Lithia Motors, Inc. (LAD) Q3 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Lithia Motors Third Quarter 2013 Earnings 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 2013 earnings conference call. Before we begin, the company wants you to know that this conference call includes forward-looking statements. Forward-looking statements are not guarantees of future performance. And our actual results of operations, financial condition, liquidity and development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements in this conference call. We urge you to carefully consider this information and not place undue reliance on forward-looking statements. We undertake no duty to update our forward-looking statements, including our earnings outlook, which were made as of the date of this release. During the call, we may discuss certain non-GAAP items, such as adjusted net income and diluted earnings per share from continuing operation, adjusted SG&A as a percentage of revenues and gross profit and adjusted pretax margin. Non-GAAP measures do not have definitions under GAAP and may be defined differently and not comparable to similarly titled measures used by other companies. We caution you not to place undue reliance on such non-GAAP measures, but also to consider them with the most directly comparable GAAP measure. We believe the non-GAAP financial measures we present improve the transparency of our disclosures, providing meaningful presentation of our results from core business operation because they exclude items not related to core business operations and improve the period-to-period comparability of our results from core business operations. These presentations should not be considered an alternative to GAAP measures, and a full reconciliation of these non-GAAP items is provided in the financial table in today's press release. We have also posted an updated investor presentation on our website, lithiainvestorrelations.com, highlighting our third quarter results. Presenting the call today are Bryan Deboer, President and CEO; Chris Holzshu, Senior Vice President and CFO; and Sid DeBoer, Executive Chairman. At the end of our prepared remarks, we will open the call to questions. I'm also available in my office after the call for any follow-up you may have. It's now my pleasure to turn the call over to Bryan.

Thank you, John. Today, we reported third quarter adjusted net income from continuing operations of $29.6 million compared to $23.1 million a year ago. We earned $1.13 per share in the quarter compared to $0.89 per share last year, or an increase of 27% and another record quarterly result. From this point forward, all comparisons will be on a same store basis. In the third quarter, total same store sales were up 15%, reflecting increases in all business lines. New vehicle sales increased 16%. On a unit basis, we sold approximately 17,000 new vehicles, an increase of 2,200 units or 15%, which was above the national average of 9%. Our domestic sales increased 13% compared to 8% nationally. Our import sales were up 20% compared to 9% nationally, and our luxury sales were up 9%, on par with national averages. Our third quarter new vehicle sales growth moderated through the quarter. New vehicle unit sales were up 29% in July, 15% in August and 1% in September, representing a slowdown in the cadence we have experienced over the last few quarters. We believe this can be attributed to a pull forward of September sales in July and August, coupled with tapering consumer confidence, which had been impacted by recovering vehicle sales rates. October is off to a solid start with new sales rate pacing an increase of 6% through today. Chris will provide you with more color on local market trends in a moment. Retail used vehicles increased 17% in the quarter. We sold approximately 14,700 retail used vehicles, resulting in a used to new ratio of 0.9:1. Unlike new vehicles, the cadence of retail used vehicle sales was consistent throughout the quarter. We sold a monthly average of 57 used vehicles per store, up from 52 units in 2012. We continue to target selling an average of 75 used vehicles per store. Our performance improved in all 3 vehicle categories in the third quarter. On a unit basis, certified pre-owned grew 24%. Core product or vehicles 3 to 7 years old increased 8%. And finally, value autos or vehicles over 80,000 miles increased 9%. Our F&I per vehicle was $1,106 per unit compared to $1,069 per unit last year. Of the 31,700 vehicles we've sold in the quarter, we arranged financing on 72%, sold the service contract on 43% and sold a lifetime oil product on 37%. Our penetration rate in service contracts and lifetime oil sales increased 170 and 150 basis points, respectively. Our service, body and parts sales increased 6% over the third quarter of 2012. This was on top of last year's 6% increase over the third quarter of 2011. Customer pay work increased 4%, which is the 17th consecutive quarter of improvement. Warranty sales increased 11%, which is the fourth consecutive quarter of improvement. Wholesale parts increased 9% and body shop increased 3%. Our stores continue to focus on a volume-based strategy to increase the number of new and used units sold. The key benefit is the increased number of units and operations that were returned to our service departments for future maintenance. Given our exclusive franchises that are typically the sole location for warranty work within a market, along with increasing vehicle complexities requiring specialized diagnostic equipment, we believe service work on these incremental unit sales will be a tailwind in future periods. Gross profit per new vehicle retailed was $2,111 compared to $2,365 in the third quarter of 2012, or a decrease of $254 per unit. Import margins decreased 120 basis points, domestic margins decreased 70 basis points and luxury margins fell 40 basis points. Gross profit per used vehicle retailed was $2,707 compared to $2,519 in the third quarter of 2012 or an increase of $188 per unit. New vehicle gross margin compression is a frequent area of focus for our shareholders, particularly when coupled with the volume-based strategy I previously discussed. Our store personnel closely monitor the average overall gross profit per vehicle sale to evaluate their performance. To calculate this, we add total gross profit on new and retail used vehicles, plus F&I profit and wholesale profit, and divide it by the total new and used retail units sold. In the third quarter, the blended overall gross profit per unit was $3,514 compared to $3,505 last year or an increase of $9 per unit. Our store leaders are working hard to maintain gross profit on a blended transaction basis. And while there may be a shift in the allocation of gross profit by business line within vehicle sales, the overall result is slightly higher. The biggest benefit from our volume-based strategy was greater overall gross profit. In the quarter, our stores increased total gross profit $15 million or 11% over the prior year. Driving incremental gross profit dollars into the organization allows us to leverage our scale and gain efficiencies in operation. Our overall gross margin was 15.4% compared to 16% in the same period last year. Increases in vehicle sales continue to outpace our growth in service, body and parts revenue. And this mix shift explains the majority of the decline in overall margin. We remain focused on achieving the 3 milestones for long-term growth that we laid out in 2012, which doubled our size in the 3- to 9-year period. Each milestone grows our top line revenue by 25% through a 10% to 15% increase in same store sales and a 10% to 15% growth through acquisitions. Due to decelerating sales resulting through the third quarter, we believe that we are on track to achieve the first milestone of 25% growth in early 2014. Slightly longer than we anticipated earlier this year, this is still on the shorter side of the 1- to 3-year time frame we have targeted for each objective. This also means that acquisitions will become more important to provide growth in both store count and top line revenue in the years to come. Over 90% of the dealerships in the U.S. is still privately owned, and we anticipate accelerating the number of acquisitions we complete. We believe the opportunity for consolidation is ripe and is the foundation of our continued expansion in 2014 and beyond. We seek exclusive domestic and import franchises in midsized rural markets and exclusive luxury franchises in metropolitan markets. Earlier this month, we purchased a store in Stockton, California, with an estimated annual revenue of $45 million. This brings the total new locations added in 2013 to 5, including the 3 Salem stores we purchased and the MINI store we added in Anchorage, Alaska earlier this year. With that, I will turn the call over to Chris, our CFO.

