Lithia Motors, Inc. (LAD) Q3 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Lithia Motors Q3 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John North. Thank you, Mr. North. You may begin.

Thanks, and good morning. Welcome to Lithia Motors Third Quarter 2012 Earnings Conference Call. Before we begin, the company wants you to know that this conference call includes forward-looking statements. These statements are necessarily subject to risk and uncertainty. Actual results could differ materially due to certain risk factors, which are outlined in our filings with the SEC. We expressly disclaim any responsibility to update forward-looking statements. During this call, we may discuss certain non-GAAP items, including adjusted selling, general and administrative expense, adjusted operating income, adjusted income from continuing operations, adjusted earnings per share from continuing operations and adjusted cash flows from operations. We believe this non-GAAP disclosure improves the comparability of our financial results from period to period and is useful in understanding our financial performance. These presentations are not intended to be provided in accordance with GAAP and 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 also have updated an investor presentation which is posted on our website, lithia.com, highlighting our third quarter results. Present on the call today are Bryan DeBoer, President and CEO; and Chris Holzshu, Senior Vice President and CFO. At the end of our prepared remarks, we will open the call to questions. I am available in my office after the call for any follow-up you may have. It is now my pleasure to turn the call over to Bryan.

Good morning. Today, we reported record third quarter income from continuing operations of $23.3 million. This is compared to $16.3 million a year ago. We earned $0.90 per share in the third quarter compared to $0.61 per share last year, an increase of 48% or double our revenue growth of 24%. Total same-store sales were up 23% in the quarter, reflecting increases in all business lines. All comparisons from this point forward will be presented on a same-store basis unless otherwise noted. New vehicle sales increased 30%. This increase was on top of a 28% increase in new vehicle sales in Q3 2011. On a unit basis, we sold approximately 14,500 new vehicles, an increase of 3,400 units or 31%, well above the national average of 14%. Our domestic sales increased 19% compared to 5% nationally. Our import sales were up 51% compared to 25% nationally, and our luxury sales were up 38% compared to 3% nationally. These results show that each market is unique, and the dominant brands we represent in our markets respond differently than national trends. We have continued to challenge our store leaders to evaluate their business and tailor solutions that improve performance in their local markets. As a result, many of our stores are achieving success in ways we have not seen before. Earlier this month, we held a meeting with our general managers in Portland, Oregon. I was both humbled and excited by the energy our store leaders brought to the event. Our team believes there is still work to be done and can continue to outperform in their markets with focused efforts, creative thinking and a lot of hard work. As I mentioned, last quarter, many of our Western markets are still experiencing new vehicle registrations significantly lower than historic levels. To put this in perspective, we have compared registration data in our local markets at current levels compared to levels experienced before the recession. We calculated that in our markets, current sales volume equates to a SAAR of under 13 million units compared to the 16.5 million SAAR we experienced during peak historic levels. We are encouraged that as these markets continue to recover, we can capture more than our share of the volume increases. Used retail vehicle sales increased 24% in the quarter. We sold approximately 12,900 retail used vehicles, resulting in a used-to-new ratio to 0.9 to 1. We sold a monthly average of 52 used vehicles per store in the third quarter of 2012, up from 40 used vehicles per store in 2011. Our previous goal is to sell an average of 60 used vehicles per store. As we have improved our performance in this area, we are increasing our goal to sell an average of 75 used vehicles per store. The key to our success in accomplishing this objective is to grow our core vehicle offering. These 3- to 7-year-old cars are most difficult to source, and our stores must effectively mine the 5 channels for procuring this inventory. These channels are customer trade-ins, auctions, wholesalers, private parties and other dealers. As we have more success in selling core vehicles, we will turn to generate more inventory in our value auto category through the trade-ins received on these sales. Success in core vehicle drives our performance in the rest of our used car offerings. As new vehicle sales continue to recover, certified preowned vehicles continue to increase. In the quarter, this category grew 33% due to a larger number of off-lease vehicles compared to the low levels experienced last year. In the quarter, value autos, or vehicles over 80,000 miles, performed well. This segment grew 56% year-over-year with a gross margin of 21%. In the quarter, our F&I per vehicle was 1,072 per unit. On a GAAP basis, we arranged financing on 76% of the vehicles we sold. We sold 41% of our customers a service contract and 35% of our customers a Lifetime Oil product. Our service, body and parts sales increased over 6% in the third quarter. Wholesale parts and body shops showed significant increases of 9% and 18%. Customer pay work increased 6%, which is the 13th consecutive quarter of same-store sales improvement. Warranty still faces a headwind, declining 2%. We continue to anticipate lower warranty revenues for the remainder of 2012 and into 2013 due to a lower number of units in operations from lower sales over the last few years. Warranty comprises 15% of our service, body and parts business and can be more than offset by concentrating on growing the other 85% of the non-warranty activity. Our gross profit per new vehicle retailed was $2,399 compared to $2,597 in the third quarter of 2011, a decrease of $198 per unit. Gross profit per used vehicle retailed was $2,531 compared to $2,550 in the third quarter of 2011, a decrease of $19 per unit. Both of these numbers are lower as we continue to emphasize increasing the number of units sold per store. Additionally, our stores are increased on total gross profit dollars generated in each department, while increasing market share for new and used vehicle sales. Our gross profit on a same-store basis increased 19% over the prior year. As I mentioned at the beginning of our remarks, our EPS growth was double our revenue growth. Driving incremental gross profit dollars into the organization allows us to leverage our scale and gain efficiencies in operation. Much of this is due to the efforts we have put in to cost controls, which Chris will be discussing in more detail. In the quarter, our overall gross margin was 15.2% compared to 16.8% in the same period last year. Increases in new and retail used vehicle sales outpaced others business lines and explains the majority of the decline in overall margin. Despite a lower margin percentage, overall gross profit dollars increased 20% over our third quarter 2011 results. Now to update you on corporate development activities. We seek exclusive domestic and import franchises in midsized rural markets and exclusive luxury franchises in metropolitan markets. In August, we acquired a Chevrolet store in Killeen, Texas with estimated annual revenues of $60 million. Our guidance has been updated to reflect the impact of this new store. The last thing I wanted to leave you with is a discussion on brand mix. National market share is 56% import luxury and 44% domestic. Our brand mix is 53% domestic and 47% import luxury. However, when evaluating market share by manufacturer, it is important to note that 3 of the top 4 manufacturers are domestic brands. Within the smaller markets we operate in, the larger manufacturers control a greater share of the market. We believe that controlling the dominant brands in the markets we do business in is a competitive advantage. We will continue to align our brand mix with what sells where we operate, and we are comfortable on a domestic versus import luxury basis. We still remain focused on reducing our concentration to less than 20% of any single brand, but plan on doing this by acquiring other brands over time. To summarize, we believe that our ability to increase market share through world-class store leadership and economic recovery in the Western markets that is still in the early innings, a brand mix that matches the markets where we do business and an aging fleet of vehicles all point to the potential for continuation of the multiyear sales recovery. With that, I will turn the call over to Chris, our CFO.

