Asbury Automotive Group Inc (ABG) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Asbury Automotive Group second-quarter 2013 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to the Treasurer, Mr. Ryan Marsh. Please go ahead, sir.

Thank you, Jennifer. And good morning to everyone. Welcome to Asbury Automotive Group's second-quarter 2013 earnings call. Today's call will be recorded and will be available for replay later today. The press release detailing Asbury's second-quarter results was issued earlier this morning and is posted on our website at asburyauto.com. Participating with us today are Craig Monaghan, our President and CEO; Michael Kearney, our Executive Vice President and COO; and Scott Krenz, our Senior Vice President and CFO. At the conclusion of our remarks, we will open up the call for questions and I will be available later for any follow-up questions you might have.

Before we begin, I must remind you that discussions during the call today are likely to contain forward-looking statements. Forward-looking statements are statements other than those which are historical in nature. All forward-looking statements are subject to significant uncertainties and actual results may differ materially from those suggested by the statements. For information regarding certain of the risks that may cause actual results to differ, please see our filings with the SEC from time to time, including our Form 10-K for the year ended December 2012, any subsequently filed quarterly reports on Form 10-Q, and our earnings release issued earlier today. We expressly disclaim any responsibility to update forward-looking statements. It is my pleasure to hand the call over to our President and CEO, Craig Monaghan.

Good morning, everyone and thanks for joining us. We are pleased to once again report record quarterly results. Adjusted EPS from continuing operations increased 48% for the second quarter. Our stores successfully maximized sales and service opportunities across all business lines while maintaining continued expense discipline. Both revenues and gross profits were up 16%.

We improved our cost structure, reducing SG&A as a percent of gross profit by 270 basis points. And we achieved record income from operations with an adjusted margin of 4.7%, placing us among the leaders of our industry. Additionally, we are excited to announce the acquisition of Hyundai, Kia, and Toyota franchises in our Atlanta market. This follows the acquisition of Bentley and Volkswagen franchises last December. We're making great progress in achieving our $500 million acquisition target.

Michael will provide more color on the acquisitions during his portion of the call later. In addition to validating that we're on the right track, our results reflect the talent, hard work, and commitment of our associates across the Organization. We couldn't be more proud of what our team is accomplishing. Now I will turn the call over to Scott.

Thank you, Craig. Our second-quarter adjusted results of $0.98 continue to demonstrate the operating leverage we worked hard to build into the Business. Our results this quarter include real estate charges of $3.2 million after tax or $0.11 per diluted share. These charges are primarily related to the two leased properties we bought out during the quarter and were reported in the Other Operating expense line in the income statement. With respect to our SG&A-to-gross profit margin, we hit an important Company milestone for the quarter by moving below 70%. Our margin was 69.5%, which is a 270 basis points improvement compared to the prior period.

We have made great progress in both reducing costs and making our cost structure more variable. Having said that, there is always more to do and we continue to focus on future productivity enhancements. Excluding rent expense, which we view as a financing decision, our SG&A as a percentage of gross profit ratio was 65.8%. Our strong cash flow generation during the second quarter, in addition to the $100 million add-on to our bonds due in 2020, underwrote continued investment in our Business, the acquisition of a group of stores, the completion of another two lease buyouts, and our ongoing share repurchase program.

During the second quarter, we spent $9 million on CapEx. We are budgeting approximately $45 million of CapEx for 2013, as we continue to upgrade our stores, expand service capacity, and invest in technology enhancements. As is our custom, CapEx numbers exclude lease buyouts and real estate investments. We spent $14 million purchasing two properties we had previously leased. We anticipate $1.5 million in annualized rent savings, and we continue to evaluate other opportunities to buy out leases.

During the second quarter, we repurchased $5 million of our common stock, or 127,000 shares. During the first half of the year, we have repurchased $12 million, or 340,000 shares and are on pace to repurchase $25 million to $30 million for the year. We have $38 million remaining under our authorization, and we will continue to return capital to our shareholders in 2013. During the quarter, we raised a little over $100 million through an add-on offering to our existing notes that are due in 2020. We view this as a great opportunity to lock in long-term capital at extremely attractive pricing. We sold the notes at an effective rate of 5.628%.

