John North - Vice President of Finance and Chief Accounting Officer Bryan DeBoer - President and Chief Executive Officer Chris Holzshu - Senior Vice President and Chief Financial Officer Sidney DeBoer - Founder and Chairman of the Board of Directors.

Steven Dyer - Craig-Hallum Capital Group LLC Michael Montani - Evercore Group L.L.C. John Murphy - Bank of America Merrill Lynch Richard Nelson - Stephens Inc. Paresh Jain - Morgan Stanley James Albertine - Consumer Edge Research, LLC Bret Jordan - Jefferies Group Chris Bottiglieri - Wolfe Research, LLC William Armstrong - C.L.

King & Associates David Whiston - Morningstar, Inc..

Greetings, and welcome to the Lithia Motors Third Quarter 2016 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As reminder, this conference is being recorded. It is now my pleasure to introduce your host, John North. Thank you, Mr.

North, you may begin..

adjusted net income and diluted earnings per share, adjusted SG&A as a percentage of gross profit and adjusted pre-tax margin. Non-GAAP measures do not have definitions under GAAP and may be defined differently and not comparable to similarly titled measures used by other companies.

We caution you not to place undue reliance on such non-GAAP measures, but also to consider them with the most directly comparable GAAP measures.

We believe the non-GAAP financial measures we present improve the transparency of our disclosures, provide a meaningful presentation of our results from core business operations, 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. A full reconciliation of these non-GAAP items is provided in the financial tables of today’s press release. We have also posted an updated investor presentation on our website, lithiainvestorrelations.com, highlighting our third quarter results.

Presenting the call today are Bryan DeBoer, President and CEO; and Chris Holzshu, Senior Vice President and CFO. Also in the room is Sid DeBoer, Chairman of the Board. At the end of our prepared remarks we will open the call to questions. I am also available in my office after the call for any follow-up you may have.

And with that, I’ll turn the call over to Bryan..

Good morning and thank you for joining us today. A few hours ago we reported record adjusted earnings of $2.06 per share or $52 million for the third quarter. We grew sales in all business lines, for total revenues of $2.3 billion, up 9%.

We remain focused on sourcing incremental acquisitions, integrating new locations, improving overall store performance and attacking market share. All numbers from this point forward will be on the same-store basis. In the quarter, new vehicle revenues increased 1%, driven by higher average selling prices.

Our unit sales mirrored national results, which decreased 1%, resulting in a quarterly SAAR of $17.5 million. Gross profit per new vehicle retail was $1,972 compared to $2,061 in the third quarter of 2015, a decrease of $89 per unit. Domestic and luxury gross profit per unit increased, but they were offset by lower import growth per unit.

While absolute unit sales were down slightly, our share of total new vehicle sales in our market increased 1.7%. Retail used vehicle revenues increased 11%, of which 9% was due to increased units and 2% from increased selling price. Our used to new ratio was 0.77 to 1.

In the quarter, certified and core units both increased to 11% and value auto units were flat. Gross profit per unit was $2,344 compared to $2,379 a year ago, a decrease of $35. This was primarily driven by lower gross profit per unit on certified vehicles due to greater supply.

On a 12-month rolling average we sold 65 used units per store per month, up from 61 units in the comparable period last year. We continue to make incremental progress towards our goal of 75 used units per store. Our F&I per vehicle was a record $1,302 compared to $1,204 last year, an increase of $98.

Of the vehicles we sold in the quarter we arranged financing on 73%, sold a service contract on 44% and lifetime oil product on 27%. Our finance penetration rates decreased slightly, but penetration increased for both service contract and lifetime oil products compared to last year.

In the third quarter, the blended overall gross profit per unit was $3,449 compared to $3,405 last year, an increase of $44 per unit. This was complemented by a 3% increase in combined unit volume. Our store personnel have increased total gross profit while focusing on taking market share in a declining new vehicle sales environment.

To achieve this increase we’ve experienced slightly higher selling costs. Our service, body and parts revenue increased 10% over the third quarter of 2015. Customer pay work increased 8%, warranty increased 17%, wholesale parts increased slightly, and our body shop increased 18%.

Our total gross margin was 14.9%, unchanged from the same period last year. As of September 30, consolidated new vehicle inventories were at a days supply of 65, a decrease of 1 day from a year ago. Used vehicle inventories were at a days supply of 57, an increase of 3 days from a year ago.

Our core value of continuous improvement challenges us to constantly evolve to drive incremental performance improvement. Earlier this morning we announced that effective January 1, 2017, Chris Holzshu will be promoted to Executive Vice President and Chief Human Resource Officer with oversight of Store Administration and Information Technology.

Given our ambitious acquisition growth, and significant opportunities to increase revenue and earnings in many stores, talent development is critical to improving both culture and performance. In our recent history, our competitive advantage has been our people and we believe we have only scratched the surface of our employees’ potential.

