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Executives

Dan Werthaiser-Kent - Manager of IR

Sid DeBoer - Chairman, CEO and Secretary

Jeff DeBoer - SVP and CFO

Bryan DeBoer - President and CEO

Dick Heimann - Vice Chairman

Analysts

Rick Nelson - Stephens

Matthew Fassler - Goldman Sachs

Rex Henderson - Raymond James and Associates

Scott Stember - Sidoti & Company

Matt Nemer - Thomas Weisel Partners

Jonathan Steinmetz - Morgan Stanley

John Murphy - Merrill Lynch

Edward Yruma - JPMorgan

David Lim - Wachovia

Lithia Motors Inc. (LAD) Q4 2007 Earnings Call February 20, 2008 5:00 AM ET

Operator

At this time, I will like to welcome everyone to the Lithia Motors fourth quarter 2007 conference call. (Operator Instructions)

Thank you. It is now my pleasure to turn the floor over to your host, Mr. Dan Werthaiser-Kent. Sir, you may begin your conference.

Dan Werthaiser-Kent

Thank you, Vanessa. Good afternoon, everyone, and welcome to Lithia Motors fourth quarter 2007 Earnings Call.

First, the company wants you to know that this conference call includes forward-looking statements. These statements are necessarily subject to risk and uncertainty, and actual events, results could differ materially due to certain risk factors. These risk factors are included in our fourth quarter and yearend earnings press releases and in the company's filings with the SEC.

Now, I'd like to thank you all for joining us for our fourth quarter 2007 earnings conference call. Presenting the call today are Sid DeBoer, Chairman and CEO of Lithia; and Jeff DeBoer, our Chief Financial Officer. And at the end of their remarks, we'll open up the call to questions. And we also have with us today for Q&A, Bryan DeBoer, our President and Chief Operating Officer; and Dick Heimann, our Vice Chairman.

Now, it's my pleasure to turn over the call over to Lithia's Chairman and CEO, Sid DeBoer. Sid?

Sid DeBoer

Thank you, Dan. Good afternoon to everyone. Thanks for joining us today. I expect that all of you on the call have had the opportunity to review our press release. I will cover a number of those items in more detail and discuss several other points not included in the press release.

Our fourth quarter net loss from continuing operation was $3.6 million and loss per share was $0.18 per share. We are encountering two major issues that, despite their significance, are only temporary. The macroeconomic issues facing our country right now are apparent to everyone. They make it difficult for even the most stable and profitable businesses to shine in times like these.

Recessionary market conditions accelerated in the fourth quarter for us, for Lithia. Since we sell a large ticket to consumer discretionary products that must be financed, we felt the impact. Most of our regional markets were more impacted than the rest of the nation, particularly in Nevada, California, Oregon and Colorado. Customer visit counts at most of our stores were measurably lower than anticipated.

In dealing with the difficulty of the economy, Lithia is taking steps to adjust our cost structure to match lower customer demand. These steps include cost cutting in the areas of personnel, advertising, travel and other inherently variable expenses.

Our change to a new way of serving our customers is a cultural change that is also having an impact on our short-term results. These changes are critical to our long-term success as a national provider of automobiles and related services. They markedly improved our customers’ experiences and will reduce our operating cost as we take out complexity in all the ways that we do with our customers.

Our improved sales processes offer our customers a refreshing sales environment that operates on a single Drive It Now Price posted on every vehicle that is always at or below MSRP. This means there are no longer any additional dealer mark-ups or document fees unless they've been specifically allowed by a state; nor are there any other hidden costs for our customers.

Our extensive consumer research shows overwhelmingly that this is the customers’ preferred way of doing business. The transparent pricing goes hand-in-hand with our 3-day 500-mile return policy. That's both on new and used cars. Customers may bring their new or used vehicle back for a full refund, including the return of their trading vehicle to them, no questions asked. No longer will a customer be burdened with regrets or second thoughts after purchasing a vehicle.

As these processes take hold, not only are we seeing greater satisfaction with our customers, but our sales people also are enjoying their jobs much more. The simpler processes have helped them to become more efficient and customer-focused. In our last call, we projected that all stores would have these new customer guarantees in place by late winter of 2008, and we have succeeded in that first step ahead of schedule.

Lithia Motors is also changing the way we service vehicles. We are trying to go beyond what is currently offered in the marketplace and stand out as having unique processes there as well. When you bring a used vehicle into a Lithia service center, we will take care of you on your schedule. Your car goes in right away for service, so you can be on your way quickly.

You will also never pay for the same job twice. We stand behind every repair we make for a full three years or 50,000 miles. If the repair fails, we'll fix it for free, and that includes parts and labor. Our upfront pricing also assures a complete and detailed quote for the work that needs to be performed on the vehicle before any work begins.

You will also know the exact price for the repair and we guarantee we won't charge any more than that price that is promised. We are excited about the response that we have seen so far from our customers. Now that we have all of the new customer equities in place at all of our stores, the next step is to align our pay plans and the management structure to match these new processes.

With centralization of pricing, inventory control and back office administration, the task remaining in the stores are much more simplified, and therefore, do not require the same skill set, nor do they require as many people. This means that store management will focus almost exclusively on employees and customers.

For example, there is a new position of the Merchandising Manager that will replace our normal Used Car Managers. This new position will be about half the cost of the current positions. This person's duties will be essentially to be the eyes and ears of the Lithia car center and you will hear more of that in the future. It is an appraising and managing of the inventory center.

The car centers is a new department in Lithia, formed within the last three months that we've envisioned for sometime; it is run by a team of industry experts who have the vast experience and the valuation, redistribution, pricing and purchasing of used vehicles. This group was originally organized as part of our incubator L2 auto store concept and has already extended it's purview into the Lithia store operations.

This centralized car center will be operating all used vehicle operations at both Lithia and L2 auto stores in the near future. Our goal for this new store structure should allow us to deliver a vehicle to a customer in about half the cost as it is today.

As we fully transition into the new sales model, our sales staff will receive a base salary, with volume based incentives. We will no longer be paying them on a commission basis, since store personnel will not control the pricing or the trade valuation of the vehicles. Again, aside from the very obvious customer benefit of this program, Lithia will realize better employee retention and a lower cost of delivery of each vehicle.

By offering a simplified new way to buy vehicles, the satisfaction and retention of our customers is rising dramatically. This should in turn, enhance our relationships with our manufacturers who are mostly concerned about the customer satisfaction and sales volumes. This should also result in more opportunities for Lithia to acquire more stores. All of these changes are dramatic improvements, which allow Lithia to be more competitive, more web centered and more agile.

Furthermore, the future of auto retailing demands that these changes occur. But change, as you know, is not easy and does require cultural reevaluation and retraining of all employees. All of these changes are dramatic improvements, which allow Lithia to be more competitive, more web centered and again more agile.

Looking now past the current recessionary environment and the exciting changes we are making to our current business model. We see earnings above $3 per share by 2011 as an achievable goal for Lithia. One of the biggest factors in this objective is SG&A expense as a percentage of gross profit, reaching again, the low 70% range. A large part of our business plan going forward is a focus on this cost reduction. In our model, revenues are expected to be over $5 billion by 2011, with operating margins pushing 4%.

To give you an update on L2 Auto, we opened two stores in Texas, as planned in December of 2007. The customer traffic is better than we predicted at those stores and sales are very encouraging. People feel good about our process and how it helps them buy a used vehicle or sell us their vehicle. From their onsite or online research and search, to the negotiation free pricing, to the easy close of the deal, to the firm bid to sell us their car; we know we will be seeing L2 customers again and again for years to come.

We look forward to the future of these stores and the success they will bring to L2 auto and the entire Lithia organization. Our four stores are scheduled to be open in the second quarter in Cedar Rapids, Iowa. A couple more are coming online in late 2008 and early 2009.

By the end of 2010, we will have opened 12 to 18 L2 stores. We believe that L2, in aggregate, will be solidly profitable in 2010, based on our current projected store openings. If you have not visited the website at L2auto.com, we strongly encourage you to take a 5-10 minute browse to get a feel of its ease of use.