Thank you, Bryan. Over the past 18 months, we've commented on the new and used registration levels within our market compared to 2006 as the baseline year. This comparison has been one of the primary ways we've evaluated both our store performance and the opportunity ahead as we emerge from the great recession in 2008 and 2009. For the first half of 2013, we saw significant increases in registration levels within many of our Western states, pacing above the improvement incurring nationally. Our Western states are still significantly below peak registrations experienced in 2006, and we cannot identify any significant structural issues in terms of population, migration or a change in regional industries or employers that would preclude these markets from making a full recovery. We expect the continued recovery in housing to benefit both timber and construction-related industries, which drive significant economic activity in the West. However, in the third quarter, we saw a moderation in registration growth in many of these markets. We believe this is a purely, a transitory factor that it indicates the recovery will not be linear. We remain confident that the Western markets will eventually eclipse the prerecession registration volume. But this development has led us to slightly temper our outlook for the remainder of 2013 and into 2014, particularly around vehicle sales opportunity. In future periods, more of our vehicle growth may need to come from increasing our market share rather than the organic growth in the underlying market. Of the vehicles we financed in the third quarter, 11% were to subprime customers, consistent with the third quarter of 2012 but below the national penetration numbers of 16%. The absolute number of contracts originated for subprime customers increased 18% year-over-year, in line with the total number of customers financed. We believe that the mix of subprime customers remains underweight relative to normal market condition. Given our rural market and domestic brand exposure, we believe our customer base is more dependent on subprime financing than broad national trend. We anticipate our normalized volume of subprime customers should be approximately 20% of the overall mix of financing. Banks are continuing to increase their appetite for lower credit quality customers, but we believe an improving employment environment will be the most significant factor to increase subprime lending. In the third quarter, we saw an increase in the average duration of auto loans of approximately 1 month to 66 months and a decrease in average rate by approximately 30 basis points compared to last year. We continue to focus on leveraging our expense structure off an increasing revenue base. In the quarter, SG&A as a percentage of gross profit was a record low 65.6%, a reduction of 120 basis points from the third quarter of 2012. Throughput or the percentage of each additional gross profit dollar over the prior year we retain after selling costs and adjusted to reflect same store comparison was 41%. This result was below our expectation of 50% incremental throughput. The primary reason for the shortfall was related to certain reserve adjustments required under GAAP that reduce gross profit and increase SG&A expense. Additionally, there were expenses in SG&A associated with contingencies on the noncore tax benefit we called out as a pro forma adjustment. Excluding these factors, our throughput would have been approximately 47% and within a more normal tolerance of our 50% throughput objective. As sales increase, we believe SG&A as a percentage of gross profit can remain in the upper 60% range. We continue to use incremental throughput as a way to measure our cost control effort, and our target of 50% remains unchanged. At the end of the quarter, we had $16 million in cash and $165 million available in our credit facility. Currently, $160 million of our operating real estate is unfinanced. These assets could provide up to an additional $120 million of available liquidity in 60 to 90 days. This brings our total liquidity to $300 million, and we remain comfortable with our overall level of capital. At September 30, excluding new vehicle floor plan financing, we had $225 million in debt, of which $167 million is mortgage financing. We had no mortgages maturing until 2016. We have no high-yield bonds or convertible notes outstanding. We were in compliance with all our debt covenants at the end of the quarter. We maintain approximately $625 million in LIBOR-based variable-rate debt. Therefore, we anticipate that each full percentage increase in LIBOR would increase annual pretax interest expense by $6.3 million. This assumes no change in inventory days supply or ever -- other efforts to lower interest expense. As of September 30, new vehicle inventories were at 565 million or days supply of 76 days, an increase of 1 day from a year ago. Used vehicle inventories were at 158 million or a days supply of 52 days. This is 2 days higher than our days supply level a year ago. We are comfortable with our inventory level as we enter the seasonally slower fourth quarter selling season. Our free cash flow, as outlined in our investor presentation, was $29 million for the third quarter of 2013. Capital expenditures, which reduced this free cash flow figure, were $12 million for the quarter. We estimate our 2013 CapEx will be approximately $55 million. This budget is based on new facilities, facility improvements and remodels, strategically exercising purchase options on leased facilities and other business development opportunities. Based on this CapEx estimate and our full year guidance, our 2013 free cash flow is estimated to be $90 million. We focus on the prudent allocation of capital and believe a balanced strategy of acquisition, 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 for Lithia's future. We are providing guidance for the fourth quarter of 2013 of $0.88 to $0.90 per share and increasing full year 2013 guidance to $3.90 to $3.92 per share. We're also introducing guidance of $0.91 to $0.93 per share for the first quarter of 2014 and $4.15 to $4.25 per share for the full year 2014. For additional assumptions related to our earnings guidance, I would refer you to today's press release at lithiainvestorrelations.com. This concludes our prepared remarks. We'd now like to open the call to questions. Operator?