Through Chris’ newly created role, we will accelerate the number of high-performing candidates for advancement, support improved store operations, attract the best automotive leadership, and build a stronger company for the future by ensuring we have a team focused on first-class customer experience.

Additionally, John North will be promoted to Senior Vice President and Chief Financial Officer. Many of you have had the pleasure of working with John as our VP of Finance and Head of Investor Relations.

His depth of knowledge in automotive retail, accounting, tax and finance, will serve us well as he assumes the role of CFO, and continues to advance our strategies. Both Chris and John exemplify our core values; and on behalf of the entire organization and our Board of Directors, congratulations. Now, on to acquisitions.

Through October of this year we have completed the acquisition of 14 stores and opened 1 store, together representing over $1 billion in annualized revenue.

Because of our growing pool of high performing leaders and our entrepreneurial approach, we can acquire dealerships in diverse locations, with varied performance levels and differing market strategies.

Said differently, we buy dominant franchises that are underperforming their potential and know that people will make a difference and maximize returns for our shareholders in the future. The acquisition market is robust. The benefit of a moderating new vehicle sales environment is more rational seller price expectations.

Our active target list, which is the internal database of marketed stores that fit our criteria, currently totals over $15 billion in revenue opportunities. This is substantially higher than the amount we have seen over the last five years.

By seeking stores where opportunities to improve performance are plentiful, we position ourselves to purchase at attractive multiples and generate industry-leading returns on investment.

As one of the fastest growing companies in both revenue and earnings in the Fortune 500, we will drive our growth trajectory to continue past our $8 and $9 EPS milestones, and reach our aspirational goal to more than double our current revenue base and earnings per share.

Finally, we’d like to acknowledge the 8 stores that were recently recognized by Automotive News as one of the hundred best dealerships in the country.

Congratulations to Audi Des Moines, Mercedes-Benz of Des Moines, Island Honda, Melbourne Audi, Montclair Acura, Torrance Toyota and Honda of Temecula, and one of our most recent additions, Carbone Subaru.

These leaders and their teams epitomize the belief that people make the difference, and Lithia’s values will continue to allow them to be themselves and achieve high performance. With that, I’d like to turn the call over to Chris..

Thank you, Bryan. First I would like to say that I am honored to take on the role in 2017 and will continue to serve our 11,500 team members as we build a stronger company together.

At September 30, 2016 we had approximately $146 million in cash and available credit, as well as unfinanced real estate that could provide another $193 million in 60 to 90 days for an estimated total liquidity of $339 million. At the end of the third quarter we were in compliance with all our debt covenants.

Our free cash flow as outlined in our investor presentation was $36 million for the third quarter of 2016. Capital expenditures, which reduced this free cash flow figure, were $38 million for the quarter. For the full year, we expect to generate $157 million in free cash flow.

We have been aggressive buyers of our stock in 2016, deploying $108 million year-to-date, as we repurchased over 1.2 million shares or 5% of our outstanding float, at an average price of approximately $79 per share.

After these repurchases we have approximately $197 million remaining under our current authorization and will remain opportunistic on repurchases in the future. In 2016 as Bryan stated, we have acquired an estimated annual revenues of over $1 billion, investing approximately $110 million on an equity basis.

Including the cumulative impact of these investments and a significant share repurchase activity, as of September 30 our annualized net debt to EBITDA is 1.96 times, which remains among the lowest in our sector. We spent the last five years preparing our balance sheet to remain acquisitive through the new vehicle sales cycle.

We are confident that we will continue to identify attractive acquisition candidates. And that given both our organic cash flows from operations and the significant capacity in our balance sheet, we can deliver meaningful revenue growth in the future years.

Our capital strategy is unchanged, as we balance acquisitions, internal investments, dividend and share repurchases. 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 that generate solid long-term returns.

Our third quarter adjusted SG&A as a percentage of gross profit on the same-store basis was an estimated 67.2%, an increase of 130 basis points over the third quarter of last year. On a consolidated basis, including the effect of recent acquisitions our adjusted SG&A as a percentage of gross profit was 67.6%.

Our SG&A expense was higher than anticipated in the quarter as a result of higher selling expenses, primarily personnel costs and advertising, which increased same-store gross profit growth of $14 million or 4.4%, but did not provide the degree of operating leverage we expected.

In moderating markets we are challenging our team to push for volume and generate additional growth, then manage costs more efficiently over time. This will result in additional customer interactions, generate incremental service work and migrate into repeat vehicle purchases over time.

In addition, we incurred certain insurance expenses related to hail storms, medical insurance and work comp programs they were a $0.06 headwind in the quarter.