The longer term plan is to integrate this leading edge technology and the processes into all of the Lithia used vehicle operations over the next two years, or may be even sooner. Ultimately, our goal for all Lithia stores is to be operating under the L2 auto used vehicle selling system. In essence, creating over 100 L2 outlets for Lithia. In essence, every Lithia store has the potential to double our used sales volume by utilizing this selling system.

There has been quite a bit of attention on our manufacturing partners and the sweeping changes made by some of these partners and their management teams. Cerberus, for example, has been working hard to improve the Chrysler brand, and consolidate product and dealers with their Genesis program. This initiative is very beneficial for Lithia. Currently, 65% of our Chrysler stores are in alignment with their program. Of the remaining 35%, we control what we consider one of the two major franchises, either the Dodge or the Jeep. We do not have a single standalone Chrysler store, which is where we feel most of the change might occur.

With that, I will turn the call over to Jeff, our CFO, who will comment further on the company's financials. Jeff?

Jeff DeBoer

Thank you, Sid. I would like begin by pointing to the fact about our results being preliminary at this point, penning the completion of the annual audit by our independent accounting firm. Specifically, we are completing a review of potential reporting irregularities associated with retail sales at certain store locations and until this review and analysis finalize Lithia's financial statements and the audit cannot be completed. While we do not expect the completion of the review to result in a material additional charge to income, we believe the exposure is no more than $0.03 to $0.05 per share, though no assurances can be given. Our final audited results will be included of course in our Form 10-K filing.

We currently have 13 of our 15 states in our same store sales mix. North Dakota and Iowa still do not have sufficient time open for comps. You can refer to our press release for the contribution by geographic region. No one market is larger than 24% of sales. So our geographic diversification plans are working. Again, this quarter it happens that our biggest state, Texas, is also one of our strongest states. We still expect to see continued growth from this Texas market.

As Sid has already outlined, sales continue to be slow in most of the regions where we currently do business. The exceptions have been in the states of Texas, Montana and Iowa and New Mexico, where we have seen continued healthy retail sales. And these states comprise approximately 33% of our total same-store sales base.

I'll now list these stores in order of increasing sales performances for the quarter. Texas did the best followed by Montana, New Mexico and Washington. Stores with decreasing same-store sales for the quarter in order of best to worse were Alaska, Nebraska, Oregon, South Dakota, Idaho, California, Colorado, Wisconsin and finally Nevada. We believe Texas had the best overall performance considering once again, it was up against large double-digit same-store sales gains in the fourth quarter of last year.

Our domestic import mix for the quarter on a same stores unit basis was 60/40 in contrast to fourth quarter of last year, which was 64% domestic and 36% import. So we're making progress on our manufacture diversification program as well. The truck-SUV crossover minivan segment declined slightly from 67% of total unit sales in 2006 to 64% of total unit sales in the fourth quarter of 2007. We saw these declines across both domestic and import lines. On a sales basis, 69% were from truck-SUV crossover minivan versus 72% last year.

Now let's talk about inventories. In response to the challenging retail environment, we have managed our new vehicle inventory levels with great discipline. As of the end of the December, our new vehicle inventories were at record low levels, which is nine days lower than the five-year historical average day supply for Lithia. We expect to continue this discipline in response to the weak economic conditions in our improved business model.

Used vehicles have been more of a challenge for Lithia, given softness in this market, and our conversion to the centralized car center model that Sid has described. Our day supply for used vehicles at the end of the year were 15 days above historical average levels for December. We are working hard on bringing this back in line, and our new car center approach will ultimately result in a much lower level than we've historically been able to maintain.

In the F&I, or the financial and insurance area, we continue to be a leader among the auto retailers. Our F&I per vehicle for the fourth quarter was $1099 per unit. Although revenue per unit was down 1.9% from the fourth quarter of last year, it is up for the full year by 3% per unit sold. We had penetration rates for the financing of new and used vehicles of 77%, service contracts were 41% and our lifetime oil and filter product at 35%.

Our service and parts business continues to be a relatively bright spot for Lithia, although our profit margin in service and parts was down by 180 basis points to 46%. Same-store sales increased 2.8% for the quarter. Warranty work accounts for approximately 18% of the company's same-store service, parts and body shop sales. Same-store warranty sales in the fourth quarter were up 1.4% with domestic brand warranty, about flat; and import warranty increasing 3.4% for the quarter.

We also did well in the customer pay part of our service and parts business, which is 82% of the majority of this business with an increase of 3.1% for the quarter. Margins in service and parts, as I mentioned, were down as a result of a negative mix shift towards selling more parts and accessories that carry lower margins than the service business, such as tires.

So, while margins are down by 180 basis points, we are driving more volume, and as a result, the same store gross profit is only down 1% despite the recessionary environment. We see even more opportunity for growth in this segment of our business with the new customer offerings that Sid described earlier and expect to see the gross profit to continue on an upward trend in the future.

New vehicle margins were down 60 basis points from fourth quarter of last year to 7.2% with the challenging retail environment. Used retail vehicle margins were also down by 120 basis points from the fourth quarter of last year to 13.4% for the same reason.

SG&A as a percentage of gross profit worsened to 89.9% from 78% in the fourth quarter of 2007, as we lost leverage due to the sales declines in one of our seasonally weakest quarters. Adjusting for the one-time franchise impairment of $1.77 million, SG&A, as a percentage of gross profit, was 88.4%, 450 basis points better.

For the full year of 2007, which is more reflective of where our cost base is, since the fourth quarter is a seasonally weak and a somewhat unusual quarter at the end of the year, for the full year, our SG&A, as a percentage of gross profit, increased to 79.2% from 75.4% in 2006.

Our overall gross margin declined by 70 basis points from the fourth quarter of last year due in part to efforts to maintain market share in a difficult retail quarter and the lower margins just described in the various business lines. Operating margins were lower by 230 basis points to 0.9% in this seasonally weak fourth quarter, but we expect them to rebound to levels between 2.4% and 2.7% for the full year of 2008.

For the quarter, the total flooring and other interest expense, as a percentage of revenues was 1.7% and was flat with last year. For the quarter, we had a decrease in flooring expense of approximately $929,000. The decrease in this expense is largely due to more disciplined inventory management, as well as LIBOR interest rates being slightly lower than last year. Lower interest rates contributed $524,000 to the decline, lower volumes contributed $746,000 and an increase of $343,000 related our interest rate swaps. As rates decline, we have additional expenses of interest rates swaps, because we fixed it. About 50% of our total debt is now hedged through interest rate swaps. In the third quarter, other interest expense increased by approximately $949,000, essentially all of which was due to higher outstanding balances on our line of credit.

Including swaps our average annual interest rate on all debt is now 6.3%. Looking at the balance sheet, we have $24 million in cash and $54 million of contracts in transits for a total of $78.6 million at the end of the quarter. Our long-term debt to total cap ratio excluding real estate is 35%, and our goodwill, as a percentage of total assets continues to be well below 20%.

Now I would like to breakout our non-flooring debt as of the end of the year. In total, non-flooring debt is $455 million, broken down into convertible notes of $85 million, line of credit $184 million, mortgages of $179 million and other sellers notes of $7 million.

Lithia's book value per share on a basic share basis is now $26 per share. This does not include the appreciated value of real estate on our books. Our non-financial CapEx for the full year 2007 came in at $24 million. For 2008, we're currently projecting non-finance for CapEx in the $25 million to $30 million range.

We have provided first quarter EPS guidance of a loss of $0.05 to $0.10 per share. We've revised our full year 2008 guidance with expectations to earn $1 to $1.30 per share. These projections call for a continuation of difficult economic conditions through 2008. But we expect that our centralization efforts and our selling and service programs will prevail in growing EPS towards the latter part of the year in particular. Our guidance is based on income from continuing operations and assumes $0.15 to $0.20 of development expenses associated with L2 Auto. Any acquisitions or dispositions will affect guidance this year, as they are no longer included; and we've also included a data table in the press release that gives you our key assumptions on our guidance to help the analysts with their models, as our model is very quantifiable and quite easy to look at the numbers on.