Thank you, Brian. As we have discussed for several quarters, an important driver of the recovery in auto sales is the expansion of consumer credit, particularly for lower-tier customers. Consistent with the past few quarters, lenders have shown their commitment to increasing their portfolio of automotive loans and are loosening their lending criteria to accomplish this objective. For example, the average loan to value, which represents the percentage of dollars financed to the overall vehicle value, was 91%, the highest level we have seen since 2008. Of the vehicles we financed in the third quarter, 11% were the sub-prime customers, up from 10% in 2011. However, the absolute number of contracts originated for sub-prime customers increased 49% year-over-year. Given that the total number of customers' finance is up 35%, this highlights the expansion of sales to this segment. Continued expansion here represents the next leg of the recovery in vehicle sales. As Bryan mentioned, we have challenged our store leadership to increase the absolute number of gross profit dollars earned by our stores. We also challenged them to retain as many of those dollars as possible through prudent cost control around the 2 largest areas of SG&A expense, personnel and advertising, which comprise 75% of this balance. We monitor expense management through the use of consolidated information system and a standardized reporting structure. This competitive advantage allows our stores to quickly identify areas of opportunity to work on. For example, we evaluate payroll and benefit cost by store, by position and by person, looking at both the absolute productivity and the individual performance of our team members. This in-depth evaluation ensures we provide exceptional pay for exceptional performance while identifying areas of opportunity on an individual headcount basis. In addition, we aggressively deploy marketing dollars when prudent to increase individual lines of business. As a result, our advertising spend as a percentage of gross profit increased on a year-over-year basis. Our same-store sales increased above the market rate in all business lines, validating the investment we made to increase customer traffic. We are confident that additional marketing campaigns in new and existing delivery modes are helping us grow all these lines of business. In the quarter, SG&A as a percentage of gross profit was a record low of 67%. Throughput or the percentage of each additional gross profit dollar over the prior year we retain after the selling cost [ph] adjusted to reflect same-store comps was 55%. We believe that incremental throughput is the best way to measure our cost control efforts, and our target of 50% incremental throughput remains unchanged. However, we are updating our target of SG&A as a percentage of gross profit to the high 60s for 2013 and beyond. As a consolidator, we understand the need to drive leverage in our model and are confident our team will deliver on that expectation. At the end of the quarter, we had $20 million in cash and $29 million available on our credit facilities, bringing our immediate liquidity to $49 million. The available credit on our syndicated facility is $47 million lower than at June 30 of this year. There are 3 reasons for this change. First, we completed the acquisition of a Chevrolet store in Killeen, Texas. Second, we completed the construction of several new facilities that remain on mortgage. And third, we increased our new truck inventory to prepare for the production changeover related to the new Chevrolet K2xx pickup and Chrysler heavy duty pickups. Currently, 115 million of our operating real estate is unfinanced. These assets could provide an additional $86 million of available liquidity in 60 to 90 days. This brings our total liquidity to $135 million, and we remain comfortable with our overall level of available capital. At September 30, excluding floor plan, we had $269 million in total debt of which $168 million is mortgage financing. In the quarter, we refinanced $16 million of mortgages, extending the maturities and fixing the interest rates. We also retired $5 million in higher rate mortgage debt. As of today, 60% of our mortgages are fixed, and we have no mortgages maturing until 2016. Finally, we were in compliance with our debt covenants at the end of the quarter. Our free cash flow as outlined in our investor presentation was $44 million for the first 9 months of 2012. We estimate this number to be $34 million for the full year 2012 due to increased earnings offset by planned CapEx as we continue to invest in projects that grow our business. Our capital expenditure estimate is $67 million for the full year 2012, and this budget is based on new facilities, facility improvements and remodels, the consolidation of our headquarters' facilities into a single location, strategically exercising purchase options on lease facilities and other business development opportunities that are currently in progress. On a rooftop basis, we own 60% of our facilities, and owning real estate has been a strategic decision we have been committed to since we went public. This is a key differentiator for Lithia, and something we will continue to pursue in the future. As such, we seek opportunistic lease buyouts when accretive. We estimate $26 million will be spent on strategic lease buyouts this year. Without these transactions, our CapEx for the full year would be approximately $41 million or 7% under the benchmark we established in February. We estimate our 2013 CapEx will be approximately $25 million. We focus on the prudent allocation of capital and believe a balanced strategy of acquisitions, internal investment, dividends and share repurchase is appropriate. Our first choice for capital deployment remains to grow through acquisitions and internal investment. Regardless of category, all investment decisions are measured against strict ROE metrics and will be solid long-term investments in the future. As of September 30, new vehicle inventories were at $504 million or a days supply of 75 days, an increase of 9 days from a year ago. This increase is partly related to the build-out of certain truck models prior to manufacturer plant platform changes when production is halted and additional vehicles are not available, as well as the anniversary of production shortages related to the J3 inventory as a result of these anomalies. Used vehicle inventories were $126 million or a day supply of 50 days. This is 3 days lower than our day supply level a year ago. Import inventory levels are back to normalized levels at the current time, although acquiring late-model used vehicles still remains a challenge. We have increased our guidance for 2012. Our EPS estimate for the fourth quarter is in the range of $0.64 to $0.66, with a full year expectation of $2.88 to $2.90. We have introduced EPS guidance for the first quarter of 2013 of $0.65 to $0.67 and full year 2013 guidance of $3.11 to $3.21. For additional assumptions related to our earnings guidance, I'd refer you to today's press release at lithia.com. This concludes our prepared remarks. We would now like to open the call to questions. Operator?