As we adjust to a moderating new vehicle sales environment, we believe that low-single-digit organic growth, coupled with plentiful acquisition opportunities, can provide significant earnings per share growth through the cycle.

Consistent with prior periods we will provide an outlook in the quarter that does not forecast the reversal of expense trends we recently experienced, though we are working diligently with our stores to improve them.

As a result, we are adjusting our 2016 outlook to a range of $7.40 to $7.45 and introducing 2017 guidance in a range of $8 to $8.30 per share. Our 2017 Outlook represents an increase of 10% in EPS, and serves as a good baseline-assumption for earnings growth objectives in subsequent years.

Additionally, we’d again call your attention to the sensitivity analysis we provided in July. Under these assumptions, our upside earnings estimate is $11.20 per share and our downside earnings estimate is $6.75 per share.

Given the uptick in the acquisition activity we have seen as a result of moderating new vehicle sales environment, we believe the analysis remains valid and reinforces our assertion that acquisitions will accelerate in the future.

For the assumptions related to our earnings guidance and the sensitivity analysis, please refer to today’s press release at lithiainvestorrelations.com. This concludes our prepared remarks. And we’d now like to open the call for questions.

Operator?.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] One moment please, while we poll for questions. Our first question comes from the line of Steve Dyer with Craig-Hallum. Please proceed with your question..

Thanks. Chris, John, congratulations, well-deserved..

Thanks, Steve..

You talked a little bit about SG&A, the growth being high in the quarter and referenced I think a $0.06 headwind.

Can you kind of break down the components of that again to the extent that you can?.

Yes. I think, Steve, this is Chris, when we look at our guidance that we provided and the opportunity that we had to that guidance, we had a couple of things that happened. First off, in our prepared remarks we talked about what happened on the growth side.

So we are continuing to encourage our stores to push for volume, which I think Bryan can comment further on if you have questions on that. And that was a headwind of about $0.04. On top of that, we had a number of expense items that came in higher than expected. That was in kind of our personnel costs, advertising.

We had some insurance hits, that’s at our retention levels, caused us the headwind. We had some bad debt write-offs that were higher than expected in one of our business lines. And putting all that together we had about a $0.18 headwind that had we not have that, we would have had a pretty significant beat in the quarter.

So all in all, we feel pretty good about the momentum that we have. Top line and I think we had some one-off issues that hit us in the quarter that really drove the miss to our guidance that we provided in Q2..

Okay, great. Recall activity seems to have died down a little bit, I don’t know if your parts and service is seeing any change.

Did that help you either, whether it is stop sales, trying to sell new stuff or helped you on the parts and service area; any outside implications in the recall activity in the quarter?.

Steve, this is Bryan. Our warranty sales continue to grow. They were up 17% for the quarter, which is still sizable. The stop sale activity is mainly behind us, as those parts have mostly loosened up and now fairly available. However, there is still a tail on that as the parts continue to trickle in..

Great, and then, last one for me as it relates to acquisitions you made some recently, can you remind us if there is sort of a target leverage level that you’re comfortable with in making acquisitions?.

Yes, Steve, this is Chris. We have consistently maintained at - three times leverage ratio would be very comfortable with.

And I think with the cash flow that we’re generating of north of $160 million a year right now and the acquisition runway that we see in front of us, we think we have ample opportunity to continue to grow and maintain that leverage..

Great, okay, thanks..

Thanks, Steve..

Thank you. Our next question comes from the line of Mike Montani with Evercore ISI. Please proceed with your question..

Hey, guys, good morning. First off, congratulations to Chris and John..

Thank you..

If I could, I wanted to ask about the revised outlook on gross margins on the new vehicle side.

Can you just discuss a little bit how things have changed just in the past couple of months; and in particular, the dynamic you are seeing from your OEM partners in terms of incentive spend, production relative to where the natural demand levels might lie?.

Mike, this is Bryan. Great question. It’s what we’re - what we’re trying to balance is that idea of do we get volume which helps us accelerate our future growth by gaining manufacturer support or do we hunker in and make the growth that we need to bring to the bottom line.

And I think what we have really chosen is we really want to provide the opportunity to our people to be able to find new stores and provide growth opportunities for them. So we have kind of leaned a little bit more towards the volume model. So we are obviously willing to sacrifice some of that gross margin to drive that approvability.

We really also believe that taking share allows us to capture more trades. And most importantly it allows us to build our future service work, which is huge to us. The actual results and I mentioned in the prepared remarks, we were up 1.7% in market share which is a sizable move.

In fact it is the largest move that we’ve had in almost five years in regards to what we do in our markets relative to our competitors. And for us that’s good indications that there is a stability of support from our manufacturers to be able to continue to buy, at a cadence that we want to buy, can still occur and keep things active.

