to see at mid term. We didn't give an exact timeframe on that and we didn't bake mid-65 into our guidance for next year.

Still lots of opportunity.

Yes. Okay. Great. And then you touched on DCH a little bit. Did you see any margin pressure on the imports, midline imports, in the quarter just based on gas prices being where they are?

Steve, this is Bryan. Actually, one of the things that we with the DCH team thought that there was an ability to grow was $100 or $200 per unit in the competitive markets and somehow they seem to extract that additional gross profit from their stores, which is a lot of the reason they're able to perform so well on their SG&A. More recently there has been some pressures with Toyota and Honda, but all in all we're really satisfied with what we're seeing in the marketplace and it doesn't seem to be destructive in any way, shape, or form.

Thanks. Two more quick ones. I noticed inventory was up quarter over quarter which I don't think seasonally normally is the case, and I know both new and used on a days sales perspective it's relatively in line. Any more commentary there or is that just a function of making some acquisitions late in the quarter? Anything there would be great.

Steve, Bryan again. That is a function of the three acquisitions that we just did but more importantly, seeing an 18.2 SAAR in September. And if you start to look at the trends in those numbers we're pretty confident that a quarterly number at 17.8 may be more typical which is going to require a little bit more inventory. I think we were down seven days in new vehicles, but some of that is a function of DCH rolling in because that's not as same-store number. On used vehicle we're at same day supply as we were last year but we're okay with that being that our same-store sales rates in both new and used are up 10%, and the trends when we start to look at SAAR are looking like we may see some quarters and possibly years that are above the norm.

Great. And then lastly as you look at leverage you talked about de-levering I think a half a turn since the beginning of the year. Do you sort of have a target leverage figure in mind or how are you sort of approaching that going forward?

Steve, this is Chris. I think internally the leverage ratio that we would see probably on the max side would be near that 3 times number, and as you can see we're quickly de-levering from where we started 2015. And looking forward as far as we keep talking about acquisitions and being the next phase of our growth plan, I think it's important for us to make sure that we have a balance sheet that can acquire a significant number of stores as they come to market. And so before DCH our leverage ratio was about 1.3 times, so we still probably got another year to get down there, assuming that we don't do a lot of acquisitions, but I think we feel that the acquisition pipeline is full right now and our leverage ratio will probably at least stay where it's at or climb a little bit through next year.

Great. Thanks a lot, guys. That's it for me.

Thanks, Steve.

James Albertine with Stifel

Great. Thanks for taking the question and good morning, gentlemen. So it seems like as good a day as any to ask a hypothetical about going back to the future. I know John appreciates that reference.

All day long, James.

Keep it coming. I'll make like a tree and get out of here. Anyway. Quite seriously, there's a lot of consternation about where we are in the new vehicle selling cycle and do we want to own or recommend dealers given the progression we've seen for new vehicle sales and now tracking above 18 million SAAR. So I guess my question is let's run a hypothetical, if you will.

What's different today about Lithia as it structured as used in parts and service and other sort of ancillary business maybe historically are bigger contributors to EBIT margin today. What would happen if in fact we saw more of a precipitous decline, if you will, in new vehicle selling cycle and maybe this is sort of an add-on to an earlier question as it relates to residual values and Manheim rolling over, but help us understand how you're protected if the market does in fact -- and I don't believe it will -- but let's just say hypothetically that it does in fact turn for the negative?

Jamie, this is Bryan. Chris may have some thoughts here to share as well. I think the big difference between Lithia culturally is that our stores are guided, to some extent, from Medford corporate offices. However, they have the autonomy to move as their individual markets determine and as their teams see fit and I think that's vastly different than the top-down culture that Lithia was seven to ten years ago when this management team began to take over and to change the culture to a store-based, customer-based, competitive-based, individual model.

And I think that may not sound like a lot, but what happens is the responsiveness and the time to market to be able to change your approach is much more proactive, and I think you can see it in our market share as an organization up 10% to 12% as a whole over that time period which is a vast amount when you're talking about conquesting share. I think when you look at our ability to respond to the marketplace and the intellect that occurs even at corporate level that I think we're more shrewd in terms of how acquisitions are looked at and the ability to strike quickly if there is a downturn that I just believe that the organization is positioned in a nice manner to be able to respond in multiple ways.