We ended the quarter with an adjusted leverage of 2.6 times total debt-to-adjusted EBITDA, which is well within our target leverage range of 2.5 it times to 3 times. Because of the timing of our debt offering with respect to a couple of large transactions in our pipeline, we ended the quarter with a relatively high level of total liquidity -- $408 million, which includes $233 million under our revolving credit lines, $67 million in cash, and $108 million available in floor plan offset accounts. Let me give you a better picture about current liquidity and near-term plans. You saw in our press release this morning, we closed on the acquisition of a group of three franchises in the Atlanta market that we funded with cash on hand. Additionally, we have a large lease buyout, in the $25 million to $30 million range that is scheduled to close within the next month. Finally, we intend to call our 2017 bonds sometime between now and the end of the year.

I also want to highlight that largely due to the issuance of the add-on notes, incremental interest expense will be approximately $1.9 million higher in the third quarter. As we fund these activities over the remainder of the year, we intend to continue raising capital via mortgages with our captive finance partners and banks in order to take advantage of the current low rate environment and attractive terms. However, taking this all into account, we would expect to end the year with leverage somewhere near where we began the year. Three quarters ago, we announced a capital allocation plan through 2015. The activities this quarter and so far this year demonstrate our disciplined execution of that plan. We believe the balanced approach of investing in our existing business, acquiring new stores at attractive prices, and repurchasing shares continues to generate shareholder value. I will now hand it over to Michael to discuss our operational highlights.

Thank you, Scott. I would like to remind you that everything I will be covering with respect to operational highlights will pertain to same-store retail performance during the second quarter. New vehicle revenues and gross profit increased 13% and 5% compared to the prior year. Our new vehicle unit sales were up over 12%, outpacing the industry growth rate of 9%. Although the new vehicle margins for the quarter were 6%, down 50 basis points, the increase in volume more than offset that margin decline. On a sequential basis, our new vehicle margins were essentially flat compared to the first quarter, and as stated in the prior quarter, we do not anticipate significant new vehicle margin erosion from the current levels this quarter.

We want to highlight again the fact that our total front-end gross profit yield -- that is, new and used vehicle gross profit per vehicle sold plus our F&I profit per vehicle sold -- of $3,198 for the second quarter is almost $50 more per vehicle than the second quarter of the prior year. The ability to essentially offset vehicle margin deterioration by increasing F&I PVR shows how the automotive retail model responds to a constantly changing sales environment. We ended the second quarter with $552 million of new vehicle inventory, or a 68-day supply on a trailing 30-day basis. We are comfortable with our current new vehicle inventory levels but we continue to watch them very closely.

We increased used vehicle revenues 23% over the second quarter of last year, as we continue implementing Phase Two of our Asbury 1-2-1 program. Although margins decreased 30 basis points to 9% compared to the prior-year period, gross profit per vehicle remained essentially the same. The average selling price increased approximately $430 a unit. Our used-to-new sales ratio was 79% for the quarter, as our markets continue to react favorably to the increased availability of pre-owned product. The impact on Asbury's overall financial results due to the Asbury 1-2-1 program is evident considering the incremental gross profits we are generating from the increase in used vehicle sales, the associated F&I, and the internal reconditioning work from parts and service. We believe the supply of pre-owned vehicles will remain at levels necessary for our continued growth in this sector. We ended the second quarter with $121 million of used vehicle inventory, or 36-day supply on trailing 30-day basis, essentially the same as Q2 of 2012.

Our F&I business remains an important source of earnings growth for us. Our strategy and practice remain the same. Disciplined execution of F&I sales processes and training, create solid, reliable growth and results. Second-quarter F&I revenues grew 25% compared to the prior period. F&I per vehicle retail for the quarter was $1,306, up 9% year over year. A more favorable lending environment, coupled with our internal programs, has produced record F&I results for the last five quarters.