You also mentioned incentives. We expect that there will be further acceleration as the year comes to a close; as well as this last quarter was pretty robust as well which is exciting.

In fact, Sid may have some additional comments as well, as he sits on Chrysler’s National Advisory Board, and then also have some input as the Director of NADA, as well.

Sid, you got anything?.

Yes, I would like to add. This is Sid. Chrysler specifically is - I am involved pretty intensely in helping them design their stair-steps and their incentive programs. And they’ve asked me actually to serve a couple more years again. And so, we try to make it fair.

But they are definitely going to continue to try to take share and grow their business with both Jeep and Ram. And I think there’s a real bright future there yet for both the operations. And just enjoying that exposure with them..

Thanks, Sid..

Thank you..

Thanks, Mike..

Thank you. Our next question comes from the line of John Murphy, Bank of America Merrill Lynch. Please proceed with your question..

Good morning, guys, and congratulations to Chris and John. It’s great, great news. Just a question - first question here on the guidance, and you made I think a comment.

I just want to make sure I understand it, about the SG&A reversal not being part of your guidance, meaning you don’t - you are not anticipating an improvement in SG&A in your updated 2016 and 2017 guidance.

Is that correct and is there some incremental opportunity on SG&A to make that guidance better basically in the near term and into 2017?.

Yes, hey, John, this is Chris. Yes, I mean, consistent like what we have done for the last several years, we continue to manage a bottoms-up forecast that focuses on the current trends that we are seeing in our stores.

And so, while we understand that there is significant opportunity for us to outperform that number, we feel like it is prudent for us just to lay out the number based on what we’re seeing today and not putting a lot of hype into the future. But with that, I can tell you that we bought $1 billion in acquisition revenue this year.

We bought about $250 million in acquisition revenue in 2015. And of course a number of those stores that we acquired aren’t performing at the level of our existing stores.

And so, we’re going to continue to work on improving and integrating those stores as fast as we can and drive as hard as possible to beat the top side of our guidance in 2017 at $8.30, so we think there’s plenty of opportunity for us to grow..

But the guidance as you’re talking about it today includes the higher sales and advertising, the sales comp and the advertising dollars that you incurred in the third quarter.

And you kind of assume that that sticks around as you try to take market share going forward?.

That is correct..

Okay. And then a second question, you also mentioned $15 billion of acquisition potential in your databases that you are assessing.

I’m just curious how much of that is actually really live and on the market and how much of that is discussions that you are having with owner-operators or families that may consider selling those stores or that revenue sometime in the next 1 to 5 years as opposed to real live deals right now..

John, this is Bryan. The $15 billion is only our active target list. And that specifically means that it’s actively listed and it has a committed price.

It also meets our 6 out of 10 minimum quality rating, which involves dominant franchise diversification, real estate ownership, and another 17 qualities that Lithia, DCH and Carbone look at when they assess dealerships. It also is believed that price is the only major hurdle, okay. And these stores are geographically aligned with our current stores.

So the larger list is 6 or 7 times that, believe it or not, and is actual listed stores as well. So there is a lot of activity out there. And as I said in the prepared remarks, this is two or three times the typical number that we see. And it’s part of the reason why we have been able to do almost $1.1 billion in acquisitions in the year.

I think that can continue.

And I think most importantly, our ability to continue to grow and develop people and the idea that we are retooling things with Chris and John, which actually hasn’t cost us a single penny, because they will still be here, we’re not adding actual roles, will allow us to accelerate the growth of our people at a faster rate and build the culture to attract people at a faster rate..

That is exciting and very encouraging. Another question on the parts and service, simplistically you are looking for 8.5% same-store sales growth in 2016, but then add a deceleration of 5% in 2017.

Is that something that you are looking at because of tough comps or is there something that you are seeing in your base of UIOs or something like that that would lead you to believe that that would slow down, because it seems like your UIOs are increasing dramatically?.

John, this is Bryan again. A couple drivers there, first and foremost, I don’t know that we can continue to expect 17% warranty increases with recalls or stop sales. So that could be a part of that. I also believe that our year-over-year comps - we’re going on our third year of near double-digit same-store sales increases in fixed operations.

So balance those two things and we somehow get into a little bit more conservative number..

Got you, it makes sense. And then just lastly, obviously there was a big lease push in the first-half of the year. Just curious what you saw in the third quarter. We’re still looking at 30%-plus lease penetration.

And when do you think that actually becomes an issue or is it more of an opportunity, as those vehicles come back to the market for you in the next couple of years?.

Well, we’ve got some good news. LAD’s up to a 13% leasing, which is about double where we were before the combination with DCH. And DCH keeps clicking along at about 40% leasing.

And I see no reason, especially on the LAD side that there’s not a lot of upside still in that arena, and I think that is another reason why we are able to continue to drive market share increases..