[Operator Instructions] Our first question today is coming from Ravi Shanker from Morgan Stanley.

So I just wanted to ask on your new vehicle trends, you said that some of the weakness you're seeing in your regional markets, you think, are transitory. Can you just talk about what do you think may be the drivers of this and just how transitory is it? Meaning, is it, a, a couple of months thing? Is it like a 6-month thing, or do you even have that level of visibility?

Ravi, this is Bryan. I think what we'll find as we start to approach that 16.5 million, 17 million SAAR again is that as we reach it, I think there's going to be market fluctuation that occurs. And it's what we're really seeing in some of the Western markets. We saw it last year in some of our Midwestern markets where they were starting to reach peak levels. And I think as we look forward, we're going to have to be able to, to some extent, adjust and attack market share rather than get what's out there in the marketplace. Probably when we look at new vehicle sales, I mean I think we've built the organization in a way that it's a little different than what we were in the past, so we're able to respond to what's happening in the marketplace very quickly. We were up, what, 16% in same store sales for the quarter when the nation was up 9%. So that gives an indication that our market conquest is still improving. And then our markets may be improving a little more than what's out there.

Got it. And just on the subprime data that you provided, I was a little surprised to see your subprime kind of flat year-on-year. You did mention in your comments that you think there is a lot more room for penetration there. We have heard of the banks getting a lot more aggressive at buying subprime paper. Are you disappointed with how that penetration has gone? And are you taking steps to increase that in the coming quarters?

Ravi, this is Chris. Yes, I think we're a little disappointed in the way the numbers play out, especially when you compare to the national penetration at 16%. But at the same time, as Bryan alluded to, I mean our Western markets are still depressed and a lot of those consumers are still subprime customers that need a job in order to get financed. So I think there's a lot of opportunity and upside there. We alluded to, it's going to still be a driver of the recovery out West as far as employment is going to drive the market recovery. And we anticipate to see that improve through the next few years.

Chris -- this is Bryan again, Ravi. One other thing, if you look at the drivers of subprime, if you look at what happened this quarter in regards to our used vehicle same store sales growth and you look by individual segment, our core product was finally higher than our value auto. And it was a higher number than in previous quarters meaning that, that core product, which drives that third-generation trade-in of a value auto vehicle, is now starting to take hold, which is what we'd like to see. We want to see that growing faster than some of the other categories because it means that we'll be able to grow our value autos. And that's probably the hardest of the 3 categories to find increases because it's got -- solely based off going and procuring cars, right?

Right, good answer. Just finally on 2014, it looks like the margin guidance in pretty much every segment is lower versus what you expected during 2013, especially in P&S, which is a pretty decent step down. Can you talk about some of the headwinds you may be potentially seeing out there? Are you just conservative, just given what the SAAR's doing and potential slowdown there?

Ravi, Chris again. Our guidance philosophy has gone unchanged for the last 12 quarters. And what we continue to do is look at our current markets. We do a bottoms-up forecast for each store, and we look at the current trends. And when you see the cadence of sales that Bryan talked about in his prepared remarks, it's hard to project out to the end of 2014, which is 15 months out, what to expect. So we're continuing to maintain the philosophy that we've had on guidance, which is roll forward how our stores are doing today. But if there's upside and our markets are posed for upside, we're going to take share and we're going to get leverage and we're going to drive throughput. And that's what we've done for the last 3 years and that's what we're going to continue to do.

Our next question today is coming from Simeon Gutman from Credit Suisse. Simeon Gutman - Crédit Suisse AG, Research Division: A question about Q3 and then maybe put it in the context of the whole year because I realized that one quarter may be a narrow time frame. In the past, and I think today, you said that Lithia is pursuing this volume mentality, while still being mindful of margin, but you're looking at whole deal gross profit. Can you try to parse out how much, I guess, of the margin degradation, either this quarter or year, was due to that type of focus versus market factors just bringing the margin rate down themselves?