[Operator Instructions] Our first question comes from the line of Simeon Gutman with Credit Suisse.

I'm going to ask some questions. I'm going to ask them upfront in case my connection drops. First, can you talk about acquisition pipeline, what you're seeing today and then what you're seeing going forward? And then the second question, regarding some of the markets that have yet to recover, some of that you mentioned earlier, what's the trajectory of improvement that you're seeing there today? Is it getting faster? Is it tying in with housing improvements that we're starting to see? Any comments on that.

This is Bryan. Let's talk first about the acquisition pipeline. We had talked previously about the tax rate possible changes going away at the end of the year that was driving some activity. There has been a lot of price increases, and it's been very competitive with some privates. However, we do have some good news. Later this morning, we'll be closing on an acquisition in Missoula, Montana, a new Toyota store, which adds to our base in Montana where we have wonderful strength. That's exciting. And we have other things in the hopper, they may not happen by the end of the year, and but there is still a lot of activity. But for some reason, it seems like there's a lot of cash out there that's driving prices up and we're going to maintain discipline. Any other questions on that Simeon?

No, that's helpful.

Perfect. And then in terms of market recovery in the West, let me quickly provide you with state-by-state information. In terms of new vehicle same-store sales, Nevada was our #1 state at 34.2%. Our #2 state was Oregon at 34%. Let's see here, Iowa was 30.2%. North Dakota was 28.9%. And lastly, Washington was 29% as well. So a lot of the West is recovering like we were expecting. And I think you touched on it nicely, there is no question that inventory and housing is starting to dry up, which has helped driving truck sales because there's people working again and building homes. Additionally, despite these increases, we still believe that the West has substantially higher gain opportunities than what nationally reflects.

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

Bryan, can I just follow up on that last response. Are you saying that you expect these markets to outperform the overall SAAR in the coming years or do you think that they'll catch up due to the overall national level once you do have that housing recovery?