Great. Thank you very much..

Thanks, John.

Thanks, John..

Thank you our next question comes from the line of Rick Nelson with Stephens. Please proceed with your question..

Thanks, good morning, guys. Congratulations as well to Chris and John. I’d like to ask you about the upside, downside scenario that’s in your slide deck on Page 6, $2 billion in incremental acquisition revenue.

Is that over and above the billion that you’ve acquired to date, or are we thinking about $1 billion in incremental acquired revenue?.

Yes Rick, this is Chris. We put that in as an example. I think that we feel like the opportunity on acquisitions, right now, as Bryan’s alluding to, is much higher than that.

But I think what we just wanted to lay out is, what runway we have in front of us more on a midterm basis, and the expectations that we have definitely are geared more towards the higher end of that. So, I think we can outperform that for sure in a midterm basis..

Okay, got you. Thanks. Carbone is the most recent, most sizable acquisition you’ve done. We’re packing in to a 1% net margin for Carbone based on the EPS and the revenues that you gave us.

Lithia core net margin is 2.3%, if you could talk about the opportunities you see to improve on Carbone’s performance and any evaluation metrics would be helpful too?.

Rick, this is Bryan. I think to start with our initial expectations for Carbone was a plus up of $0.20 to $0.25 in accretion in the full year of 2017. I think if you calculated it you’re pretty accurate at that 1%.

I think what we are finding initially is that the ability to leverage Anessa, and her team within the Carbone organization will allow that margin to increase, but it will come through adding stores most likely.

It has been an exciting six months together getting to know each other, and I think much like DCH their team is hungry, and I think they have really grown over time, but there are just - it’s just a little tightly wound, meaning that their people are constrained, because they have been able to grow people, but not deploy the capital, because they had a generation that wasn’t really looking to add stores.

So their good people are really pent up, and I think what we’re going to find is our ability to get closer to that 2.3% similar to Lithia. And I really believe we can get there, because it is a Lithia-type market will come through the leveraging of their team, and expanding past their current nine-store footprint.

One other thing to remember on Carbone is they actually will have 13 stores within two years. There was four stores that had multiple duals in them, and that will also be able to help grow used car business as well as fixed operations and the expansion and utilization of their people..

Okay.

Thanks for that color, and any different color on the multiple items that you paid?.

The neat thing was, Rick that it fell right within our 10% to 20% of revenue guidance. And still had the upsides of the de-dualing [ph] which we think is the real positive aspect. More importantly than that, we get Anessa and Alex and their entire team to be able to leverage.

So overall we think it was a great purchase and will really be a great combination..

Sounds good. Thanks, Bryan, and good luck going forward..

Thanks, Rick..

Thank you. Our next question comes from the line of Paresh Jain with Morgan Stanley. Please proceed with your question..

Good morning, everyone, and congratulations, Chris and John. Let me start with a question on market share, Bryan, you talked about being more competitive and it’s somewhat being reflected in your new margin guide as well.

My question is, what gives Lithia the edge in being more aggressive than the competitor in any region? Why wouldn’t they be as aggressive? And then on the used front, they are going to see an increase in supply particularly of these vehicles that’s very well understood.

So the argument there is, should that naturally help franchise dealers over independent dealers? Or the push back to that could be that franchise dealers may not have that kind of capacity to absorb all of this increase, and a lot of the bid will end up at auction anyways.

Just trying to understand Lithia’s natural edge in gaining market share?.

Great, Paresh. This is Bryan. I think, you have probably heard this response from me in the past, but people make the difference.

In our culture, allowing people to be who they are and be the entrepreneurs in each of our markets allows them to respond to the competitors, and create relationships with manufacturers that are different than what is typical.

Additionally, our transparent performance management metrics allow them to see where they are at, and to be able to drive the results, and trend upward, and diagnose when there is opportunities of plateauing to continue to find and reinvest to be able to capture that demand.

It seems like a simple formula, I am sure, but the idea of growth within our organization stems 100% from our people, and our ability to continue to grow those people, and it is obviously, like Chris is moving into the role he’s at, is to accelerate the development of our people.

We believe that this is only slightly tapped, and that we can accelerate that growth by 50 to maybe even double the rate of advancement opportunities.

If we can do that, then that $15 billion in possible acquisition revenues becomes more and more of a reality, because of this ability to continue to gain market share, and meet our manufacturers’ desires to continue to grow..

Got it. Thanks for the color. Second question on your used strategy, now I know having a separate brand of independent stores is not something you favor.

But has there been any change or perhaps a greater push towards fully online transactions? I just wanted to get a sense of where are you in terms of investments in those capabilities, and spending marketing dollars to get traction for that business.

And then, recruiting and developing talent for that is that something perhaps you would be looking at as well Chris, in your new role?.