Sure, Simeon. This is Bryan. The way that we operate our stores is when our store leaders or ourselves are in our stores, we challenge our stores to look at the total gross profit within the dealership that they generate. And we all know that we've talked about that for many years. But the way that you apply that as a leader of a store comes much differently. Many people have -- could possibly have teams that have a lot of opportunity for growth. And it may take a while to convince their teams that they're going to sell every vehicle, which means at times, you have to lower margins to be able to convince them of that. And I think what we're finding is when we're out there that each general manager attacks a little differently. But what we typically find over time is that the stores, through good management and development of their team, are able to recapture those margins. We probably have somewhere around a dozen stores today that are in that quandary of market share versus gross profit per deal. And they're struggling through that, building teams and growing their business. However, what we're finding, as many of those are starting to come back and I think it's important to note, that despite the new vehicle degradation of margin, if you look at the overall deal margin, which includes your wholesale, your used vehicles, your new vehicles and F&I, we're up $9 year-over-year. And that's having that dozen stores or so that are still in that quandary state. So I think you'll see it stabilize, and I think you'll even see that we continue to get our arms around those new stores that have some development of people that's necessary still. Simeon Gutman - Crédit Suisse AG, Research Division: And drilling that -- on that a little bit further, if you think about the mechanics of how, I guess, the whole deal is thought of, if someone goes and purchases a car and you negotiate a price on the new car, the F&I sale hasn't happened yet. And so at the individual dealer, are they looking at an averages of F&I penetration that they expect? And what if a used car is not on the other end of that sale? I mean are all those things taken into account at the dealership level? How involved is a salesperson versus how involved is the store manager in that process?

Absolutely. I mean the total deal gross profit is looked at. And if you decide to sell a vehicle for too little of money or something that you believe that is less than what the marketplace is yielding, then you look at what the implications of the F&I or the trade-in or the downstream service and parts business that can occur from that. So I think yes, most of our people are very good about thinking the big picture as to what happens in a transaction to be able to make a decision of whether to sell that car or to not sell that car.

Ravi (sic) [Simeon], this is Sid. I mean they're really empowered to make those decisions in the format that we're involved in currently in. And it's a wonderful story actually of how we're improving volume and building customers. And it's so important for the future of our company that we build that owner base. So I mean that focus is huge in the company.

Simeon, just a quick -- a tidbit of information that we look at in terms of are we still gaining market share. In the quarter, we increased our market share about 2.5% over the previous quarter, which means we're still able to capture market share in conquest from our competing brands, right? And I think it's right. I mean that's what we look at, and I think we'll continue to challenge our stores in that light until we reach a saturation point in there. There may not even be one because we have plenty of our stores that sell 2 or 3x what their average market share should be. Simeon Gutman - Crédit Suisse AG, Research Division: Okay, and then a follow-up, more of a big-picture question, the way that the business is managed or you've talked about in the past just looking at it as business in thirds. And so if you look over the last 12 months, and again, I don't want to be too narrow of just this last quarter, can you talk about just directionally which bucket, whether the top, the middle or the lower end has shown the greatest progress? And what I'm trying to get at is understanding where some of the opportunities lie from an internal perspective, and I guess external, of where the improvement is going to come from going forward.

Simeon, this is Bryan again. You know our story well. We obviously manage our stores by thirds. But I would say this, our buckets continue to move upward, all 3 of them. I think the biggest improvements are coming from the middle bucket right now. We still believe that our lowest bucket has tons of opportunity for growth. And I think when I talk back at that 13 stores, 12, 13 stores that are continually struggling with margin pressures and volume pressures, it typically comes from leadership and teams within the stores. And I think that's where we spend a lot of our time challenging them and training them on where their opportunities are. Last week, we spent a couple of days with our general managers in Portland with a very pinpoint focus on looking at our customers' needs and figuring out how to anticipate their needs at a higher level than what our competitors, what we believe our competitors can because it's easy to get very blinded in the business based off your results. And I think what we -- what the takeaways were is a lot of stores, including some of those in the lower bucket, that really have been clouded by partial success and their inability to be able to see what their customers are really asking for and give it to them before they even know it themselves. And I think that's our challenge to our teams today and going forward is how do we accomplish what they're asking for before they even know what they want. And I think that takes some very insightful thought about our processes, their emotions, their buying triggers and so on.

Our next question today is coming from John Murphy from Bank of America Merrill Lynch.

Just a question on the guidance for next year of $4.15 to $4.25. You're not including acquisitions in that. That is future acquisitions, and it's -- but it does include the 5 that have been made to date in 2013, is that correct?

That is correct, John.

Okay. And if we think about the acquisition contribution for full year '13, how much do you think your acquisitions have contributed to full year of '13? Is it 5% to 10% of earnings? Do you have a sort of a general bucket?

Yes, we don't disclose that, John, specifically. 5% to 10% is probably a little high. I'd say it's probably...

It's probably around 6%, 7% of revenue, which is probably a little bit less on earnings because it takes 12 to 18 months, typically, to get them up to a average state in our business, okay? And we did about a little over $200 million so far in 2013.

And you would think that the pace of acquisitions may pick up given what you're seeing in the market, is that a fair statement and given sort of your focus on that?