In the second quarter, our parts and service revenue grew 7% and gross profit grew 12% compared to the second quarter of '12. Parts and service gross margin for the quarter was 61.3%, up 270 basis points compared to the prior year. The year over year gross profit improvement was driven by a 26% increase in reconditioning work, a 6% increase in customer pay, and a 26% increase in warranty work. We did have a number of recall campaigns during the quarter that were either completed or are winding down as we entered the third quarter. As I have stated in the past, you can never predict recalls.

We believe we can continue to grow our parts and service business in a mid-single-digit range while maintaining our current margins through our ongoing customer retention programs. We are now seeing an increased amount of customers return to our shops, as a result of the tire program that we started in late 2011. As an example, in our pilot market, from late 2011, we are seeing tire sale customers return for maintenance work at a rate of almost 1.5 times the rate for those who did not purchase tires from us.

I want to follow up on Craig's comment about our acquisitions. We are very pleased to add three strong mid-line import brands -- Hyundai, Kia, and Toyota -- to our Atlanta market. We expect these three dealerships to produce approximately $115 million of annualized revenues. We closed on the acquisition yesterday and they are up and running as Nalley stores, utilizing all of our Asbury processes and technology today. The acquisition and integration teams have done a fantastic job. Thank you very much. We continue to evaluate acquisition opportunities in our core and adjacent markets.

Finally, I would like to once again express my appreciation to all of our associates in the field as well as those in our support center. Our Company has grown substantially and is producing best-in-class results in many areas. This is a result of your dedication and efforts. Thank you again. With that, I will hand the call back to Craig to conclude our prepared remarks. Craig?

Thanks, Michael. Considering the current age of the vehicle fleet, the extremely attractive financing rates, and the availability of exciting new product, we believe that current pace of business should continue. The outsized performance we delivered in the second quarter relative to the underlying SAR growth proves that we have portioned our Company to outperform the industry. We believe our strong brand portfolio, attractive geographic locations, and proven ability to execute our strategies will allow us to grow across all business lines. I'm excited about Asbury's future and remain encouraged by the recent positive momentum from five trailing quarters of record profits during an uncertain economy. In closing, I want to thank each of our associates. Our record result and momentum are a direct result of your dedication and hard work. I would now like to turn the call back to the operator and we would be happy to answer your questions. Operator?

(Operator Instructions)

Rick Nelson, Stephens.

Congrats on a terrific quarter. Ask you about the incremental gross profit flow through. Our calculations ex rent, you were at 46% in the quarter. I'm curious if you think this is a level that can be sustained. And if you could address the flow-through in the service and parts segment because it looks like counts and gross profits are starting to accelerate there?

Rick, it is Craig. I will start and then maybe Michael or Scott can jump in behind me. But we've always said that we think flow-through in the Business on a stand-alone basis should be in the 30% to 40% range. We have been targeting something higher than that. We've been talking about -- we're targeting 40% to 50%. We can only get that if we can find incremental places to drive productivity. Some of that you see, for example, in our lease buyouts. There are still some more things that we think -- some more advantages that will come with the roll-out of technology enhancements. Keith Style is working on trying to make us more productive in our back offices. So those are the things that are helping us get that incremental flow-through today. And we think there is still more there. There is not a lot more there. We've been able to pick up all the low-lying fruit. But we're still not at the point that some of our peers are with respect to the consolidation of back office processes, for example. We are making good progress but there is still more to do. Michael will talk a little bit about fixed.

So, Rick, so on the parts and service piece, with the incremental growth in the used car part of our business, we generated a substantial increase in our reconditioning work, which is a very high margin work in parts and service. We did experience some -- I wouldn't necessarily say abnormal but unexpected recall business at the end of the first quarter, and throughout most of the second quarter. And that spike in warranty business was brought about by that and that influenced that margin also. And then of course, we just constantly work on our cost structure in those departments, to follow up with what Craig said, we apply the same principles that we do -- we're approaching the back office part, into the parts and service operation. So those were the big drivers on the incremental margin that we saw in the parts and service side.