That concludes the presentation portion of the conference call. Thank you all for joining us, and we would open the floor. Vanessa, to questions, please.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is coming from Rick Nelson of Stephens. Please go ahead.

Rick Nelson - Stephens

Good afternoon.

Jeff DeBoer

Hi, Rick.

Rick Nelson - Stephens

Can you provide more color on the reporting irregularities -- how many stores and exactly what was happening in those stores?

Sid DeBoer

It's a limited number of store locations. But we are looking at others to be comfortable with these isolated incidences. And that's pretty much yet Rick. We are not over-alarmed by it. But it is one of those things we have to find a way to monitor better. Our centralization of our office functions will eliminate some of those problems that we may have had in the past in that area.

Rick Nelson - Stephens

I am surprised that, with all of the controls and Sarbox, that something like this could happen.

Sid DeBoer

They will make more than it is. We don't actually figure there is going to be any material involvement in it. But we couldn't get the financial report done and get the news out about our quarter without finishing this. So we need to get this done and get the news out, and then we will deal with anything that might come from that.

But we don't anticipate anything as our statements say. Although there is no assurance. We have to be sure everything is in line with our accepted practices.

Rick Nelson - Stephens

Shortfall in the quarter versus your guidance. How much of that do you think is macro-related, and how much of it is cultural shift and the move towards assured pricing?

Sid DeBoer

I think most of its macro, in reality. It's really hard to put a number to that, Rick. Some of it, the traffic count thing, I don't know that we spend enough marketing or not, but I know that we are trying to get the expenses in line at the same time. And the assured message takes time for people to respond to. It's not an immediate sell today message.

So it's hard to measure that. But I think its macro more than anything, because of this account, it was way down.

Rick Nelson - Stephens

How quick do you think a consumer at the store level can respond to these new assured pricing, is it months?

Sid DeBoer

Well, we see pretty good response in the Alaska, where it's been in place longer than anywhere else. But there was a J-curve there too, it took time.

Rick Nelson - Stephens

And how long did it take there?

Sid DeBoer

We saw improvement in September finally after we put it in, in May.

Rick Nelson - Stephens

Okay. And would you expect the same sort of --

Sid DeBoer

We hope to shorten that time. We're getting better at it.

Rick Nelson - Stephens

And how about acquisitions now, are you going to slow the pace, and what's the view on buybacks if your stock opens low tomorrow?

Jeff DeBoer

As far as the acquisition climate is concerned, we're waiting for prices to drop. We believe there is a recession on. And certainly, from our view, in our business we've seen a recession. The government hasn't recognized it yet, but I do believe the price of auto stores is going to drop, and I think we can find better buys on the stores we've targeted in the markets we want to be in.

And as far as the stock repurchase program, we purchased a small amount. But we want to save all the money we can to run our company with and be darn sure we've got all the money to invest in these initiatives in L2. So we're not going to be aggressively pursuing our stock repurchase.

Rick Nelson - Stephens

Just a follow-up on the Chrysler Genesis program, 35% of your stores are single-point or dual-point. I guess what happens, how do you consolidate and move to three main place in those markets or you a seller in those markets or…

Sid DeBoer

Generically, we are a buyer. For instance, we pick up a Jeep franchise in Pocatello this last year, and we picked up another one somewhere else and that completes those stores. We have in some markets, Rick, stores that sell Chrysler Jeep in one and Dodge in one in the same market. So we're going to be able to enable the consolidation. It's just what do you do with the existing real estate. L2 may provide an avenue for us to use the excess real estate.

Rick Nelson - Stephens

So do you see us helping a bigger Chrysler dealer once this program evolves or a smaller Chrysler dealer?

Sid DeBoer

I think that as a percent of our sales overall, Chrysler won't grow static. It would be static at the low end, but probably shrink as we find more mix issues. We need to get a different mix than we have. We have really a lot of confidence in what they're doing. But I've an optimist all along. So, hopefully, everything they are doing will make a big difference.

I have a lot confidence in Jim Press and Bob Nardelli and Steve Landry, the leadership there are all active on their national dealer council. We were instrumental in getting them to change that VPA. As you all know, lot of our results last year were a lack of earning that VPA because of sales declines when it was based on an escalating objective. And that's gone.

We're getting this year the full $200 when we buy the car and $200 when we sell it, and we are not recording any of that as income, obviously, until we sell the automobile. But that's a fixed dealer incentive that's out there now that wasn't there last year, that we don't have to earn by selling more volume than we did the year before should help. And they've made a lot of other structural changes. So I'm not negative on Chrysler, but we think it's prudent to have a better mix, a more broad mix of different manufacturers.

I'm going to drop the name in our discussions internally, domestic and import, because those two are so clouded to me. I mean not every import is going to successful in the future just because you have some. Certainly, Toyota, Honda have been recognized as the leaders and we are pursuing those, but they are very expensive yet, those stores, and if they don't perform as well as they did because of a recession, maybe some of the prices will come down and we can be more aggressive buying those.

Rick Nelson - Stephens

I've got other questions, but I'll let others ask. Thanks.

Sid DeBoer

Okay, Rick. Thanks.

Jeff DeBoer

Thanks, Rick.

Operator

Thank you. Your next question is coming from Matthew Fassler of Goldman Sachs. Please go ahead.

Matthew Fassler - Goldman Sachs

Good afternoon all of you. I'd like to start with little bit of a deeper dive to SG&A. First of all, I'm not sure if you mentioned this, but can you just sum up the impact of the L2 initiative investment and then your operating losses on the fourth quarter and then for the year 2007, please?

Jeff DeBoer

Yeah. For the year, our L2 operations came in exactly in line with what we guided in the past in terms of the $0.14. It was within $40,000 actually. There was nothing new there. And then with the new stores opening, and that was a part of our plan this year, we're guiding for $0.15 to $0.20 of a loss this year from that to startup business operation.

Matthew Fassler - Goldman Sachs

Got you. Secondly, as I think about SG&A -- and I just look at the typical seasonal -- trends, once again, you address this to some degree in your prepared remarks, but just to put it in this context, your SG&A dollars had a very, very nominal sequential decline from Q3 to Q4, much less than you've typically seen in prior fourth quarters. So am I missing something on one-time items as we get to that, or was there a driver of that reduced drop-off in expenses for you?

Jeff DeBoer

Well, the $1.77 million on the asset impairment for franchise is in there obviously.

Matthew Fassler - Goldman Sachs

Sure.

Sid DeBoer

And it's real hard to predict fourth quarter number, because every adjustment we make in any of our reserves for any the charge backs on finance charges or any the reserves for workers comp, they all flow through that bonus, they all flow through that quarter and the final year-end adjustment. So it's hard to compare fourth quarter to fourth quarter year-to-year. I think you have to look at our books on an annual basis to have a meaningful understanding of the business.

Matthew Fassler - Goldman Sachs

So to the extent, the past two years you were down sequentially. Something in the neighborhood of $10 million extra charges. You were down something more or like $4 million sequentially. Would you say that a chunk of that was true-ups and other things that we shouldn't consider, considering operations obviously from a presentation perspective there? But you are saying that you are not reflective of sort of recurring expenses?

Jeff DeBoer

Well, if you look at our largest-cost items, there are sales compensation and salaries and wages, I mean those are down in line or even greater than our sales decline. So our biggest expenses are very much in line, same thing for the year. So I mean those are really the true costs that we are managing, and those are down more than sales.

Matthew Fassler - Goldman Sachs

And I guess my final question is: as you transition to a new compensation model, what does that due to the flexibility of SG&A? Does that create more operating leverage in the business, or do you feel like you still have the wherewithal to control cost as sales fluctuate?

Jeff DeBoer

No, I think it's fair to say. Let me touch on two things here.

Matthew Fassler - Goldman Sachs

Sure.

Jeff DeBoer

Seasonality, we always manage this time of the year very closely. I think we missed the predictions on seasonality, and there were bigger macro issues. So we missed it by a little bit there this year that obviously had some impact.