John, this is Bryan again. You're right on. I mean what we've really been doing over the last number of years is building our teams to be able to put more on their shoulders to some extent. And I think the way that we've built the organization is much different than in the past. It's built off great people that are challenging each other to do more. If we look at the acquisition pipeline, I think what we'll find that as these fluctuations occur in our internal same store sales growth, we'll be able to really subsidize those fluctuations with acquisitions. And I think right now, what we have is a fairly good backlog of things under contract that should get done around the end of the year, some maybe before the end of the year and some a little bit after that. But more importantly than that, that bucket of deals that we're in negotiations on has increased even from the levels that we were talking about last quarter. So it's pretty exciting as to what's happening out there. And more importantly, we're built to be able to operate those stores if it accelerates.

John, this is Chris. Just to jump in on your first question, on Page 25 of our IR presentation, you can see that our -- we do give annualized EBITDA expectations at $5 million for the acquisitions that we did in '13 and $168 million in revenues, so you can put that into your model on a go-forward basis.

That's great. That's very helpful. I appreciate that. Second question, as we look at the information you gave us on the gross profit per unit of $35.14, it was up $9 a year, I think that's incredibly helpful and illustrative to people of how you operate the business. But as you think about the potential for parts and service gross off the back of that, how do you think about that in that process? Because, obviously, you're looking at a good solid 5-year tail off the sale of those units and I would imagine that would have to go into the thought process as you're running the front end of the business.

John, referencing our IR deck again, on Page 18, we have a slide that actually points out what the life cycle of -- in service gross profit is from a new and used vehicle sale. And what we anticipate is in the first 5 years, we expect to see an additional $550 in gross profit for each incremental vehicle that we sell. So that's the way that we look at it. We track it and what we want to do is continue to capture more of those customers into the service drive and move that $550 up to $600, $700 and beyond. And again, that's the first 5 years, so if we can retain the customer for 8, 9, 10 years, you're looking at $1,000, $1,200 in gross profit per vehicle.

And sort of a second question to that, is there any way that you would consider lowering your grosses at the front end of the business if your grosses in the parts and service went up? Are these 2 different decision nodes in the decision tree in a transaction?

John, this is Bryan again. I believe that part of the decision is the reciprocal effect in service and parts. I do believe it is somewhat 2 separate decisions, and I don't believe that margins in fixed operations are really intending to go up. I believe it's about capturing that tail for a longer period of time. Really, the way to -- operational standpoint of what we spent time with our general managers was to show the implications, like Chris just spoke to, of what happened with the units in operations. Because really, today, we're still at a pretty low trough of what our total units in operations are, okay? And as we have more 15 million, 16 million SAAR years, this number builds pretty quickly. And if you recall on previous calls, we've talked about our current stall utilization rates within our facilities, which means the capacity for us to grow our business, are only sitting at around 50% to 60%. Meaning that we could grow 50%, 60%, 70% and not have to spend a ton of capital. However, we do still find ways to improve our stores to be able to make our customer experiences better. And I think more importantly than that, our stores continue to explore ways to make that event when a customer enters our dealership, more expedient, more cost effective and hopefully retain that customer for that 6-, 7-year period. And hopefully, if they choose to even trade that car in, how do we retain that person that now traded it in, or if they sold to private party, how do we help that customer translate that into a permanent customer within our service and parts department. And those are the nuances that we've been really attacking in each and every store.

And then just one last question and sort of a follow-on to that. It seems that we may be close to the nadir of the turn in UIOs. Really, for the last 2.5 years, you guys have been putting up very solid mid-single to high single-digit same store sales on parts and service and that's because of your efforts, obviously. You're facing real headwinds. But do you think we really are at the nadir of this turning growth of UIO that will flow through your parts and service base? Or is that something that is probably more of a 2014, mid-2014 event, and then all this great stuff that you're doing is creating these mid-single, same store sales comps and we could see a little bit of a bump as the UIOs really do begin to grow?

John, this is Bryan again. I do believe we're past the trough. I think we're starting to climb back out of it now. And I think with continued new and used car sales, it will help things. I think -- I would also say this that as we look forward at our business, most importantly, remember -- you know what, let's just go back a second. Remember, our fixed operations do not include our used vehicle reconditioning as well, so it's a pure number, right? And we were up 6%. Now there was one more day than last year, which, if you equalize that, it may be 4.5%, is that fair? But I think when you look at that 4.5%, I think that's a sustainable number for a number of years. And I believe that if we continue to do better at capturing that 6-, 7- and 8-year-old customer, I believe that's beneficial. We also can look at the fact that maintenance contracts are now becoming more of a norm than an exception, which obviously increases our gross as well. Warranty is still growing at 11%, 12%. Now it's the fourth consecutive quarter. I think our transportation commissions are helping us with recall. I mean, there's a lot of stuff out there that are real positive tailwinds that can help this thing continue to grow. And obviously, it's the easiest area of the business to maintain throughput and put it to the bottom line.

John, this is Chris. Just adding a few numbers to that, in year 4, we see about -- we only see about 35% of the customers that we sold a used or new vehicle to come back into the shop. And that means that 55% of those customers are going somewhere else. And I think -- 65%, sorry, 65% of those customers are going somewhere else. And that just means we have a lot of opportunity as this warranty business is coming back in to capture those increasing sales. But also, if we can just retain more of those older vehicles, which actually generate more gross profit for us, then the upside in service is only going to get bigger. And to your point, we haven't modeled the huge upside in service, but it's there. And once we start to see that trend, we'll start putting it into our models and we'll start putting it into our forecast.