What do you think the flow-throughs are in the service business?

Just on the -- if we just isolate the parts and service side, at the level at which we operated in that quarter, I would say the flow-through is somewhere north of 55%.

Okay, got you. Okay. Thank you for that. The acquisition pace seems to be picking up. You acquired three franchises this quarter. You can talk about the pricing of those and how the pipeline might look on a go-forward basis?

Yes. Rick, it is Craig again. We're very happy with what we've been able to do on the acquisition side. When you include the Bentley and the Volkswagen store that we picked up in December, we have picked up about $150 million worth of incremental revenue in the last six, seven months. So feel good about that. You asked a number of questions there. So let's talk about the performance of those stores, like Michael said, we -- let's go down that path for just a second. Those stores are up and running as Nalley stores today. All of them. All five of them. We have been fortunate that the sellers that we have worked with have let us get into those stores weeks ahead of time. So well before we closed, we are putting in bigger pipes, if we have to, T1 lines are going in. In some cases equipment goes in. Training starts. So that when we hit a store, and we close, that store converts immediately. So I will just speak to this last weekend. We had a great compliment from one of the people in the store, said to me over the weekend, wow, you guys are like ants, you're everywhere.

And what it was we had IT people everywhere, we replaced all their PCs, we replaced most of the printers. They were converted to a new DMS. They were converted to a new CRM. They were converted to a new used vehicle management program. And, like I said, sign went on the store on -- we were doing that all through the weekend and on Monday morning, that sign went up and that is a Nalley store today, running on our systems, with a lot of our people from across the country still in that store, holding their hands to help them make this transition. So with respect to the returns, we expect the same returns from those stores that we get from the rest of our stores. And we expect those returns -- it may not hit it immediately because there will be a little bit of people turnover but we expect those levels of returns very quickly.

And as far as the pipeline is concerned, finding stores is hard work. As you are well aware, it is a great time to be in the automotive retail business, people are making a lot of money. As a result, we don't find a lot of sellers that are willing to sell stores at prices that we think makes sense, so we've got to go out and pound the pavement a little bit. We're doing that. But it takes a lot of energy and we will just have to see what comes. We are talking to people. But I would tell you that there is nothing imminent at this point.

But we did -- this is Scott -- we did lay out a plan, over three years, and you should note that we're running ahead of the plan. So we don't feel badly about our execution here at all. We're running well ahead of the plan.

Great. Thanks a lot. And good luck.

John Murphy, Bank of America Merrill Lynch.

Just a first question, on grossage. We're seeing the average transaction prices increase, at the same time as the gross dollars are actually going down on a yearly basis, which is driving the margin compression. I'm just trying to understand, if there's something is changing in the dynamic with your suppliers or the automakers, that they are really pushing on you to keep more of the profits because that is where the benefit is landing, is with the automakers, just trying to understand, are they doing anything with stair-step programs or incentives, or anything else that is really changing the dynamic here?

John, this is Michael. I don't think there is anything that is radical out there. There's constant movement in the incentive world. We see some manufacturers deal heavy on stair-steps and some manufacturers back off of them. Sometimes the stair-step programs have objectives that are stretched, sometimes not so much. But I don't think it is anything that is radical or anything that is different. From my view, the biggest piece that puts pressure on our margin is market share grab. Every manufacturer is trying to gain market share. And with that, there comes a substantial amount of competition in the marketplace, and we respond to what other dealers in our local markets are doing. But we have seen not quite as much of an acceleration of that compression. I hope and believe that it is sustained where it is right today. As I've mentioned the last couple of quarters, we don't see a big swing, don't anticipate a big swing. But I don't -- also don't see any radical behavior in the incentive market right now, either.