Paresh this is Bryan, and I can spin it to Chris. If you noticed in the quarter, our value auto sales were flat which is where some of our used car margin typically comes from.

And if you recall from previous discussions that bucket of vehicles of seven to eight years and older is now right in the middle of our lowest SAAR rate that generated those used vehicles, which is affecting us slightly. Okay.

We believe that it is going to improve, which can allow us to create the higher margin business, which is upwards of 20%, which affects that obviously a little bit.

Chris, do you want to talk specifically about the development of the leaders?.

Yes, I think not just as it pertains to our used car managers, and what we’re doing online, but what we’re really trying to do is refocus our efforts, and start really at a high level, and continue to entrench our mission and values into the stores at all of our levels which - if you’ve ever seen our core values, they are making sure we focus on the customer experience.

We want to develop our teams at as fast a rate as possible to provide further growth that Bryan talked about, and we are going to continue to do that to focus on delivering solid returns for the long haul. And that includes used cars, F&I, new vehicles and service and parts.

And so - I guess, with our largest line item in SG&A - 66% of our overall SG&A is in personnel costs, I mean we feel like putting those two things together to develop our people, maximize productivity and continue to leverage our cost structure over time makes this a good role for me to focusing on going forward - looking forward to it..

Thank you..

Thanks, Paresh.

Thank you our next question comes from the line of James Albertine with Consumer Edge Research. Please proceed with your question..

Great, thanks, good morning, and congratulations as well - very well deserved for both Chris and John. I wanted to ask, apologies I was on a few minutes late, so apology to someone early asked this question, but it struck us as interesting that your new vehicle inventory fell as much as it did from 2Q sequentially to the end of 3Q.

I wondered if there was something going on there that may help to explain the volume versus margin sort of dynamics that we saw during the quarter? Thanks..

Jamie, Bryan. Most of our manufacturers are on a turn and earn basis. So when you grow market share at the rate that we did, when it was accelerating past where our competitors were in the same brand, we typically are able to reduce inventories. That was the effect of that more than anything..

Okay, got it.

so just as a follow-up then, so if I look at your current inventories it’s sort of back within the bandwidth that you are comfortable operating in, and should be a pretty healthy position looking ahead to the fourth quarter, if I’m interpreting that right?.

Correct. In both new and used..

In both new and used. Very good. Thank you very much, I appreciate that and best of luck in the fourth quarter..

Thanks, Jamie..

Thank you our next question comes from the line of Bret Jordan with Jefferies. Please proceed with your question..

Good morning, guys..

Hi, Bret..

If we look at the $0.18 on SG&A, I think you sort of had $0.04 of volume associated expense, and $0.06 in insurance.

Could we sort of bucket the other pieces, and sort of look at what is really nonrecurring versus, what is sort of recurring strategically in that $0.18 you called out?.

You bet, Bret. In fact, let me just walk through how we looked at capturing the opportunities, whether it was in the nonrecurring items. Okay. In fact - you want to talk about the - yes, in nonrecurring items.

So we really believe that because of our data analytics and performance management, our ability to diagnose and know where the opportunities stands are pretty apparent, which is exciting. If you recall, we grew revenue in all four departments which is exceptional in the market that we are in.

But more importantly than that, our cost management is not been achieved at the rate - and we spoke a little bit about new and used vehicle margin compression and how that was worked around to be able to continue to grow in acquisitions.

We are really challenging our leadership to respond to the trends that they are seeing by adjusting personnel costs, and advertising while they grow their volume, and I think that balancing act is something that really comes through great people, and we are able to grow people.

In fact, we had 19 store leadership changes within the last 60 days, of which 12 were in Lithia and seven were within DCH, which we believe that’s indications of the health of our ability to grow people. Which I think will come through in the coming quarters.

We are going to continue to accelerate the development of our teams to continue to build and drive the performance of our organization upward. In fact, I think to summarize this, we had 68 stores so far year to date that we believe have considerable profit potential.

And when I mean considerable, we’re talking about that they are currently operating at 25% to 75% of their potential earnings, okay. That means in those 68 stores we could double or triple our earnings, okay.

This is a combination of new stores and underperformance, and that to us means that even though we are able to grow people, and even though we may be ahead of the eight ball, and we are buying stores, it means that there is still 68 opportunities that are pivotal.

And we hope that all - that part of our team makes it, but we also know realistically that they won’t. And we need to continue to grow to be able to capture the opportunities in those 68 stores..

Okay. All right. Thanks. And one question, the customer pay was still pretty strong and the warranty was obviously very strong.

How much cross sell did you get in customer pay from the traffic came back to you on the warranty side?.

Our typical up sale on a warranty job is around $100 a unit..

Okay..