[Operator Instructions] Our next question is coming from Scott Stember from Sidoti. Scott L. Stember - Sidoti & Company, LLC: Could you talk about the rebound in October that you talked about? Was it within the last week or so? And one of your competitors talked about possibly October having to do with the government shutdown. Could you maybe just speak to that?

This is Bryan, Scott. I think we definitely saw in September's maybe a touch of implications from probably the budget balancing. But I think once it was resolved, it seems like things are broke loose a little bit again. I mean, it's not robust. I think we're definitely starting to taper in terms of where our sales volumes are. But what we are seeing early in October is about a 6% increase in new. Additionally, our used are up about 15%, which seems like it's on track again, and we're pleased with what we're seeing there. Scott L. Stember - Sidoti & Company, LLC: And the rebound that you saw in October so far, could you maybe break it out between your markets, within your smaller regional markets or the Midwest markets? Has it been linear across the board?

I would say it's pretty linear. I mean, it's similar to what's been occurring over the last few quarters. There's no anomalies out there. Scott L. Stember - Sidoti & Company, LLC: Okay. And Chris, could you maybe just give us a little bit more color on the insurance reserves and the -- some of the other items which affected the throughput in the quarter?

Yes, Scott. I think that, one, the number that we had that had to do with the reserves is about $1.1 million, $1.2 million. And that had to do with some general reserves on finance, service contract cancellations, workers' comp, P&C insurance. And what you're going to see, as we continue -- as sales rates slow down a little bit is the gross that we're generating to calculate throughput is getting a little smaller. And so when we have these adjustments, they have a much larger impact on the overall throughput calculation. And so you take $1 million in a quarter and it can have a 5% swing in your overall throughput number from 50%, let's say, down to 45%. But over the long term, we are going to continue to see throughput in that 50% range. You just might see a little bit more volatility on that as the overall gross change gets smaller.

Our next question today is coming from Rick Nelson from Stephens.

I'd like to follow up on that, if I could. The guidance for 2014, what sort of throughput does that assume?

Yes, Rick, this is Chris. We don't guide SG&A, but I can tell you that our target is going to continue to maintain the progress that we've had. And so if we can continue to generate 50% throughput, we're going to continue to bring down our SG&A, which right now at 65.5% is the lowest in the group. But we know we still have opportunities, and we still have stores that we continue to work on to leverage our expenses as we continue to grow.

Got you. And then the free cash flow that you provided, $90 million for next year, curious what sort of revenue that would support if -- with the acquisition if you were to deploy all that capital toward acquisition?

Rick, this is Bryan. We typically say, if you recall, that our investment is somewhere between 10% to 20% of revenue. If you apply that to a $300 million number, you get $1.5 billion to $3 billion in revenue approximately, right?

And Rick, I'd add to that. About 50%, 60% of the CapEx that we have that's in that free cash flow number is financeable. We don't net that out. And about 50% of it is also due to acquisitions and open points that we're working on right now as well, so things that are going to continue to generate the top line growth.

Got you. And if you could characterize the current M&A environment. This year, you've acquired $168 million in revs to date. Can you size that up as we move toward 2014?

Sure, Rick. I can give you a little bit more color there. I know that the organization was built around the ideas of these milestones. And our external numbers on each of the 3 milestones is a 1- to 3-year time frame. We obviously are tracking a little -- kind of in the middle of that range in terms of acquisitions. More on the upper end of that range when we talk about the internal growth on the milestones. But what we're finding is that they're starting to accelerate, and I don't know how to express the level of acceleration other than it's a greater level than it has been quarter-over-quarter. We have a number of deals currently under contract that will be closing in the coming weeks and months. We probably have another two- or threefold that are in negotiations that may or may not come into play. But we're pretty confident that over the next 12- to 18-month outlook that we have the ability to achieve a single milestone within that period of time with what's in the pipeline.

Our next question today is coming from Steve Dyer from Craig-Hallum.

Just wondering, kind of to dig down on the service element a little bit more. I certainly understand the volume base strategy you're going with. Do you have any sense as to the average age of a light vehicle in your markets, either anecdotally or specifically? And then sort of how that relates to the overall industry?

I think we're real similar with the industry, average age of a vehicle right now at 11 years. The only thing I'd add to that is average age of a truck right now is about 14 years. So if we have a higher percentage of truck sales in our market, the age of those vehicles is older than the average. And I think, again, as those markets start to recover, especially out West, you're going to see a higher propensity of truck sales.

Got it. And do you have any sense or how do you sort of envision the service component of your business playing out? Because in the near term, it doesn't seem like there's necessarily an acceleration. And I know there's a lot of new vehicles on the road, implying not a lot of service. But is that sort of a do we hit a point, whether it be in '16 or '17, when you sort of see this strategy really come to fruition?

Yes. Rick -- or Steve, this is Bryan. I think when we look at the spectrum of operational performance within our stores, we see such vast differences in the units in operations that are out there and what the equivalent service and parts, flat rate hours or gross profit generated off of those units in operation are. And when we look at the spectrum, it's so disparate, meaning that our bottom stores do approximately 1/2 to 1/3 of what our top stores do. And we look at the opportunity within, probably over half of our stores and the ability for those to satisfy and meet our customers' needs and to achieve what our best stores do, it's amazing. So this isn't just a UIO recovery story which at 5%, 6% recovery enable to put throughput of 50% to the bottom line. Those are pretty substantial numbers in their own right, but when you look at the spectrum of performance within our company, there's huge disparity. And I think that's where we spend our time and that's where we'll see a lot of the pop in service and parts in the future.