In terms of the new compensation model, what the new compensation model really allows us to do, we are in a mode where we really believe we were in a variable expense structure in terms of personnel costs. But we kind got into a mode, where it was at the bottom end of the variability, and it became a fixed expense to some extent. So this new model will really look at compensation in terms of productivities and efficiencies and be able to reduce headcounts at some level, increase productivity and really be able to pay our average employee more, because their production is higher. But the company will also be rewarded with that higher productivity, so we can pass some of it along to the employee and keep the majority of that for the company in the long run.

One thing that it does is it allows us to be more competitive, because our personnel cost delivered each vehicle is considerably higher than we have now proven it needs to be through L2 and through additional studies, productivity studies in terms of what are the roles in the sales department.

Sid DeBoer

It will be more variable, not less. We are fixing those things that cause it to flatten out. So don't feel like this is changed, because it is still going to be based on number of units that a guy sells. Just they won’t be on the gross margin. We have already proven in L2 that the costs directly related to selling the automobile can be cut in half. So we just got to get that model into Lithia.

Matthew Fassler - Goldman Sachs

Understood. Guys, thank you so much.

Jeff DeBoer

You bet, Matt.

Operator

Thank you your next question is coming Rex Henderson of Raymond James and Associates. Please go ahead.

Rex Henderson - Raymond James and Associates

Good afternoon.

Jeff DeBoer

Hey, Rich.

Rex Henderson - Raymond James and Associates

I wanted to quickly return to the issue of the review of the revenue from some of the stores. Could you characterize that for us a little bit about what kind of issue that is? Is it an accounting issue, a revenue recognition, a timing issue, or perhaps is there some employees getting creative out there in terms of inventing revenues that weren't there?

Sid DeBoer

No. It was nothing really to do with revenue, it’s more to do with gross profit and whether we had earned a manufacturing incentive or not, in the time period that it was allocated in. And that's really it is. It ultimately ends up with the same amount of money probably in the company. But time might be different.

Rex Henderson - Raymond James and Associates

Okay. So, it's a timing issue and an accounting issue, not a fraud issue or something like that?

Jeff DeBoer

That's our read on it. I don't know how you define the word fraud. But that's another discussion.

Rex Henderson - Raymond James and Associates

Okay. Thank you. The other thing is, as you have rolled out this new selling strategy, and the new business model, can you kind of characterize how customers have responded. As you make a changeover in a store, what happens to traffic conversion over the first few months through the subsequent four or five months? What have you seen there?

Sid DeBoer

Well, I'd tell you. It's just so rewarding for a guy 64 years old, has been selling cars for 40 years to see customers overjoyed, their jaws drop. They cannot believe that they can buy an automobile this way without the fear. There is going to be a day, when you can come in any Lithia store, and you will all be treated be the same. You can send your daughter and your mother and father-in-law, and you don't even have to help them. They won't need a third basement, as we call it in the industry, to help them buy an automobile because we are taking all of that out and we have done a lot of it already. We are doing more as we go forward. We are going to as close to negotiation free as we can get.

And we are testing that in several stores right now as a complete, negotiation-free model. And we are going to pay the cultural change clause that it takes and our investors need to pay it with us, because we are not private and we are public, and that's the core part that we want our investors to share with, in long term. Because when we are making $3 a share in 2011 and pumping up and doing even better than anyone expects, you are going be obliged you owned the shares. I realize that it's a long-term promise, but it takes that to get the focus. The focus completely changed and be able to set the standard for the industry in terms of customer satisfaction and the processes that customers want. If nothing else, we put everything back on the table and recreating how we sell and service customers.

Rex Henderson - Raymond James and Associates

Can you give us some idea of what's happening on some metric like conversion or traffic when you make this change and --

Sid DeBoer

Absolutely.

Rex Henderson - Raymond James and Associates

-- the first few months?

Bryan DeBoer

Rex, I think you got to take both of these a little different. L2 is one thing where there is new people coming in. They have no opinion of what things should be like or shouldn't be like. It's a much easier transition culturally because they just come into a culture where this is just expected.

Now when we get into the Lithia conversion, I think that's maybe what're are asking obviously because that's 95% of our business, is now you have cultural expectations of what people think is right and wrong. So it takes a good 30 to 60 days in those stores to get to the realization that this is changing at how we do business in those people's minds.

Despite the fact that the consumers are loving it, there is a mental state in our employees mind that they're getting through in the fourth quarter -- and continuing probably into the first quarter, where we're having to convert their mindsets that this is about the consumer, this is not about how we negotiate a deal or how we set the deal up. It's about doing things their way.

If we look at traffic counts, really we're not doing dramatically different things in terms of how we're bringing consumers into the car. It's more of that mental attitude. In terms of closing ratio, if we're looking at that what we're finding is once they pass that mental attitude, the closing ratios are actually better than what they are in the typical model.

In fact, in our L2 models where it's clean and there is no cultural disparity, as we put it, the closing ratios are about 15% to 20% higher than what they are in our typical Lithia stores and they are pushing upwards to 25% of every customers that comes in, buys a car either on the first, second, third or fourth visit, okay, does that make sense, because it's a different model. You actually allow the customers to choose what they need to do and they can come back.

Jeff DeBoer

Make a lot of that piece because in the old model you don't want a customer to leave. In the new model, they leave and come back, they leave and come back. And we're going to deal with that and that's hard for sales people to get their minds around. And that's the cultural change. We don't panic, we give them the price, we make everything transparent, and we let them leave.

And the 'be back' close ratio was much better.

Bryan DeBoer

It's actually upwards of 60% of the people that buy from us had been in multiple times, which in our Lithia typical stores that's on, that's sack religious to some extents, right, because you basically build everything to get the person on the first visit. Well, unfortunately when you do that, and this is the typical model in the industry, you take 80%, 85% of your people and you, to some extent, upset them to the point where they either buy or they leave.

Sid DeBoer

And they don't come back.

Jeff DeBoer

Even the 15% that buy from you were kind of pushed to their limit. That's not what customers are demanding. And we are very clear now that this model is going to take us into new ways, and we're seeing that by having these two divisions as ones perfectly clean and ones transitioning. Despite not the best result of what we'd like to see, we see a very bright future, and we're very confident in what we're doing.

Rex Henderson - Raymond James and Associates

Okay. And finally, what have you seen in terms of sales-staff turnover as you make this transition?

Bryan DeBoer

Surprising enough, the sales staff seems to stick. It's more the middle managers that are having that cultural change because their job is changing dramatically. It's not what was typically called in the industry a desk person or a sales manger where you are managing a single deal. You are managing a process where you are getting involved with your sales people the whole way through. So it's probably the biggest shock to that middle-level manager in the store.

The sales people typically are there to be led by these sales managers. And once they get over the hump, the sales people pretty much come along with it.

Sid DeBoer

They really like it better because they are empowered to complete the deal with the customer and not needing that back office approval and that back-and-forth that people just hate. I mean that's the biggest thing you will hear. Two things customers hate the most, and we've have done the research, and we know it's true. They hate a bunch of salesmen waiting to wait on you upfront. They hate to even stop at a store, and they hate the back and forth. So it's transparent now for Lithia.

And that's a cultural change. And yes, we did see some impact in the fourth quarter from that, but it's not coming from the salesmen, it's just coming in our ability to execute and our customer's ability to believe it. For instance, at Amarillo, we're getting a terrific amount of traffic. Not closing very higher ratio yet because people are coming in, and they're finding out this is different. Amarillo is a pretty credit challenged area and town, and this is all new to them. And it's just exciting to see the response.

When they come back and say, "You know what, you guys were right. I went somewhere else, and I wasn't treated this way, let me have that automobile," we think we're going to build residual customer bases that we haven't had before.

Bryan DeBoer

Rex, the other thing to remember is when you're able to stabilize that model in the bricks and mortar, what it allows us to do in L2 that we're quickly seeing is it allows you to leverage it across electronic forms, which is powerful that we have not bee able to do is simply in the past. So once you get into that space then it's a matter of where does the competition go from there, how are we able to react, and where can we really drive outside that bricks and mortar into different parts of the country and we are getting pretty good response transferring vehicles to different places having people fly in and we are picking them at the airport. It's exciting to be able to do some of those things that we were, to some extent, not in the game with.