As far as the pay cap is concerned, that’s not something we typically disclose. It is a hard number to get your arms around just because of the incremental customer pay that comes in with those warranty claims. So it is not a number we feel comfortable giving you accurate data on..

Okay, great. Well, thank you..

Thanks, Bret..

Thank you. Our next question comes from the line of Chris Bottiglieri with Wolfe Research. Please proceed with your question..

Thanks for taking the question. I have a quick question on the CPOs. It sounded like you’re seeing some gross profit weakness there, kind of back into, the full 35 was attributed to lower demand, that kind of assumes like a $100 run rate, pretty significant. I’ll get a sense for what you are seeing there for the overall marketplace.

I think we’ve gotten to a point where just the CPO market is saturated, do you think there is still more runway overall, just your thoughts there?.

Chris, this is Bryan. You’re absolutely right. I mean, there is - it is plentiful in supply there’s no question. And I think now because of that it’s a little bit more competitive. I believe it can still continue to grow, because I go back to those 68 stores, many of those haven’t reached saturation.

So I really believe that can continue to grow but I don’t see that it is going to be any stabilization in margins. I think the 9.5% or so is probably where we will be able to sit..

Got you. Okay. And then just to follow-up on your acquisitions this quarter, you’ve been on a big streak, right now. One, I mean, it sounds like a lot of the future margin growth is going to come through the scale essentially. I was wondering if directionally you may be able to give some insight into kind of the opportunities.

Is there used to new ratio collectively for these stores significantly challenging, if the F&I lower because of oil penetration, is the SG&A throughput just not there in general? I guess just an overall guidance if you could provide it there..

Chris, you did pretty well there. There is no question, the biggest opportunities that we typically see in average or underperformance is the availability and the development of the used car business. There is no question about that. There is also a lot of legacy cost typically.

Our ability to manage costs in a more efficient manner, or in Carbone where we are just a matter of leveraging great people that’s typical.

And then what we always see is that F&I, whether it’s penetration rates or whether it’s finding the downstream business with F&I by managing really the reserves and the pricing methodologies, we are able to really extract those profits out of the store. It is shocking how quickly you are able to do that in many cases.

But sometimes it does take a little bit longer to get that done. But I think maybe a good example would be, I mean, Hawaii we have now been in the state I believe for 2.5 years? Is that accurate? I think 2.5 years with about 3/4 of the stores really in the last 18 months. They are starting to gain stride which is what we want to see.

They were up 40.4% in revenues year over year, they produced 44% more gross profit than last year, and their probability was up 140%.

So we really believe that is an example of a three-year evolution as to what can happen as you begin to become localized in the market, and you become able to attract the good talent within the market, or develop the people that are within the stores to be able to capture those opportunities..

Okay, great. Then just one last final question, after [ph] this one. Overall why - it kind of seems like you’re - I guess, posing Carbone as a kind of new segment to go with DCH and Lithia.

Why - it’s a small franchise to begin with, kind of why - I guess, why give them their separate breakout? Is it - do you need to grow the talent pool, or is it just they have a strong presence in the market already kind of your overall thought process rather than just like rolling out it to Lithia per se..

You bet, Chris. What we find is we are trying to attract groups that have wonderful brand recognition within their communities. And like Carbone, it has taken 80 years to build the Carbone name. There is a lot of value in that that has not been realized.

We believe that if we can then go buy underperforming stores that maybe don’t carry the Carbone name, that it can be rebranded with that.

So the idea of allowing people to be who they are, and then leveraging and finding the opportunities within their own organization is really what the entrepreneurial spirit of Lithia is about, and I think that exemplifies that scenario, because Carbone truly is a Lithia-type organization in the east.

And we really believe that the ability now to leverage them is going to take us far in upstate New York and Vermont..

Okay, great. Thanks for all the help. And I appreciate it..

Thanks, Chris..

Thank you our next question comes from the line of Bill Armstrong with C.L. King & Associates. Please proceed with your question..

Good morning, gentlemen. I was wondering if you could update us on trends you’re seeing in some of the energy markets in Texas and elsewhere? We heard one of your competitors this morning talking about how the declines there are actually accelerating. I was wondering if you could update us on what you’re seeing..

Sure, this is Bryan. So our big energy markets are Alaska, Texas, and North Dakota. Alaska, we have actually seen stabilization, they were down in sales just under 4%, but profits were only down about 1%, which we would consider that a good result relative to the market that was down about 8%.

Texas, unfortunately still remains under pressure, revenues were down about 5%, but unfortunately earnings were down 22% in the quarter. That’s not what we want to see, obviously. Our stores in Texas seem to be spending more money to maintain their current market share, and it is mainly offset by - we hope to offset it with revenue and gross profit.