This is Bryan, again. By the way, thank you for picking up coverage. We're glad to have you on the team. What -- I would say this, recoveries are slower than, obviously, declines. So even though we're seeing increases in the Western markets, we believe it could take a number of years to achieve that. Because if you remember, even those numbers that I just talked about in each state, we average 23% as a company. So those numbers aren't like dramatically better. We're talking about 4%, 5%, 6% better than what our company is doing. So there's not big anomalies, and we really believe that this going to take a couple of years for that economy to get going again. And for some reason because our smaller economies don't have quite the industry diversification or economic diversification, they respond a little bit differently than metropolitan areas. And I think because of that, that industry then has to get going whatever that primary is within that market, which can slow it down as well. So we think it's a pretty controlled, sustainable recovery that may take a couple of years to recover.

This is Chris. One thing that you'll notice in our guidance that we do is we look at actually each individual market when we project and forecast what we anticipate our earnings will be for next year. And so what you'll see is you might have a market like Des Moines, Iowa. They might have a 3% built-in recovery next year. But then, we'll take another market like Boise, Idaho, and that might have a 10% to 12% improvement next year. And so the compilation of each individual markets rolls up to how we set our guidance and our projections next year. I think new vehicles for full year 2013, we're guiding up about 11%.

That's very helpful. If I can switch to new vehicle margins. You said in your slide that there may have been a hit to new vehicle grosses from aggressive share gains. Can you expand on that a little bit? I mean, are you putting an effort to try and gain share and maybe undercut pricing, or is this something that's more symptomatic of what's going on in the industry?

This is Bryan again. In terms of our new vehicle margin, for the last couple of years, we pretty clearly stated that we wanted to increase our market share, as well as the increase that national is recovering or individual market. And we've always pinpointed really a 5% target in those arenas. And what we're seeing now is we're still capturing that additional 5%, and the reason we do it is we believe that it's best for our organization in the short- and long-term. Yes, you give up a little bit on margin, and I think we're down 200 basis points year-over-year -- what was it?

$200.

$200 year-over-year, excuse me, which most of that is driven by the import because our comp last year was so high, because there was a shortage of the J3 inventory. So that started the reflection. But we look at total gross that's coming into the new vehicle and used vehicle departments. And we're okay sacrificing some of that because we know that those sales drive 2 very important things for our business. One is it drives used car trade-ins, which you're seeing what's happening in our used car trade-ins, which is now another cycle that's 2 stages down, that drives value auto vehicles. Okay? Additionally, we're starting to see we were up 6% in service, parts and body shop work, and we believe a lot of that is driven from units in operations. So it's almost an annuity that if we can gain that initial sale in new vehicles, it's the top of the food chain that drives the rest of our business. So we believe that there is great balance there, and we'll continue to maintain that and at times, may have to sacrifice a little margin to be able to capture that additional business in the future.

Okay. And just lastly, can you talk about the new 2013 Ram 1500? Has that hit the lots, and what's the reception to that been? Because I think it has a new fairly -- a fairly fuel-efficient powertrain?

Ravi, we haven't seen a big influx of inventory on the 2013 models. But what we have done is we've stocked up on the heavy duty models for 2012. And if you notice, our day supply in new vehicle inventory is up to 75 days at the end of the quarter, and a big reason for that is our Chrysler store is ordering the heavy duty Rams, so that we don't have a shortage of inventory going into the fourth quarter or even the first quarter. So we haven't seen a lot in the 2013. I know the price point on it is going to be a lot higher than the current version. It does have a lot of new technology added to it, and we'll see what sales look like later on.

Our next question comes from the line of Steve Dyer with Craig-Hallum.

Just kind of, I guess, touching on that last question. Overall '13s versus '12s in the inventory mix. What's -- I don't know if you know that split off the top of your head, do you feel like you're well-positioned with '12s still on the lot, not having too many of them, et cetera?

Steve, this is Bryan. I'm pretty confident the '12s -- we have enough to get us into -- heavily into the fourth quarter. Our 2013s, we don't have the exact split, but I would guess at this time of the year we probably -- I'd probably say 60-40 to 2012. Is that probably about right, Chris?

Yes, we can get that to you if you want to...

Yes, we can get that offline, but it's still -- we still believe that there's -- obviously, those Chryslers, as well as Chevrolet has a big model changeover in their 1500 as well, in the Silverado. And there's going to be a shortage of those, so we ordered up really heavy there.

Okay. What's the incentive environment, and how do you see that sort of playing through the end of the year?

Really, I mean, the domestics obviously have their stair-step programs that they typically plan. That's helpful. But I would, overall, say that it's pretty static. I don't think incentives are what really drive volume. We always believe that we take what we can control, which is our people can drive volume. So we work on growing our teams and making sure that we have the best talent there, ready to listen to our customers and respond to their needs. And we find when we do that, that whether or not these other things are occurring, it kind of takes a lot of the guesswork out of it.

Okay. Two more questions. One, were you inventory-constrained at any particular brands during the quarter?