Rex Henderson - Raymond James and Associates

Okay.

Jeff DeBoer

Rex, the other part that you touched on a little bit was the -- this is Jeff -- once we get through this recessionary period here, when we are set up with our new program, I mean, we not only have top line sales growth from the customer acceptance of this new way to sale cars, but the cost side. And we modeled all that out and to get to that $3 a share in 2011 and that part is very important to this model, and we are very focused and understand that piece and that's critical and it's really exciting to see how much dollars can be saved with this new structure with fewer people, more efficient, half the delivery costs, it's dramatically different. And that's really exciting. Think about both cost savings and sales top line combined.

Bryan DeBoer

I want to you to be sure you understand Rex and those that are listening that the incubator that has become L2 Auto, it has become an incubator and we underestimated the value of that to our company. How much it can change, Lithia? And I am so encouraged by that because that was the underlying hope. It's not just about L2, it's about Lithia and L2 coming together and having that customer focus process delivered much quicker than we could have done it by trying to change Lithia. L2 is the engine for that. The people that are running that, the senior executives we brought in that fully understand that, it's almost like a religion to them, and they are bringing that now to our company.

Rex Henderson - Raymond James and Associates

Okay. Thanks a lot. That covers my questions.

Jeff DeBoer

Thank you, Rex.

Sid DeBoer

Thanks, Rex.

Operator

Thank you. Your next question coming from Scott Stember of Sidoti & Company. Please go ahead.

Scott Stember - Sidoti & Company

Good afternoon.

Jeff DeBoer

Hey, Scott.

Sid DeBoer

Hi, Scott.

Scott Stember - Sidoti & Company

Could you may be break down a little bit more so the sales by brands, maybe Chrysler versus GM, Toyota and a few of the other key brands that you sell?

Bryan DeBoer

Sure.

Jeff DeBoer

We got that. Hang on a minute, Rex, we are grabbing it.

Scott Stember - Sidoti & Company

Scott.

Jeff DeBoer

Do you have any other questions, Scott, I can look that up while you are asking another question?

Scott Stember - Sidoti & Company

I was going ask also maybe just within the quarter, if you drill down a little bit more on the costs to roll out the assured pricing. Do you have anything on that or is that something that has just been going on throughout the year?

Jeff DeBoer

It has pretty much been going out throughout the year. I don't know if you could specifically lay out, what costs we've added because of assured.

Bryan DeBoer

Yes. I think the difficult thing is you are again balancing that between the macro issues and the cultural issues. The one thing that we do know for sure, that we have been tracking very closely is, we spoke about this over the last few conference calls, is office automation and centralization. We reached a breakeven point on that in September, and now it is substantial to say and we see that continue into 2008.

So Rex, I will give it to you for --

Jeff DeBoer

Scott, I am sorry, we got Scott now. On year-to-date, I have quarter as well, but I will just give you year-to-date, for do it on a unit basis, we have Chrysler at 40%, General Motors, which includes Saturn and the other brands, mainly Chevrolet for us is 15%, and then Toyota is at 14%, and then the next biggest one is Honda at 6%, and then Ford at 6% and BMW at 4%, and Nissan at 3% and on down.

Scott Stember - Sidoti & Company

I appreciate that. I was also really trying to look to drill down the sales trends for those brands within the quarter. If there was any brand that had a magnified weakness compared to the other?

Jeff DeBoer

By brand.

Bryan DeBoer

We didn't see anything that was alarming to us. It's pretty consistent with the national numbers relative to their performance.

Scott Stember - Sidoti & Company

I was just trying to figure the foreign brands.

Bryan DeBoer

I am selling vehicle in Oregon, where we have a huge Chrysler presence. A Dodge Ram Pickup outsells Toyota. And Ford and Chevy.

I always make that case that brand specific marketing can determine in any given market, the actual penetration rates, and they vary all over the board, based on the strength of the dealer, not the brand.

Scott Stember - Sidoti & Company

Okay. And Jeff, maybe just a housekeeping item. It looks like in the quarter that the contingent convertible was not dilutive to earnings in the quarter. Could you just explain that and may be talk about --

Jeff DeBoer

It has been put in on the press release. You basically don't count anything that would be anti-dilutive. Those securities are only counted when you're making money. So when you lose money, you can't count it, because it would be anti-dilutive. They only can be dilutive. Ask the accountants about that one. It doesn't make any sense.

Scott Stember - Sidoti & Company

Yeah, it doesn't make any sense. But --

Jeff DeBoer

So you can't add the quarters anymore.

Scott Stember - Sidoti & Company

All right. So with 2008, assuming that you are going to make money, obviously we are looking at the higher share count here?

Jeff DeBoer

Right. Yeah that will be the share count in any quarter where we have earnings.

Bryan DeBoer

We have earnings. Again, if we lose money in the quarter like this quarter, then you have the lower one.

Scott Stember - Sidoti & Company

Got you.

Jeff DeBoer

I haven't yet balanced that in the model, but you guys can figure it out.

Scott Stember - Sidoti & Company

Thanks a lot. That's it.

Operator

Thank you. Your next question is coming from Matt Nemer of Thomas Weisel Partners. Please go ahead.

Matt Nemer - Thomas Weisel Partners

Hi, everyone.

Jeff DeBoer

Hi, Matt.

Matt Nemer - Thomas Weisel Partners

So my first question, I just wanted to follow-up on the other math question about SG&A, in terms of, not so much the sequential change. But year-over-year, it was up about 8.5% excluding the one-time items, and you mentioned that the major line items there like comp, and I think advertising were down more than sales, which would mean down more than 1% to 2%. So I'm just wondering what's in that line that's up more than 10% or 15 or 20%, what's driving the growth there?

Jeff DeBoer

Yeah. There really isn't any one item to point to Matt. We looked at it real hard. I mean, it's really just losing the leverage, and the decline in the sales on that base of costs, and there are little things here and there, but there is nothing major. All the big ones are down.

Matt Nemer - Thomas Weisel Partners

But are you surprised just the dollars spent are up just under 9%?

Sid DeBoer

Don't forget the L2. That's a big piece of it.

Jeff DeBoer

We have L2 in there.

Sid DeBoer

Because all that expense there is going right to SG&A.

Matt Nemer - Thomas Weisel Partners

Okay. And did you have a quarterly estimate for the impact of that?

Jeff DeBoer

We didn't break that out on the quarter. Maybe it's $0.14.

Sid DeBoer

$0.14 for the year, I don't remember.

Matt Nemer - Thomas Weisel Partners

Any reason why it would have been accentuated in the fourth quarter?

Jeff DeBoer

We had the two store openings in Texas.

Sid DeBoer

There were probably additional expenses.

Jeff DeBoer

Figure relative to the rest of the year, and it wouldn't be the same going forward. Anytime you are opening stores is when most of the expense is…

Bryan DeBoer

You have ramp-up cost in the 60 days prior. We opened them in December, so all three months got hit with no revenues.

Matt Nemer - Thomas Weisel Partners

That makes sense. Okay. That must be the bulk of it.

Bryan DeBoer

SG&A would have pushed it there.

Matt Nemer - Thomas Weisel Partners

Yeah. That makes sense. Just as a follow-up to that, can you talk about the number or the percentage of L1 stores that have already had a reset in terms of the middle manager job descriptions, and the compensation factors for both middle managers and sales people?

Sid DeBoer

We're just now doing it. It’s not done, Matt. We got the customer-focus things in, now we're doing those structural changes at the store.

Matt Nemer - Thomas Weisel Partners

And how long do you think that takes it?

Sid DeBoer

Let Bryan answer. He is doing it.

Bryan DeBoer

We're actually starting that this week. We've been having conference call with our General Managers to help walk these people through the preliminary stages, and then we have a number of pilot stores that are going get it much quicker than that. And that actually started today as well. It wasn't by coincidence, obviously.

So those are going take in the four-to-five month range. We hope to have them in place and going by the second half of the year. And obviously to be able to accomplish those things centralization has to be fully kicked in. Make sense?