We have noted that our DNA in Texas hasn’t been as efficient at selling used cars, so the development of their used car business we believe is critical to the stabilization, whereas in Alaska we have decent used car strength there and have been able to respond. On a positive note, North Dakota, revenue was actually down 2.7% while profit was up 46%.

So that’s maybe an indication of what can be done in the right market conditions..

Okay, great. Thanks. In terms of F&I per unit, your used comps have been exceeding your new and I was wondering if you could help us, remind us how to think about F&I per unit as we see changes in the mix, whether going more towards used and then within used we’re seeing strong numbers in CPO.

How should we think about the different impacts of the mix change on your average F&I per unit going forward?.

Yeah, hey, this is Chris. I mean, I think the focus that we have on our F&I business has really taken hold. We’re focused on three core areas. I mean, number one, we’re focused on getting the right people in our F&I offices and motivating with the right pay plans that really generate additional sales for the company.

And so in often cases that means providing less transactions to each F&I manager, but encouraging to make sure they offer all the opportunities that we have for customers to protect their vehicles. The second thing is making sure that we have the right product.

So we’ve done a lot with our partner vendors to try and make sure that we’re bringing in new products that are refreshed, and really meeting the customer’s needs in this environment. And so we are adding on coverage, we’re changing the structure of things, and we are providing, I think some products that customers are really finding interesting.

And lastly on that we are adjusting our pricing. So we went through several years with kind of a stale pricing template, and we’ve done a lot over the last 12 to 18 months to make sure that we have the right prices in front of the customers at the right time.

And so I think those three things together have really led to what you’re seeing overall in F&I which is, in the quarter we have a 200 basis point penetration increase in both service and our LOF products. And I think, we find that very encouraging.

But like everything we do, when we break it down into the individual stores, we’ve got a lot of stores that are really outperforming our expectations in F&I, and we have a lot of stores that are still fighting to move up above that $1,000, $1,100 number.

And so we are continuing to try new things, focused on our people, and we feel like there is still upside to F&I going forward..

Okay, great. Thank you..

Thank you. Our next question comes from the line of David Whiston with Morningstar. Please proceed with your question..

Thanks, good morning, guys.

First question is on the M&A pipeline, obviously pretty high at $15 billion, but in a downturn how much would you expect sellers to withdraw from the marketplace?.

David, this is Bryan. I really believe that we’ve got pretty good runway for the next few years. I don’t believe that the market is going to adjust enough that people will exit the market. It seems to be building and I think it will continue to build over the coming quarters and years..

Okay.

And as you know, Ford is suspending F-150 production, I was just curious in your markets do you think that was an inventory adjustment like that is needed?.

This is Bryan, again. I like to see that manufacturers respond with changing supply lines rather than incentives, so I think that is a positive move.

I think in most of our markets we are able to adjust, even if we are in strong truck markets to be able to still continue to grow our business, even if supply becomes short, where we can just go buy cars from other parts like metropolitan areas that maybe, there is a higher supply..

Okay. And my last question is on the store base that you talked in the past, I think referenced it earlier today about a certain portion of stores are underperforming.

How set up are those stores to not massively disrupt earnings for the overall company if a downturn were to happen as soon as next year?.

That’s a good question. What I would say is about two-thirds of those stores have great leadership in them. They just haven’t found their way with their team.

So they are in the process of building their team, but I think they are agile enough leaders that they understand and if, God forbid, there was a hard recession that dropped us into the 2016s or 2017s again, then I think that they still have the ability to respond.

A lot of it again comes from the ideas of productivity and efficiency within your people. Ability to sell those used cars and developed your F&I, and I think those are really the fundamental drivers that make you more recession-proof.

The service and parts business is obviously, where many of those stores still haven’t hit stride, which does take a little bit longer, but ultimately even in a recessionary period, you should be able to still grow your used cars and stabilize your team and grow business..

Okay. Thank you..

Thanks, David..

Thanks, David..

Thank you. Our final question is a follow-up from Michael Montani, Evercore ISI. Please proceed with your question..

Hey, guys, thanks.

I just wanted to ask on the service and parts side where the margins were down, is there any shift there in terms of trying to be promotional to increase kind of retention rates, et cetera? Or was it some sort of temporary mix adjustment that was going on there?.

You’ve got it, Mike. It was just a mix adjustment..

Okay. And then just to follow-up on the stop sale.

Can you provide the number of units that are on stop sale for new and used, and also on a same-store basis, the year-over-year change in inventory units themselves?.

Mike, we’re actually - we are not tracking it any longer, because we’ve - it is behind us, primarily..

Mike, I will get off line with you on the absolute unit volume amounts..

Okay. Thanks a lot, guys..

Thanks, Mike..

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Bryan DeBoer for closing comments..

Thank you everyone for joining us today, and I look forward to speaking with you again in February..

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation. And have a wonderful day..