Got it. That's helpful. As it relates to the incentive environment, what are you seeing as it -- the OEMs, are they getting -- it seems with the sales perhaps plateau-ing a little bit, any movement there, either to the positive or negative?

Yes, it's not big implications, Steve. I think it's up $100 year-over-year.

Got it. Okay. If I could get granular on a couple of different programs or platforms. Was the delay in the Cherokee, did that have any meaningfully impact on you in the quarter?

That's a good question, Steve. We would say yes, that it most likely did. In most of our Chrysler stores, which is around 1/3 of our business, we expected to be able to gain somewhere between 6% and 8% additional sales from that Cherokee sale, those Cherokees coming in. They're fortunately now only 10 to 14 days out from hitting our lots. So I think that, that small loss within those Chrysler stores, we should be able to get back a little bit in Q4. But it did have some implications.

Okay. And then secondly, any commentary on the new K2XX vehicles, how they're selling? There's been a lot of chatter about not necessarily keeping pace with the incentive environment of their competitors. But what are you seeing?

I think we're seeing that they're right on target. Chevy did a nice job on the launch of that product, and our stores are motivated by it and it seems to be sitting well in the market and being received well.

Perfect. Okay. Last question, even though your inventories on an absolute basis are up meaningfully year-over-year, floor plan was down. Was there sort of an anomaly there? Are you taking more equity in the floor plan? Or how should we think about that number going forward?

Yes, Steve, this is John. I think the biggest thing we've been able to do is that the acquisition pace has been a little bit, I think, slower than we'd like. The flip side of that is our free cash flow generation has been better, and we've been opportunistic in paying down some debt on a transitory basis. To Bryan's point, I think the acquisition pipeline looks pretty good. And so I would anticipate that we're going to be more closely to fully floored, and so I wouldn't necessarily model the third quarter in going forward. But I think we're going to flip that by deploying it for a much higher return by investing it in acquisitions.

Our next question today is coming from Brett Hoselton from KeyBanc.

Just first, I want to ask a couple of questions on your guidance, which as I look at your gross margins, whether it be new or used or parts and service, you kind of got it down just slightly and then F&I kind of flattish. Is there any structural driver to the decline? Or is it just simply those appear to be somewhat reasonable expectations or being maybe a little bit on the conservative side and there's some upside?

Yes, I'd say that, again, just looking at where we trended in the third quarter, we look at those numbers, and like I said, we look at our current trends to see how to project going forward, we think there's upside in every single business line that we have. There's not a store that doesn't have an opportunity in at least one of the segments of the business that we operate in, and we're going to continue to execute on those. But our guidance doesn't bake in the upside that is there.

And then as I think about your used vehicle sales, it seems like with some of your initiatives, and I look at, for example -- and, of course, your certified preowned sales obviously doing quite well this quarter. It seems as though your used vehicle sales, given some of your initiatives, might actually begin to outpace your new vehicle sales, especially given maybe some of the increase in off-lease vehicles and late-model used vehicle availability and so forth. Is that a reasonable expectation? I know your guidance doesn't necessarily reflect that. But is there some potential for some outperformance there?

Brett, this is Bryan. I think you're absolutely right because as the new vehicle market begins to taper a little bit and reach those peak levels, our used vehicles is our single biggest opportunity on the top line sales increases. There's no question about that. And it's driven again through that core product. So you may quickly see the used vehicles -- and I think in the October numbers we're already seeing that, where used is trending at a 15% up and new is only at 6%. And I think that is intentional. That's predicted and it's very lucrative in terms of what the benefits are downstream in both additional used vehicle trade-ins plus the units in operations in service and parts.

And then finally, as I kind of compare your revenue guidance, gross guidance versus your earnings growth guidance, typically in recent years, you've done a very nice job of your earnings growth outpacing your revenue growth, and your guidance kind of implies that your earnings growth is going to be a little bit less than your revenue growth in 2014. I'm wondering, is there any structural changes that you're seeing in the business that might cause your earnings growth to lag your revenue growth? Or is it kind of just some conservatism on your part, possibly?

Yes, Brett, again, looking at current margins from where we started the beginning of the year and where we're finishing up this year, they are down a little bit, so that has an impact. And then the other thing that you have to bake in and anticipate is things like tax rates and interest rates and things like that, that do have a sizable impact on overall EPS for next year. And we have assumptions that we bake in. We don't give all those assumptions out, but the numbers kind of fall out based on where we guide each of those items.

Brett, one addition to that point, too, is as we look forward and as acquisitions become a bigger driver of the achievement of each milestone, then obviously, acquisitions have a little bit of lag in earnings typically because of that ramp-up period of 12 to 18 months. You may see a little bit of lag in earnings in relationship to revenues.

Our next question today is coming from Bill Armstrong from CL King & Associates. William R. Armstrong - CL King & Associates, Inc., Research Division: Most of mine have been answered. But just on F&I per vehicle, it's been approximately flat at around $1,100 for the last few quarters. And you're projecting that to kind of stay that in that area next year. Is there anything you can do to improve that, whether it's through penetration rates or any other levers that you can pull to maybe exceed that $1,100?