So we should think about the dollar gross per vehicle hovering around $2,000 and then maybe the margin might swing up and down depending what happens with the average transaction prices. But is $2,000 your bogey in the way you think about this?

That is pretty close to it. We do look at total yield. So that number stays in that $3,100, $3,200 range. But, if you figure $2,000 on new cars and roughly $2,000 on pre-owned, that is a fairly reasonable way to look at it.

Okay. That's helpful. Second question, just on the parts and service, the 61.3%, obviously you outlined the rationale for why you got there. But you did also indicate that you thought could operate roughly around these levels going forward. Is 60% to 61% a decent number to assume that you can operate at? That is a very high level. And it sounded like there were a lot of good guys in the quarter?

Yes. That is a little high. I would not say that we can maintain the 61%. We have stayed in the north of 56%, 57% range, and I'm quite comfortable with that number. But the 61%, again, there are a lot of stars that aligned in the second quarter that contributed it to that.

Huge piece of that is that the outstanding job our people did with used cars, because that piece is -- because of the way we account for it, that is essentially 100% margin business in parts and service, eliminate the revenue. So that 26%,I think it was, increased period over period, in reconditioning the internal work because of our used car business, contributed a lot to that 61% this quarter.

That's very helpful, Scott. And then if we -- that leads me to the next question. Is we are all very hyper-focused on the growth of the zero to six-year-old or zero to five-year-old car fleet for the flow-through to parts and service but it does create another big opportunity on the used vehicle side. I'm just curious, if you are seeing that and with the increase, obviously you're focused on the used vehicle business, so there is a lot of micro stuff that you're doing, but also just with that population growing, could we see big same-store sales comps for a while because of that factor?

John, this is Michael. I'll make sure I understand the question. As it relates to the pre-owned segment?

Yes, the used vehicle, whether it be CPO or straight retailing -- that fleet, or that supply of zero to six-year-old cars is going to be growing. Most people are focusing on that benefiting the parts and service business but it is creating more cars for to you potentially buy and sell in the used vehicle business and it seems like there was some benefit in the quarter. Should that benefit continue going forward?

Well, as I stated a number of times, the franchise dealers get approximately 30% to 35% of the total number of pre-owned vehicles that are sold in the country each year. And so there is ample opportunity for us to continue to grow same-store pre-owned business. Availability is the best it has been in a while. There is a lot of product that is out there. We, as you will note, grew our inventory, I would say substantially, in the last couple of quarters, and that also has helped in reflecting the sales. When we have this kind of a broad-based inventory, we can attract more customers. So to answer your direct question, the availability of product is better than it has been in quite a while and that we should all have some benefit from that.

Okay. Great. And then lastly, Scott, just a question on the lease buyouts. You mentioned in the quarter, that you'd would save about $1.5 million in rent expense, and the cost that you guys highlighted was $5.2 million in the quarter. And that's about an annual return of 29%. That seems like a great deal to execute on and obviously I'm sure there are some financing costs on the back end. But how do you think about the math there, on what you have left? It looks like you're going to have $32 million to $33 million of rent expense on an annualized basis, based on what you had stated in the quarter. Could we see those kinds of chunky returns as you work through this process? Or was this just an especially attractive situation on these two lease buyouts in the quarter?

I'm a little -- I'm not sure where the $5.2 million comes from. I'll tell you -- we do get attractive returns on these. There is no question. But we're talking about returns that are more in the middle-teens, that area, of a return on investment, in these, and not 29%. So the cost to do that was a little -- of buying them out was a bit more than $5.2 million. But so going forward though, we do see those attractive returns. Many times we have to wait for the opportunity to present itself. As the lease nears its termination and stuff. And we tend to get those returns, in the low, mid-teen type of area.

John, Craig, could I make -- John, could I help you out just a little bit? I think we may have created some confusion.

Sure. Because I used the charge from the -- that you guys stated in the quarter, the $5.2 million was the denominator I was using?