Chris, you may talk about our transparency and our measurements and the way that we budget and forecast because that could be more detective to be able to see those things before they occur.

Yes, Jamie, Chris. I think responding to that with Bryan's question, we spend a lot of time with each individual store looking at the opportunities on a store-by-store location, so this isn't like a big picture. This is what we're going to do as a Company. What you'll find is we have stores that execute very highly on used vehicles but maybe they have a new vehicle opportunity or vice versa or they struggle in F&I or they have a tough time keeping their service customers, so their service retention is low. I think if we keep it simple and we keep focusing on the four core parts of the business we're going to continue to execute at a higher and higher level with the teams that we have, and so I guess that's how I would respond to that.

I close with one other thought. That culture has developed people at all levels of the organization that understand the marketplace in a much wider array than what we used to. So they're not working in a vacuum and they're not looking up to us for answers. That combined with the autonomy has allowed us to attract and grow what we really believe is the best talent and will continue to be the best talent which is how you make it through those trying times in more stable ways.

And I don't think I heard you mention but I would assume as well perhaps that more acquisition opportunities if the market was to start to turn just considering the age of the average dealer owner and perhaps some of the other sort of expenses that OEMs are pushing upon dealers, would that make sense as well?

Absolutely, Jamie. The acquisition market will definitely loosen and I believe that is something that, if you have the people there to run them, it's even more of an opportunity than we have today. So, we actually, to get to the milestone [8], we need about $1 billion in additional acquisitions in revenue, so that's something that we're going to be looking at. I believe that can come before a recession would ever possibly hit. Because my true feeling is that, and it's something we provide in our investor packet, there's a slide that shows what occurs in a recessionary period and what occurs after a recessionary period and usually a recession is followed by 1.5 to 2 times of the same period of SAAR rates that are in excess of the what the average is, and I think this is going to be the first year of that in excess.

And if we assume that there's been four to six years of declines or below-average rates we could be looking at a half a decade or a decade and a half of upside, and I think if you look at the benefits of that then you start to get into the units and operations and service and the ability of supplying these vehicles to grow, plus you have the key -- the initial driver of the new vehicle sales.

Just a followup to your point just then. It sounds though, and you outlined a pretty long time horizon, but at least where we stand today from a capital structure perspective there is significantly -- there's enough liquidity rather to get you to that billion without even starting to come against any kind of internal, if you will, ceilings on debt to EBITDA or any other sort of metrics, correct?

Yes, Jamie, Chris. I think we feel right now with our liquidity position we could easily pick up $2 billion to $3 billion in revenue just by expanding our floor plan line, so we feel very comfortable that we can make that happen.

Got it. Thank you guys so much. I really appreciate it.

Thanks, Jamie.

Brett Hoselton with KeyBanc.

Gentlemen, good morning.

Good morning, Brett.

As we think about your target, gross profit throughput target 45% to 50%, I kind of tend to think of you guys as, well, is there an opportunity to exceed that as we look into next year given DCH?

Yes. Brett, this is Chris. I think what we've said all along with DCH is that we want to see them get closer on an SG&A to gross basis to what our public peers are at, which currently is somewhere around 68% to 69%. So, on a full-year basis they're still trailing or tracking in the mid 70% range and so, yes, we definitely see there's $15 million in upside in DCH if we could just pull them down to what our public peers look like that are operating in the metro markets.

Brett, one other thing that you could run the numbers on but as you begin to drive down SG&A into the mid or possibly even low 60 percentile range, the throughput number becomes more difficult because the delta between that and the gross starts to become more impactful. So pay attention to that, but obviously with DCH it does make it a little more attractive for the short term.

And I was kind of just looking at your F&I gross profit per unit and it kind of implies a little bit of deterioration into the fourth quarter. I'm assuming that's a little bit of conservatism on your part. And then as we kind of look into next year it seems as though there may be, given your performance this year, some opportunity to exceed the 1210 as well. Again, both numbers seem fairly conservative. Is that -- how do you feel about that or do you feel like you're nearing the top?

Brett, this is Chris again. Thanks for the question. The biggest indication or biggest output of how our F&I PVR is going to come out is really a mix of what's going to happen with new and used vehicles. Our new vehicle PVR is somewhere around 1400, our used vehicle PVR is around 1100. So, if we sell more used vehicles, which is a benefit to the Company and they outpace unit sales for new, well, our overall F&I PVR may fall, but gross profit dollars again continue to generate at a higher rate.