Yes. I would say that our Subaru brand, our stores were fairly short. Our Subaru sales were actually up 58% in the quarter. So we were definitely running at what? Probably a 15 to 20 day supply. In fact, one of our stores, I got to say, probably doesn't have more than one of each model on the ground over in Reno. So that's tough. Our Hyundai stores were definitely short of product. Our Toyota and Honda stores, they were pretty good. We probably had a couple of pockets in Honda that were a little bit shy on product. And then obviously, the domestics, really there wasn't a shortage other than Chrysler within certain Jeep models.

Okay. That's helpful. And then just lastly, you mentioned the Missoula acquisition you're going to announce later today. Is that in forward guidance?

It is not.

Our next question comes from the line of Brett Hoselton with KeyBanc Capital Markets.

I wanted to ask you about the used car business. Bryan, clearly you've come in and you're placing pretty good focus on the used car operation. My question is, you are outperforming the market by a fairly significant amount here, would you anticipate that out-performance to continue at this significant level for another quarter, 2 quarters, year, 3 years? Or do you kind of see, look, we've got some low-hanging fruit in the near-term, and then we hope to continue to outperform a year from now, but the pace of outperformance is probably going to slow down?

Brett, this is Bryan. This is obviously our focus as an entire organization, and it will remain such. I would say this, we don't believe that we do outperform the market even though we're 0.9 to 1 used to new ratio. I don't know that, that's a great indication of what our potentials are. What we look at is each of our individual markets, we are the dominant manufacturer within those markets. And in most cases our frontage, which is one of the primary drivers of used cars along with the Internet, there's no question in pricing. However, that used car drive by, we have the prime locations in most of our markets. And to set a goal of 60 a couple of years ago and now being reaching that pretty closely and raising our goal to 75, we believe because of our exposure in those markets and our ability, we have probably what? 3 acres per site that we can put used cars on. I mean, at some level you can put 250 cars on those lots. And we have stores that sell over 150 units in small to medium-sized markets. So we believe it's really just a matter of procurement, and that's why we focus so soundly on that middle 3- to 8-year-old core product and really what we call mining those vehicles. And I would say this, we're probably getting a C at that, okay? We have plenty of stores that are A producers, there's no question. But we have plenty that are probably Ds as well and don't understand what it means to open up each of those channels and find that 2 or 3 cars a month that can increase your sales 5%, 10% in each of those 5 categories. So we believe that there's still lots of opportunity in the used car arena. And I think it's fair to say, our initial stores here in Medford, before we grew as an organization, our stores averaged 80 to 90 used vehicles a month, in line with a 3:1 used to new stores. So there's lots of potential on these small to midsize markets, and we're expanding into value auto core and certified, and we believe that there's still lots of opportunity.

And then, Chris, you commented on the financing environment earlier on the call here. My question is how would you characterize the improvement in the sub-prime financing environment. If I look at one source of the data, it seems like it's kind of a creeping improvement, but yet at the same time talking to some dealers and also some other finance sources, it seems like we may be seeing a little bit more of an inflection point where we may see some acceleration in the sub-prime market. And I guess what I'm wondering is how would you characterize the changes that are taking place?

Yes, Brett, I think what we -- right now, percentage of our overall finance business, we have 11% of our deals are going actually to the sub-prime segment. And I think when we see normalized levels near 20%, that's when I'll feel like -- of our overall portfolio of finance business, that's when I'll feel like we're back to normalized levels. So we have a long way to go in that arena still. And while people are excited about what's happening as we are, we're getting more deals financed to sub-prime customers, there's still a long way to go to where we think we're going to see normalized levels. And when you extrapolate that out on a normalized year, I mean, that can lead to 1,500 additional units in a quarter, which is meaningful to a recovery.

Our next question comes from the line of Scott Stember with Sidoti.

Could you guys just give us a sneak peek on how October has looked on the new sites so far?

This is Bryan, Scott. It looks on track. We're not seeing any irregularities other than -- obviously there's some weather conditions in certain pockets, but it's not as challenging -- as weather-wide as we were expecting so.

All right, that's great. And maybe just talk about some of the passenger cars, some of the new things that have come out. Can you talk about whether you've seen any benefit from the Dart?

Scott this is Bryan again. The Dart is actually moving, there's no question. It's starting to make a presence for Chrysler products in that low-end segment that they haven't really played in as well before. There is definitely a move in many of our areas into cars and fuel-efficient vehicles. I believe Prius had their single biggest selling month last year of their history, right? It was last month. So there is definitely sustainability in green initiatives and obviously increased fuel prices that are affecting things. But in our markets, the housing starts and truck sales are back rising again, and we're very pleased with what we're seeing there.

Okay. And just moving back to the pickup truck with the fuel-efficient platform, I know it's a little too soon, but can you maybe just talk about how you've traditionally done with the V6 platforms in trucks versus 8s, and how much of an opportunity this really could be for you guys?