Matt Nemer - Thomas Weisel Partners

Yes.

Bryan DeBoer

Because the simplicity and the complexity comes out of the stores by centralizing. Once the simplicity is there, then you can increase your productivities, you can reduce staff and expect more out of those people. So we were looking at really in the May, June timeframe is when the bulk of the stores will get transitioned even though we'll have a good quarter to a third prior to that.

Sid DeBoer

How many stores, Bryan, does the car center appraise the cars for? They just started.

Bryan DeBoer

I believe it’s 14 stores in the car center now.

Jeff DeBoer

Plus L2, which is 17 stores right now, and they will be taking on more each month as fast as they can ramp it up.

Bryan DeBoer

I think they'll be right around 30 by the end of the quarter, and they'll have rest of these stores done by Q2.

Jeff DeBoer

And that allows us to begin the change that used car manager cost at the store level.

Sid DeBoer

We'll be giving you lots of updates on this because this is where your driver's future profitability and increased productivity in the stores comes from.

Matt Nemer - Thomas Weisel Partners

Got it. Okay. And then moving on to a different topic, I was surprised that your service-and-parts gross-profit dollars were down. That's not consistent with what we're hearing from some of the other public retailers and even some private ones. Is that specifically sort of the changes you're making in service, typically that doesn't seem to move that much with cycles in the economy?

Dick Heimann

Well, we talked about in the release the last year. So we've had a big push on accessories and parts, and that's a lower margin. So it's a mix shift. And the volume is more than making up for it. I mean it was a 1% decline when you exclude that. So that's unusual to Lithia.

Bryan DeBoer

I think the whole tone in service and parts is to foster as much as possible repeat business. And that means you maybe don't push as hard on each individual item. You are banking, to some extent, on having a great experience that meets every expectation the customer has, making it very expedient so they can get in and out of the dealership with an intent that it will drive future business and a better repetition of business.

We're starting to see some of the benefits of that already. Obviously, like Jeff said, unfortunately, your low-margin items, which is tires, accessories and those programs that are a big part of a less negotiated environment, is going to take hold and may affect margins even though we believe the profitability will be higher.

Dick Heimann

And we've talked about that on each of the last three calls. That's not a new trend. It's been that way since the last three calls.

Sid DeBoer

But your question is a good one, Matt, and we are looking hard at it. And we really feel like we need to get a lot more customers coming in. And that way we build volume and gross at the same time. And we were maybe overselling a few customers that came in. We've got to change that focus so everyone comes back to us for everything, and we will have to sell them a broader range of products.

The gross margin on some of the tires is about 10%, and it's not the same as selling an engine flush that's got 75% gross margin in it. So we're going to see a little of that mix change. But overall, what we want to see is same-store sales growth in service, in customer labor, that's the focus, and in customer parts and accessory sales. We may even break those out in times so that we can see the trends.

Dick Heimann

I think it's important to understand that the way dealership runs, there is a cycle of life in a customer that we've taken from the start of the cycle when they purchase a car from us to the point where they are able to come into our service departments and then come back through the cycle when they buy another car. And we've changed how that blends together dramatically, with both service parts and sales being modified, so they are cohesive and are sending the same messages to our consumers.

Jeff DeBoer

Our consumer too isn't the guy driving a Lexus, Matt. We don't have many of those. We've got some, you saw a 4% BMW, and if you had the richer person, you can sell him a lot more service, and when people are constrained with higher gas prices and limited budgets, it has not been as easy to selling extra work, they are buying just the minimal amount. So may be that's another reason for little less gross margin, I mean little less gross dollars profit in the service department. You made a good point.

Bryan DeBoer

And in the service department, we are not looking at a J curve in the service department, where there is a cultural shift here. Okay.

Jeff DeBoer

No.

Bryan DeBoer

I mean, we believe that we have enough other retailer programs in place that Jeff talked about to be able to offset any declines that may come from a little less pressure.

Jeff DeBoer

We are getting closer and closer to mirroring our recommended service to just what the manufacturer recommends to. And that's less frequent than in the past dealers have sold what Pennzoil recommends or Quaker State -- that company has much higher intervals and those are all issues that we have to deal with.

Matt Nemer - Thomas Weisel Partners

Got it. And then just turning to Chrysler, go for a minute. I think I understand how the Genesis program works. But I guess what I am curious about is from a model standpoint, it sounds like they are planning on cutting a number of models, and it seems like the right thing to do long-term. But from a short-term standpoint, cutting out those marginal models, any idea what kind of impact that could have on you? Do you have the sense for which models could be cut, and how many units might be lost?

Bryan DeBoer

We don't think there will be any material change in our volume overall with the Cerberus and the Chrysler partnership in the Genesis program. And we have studied that hard, there will be new models introduced at the same time to fill in, that will be more brand-specific. The best brand Chrysler has, right now in terms of consumer acceptance, is the Jeep. Second is the Dodge truck, and those two are very-strong brands, and we have no Chrysler stores that don't have one or the other of those.

I mean that's pretty much the view. They will start shifting around, maybe there is a different compass and not a Patriot, but then the Dodge gets something instead of that. The New Journey, I don't know if you have seen that yet. I know your dad's involved in the business, but that's a wonderful crossover rig right in the heart of the market right now, should do real well. And that supplements what maybe lost in some other model at the Chrysler store, we don't have a short way, but will base minivan anymore, they dropped it. And that journey fills that hole, and we think in a strong way because that's actually more what the consumer really wants.

And so I just can’t predict that that's a market change from where they have been heading in the past, that it appears from the manufacturing side to take a lot of cost out. But on the retailer side, unless you are stand-alone one brand, Chrysler may be the worse to be a standalone, but in reality if you have got Jeep or Dodge, you are probably fine. But it’s best if you can get all three together, and we are going to be working hard to get that done. That's not very hard to do right now.

Jeff DeBoer

We only have that in two-thirds of the stores.

Sid DeBoer

Yeah. It's opportunity for more acquisitions.

Bryan DeBoer

We can do four of our existing stores and put them together, once we determine what to do with the leftover real estate.

Matt Nemer - Thomas Weisel Partners

So you think that it will be sort of one for one, so they get rid of something like the Aspen, they launched something new at about the same time?

Bryan DeBoer

Right. And particularly they have Jeep and Chrysler in the same store, and that's kind of the alignment we had. Jeep and Chrysler generally together in those standalone stores, and Dodge is alone. So, as long the Dodge Truck stays, the Dodge stores are fine, and that's going to always be where the Dodge truck is about. So in the real markets we are in and what not, we have never sold many Dodge cars. So if they take a model away and substitute a different truck, we will be fine.

Matt Nemer - Thomas Weisel Partners

Got it. Okay. I will get back in line. Thanks.

Jeff DeBoer

Thanks.

Operator

Thank you. Your next question is coming from Jonathan Steinmetz with Morgan Stanley. Please go ahead.

Jonathan Steinmetz - Morgan Stanley

All right. Thanks. Good afternoon, everyone.

Bryan DeBoer

Hi, Jonathan.

Jonathan Steinmetz - Morgan Stanley

Just a few follow-ups here. I am still a little confused on the SG&A side. I understand L2 accounting for some, I understand the $1.77 million on the franchise impairment. But it still seems like there is $4 million or $5 million in that vicinity that you tried to explain, and you mentioned chargebacks, I think, and you also mentioned may be workers comp and that kind of thing. Can you give the comparisons of some of these fourth-quarter, anomalous-type items, just so we can an idea what they are?

Jeff DeBoer

You'd have to go back to last year too, because we had items come in last year that made that quarter look a little bit better, on the quarter basis. So if you look annually, I think you can examine it best, Jonathan. It's pretty hard to break out that quarter and mean anything.

Bryan DeBoer

Well, employee benefits was one that we called out last year, and that happened just like we thought. We had about 10% to 12% increase in this year because of the employee benefits and health insurance increase. We explain that, and that's about what happened. So that was one more unusual item there.