Outside of that, we do feel like we still have some opportunity to execute and it really comes down to people, products, and pricing. And we're focused on the people aspect by trying to identify both performers and underperformers and figuring out ways to move the needle there. We continue to look at the products that we offer, make sure that we have the right products in the right stores and the pricing of those products. So, about 80% to 90% of the vehicles we sell F&I products on, it's at a fixed price on F&I, so we negotiate term and deductible and so making sure that our pricing is in line with the market also has an impact on what those PVR numbers are. So there's a number of moving parts that we're looking at and we will continue to focus on those to hopefully outpace where the guidance sits right now for Q4 and next year.

And then as we look at parts and service you're looking at kind of a mid single-digit growth rate for next year. Past couple years or this year and last year you kind of been doing double-digit growth rates. Is there something in particular that you're seeing slowing into next year?

This is Bryan, Brett. We've been kind of flirting with that 10% plus or minus [one two]. What really happens is that units in operation each year is kind of rolling. It's not definitive. We don't see any big changes there, but we do believe that there are pricing pressures and other competitive pressures that could occur with independents and I think that's why we may be a little bit hesitant to be too aggressive on it. The other thing that you could look at, too, is the ideas of recalls that you got to think that at some point those are going to subside to some extent and that has a big impact on our warranty business.

Okay. Fair enough. Thanks very much, gentlemen.

Thanks, Brett.

Bill Armstrong with CL King.

Good morning, gentlemen. So kind of looking at the industry with lower gas prices. We've seen the domestic and luxury segments outperforming the midline imports. And with that as a backdrop, how do you see that affecting the pipeline of acquisitions, the potential asking prices, and your appetite for acquisitions within those three buckets, luxury, domestic, import. How do you see that playing out in the acquisition market?

This is Bryan again, Bill. I think all of these factors that you just discussed have a big impact on things. I still believe that the biggest driver of acquisitions is that we went through a decade or a half a generation of depressed value because of the recession and I think that's what's really driving it.

I think if there is some type of gloom, to some extent, like what happened a few months ago with the stock market like what may happen again. That those type of events like you suggested can be elixirs to create more acquisitions. Right now there is just so many out there that the ability to be selective has been really good from our standpoint and I think that has a pretty good runway for the next five to ten years that we will continue to see that because ultimately when there wasn't those acquisitions over the past decade they are still going to sell because obviously the age of the dealer body is what drives it.

Are you seeing perhaps maybe more in the midline imports, maybe more sellers out there testing the waters and maybe seeing prices getting a little -- asking prices get a little more reasonable within the midline imports?

I think it's across the board from luxury to import to domestic. We're not being any like spikes in any of them. I do believe that there are a considerable number of deals and that there can be some price softening because over time if they don't sell because they are asking too much, they eventually come back to where the real market is going to be at on those deals and I think that takes time and each dealer is different of how they look at it and how their financial advisors advise them. So it's hard to generalize there, but in whole we like what we're seeing.

Thanks for that color.

Thanks Bill.

Rick Nelson with Stephens.

Thanks. Good morning. I'd like to follow up on DCH. If you could put those maybe in terms of what inning you think we are in there versus the potential. You talk quite a bit about the SG&A opportunities, but operationally maybe address some of the opportunities you see there?

Thanks, Rick, Bryan. Let me talk about a couple things. I mentioned the color on the SG&A, no question. I do believe that there's revenue growth opportunity when we look at the volumes because overall our volumes have only been up low single digits so far this year even though that's not in our same-store sales numbers. So I think the DCH team is actively pursuing and attacking that again. They figured out how to make net and to control their expenses. Now they're balancing it between volume increases. So, that's still opportunity that I think can drop to the bottom line as well.

In terms of what inning are we in, in terms of integration, I like how you phrase that, that's an appropriate time. I would say that we're in the middle innings. I believe that they know who they are and what they want to become. They have a wonderful culture. They are humbly confident, much like we had talked about. And I can say this, I think it was the smoothest integration that we may have ever had on an acquisition, including the small ones that were $30 million and this at $2.4 billion was really pleasing to see that our two organizations who, if you recall, knew each other historically but never were really obviously together at this level and we're proud to have them as our teammates and companions.