Yes, if you look back 4 or 5 years ago, V6 was a nonevent. We used V6 as an in-line fix because it's basically leader pricing to be able to attract customers at a lower price. Whereas today, the V6 is the fastest moving vehicle within Jeep products and within truck products, as well as SUVs. We can't keep them on the lot. And I really see that our manufacturers have figured out how to balance horsepower and fuel efficiency, and the consumers are demanding. And I think that trend is going to continue.

Scott, this is Chris, just to add onto that. I mean the average age of vehicles in the U.S. is about 10, 11 years right now. And the truck segment, specifically, is over 13 years. So technology is definitely in our favor right now. But I also think that just the age and population of trucks is going to move new vehicle sales into the future, especially as we see agricultural markets recover, housing market recover, constructions in general recover.

Okay. And just last question. Last year or so, your body shop businesses really accelerated. Can you just maybe talk about some of the initiatives that are going on there, and how successful that is?

Absolutely, Scott. This is Bryan again. We have specific initiatives to be able to work with our DRPs, which are our insurance companies. So we spent considerable amounts of time with them attracting those into our market. I think a lot of that comes from pricing, as well as serviceability in getting the cars to the shop quicker. But I would say this, our single biggest driver is we have -- what is it, 11 or 12 body shops, of which about half of those we made personnel changes in, 12 to 18 months ago, that's now yielding the results that we needed. Additionally, a few of our body shops were taken back over by physical stores rather than run through Medford as independent businesses, and that's allowed synergies within the store and the service and parts department, which has increased business and has allowed the customers to flow easier -- easy into those departments.

Our next question comes from the line of John Murphy with Bank of America Merrill Lynch.

A question on your guidance. I know you guys are building this up region-by-region and store-by-store. I'm just curious what your underlying SAAR forecast is for the fourth quarter of this year and for next year, just on a total U.S. basis?

John, this is Chris. If we have to extrapolate that to a SAAR basis, nationally I have to say 14 to 14.5 in the fourth quarter and 15, 15.5 in 2013.

Okay, great. That's helpful. Then, second question. I mean, there has been a lot of noise around the stair-step programs, natives coming out and really kind of blasting some of the stair-step programs or aggressive stair-step programs that have been newer in the market. I'm just curious, as you look at these stair-step programs, do you view them as a negative, as a positive, or what's your approach? Because I mean, obviously Chrysler has been a big new guy in the last 2 years in these stair-step programs, I'm just trying to understand what your take is on them.

John, this is Bryan. I think from the ground level, as a sales manager or a general manager that's operating a store, it's not a negative. What it does is it motivates you on a specific number that you have to hit and you figure out ways to hit that. And you align your staffing, your marketing and your inventories to ensure that you hit that. So it's not a negative. It's a focal point to be able to achieve manufacturer expectations, which ultimately drives to the bottom line. Now, there's also a financial decision that's made, because many times they may not be lucrative enough to be able to push the volume you need to, to be able to capture that. Now, I think, it's always fair to say most of our stores are always going for those stair-step levels than the highest levels because we know that it drives trade-ins in service and parts business.

Got you. The next question is on SG&A. Obviously, you're performing incredibly well there. I'm just curious, as you look at the 75% that you mentioned, advertising and personnel cost, if you can give us any examples of cost savings that you think will stick going forward. Because we're hearing from a lot of skeptics out there, and you guys are putting up the number so it's hard to be skeptical anymore, but some skeptics think that as the sales recover on the new vehicle side that some of this focus and cost discipline may be lost. I'm just trying to understand what you're doing that you think is going to stick going forward so we can expect this really strong 60% flow-through that you're talking about.

John, this is Chris again. No, I don't think we're going to see any loss in the momentum that we have in our cost control efforts. In fact, when you dive into each individual store that we have and look at the different departments, we have opportunity across the company. And I think what we're going to see is as we continue to push retail sales and as we continue to pursue growth, we're going to continue to leverage the model that we have. And what I mean by that is if you take an average store of ours that's selling 85 to 90 units a month and you grow their business 20%, that's 20 additional vehicles per month that you're adding to their production line. So that's 1, less than 1 per day. And I think with the management staff that we have, with the office staff that we have, even with the F&I managers across the board, they have ability to continue to increase productivity, which is going to continue to drive our leverage.

John, this is Bryan. One other quick thing to add to that. We have plenty of stores within our organization, and we believe that it's possible in most of our stores to do less than 60% SG&A. So it's not absurd to think that there's lots more upside, and I think we don't have a lot of fixed costs that are changing. Our facilities are fairly well updated. We spent some capital over the last number of years to get those upgraded. So now it's a matter, like Chris said, of driving productivity and driving the top end revenues, which makes it easier to be able to bring the money to the bottom line.