No and you have the right numbers but let me put it in Dick-and-Jane language that I can understand -- Scott could do the detail accounting later but -- so I may oversimplify this, but the way I think about it, cash flow, we spent $14 million and we bought out these leases. The leases we bought out were situations where we were leasing the dirt, but we had built the store that sat on top of the dirt. And the accounting rules required us to take a write-off on the value of the building that we had on our books, on that leased property. So the $5.2 million, the vast majority of the $5.2 million was a non-cash accounting charge, because we had to write down the value of the building, but the economic return was -- we will save $1.5 million of rent on a cash outflow of $14 million to acquire the property.

In other words, the treatment--

Yes, that is so simple, even I can understand it.

Right. (Laughter)

Thank you very much.

And that gets to you the 10%, 11%, that Scott was talking about. It's the returns that we look for on these buyouts.

Got you. That's very helpful. Thank you very much.

Bill Armstrong, CL King and Associates.

Back to the warranty increase, a huge increase, obviously. And you called out recalls as helping that, are you able to maybe break out recalls versus maybe units in operation, that may have driven some of that?

Hello, Bill, this is Michael. I don't have that. And we can surely get back with you on that. But it is -- essentially what we saw in the -- again, at the end of the first quarter, and throughout most of the second quarter, there were a couple of the major brands just had some recalls that stacked up, and, as I said, in previous times, we can't predict them, we deal with them, and our shops have capacity to handle them. But we just did happen to see a number of large brands just have a number of them just hit in this time period.

Okay. Moving on to used, you had the unit, the same-store sales increase of 20%, which obviously was much higher than the overall growth in the industry. What drove that huge outperformance?

Bill, it is Michael again. A couple of things. In the implementation of our programs that we -- the 1-2-1 program that we started a number of years ago, we have executed well on the training piece, and we have executed well on the actual program itself. What we're starting to see is a maturing of that process. We have the ability now to move inventory within clusters, much easier than we have in the past. We've got experienced individuals in those markets that again have matured with this process. So it is an execution of the plan that we started a number of years ago. I mentioned earlier there is a nice availability of product. We're very aggressive in the way we price our trades. We have become much more aggressive in not wholesaling, not taking nearly as much product to the auctions. And we're finding homes for those vehicles at a variety of price bands. So there is no magic bullet to it. It is execution of what we started. It is availability of product. And it is keeping the cars that sometimes we used to send to the auction, we're keeping them and selling them now.

Okay. Well, that's definitely working for you. And then finally, just on this Atlanta -- the Atlanta acquisitions, are these three franchises -- are these in three separate locations? Three separate facilities?

Yes, they are.

Okay. And would you be -- are these facilities owned or leased?

We own two of the facilities. The third is on a leased parcel. But we intend to move that on to a property that we will own.

Okay. Great. Thank you.

Rod Lache, Deutsche Bank.

This is Dan Galves standing in for Rod. A lot of my questions have been asked and answered. Just wanted to ask about -- if you could give us some color on the parts and service business, as we look forward, units in operation will be growing pretty strongly, maybe less than five-year-old vehicles, but greater than five-year-old vehicles will probably be falling. Can you give us a sense of your exposure to those two different segments, what you've done to improve retention in six-plus, and whether you would be able to continue to gain share in that area?

So, Dan, this is Michael. I will take a shot at answering that, backwards on the older product. Generally speaking, even though the cars are in the 6 to say 9, 10-year bracket, they are still very technologically-advanced automobiles. There is a lot of technologies that's involved with doing major repair work on those vehicles. A lot of the computer modules, as well as the sophistication of the drive trains and the engine technology. So the dealers are well-positioned to handle that older product out there. Just from a standpoint of the investment we've made in training of our people, the equipment that we've got in our facilities, to handle them. So even though they are in that 5 to 10 bracket, let's say, the franchise dealers are well-positioned to handle those. On top of that, we began the tire initiative, a little over 1.5 years ago. We believe that that is a retention program. We are very pleased with our tire results. We're seeing some very, very nice results from that.