Lastly, I think it speaks volumes that their ability to grow people and their ability to attract talent into their organization now in metropolitan areas much like our exclusive areas has provided them the ability to grow now. So we are spending probably at least half our times in acquisitions talking about DCH acquisitions and we've now looked at approximately 30 deals in the tri-state area and southern California and we're pretty close on a number of different deals. And we're very fortunate that these are sizable deals relative to what Lithia's typical acquisitions are because there's higher volume. So we're proud of their team and were proud to be combined together with such a wonderful team.

And if I could just follow up to those last comments. You've made several acquisitions to date in the quarter and year-to-date a few discounts the multiples that you're paying and we're hearing about a lot of high asking prices out there. If you could comment there that would be great.

Rick, Bryan again. I think to be clear we pay three to five times EBITDA. We have not flexed on any of the deals. We don't plan on flexing on any deals. There's an opportunity, like I said, that we don't need to. We're paying 10% to 20% of revenues and the deals, some are breaking loose. As we mentioned, those couple larger deals that were $400 million to $600 million in revenue but most of the smaller deals we're not seeing -- that we're losing those deals and I don't think we will see that either because I think that there is a market for deals in certain size.

We don't think will have to flex on DCHs either. There's enough stores in metropolitan areas and there's enough dominant areas of influence with what we would call average or underperformance that we can buy stores and provide wonderful multiples to our sellers, that it's great in their eyes because they haven't been able to see the opportunities that profits could double or triple. And I think because of that our ability to continue to grow and not flex on our fairly stringent ROE hurdles make it for a nice model for the future.

That's very helpful. Also, if I could finally ask about geographic areas of strength and weakness, particularly the oil belt, if you're seeing anything different there?

Great question, Rick. So all states other than one were up on same-store sales with that one being one of the DCH segments. We actually break it down into northern and southern Cal, so that's a big state obviously, so we kind of say 15 states internally. Only New Jersey was down year-over-year in same-store sales growth. Even though that's not included in our global numbers, it gives you some color.

The energy states of Alaska were up 17%, Montana up 23%, and Texas up mid-single digits. We're not seeing a lot of weakness still there even though mid-single digits is a little more challenging than what we found in the past. It's still real positive considering it's up 40% over pre-recessionary levels.

Got you. Thanks a lot and good luck.

Thanks, Rick.

John Murphy with Bank of America.

Hey, guys. This is Liz Suzuki on for John. This is just kind of a housekeeping question but typically your fourth quarter has seasonally lower sales than the rest of the year and do you think the inclusion of DCH helps to reduce that seasonality at all? Or just having stores in the Northeast make it even more dramatic now?

Hi, this is Bryan. Remember, the seasonality with DCH they are in -- the Northeast is half of their revenues. So I would expect that it should be fairly similar to previous histories.

Okay. Thanks very much.

Thanks, Liz.

Bret Jordan with Jefferies.

Good morning. Ask my quarterly leasing question. You said leasing was up 33%. What was the total penetration of leasing?

Chris, you got that?

14%.

14%, okay. And I guess if you look at leasing -- (multiple speakers)

On a same-store basis. Leasing penetration is about 40% and the difference on Lithia being at 14%.

Okay. And as you look at leasing picking up is there a point where you can carry less used inventory because you've got better visibility of lease returns?

That's a good question, Bret. Personally, I don't think so. I believe that helps you grow your business, but I don't think you're going to reduce your overall inventory because of that because we're still trying to grow core and value autos as well. And remember core is over half of our business, so even as those off lease cars grow I really believe, no, it's not going to affect your inventories.

Okay. And then one followup question. You just mentioned the DCH -- the New Jersey comp. Is there anything specific that was going on in New Jersey that impacted the performance?

There was. Actually, if you remember January and February were hard hit with weather more typical than it normally was, which has now happened two years in a row, and because of that they were off, I think, mid teens in same-store sales those first couple months and that's still dragging. More recently, they're up mid single digits to high single digits, so it's looking better now.

Okay great. Thank you.

Thank you. This concludes today's question-and-answer session. I'd like to turn the floor back over to management for closing remarks.

Thank you for joining us, everyone and we look forward to updating you again further in February. Bye-bye.

This concludes today's conference. You may disconnect your line at this time and thank you for your participation.