If you take all the adjustments at the year-end and kind of adjust them to get just a true operation-store basis. I mean, we are closer 85% on SG&A as a percentage of growth in the quarter. And again the year is the one that means any way 79%, and we are saying going forward about the same 79% to 81%.

Sid DeBoer

For this recessionary period. But that assumes the declines of even for this year from last year. So that guidance we are giving on the dollar for instance is accelerating recessionary climate.

Jonathan Steinmetz - Morgan Stanley

Switching on to the used side, I think, Sid, you mentioned, you or Jeff, you were 15 days above the prior year on used inventory. If you are willing to disclose what the actually day basis, that would be helpful? And how heavy are you on pick-ups on the larges SUVs given sales composition because those seem to be the areas within Manheim anyway that are the weakest? I'm just trying to figure out if part of your first-quarter guidance incorporates some weakness on used as you kind of blow-out some inventory?

Jeff DeBoer

The 15 days was relative to our five-year historical averages. We are forecasting some continued weakness in used in the first quarter.

Bryan DeBoer

With an intent to reduce inventories.

Sid DeBoer

Our days supply, Jonathan, isn't a 30-day, trailing-day supply calculation. We look at a 90-day forward, and so it's seasonally adjusted. That's why we don't give the actual number because we do it uniquely. And so, we don't give the actual number. But it's not unusual at all. The numbers that we've got we're not alarmed by them. We've strategically decided to hold back on some wholesale until March because we do believe there is a recovery in prices, we've already seen it. And the SUV, believe it or not, have improved in price in the last three weeks markedly up almost 10%.

Jonathan Steinmetz - Morgan Stanley

Interesting, okay. And the composition of that would it be fairly similar to what you guys sell in terms of mix or is it weighted towards any particular area?

Sid DeBoer

No. In fact, we feel more comfortable more than we ever have because of the car center taking charge of the full inventory at all the stores in terms of moving them around, putting them in the right value and right price on the lot. We're retailing more of the over-age inventory than we have in the past. There is a lot of progress being made. I wouldn't be alarmed with anything there.

Jonathan Steinmetz - Morgan Stanley

Okay. And I guess my last question is a capital-allocation question. People touched on sort of the thought of slowing acquisition or that sort of thing, but Sid if you're sort of confident of your $3 figure by 2011, why wouldn't you stop and sort of take the cash flow that you do generate and repurchase stock, given that it looks like it's going to open somewhere around $12? I mean can you get that kind of return on investment either in L2 or in acquiring additional stores?

Sid DeBoer

Jonathan, you know the credit markets. I mean you should check the ticker tape because I've been through recessions all my life, and you preserve cash when credit markets are tight and they are tight. So that's still the overriding mantra that we put in our company at this point, and I thinks it's prudent. I don't know. I hope it loosens up again and we can readily see credit available to expand our business with overtime. But we're not sure that's going to take place for a while.

You guys don't talk to each other anymore, but you are investment bankers and they are all concerned about credit availability for everyone in the future. So we're just kind of hang on to our cash, grow our business, follow our business plan, not be investing in our stock at this point, allow our investors to share in that, because if it's really true, and it is that we'll have $3 a share in a few years. I mean those that own our share are going to be richly rewarded for buying at these low levels.

Bryan DeBoer

Jonathan, also I will make sure that you heard that right. Acquisitions are being slowed, okay. It's not a do one or the other. We are slowing acquisitions, but we will at look acquisitions that are opportunities as we always have. But we're going to be much more picky in terms of what we're able to actually complete on.

Dick Heimann

And the market prices adjust downward with the change in the economy.

Sid DeBoer

Absolutely.

Dick Heimann

There is no rush to do acquisitions when prices are changing on stores.

Jonathan Steinmetz - Morgan Stanley

Okay. And are you actually seeing some evidence so far of any, even minor adjustment in prices?

Bryan DeBoer

There is probably some. I mean Brian Evans, our Vice President of Mergers and Acquisitions, gives us some indications of that. It does look like that's occurring. It's still not attractive enough to use your capital for that when we're in the thrust of centralizing, getting these things brought in, and then reducing our cost in the stores along with that. So I think that's our primary focus at the current time.

Sid DeBoer

I think we'll be much more aggressive, Jonathan, once the L2 model is fully implemented in the Lithia stores, because then as we acquire stores, we'll change them over right away to that. The hybrid right now isn't something we want to do a lot of. So we need to move all the way into that, and that will make it easier to integrate and buy more stores in the future. So the timing's fine because it's better to weight for prices to drop anyway. There aren't anywhere near as many stores being sold today, and that's a good sign that prices have to drop in order for buyers to appear again.

Jonathan Steinmetz - Morgan Stanley

Make sense. All right. Thanks, guys.

Bryan DeBoer

Thanks, Jonathan.

Operator

Thank you. Your next question is coming from John Murphy of Merrill Lynch. Please go ahead.

John Murphy - Merrill Lynch

I just wanted to ask if you could clarify one of the statements you made. You talked about in an effort to gain or maintain market share, gross margins came under pressure. I was just wondering if that was in the form of reduced prices or really what that meant there.

Jeff DeBoer

I wouldn't read too much into that. I mean we're just pushing to maintain volume in a market where people aren't as excited about buying an automobile. So we have to get more price-competitive in that area. And you'll see it on the new car side much more than the used, although gross margin on used came down as well. But part of that was a drop in the wholesale value of the inventories we had, and the disposal of those was not at the same margins based on the cost we had in them.

John Murphy - Merrill Lynch

And Sid, how do you juxtapose that against your effort to go to a one-price, no-haggle policy in the future? Does that mean that you'll be willing to give up market share in the future because -- I mean, if you're going to one price, you'll not be able to reduce prices?

Sid DeBoer

We will be price competitive 'period'. Always.

Yeah. I think the perception of one price means is always the same price what one price to us means is that we look at supply and demand, and we price the vehicles for what they need to be sold at in the consumers eyes. Okay. And that means it could go down, at times it could go up to some extent as your supply goes down. So its still a very volatile model, when price means is everyone pays the same price for that vehicle in that time period.

John Murphy - Merrill Lynch

But you've said, disgruntled consumers that comes in one week later and gets a price as good as there friendly the week before that. Just trying to understand how this really solves that problem?

Bryan DeBoer

Well, 95% of the price changes are reductions. And there are small, incremental adjustments. And then in the new car side, there's hardly any adjustments. You base it based of what your historic prices have been. On the used car side, it's a one of a kind vehicle. So you're not able to compare a fix of the exact same model. They have different models obviously, you understand the difference there.

John Murphy - Merrill Lynch

Yeah. So it means the guy sitting next to you at the sales desk is getting the same price as you. But the guy the next week might get a different price?

Jeff DeBoer

That's right. We've to have flexibility in pricing, period.

Bryan DeBoer

Depending on what our supply and demand is. And what the competitors are doing.

John Murphy - Merrill Lynch

Okay. And Sid, if we think about your $3-plus estimate, I should say in 2011. I am just wondering if you could give us an idea of what you think the mix is going to be in that $3 from L2, and your traditional new vehicle franchise stores, and generally kind of what you think the market is going to be sized at that point? Just sort of your major factor, to go into that $3 plus assumption?

Sid DeBoer

Well, certainly a bigger portion of our business will be used cars. And that's obviously a higher-margin business with lower cost in relationship to facilities and the other items that a new car entails in it. So there is going to be growth there, and obviously we are going to do better in terms of raw volume, gross margins on new cars probably are thinner. That's okay, because we are going to do more per each store, as this consumer driven thing catches hold and we believe strongly in better brand mix than we probably have currently, but we don't know. Can you tell me what's going to be the strong sellers five years from now? I am not sure; I am not smart enough to know that. So we need a good mix, so we can go with whoever is the winner.

But more than that, we are great at used cars that isn't materially that much different. Each store will have its own brand, and Lithia can be strong like we are in Oregon with Dodge. Whether because of how sell them, because of the strong leader we are, Texas, Montana, we are doing really well domestic brands. Does the dollar-value impact on import in that old definition, ultimately make those things so price heavy that it dies. When you got to pay 200 grand for a 7-series BMW, will you still want one?