And John, because you're dealing with people's livelihood and you're dealing with people's pay plans, I mean, it's not an easy thing to fix. But the first step is identify the opportunity. And we have clear metrics and clear tools that allow us to see when there's an opportunity in a store and in a position. And so the next step on that is to work on the transition of either changing the pay plan to make it more performance-based or in some cases move positions around in order to bring somebody new in the position that you can reset the pay expectations. And that's a lot of work, and it's a big job, but our general managers in the store are committed to get that done.

But at this point, it's fair to say that you've done a lot of the heavy lifting. There's still some opportunity, but a lot of the benefit really is going to be just leveraging this increase in sales as we go forward?

Yes.

Okay. Next question, on leasing. You guys haven't talked about that much. I know that's been relatively depressed. It's coming back a bit. Where are you on leasing in your dealerships, and where do you think that can go to support the increase in sales?

John, this is Bryan. Obviously, not all manufacturers are still back into leasing, but many are coming back into it. We lease a little less than 15% of our new vehicles, and we believe that it's another large opportunity within our markets. I would say this, our stores are not as adept at leasing as they are with purchasing. And I think there's a lack of sophistication to some extent in the consumer buying public, as well as a lack of disposable incomes in smaller to midsize markets that has prevented leasing. However, we believe it's an opportunity, and we've been working with many of our manufacturer or captive partners to retrain our stores and expand the advantages of leasing within our stores.

But that's the kind of number that you think maybe could mix up into the low 20% range? I mean, that's sort of where it was more normally before. I'm just curious if you think it could get to that?

Yes, we believe that it could definitely reach the low 20s, and we believe that it's a good quartile of our future growth, is to expand our leasing opportunities.

Great. Then just lastly, you made some mention of the GM truck inventory in preparing for the ultimate launch sort of May, April or April or May next year, next spring. I'm just curious where you stand on your GM truck inventory, the Silverado, Sierra and the SUVs, and if there are any programs that you see coming to help deal with floor plan assistance or maybe even incentives if the inventory is too heavy as you go through the changeover that you see coming from GM?

John, we could be proud to say that we're 9 days -- higher days supply. Most of it comes from our General Motors trucks, okay? And we believe that we have the right amount to carry us through this next 6 months until the new product gets here. Obviously, within Texas and Alaska where we're most centric in our Chevrolet truck sales, we had to plan ahead, and we have a lot of vehicles on the ground. Fortunately, there's a lot of land in those 2 states, so we can make sure that we have room to store those.

Our next question comes from the line of James Albertine with Stifel, Nicolaus.

I wanted just to focus on the used business here, reconcile some comments that I think, if I heard them correctly, you mentioned that the CPO business was up about 33% on a year-over-year basis, granted that it's probably off of a pretty low base. Because you did also mention that's still a challenge. But I wanted to understand sort of how mix shifts in your mind as you start to target 75 units from your prior target of 60. And then as a follow-up to that, just in general, used pricing remains relatively high given historical averages. And I wanted to understand how you're viewing sort of pricing and margins going forward, and how that plays through into your guidance?

This is Bryan. Okay. In terms of our certified product, there's no question that we're coming off of a low base. We actually look at certified as an adjunct to our new car business. However, it's also -- it can compete to some extent with your new car business, so you have to be very careful there. So we actually focus most of our attention on our core product, and we really look at that core product as being 60% to 70% of what we do. And it's a fairly simple formula. Certified, it's pretty easy to buy those cars. There's no condition issues. You know how many miles they have. They're all typically less than 35,000 miles. It's pretty easy to buy those vehicles, so it's not a lot of work. It's really just a matter of work to work with your manufacturers and make sure you're visible to your customers. Core is the heavy lifting. The 3- to 8-year-old vehicles is very heavy lifting. It is so difficult to find good cars, and it always has been. But our best stores always seem to figure it out. And I will say this, the used car market has stabilized. If anything, there's a supply of vehicles in this arena more than there's been over the last 2 or 3 years, which is great for us. So that stabilizing of pricing is saying that there's more supply out there. Core vehicle, because that's our bread and butter, that's where we're going to get most of our business from -- to get to that -- from that 60 to 75 units. So we look at it this way. When we sell a core vehicle, that we take in typically about out of every 3 we sell, we take in 1 value auto car. So that core vehicle is not only a driver of a used vehicle sale, it's a driver of a value auto car as well. So for every 1 we sell, we sell 1.3, which can quickly drive the numbers up to where we need to be. So it seems pretty simplistic, but the ability to find those cars is it takes some very good skill and a heck of a lot of context to be able to get that done.

Jamie, this is Chris. And then to follow-up on your question related to guidance. When you look at the gross profit margin by segment, our core gross profit margin is about 15%, certified is about 10%, and our value auto is our highest gross profit, which is just over 20%. When we look forward to the fourth quarter and even into 2013, we don't anticipate a big fluctuation in the margins and we're actually guiding it 14.3 to 14.5. So we don't see a big change, at least right now, in what we expect margins to look like next year in used.

Our next question comes from the line of Joseph Edelstein with Stephens.