Yes, there's definitely opportunity that we have in F&I. When you compare us to our peer group, we know that there's upside there and it's going to come from a combination of things. I mean, one is continued training, to find the stores that have lower penetration rates and help them figure out how to tweak their sales process to improve those penetration rates to what our better stores do, that bottom third. Then we're also relooking at pricing of all of our products to make sure that the pricing is in line with the market. That might have some opportunities. And as credit continues to loosen a little bit and LTVs continue to -- loan to values continue to improve, it's going to allow us the opportunity to put more of the back-end F&I products on our vehicles, which will help our consumers. I mean, there are consumers out there that do want to buy a service contract and a maintenance plan, but their credit won't allow them to be able to add that to the price of the vehicle, and that hurts the F&I numbers that we have. So we believe that those are the 3 primary areas that we can continue to work on. There's upside there. And as we see that upside, we'll put that into our guidance. William R. Armstrong - CL King & Associates, Inc., Research Division: So it sounds like you think you may be underpriced in some of these products, and then there's some pricing opportunities?

I think, in certain cases, you could be underpriced. And in certain price -- in certain cases, you could be overpriced and then the product isn't attractive. And so it's finding that perfect balance of penetration and price that resonates with our consumers. And that might change by market. And we're looking at some market-specific products, some new products that some of our stores want to pilot and find the right products to offer for each of our customers. And that's what we're focused and we know there's upside there. William R. Armstrong - CL King & Associates, Inc., Research Division: I see. Okay. And then on the service contract penetration, you mentioned that some customers basically can't get -- might want it but they can't because they can't get financing for it. What can you do to maybe help the customer obtain that kind of contract?

Well, we can offer them a job. Again, it's just making sure that we have the right products with the right coverage. So maybe instead of trying to sell a comprehensive warranty that you move them into a powertrain warranty, which just gives them -- it gives them protection and peace of mind on the major components, but it may not cover things like the factory warranty does. And it just, again, making sure that we're educated on the products that we can offer to those consumers and make them at the right price point. And if we balance those things out, I think we can continue to move our penetrations and our overall F&I PVR up.

Bill, this is Sid. That F&I issue, when I was young and selling cars myself, then it was couple bucks a car. And we got stores doing $1,800 a car and there's guys that are really good at it. The store manager, the GSM, everybody has to be aligned. And the first choice is always gross on the car deal, but there's often a lot more that can be done. And as those store leaders mature and get after F&I, we think there's lift. We're really delighted to see some of the others move their numbers up because that means we have more upside as well. And we're really focused on it. It's one of the areas Lithia can provide some training and support to the stores and get results.

Our next question today is coming from Bret Jordan from BB&T Capital Markets. Bret David Jordan - BB&T Capital Markets, Research Division: Most of them have been asked but a couple of follow-ups and maybe on the used vehicle. I'm trying to understand it. It seems that, that's been pretty resilient in the face of softening new vehicle sales recently. And you say it's the area with most upside next year, yet you're guiding a used comp below -- or used comp rate below new. Is that an inventory sourcing issue that keeps you below your new sales rate? Or I guess maybe some more color on that.

Bret, just to clarify, were you asking about our new vehicle sales rates or used vehicle sales rates? Bret David Jordan - BB&T Capital Markets, Research Division: Your forecast for comp store sales growth in used being slightly below your new comp store sales growth. And given the -- but it seems they've been fairly resilient here recently, why would the used sales grow slower?

I think it's that challenge that we talk about in our stores to get our people to be able to find those additional units and sourcing vehicles like you said. And I think we go back to those 5 channels that we spoke about in the past of how to find those cars and how to get rid of the cars on the lot that aren't quick movers. So in that, it takes time. And I think as we look at our challenges in the future, that's where our stores are having to retool their people and retool their point-of-purchase and merchandising within the stores to be able to attract customers through better cars. And I think it takes time to do that. But I think that the growth in that used vehicle field, despite it being very similar to new, is going to be able to grow at a more stable rate. Whereas new, we're seeing that there are certain markets within the Midwest and the energy-based space that have already really peaked within our company. Now we still have the Western markets that still have opportunities. But even our Midwest markets, we see huge opportunities for used vehicle growth.

Bret, this is Chris. I was just going to say, if you're referring specifically to the guidance in Q4, keep in mind that December is a big new car month. And so that's baked into kind of the expectations that we have for Q4. Bret David Jordan - BB&T Capital Markets, Research Division: No, I was looking at the guidance for '14 actually. But you've got 7.6% in used, and 8.2%, I believe, in new. I guess a question on affordability and you talked earlier about the average loan duration being 66 months now. I mean, to put this in perspective relative to prerecession levels, what were duration at that point maybe for an '06? And I guess lease penetration, national average seems to be high 20s. Could you talk about lease penetration in your mix last quarter?

Yes, to answer the first part of your question, in 2007, if you look at that as a baseline year, our average interest rates were 8.8% and term was about 64 months. So we've seen a decline in overall rates and increase in duration. As far as lease penetration, obviously, the manufacturers are pushing more on the lease penetration side. Our finance managers are getting a lot more training on leases that they've had historically. But typically, I don't think we've ever outpaced the national lease numbers. And there may be opportunity there, but I don't know, Bryan, if you have any comment on that.

I think we're around 10%. I think the national average is around 22%. So we still have a lot of room for growth on that arena as well.

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Thanks, Kevin. Thanks, everyone, for joining us today, and we look forward to updating you on our results for year end in February.

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