John Murphy - Merrill Lynch

Okay. So your internal models that you are coming up with, which have a lot of factors that come with the $3 plus. I guess --

Bryan DeBoer

Most of it is improvement in costs. Getting costs out of selling the automobiles, and then good steady growth and a lot of growth in used cars.

John Murphy - Merrill Lynch

Okay. And then if you just think about your 2008 guidance -- I mean, I generally agree that the dealer business is what I thought was a little bit relatively easy business to model. But I mean, on your last conference call, you were talking about fourth-quarter earnings of $0.26 to $0.31, and you had a pretty big miss here. I am just wondering what the big swing factors were from October 25th to where we are right now, and if we think about your '08 guidance, why would you have comfort in that and if there is something that has changed since October 25th that you have a better handle on your future results than you would have at that time?

Bryan DeBoer

Most of that's macro. The recession was much worse, the traffic counts were down measurably, and we have -- you need the big month to make a quarter work. We have been missing a big month since March of last year. We have not had one. And we hope to get a good one this March. Obviously, we are prep for it. But reality is without a strong October or a strong November, which we forecasted would happen, didn't happen. And it doesn't take a lot, it [differs] between selling 7000 cars in a month and selling 8000 is about $5 million in profit.

Jeff DeBoer

Positive or negative?

Bryan DeBoer

I mean it all ends up there, and you have got a cost basis you got to cover and about 7,000 units a month does it for us. You know if we don't sell 8,000 in one month, which we didn't do, then you have the reality that all we did was cover the bases and barely lost a little year-end, and then some of the adjustments we had and ended up losing money for the quarter?

John Murphy - Merrill Lynch

Is it possible with some of these costs that we are fairly sticky in a two to three month period, which the line between fixed and variable is great clearly? As you go through the course of the year, if you do continue to see this big macro pressure that you might be able to cut those costs further, during the course of the 12 months than you would be in the three months.

Bryan DeBoer

Absolutely. That's recessionary adjustments we are making. We are doing what we did in 2001, was it 2001, Jeff?

Jeff DeBoer

2001 and 2003.

Bryan DeBoer

In 2001, we had a bad first quarter and a fairly weak fourth quarter. The fourth quarter was probably weaker, but some of the yearend adjustments don't always reflect correctly in that quarter. Just like this time it is the opposite. So reality is by the fourth quarter, we were exceeding the prior year's numbers and moving right along and we did that largely by taking costs out. The market wasn't any better. And we improved our sales rate through better marketing, different efficiencies and the different things we know how to do. This is the fourth time I've faced what I consider a recession. And it is definitely a recession in Oregon and in California and in Nevada. We've got houses sitting empty for sale and every builder are not buying a truck right now. That's reality.

John Murphy - Merrill Lynch

Okay. Thank you very much.

Operator

Thank you. Your next question is coming from Edward Yruma of JPMorgan. Please go ahead.

Edward Yruma - JPMorgan

Thank you for taking my question. I know there has been some discussion on the call about the potential for slowing the pace of acquisitions. But in terms of thinking about slowing maybe some of the more broad cultural changes that you've been making, particularly as it relates to single price, where is your opportunity to do that given the really difficult market?

Sid DeBoer

Well, it's the best time to change it, Ed. I don't want to waste a good market making changes. So we get it done now. We're not going to look back. This is going to happen.

Dick Heimann

And you come out that much stronger.

Sid DeBoer

And the sooner we do with the better.

Edward Yruma - JPMorgan

Got you. And one other final housekeeping question. When do you expect the release of the 10-K, and has this been delayed by this investigation?

Sid DeBoer

We don't anticipate a release date delay. We think it will be on time.

Edward Yruma - JPMorgan

Great. Thank you.

Sid DeBoer

We will let anyone know if it it's not. The forecast is for the investigation to be done by the end of the month.

Edward Yruma - JPMorgan

Got you. Thank you

Operator

Thank you. Your next question is coming from David Lim of Wachovia. Please go ahead

David Lim - Wachovia

Hi. Good afternoon, gentlemen. Just had a couple of questions on this new cultural change with the single prices, and I apologize if I missed this, when full implementation will take place?

Sid DeBoer

I said we'll get as close to it as our cash prove work. So to say we're going to be negotiation-free at all of our stores, we don't know that for sure. We're going to get as close to it as we can get and still have the success we want. Consumers raving about us are people easily being able to execute a transaction without all the negotiating. And we're experimenting.

Honestly, we have great people involved in our company that have done this before at the L2 level. We're getting a real incubator view of how that works there. And we also have outside consultants that have executed this strategy in other markets with other dealer groups. And we're not going to make any mistakes there. But we believe we want to get as close to as we can. If we can all the way there, we should know by the end of the year.

Bryan DeBoer

I think it's fair to say that you can put it into two buckets. It's that negotiation-free that Sid's discussing as well as centralization. Centralization is moving forward. We have good adherence to that. We've proven that model works, and the cost cuts can come in multiple areas, including the office.

David Lim - Wachovia

Got you. To follow-up on that, I think one of the other analysts mentioned this, we would see like an adjustment in price on a weekly basis or how often would take place and how do you balance that with the OEM sales objective for your respective source on a monthly basis?

Bryan DeBoer

You are correct. It's a weekly re-price where we have the ability, and we will printout the stores new window stickers, and those merchandising managers will then change those prices. In terms of what your sales objectives are, we can now track them very closely and determine where we're trending so we can react much quicker than the last couple of days of the month to know whether or not we're going to achieve the maximum, obviously, incentives that they are able to provide us. We'll able to effectuate that through price changes quicker and, obviously, marketing.

Sid DeBoer

It's easier to do the negotiation-free on used then it is new. We know that. We may have stores that have a little more negotiating on new cars and none on used. We're going to experiment, find a way that works. This is not religion, its science, it's a business decision based on facts, and we're able to test it at L2, we are able to test it at our current store base and we are excited about the opportunity to do this.

I don't mean to grin at a time when we just showed a quarter that it wasn't as strong as everyone hoped it would be. Certainly, we're disappointed with that as well. But reality is, this is the price maybe it takes to get to where we want to go. And the macro environment is the best time to do it. We wouldn't want to slow it. We can only go as fast though as our people can do it. So we can't just do it tomorrow morning.

David Lim - Wachovia

Thank you very much. I have one final question, and it relates to the single price. How will that affect your FNI business, will you be pushing that more so than previously, or how would you approach that side of the business?

Bryan DeBoer

Well, we were experimenting that as well. In a couple of the test stores where we have full FNI managers and we don't at our L2 stores, where we have full FNI managers that have already gone to the fixed price, which is in our test stores. The first week for instance, we were at $1700 a car, when we didn't change the price. When we changed the price, we were at $800. Fascinating, dynamic, that the customers, when we change the price, feel more stressed and not as open to buying additional products in the FNI room. So that's just a first blush, but we will find the way to keep or grow FNI in spite of a fixed price model and we're going to experiment with both no FNI manager, two faces, we're going to find the best way to do it.

Jeff DeBoer

I think David, you understand that we've been fixed price in FNI our whole public lives, that it has been a non-negotiated model in FNI. We think this helps substantiate it on the front end of things, and we've got some pretty good research about non-negotiated groups and negotiated groups which we always have had in terms of what international averages are. And the two in terms of national averages are about the same and we obviously exceed national average in the negotiated previous group, so we see no reason not to be in that same camp, when we become more negotiation-free.

David Lim - Wachovia

Got you. I will ask follow-up on that post the call. Thank you very much, appreciate it.

Bryan DeBoer

Okay. Thanks, David.

Sid DeBoer

Thanks, David.

Operator

Thank you. There appear to be no further questions at this time. I would now like to turn the floor back to management for any closing comments.

Sid DeBoer

Thank you all for listening. And we will continue to update you if anything changes in the future and look for successful business model this year and some additional support from all of you. Thank you.

Operator

Thank you. This does conclude today's Lithia Motor's conference call. You may now disconnect and have a great day.

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Source: Lithia Motors Incorporated Q4 2007 Earnings Call Transcript
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