You've talked a lot about the potential to get the sub-prime mix back to the 20% range, and I'm just curious which finance provider group do you think would lead the charge to bring you back to that level? Is it coming from the captives, from the banks? Just how do you see that playing out?

Yes, this is Chris. The answer to that is, yes. It's all of the above. I mean, the idea is in each market you have different lenders that represent different lines of the finance segment, and you need to have relationships with all of those. And we have a broad relationship with 30, 40 lenders, but they're not in every store. And so it's our job to make sure that we have the right lenders in each location, particularly in that sub-prime segment. And you see regions that have new lenders entering in that space that don't do business in other states that we do business. So we just tend to keep our ear to the ground, keep the relationships open and find the best lenders for each of our stores.

One other thing to add on here, Joseph, the ability to grow your sub-prime is primarily dependent on your ability to find value auto cars. Because -- and I think that is the driver. So as you see our core products generate more value auto trade-ins, you'll see our sub-prime increase, and I think that's been a big driver, as well as being able to match it with the individual dealerships.

Sure. And clearly, there's opportunity as you drive the vehicle sales, you also get the opportunity then in the fixed service and parts business. Do you think there's any need for any significant investment into the fixed operations, whether that may be handhelds or other technologies to help retain customers in the servicing lane -- service and parts lane?

Joseph, this is Bryan. We have a number of our stores that are experimenting and many that are actually have stabilized on handhelds. I still believe that it's a face-to-face interaction with our customers. That probably won't change a lot in the future because it's about that relationship and that ability to go [ph] things. What the handhelds can do is make it more convenient. It allows you to not break that link with your customer and have to go do other things and to be able to stay front and center in front of their car to be able to show them the benefits of the offerings that we're providing.

Okay. Great. And maybe just one last question then. The Missoula, Montana acquisition that you plan to announce later this afternoon. Can you at least share what the projected revenues, annualized revenues from that business would be?

Yes. It's somewhere in the mid-$40 million range.

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

I guess first, a question on brand mix. You talk about wanting to get -- have no brand being more than 20%, but you want to reduce exposure to only the -- acquiring more brands. So in terms of getting Chrysler down to 20%, it's fair to assume this will take many, many years to do, right?

That is accurate.

Okay. And for Chris or John, I'm sure you're pretty happy with your mortgage exposure now. No maturities until 2016. So in the next 6 to 12 months at least, are you going to take your foot off the pedal in terms of looking to do more refis, or do you want to keep pushing that 2016 maturity into '17, '18, et cetera?

Yes, this is Chris. David, yes, we're going to continue to keep our foot on the pedal and continue to work on refinancing mortgages. As we talked about, we have $86 million right now in unfinanced real estate at a 75% loan-to-value. So it's a big part of our liquidity, and it is something that we're going to continue to manage and work through on an ongoing basis. I don't think this is something that John is ever going to stop working on, and we're going to continue to move forward with extending our mortgages on a fixed rate basis forever.

Okay. And for the 2013 guidance, does that assume any kind of hiccups in -- specially early in the year from, say, a fiscal cliff issue?

It does not.

Okay. And down the road, if you want to take on a lot more capital to be even more aggressive in the M&A space, for example, would your preference be to do -- raise capital via equity or debt in light of how much the stock has risen?

Yes, David, good question. I mean we have $135 million in liquidity as it stands right now. If you look at our free cash flow for next year, it will be north of $50 million. And I think those 2 numbers combined give us plenty of liquidity to consummate the acquisitions that we see in the foreseeable future. Now, if we had a major acquisition come up at that time, we would make a decision on whether we do sub debt or an equity offering, but that's not something that we're going to plan this far ahead.

And is that decision made with you and Bryan or at the board level?

We have a capital group that meets on a biweekly basis which contains John, Bryan, Sid and I.

Our next question comes from the line of Efraim Levy with S&P Capital IQ.

Could you discuss how much of your -- how much contributions to your EPS guidance you have from your financial actions, including the retirement of the mortgage debt, as well as including the acquisition in Texas?

The acquisition -- this is Chris. The acquisition in Texas or the financing decisions that we made, we don't guide that granular. So, no, we're not going to give guidance on that specific level.

Okay. And I happened to notice just a small thing. In your guidance, you had gross margins and used vehicle gross margins that were totally unchanged and the service, body and parts gross margins changed by 10 basis points. Any reason why that one was the one that moved the barrier and the other one didn't move?

Yes, I think just mix shift for us. As we talked about on used vehicles, we don't see a big change in what's going to happen on our gross profit margins. But on the fixed operations side, when we continue to push our wholesale parts business and our body shop business, which are lower gross profit, we anticipate -- we forecast those on an individual basis, and the margins just kind of falls out in the guidance that we give. So we don't guide overall as one number. We look at each individual line of business and then aggregate those to come up with what the margin will look like next year.

Mr. DeBoer, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thanks, everyone, for joining us today. I look forward to updating you on our results in February again. Bye-bye.

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