We have a wiper blade retention program. Those are all geared to attract the customer who is just coming out of the warranty. That person, we want to get them to come back at our shops as soon as that warranty period expires. In addition to that, the training that we now do in the finance insurance departments, emphasizing pre-paid maintenance and extended warranty, not only do we receive the upfront benefit of increased -- the enhanced PVR, those products bring the customers back to our shops, and they bring them back on a regular basis, they bring them back during the warranty and post-warranty periods. So those are all programs we have all put in place. We are seeing the benefits of some of them. And we anticipate that we can take advantage of the increased units in operation that are out there.

Okay. Very helpful. I appreciate that. Just one last question. Just on general competitiveness on new vehicles. I know you said that you haven't seen any broad-based incentive activity, but we've noticed some increased competitiveness maybe in mid-sized vehicles, small vehicles. Is there anything you can talk to in those segments, and what's your outlook going forward?

So Dan, this is Michael again. So in the segment where -- let's put the Camry, the Accord, the Malibu, the Sonata, the Elantra, all very nicely priced import sedans and domestic sedans, there is a fierce competition from the manufacturers to gain market share. They are all outstanding product. So we're seeing -- we do see a substantial push to move that product. The pricing is very competitive, the price bands of those product is very narrow. I don't anticipate that changing. So we have to, as an industry, we will adapt to the pricing that is out there. But it is very competitive. I can't predict what the manufacturers will do in terms of incentive, but I will tell you that those -- the number of products in that segment seems to grow, and the push for market share with the manufacturers is very intense right now, and we will just work our way through it.

Okay. Thanks very much. Appreciate the answers.

James Albertine, Stifel.

Good morning, and congratulations on a great quarter. I had a quick question, if I could ask, on the F&I side. Considering the phenomenal used unit growth that you called out here in the second quarter. Just trying to peel away as you see it how much F&I lift has contributed to the used side versus perhaps more of a focus on a new vehicle transaction, to draw more F&I per unit growth there as well?

James, this is Michael. There is no doubt that the growth in the pre-owned segment contributes to some of our F&I growth. It is a little different mix of business on what we sell. Obviously, we sell a greater amount of extended warranty on our pre-owned business than we do on our new business. However, our finance penetration rates, roughly the same, across the board with those, so I don't see any particular lift on the pre-owned side of that. But there is no question that the other product sales, we do get a bigger piece of that when we sell on the pre-owned side.

Great. Appreciate the detail. And then if I can ask just a quick follow-up on the M&A side, and I'm really trying to tease out, as we think about broader market consolidation over time, what can drive the ebbs and flows of that consolidation. Based on what you're seeing and I'm sure the NDAs that you have outstanding and the M&A work that you've done, are the smaller or independent private peers doing as good of a job, certainly as you're doing but maybe as some of the public peers are doing on the used vehicle side? Or are they going to be more susceptible to the pressures that you called out, whether it is stair-step programs or other pressures on new vehicle gross profit per unit, which could presumably drive them into an M&A conversation, if you will?

This is Craig. I will take a shot. And it will be my perception, more than -- and I don't think we have the hard facts in many of these cases. But I would start off and say that automotive retail business is becoming much more complex. And when I just look at what we went through over the weekend, it is a great example. We can drop in an IT team that will put in a state-of-the-art systems in that store, or any store, but it is hard for somebody who is running a mom-and-pop store, or even two or three stores, to have that -- bring that level of sophistication that these people bring. Whether it is wi-fi. Whether it is taking full advantage of CRMs or anything else that we drop in. We have got a team of experts that can do that. Likewise, you leave the IT closet, if you would, while you're walking around the store and you bump into one of the used vehicle people, we have people who dedicate their careers to used vehicles and they too are in that store working with those people, training them to how to use our used vehicle systems, out buying used vehicles for them to help them, if you would, pre-stock their inventory. So that when that store opened on Monday, that it was ready to rock and roll.

And then the same thing happens across the board. We had some of our parts and service people, in that store, who had come from the Carolinas. And some of our best parts and service people, who are bringing a level of expertise that somebody who just has one store just couldn't possibly have. And so as a result, a lot of these things, you will find that in general, the large consolidators generate margins that are about twice what the average store in the NADA population is going to generate. And size really does have an advantage here where we're beginning to prove that. And I think you will see this consolidation continue. What pace, I don't know. Like I mentioned earlier -- stores are very profitable today, many of these people, many of the potential sellers are thinking that they might like to ride this out a little longer before they sell. But then again, there is this aging issue. And there are a lot of owners who are reaching a point in time where they need to think about succession plans and estate planning, and stores have got to the point that they're so expensive that you can't sell them to the general manager anymore. And that is creating opportunities for us to do the type of transition -- transactions that you've seen over the last few months.

I really appreciate that. And if I could just make sure I understand, and maybe paraphrase -- in the environment where SAR continues to increase, that doesn't necessarily mean that M&A won't also increase because some of the other opportunities in used or parts and service or other avenues if you will, are much more difficult to execute, is that fair?

I'm not really sure how to answer the question. M&A will move at its own pace no matter what the SAR does. There will be sellers who are ready to sell and there will be opportunities for large consolidators to go out and be able to make transactions that make economic sense in good times and bad. So we just have to see what comes. It is very hard to predict.

Understood. Thanks again, guys. And good luck in the next quarter.

Brett Hoselton, KeyBanc.

Wanted to start off, just if I'm reading the report correctly, I'm looking at new vehicles and it looks like your luxury sales increased by 11% but your gross profit was flat. And I'm wondering, can you talk about why the disconnect between the revenue growth and the gross profit growth?

Yes, so Brett, this is Michael. So that is correct. And I'm not sure I would classify it as a disconnect. I will tell you that in the luxury segment, as in the mid-line segment, competition is intense. There has been a little model shift in our business from the very expensive, call it 7-series, S-class Mercedes, down to the 5-series, or the GS and the Lexus. There has been a shift in that over time and the margins on those particular products are not as high as the other ones. We are seeing a little bit of age on some of the -- again the very higher margin vehicles in that segment, they will be replaced within the next -- most of them will be replaced within the next 12 to 18 months. But right now -- but there is a little bit of age to some of that. So it is just a combination of the consumer acquiring a lesser-priced luxury vehicle. There's the competition within the segment. And some of the margin on the older product that is out there, is -- it's got pressure and we should see a little bit of relief in that, as the new ones come out. But again, those products don't add a significant amount of volume to that business.

Thank you. And I wanted to ask you about used vehicle same-store sales. There has been a number of questions here. And as I look at your used vehicle same-store sales performance, you were up 4% in the third quarter of last year, up 1% in the fourth quarter, you are up 9% in the first quarter, and then up 20% here in this past quarter, which obviously -- a pretty significant improvement acceleration and what people are asking and driving at here is, do the next few quarters until the comps get maybe more difficult, do the next few quarters look more like up 20% or do they look more like up 1% to 4%?

So Brett, this is Michael, again. We can do better than the 1% to 4%. 20% is a big number. I will tell you that there were a couple of segments, geographic segments within our Company that had unexpected growth in the second quarter. A number of the personnel changes that were made, some realignment, impacted those tremendously. But the growth in the pre-owned business is a function of inventory, how much and the breadth of the inventory, and it is also a function of concentration of how you move that product, whether you want to wholesale it or retail it. So we can maintain quite reasonable growth. I would not commit to the 20% but we can do much better than the 4%.

Okay. And then as we think about, just so I'm clear on the parts and service sales, the warranty, it sounds like what you're saying is that you had some unusually high recall activity in the second quarter. And that's going to likely slow down as we move into the third quarter. Is that correct?

That is a fair assumption. Again, as I've said many times, don't want to sound like a broken record, it is very difficult to predict recalls. We won't know them. We just -- we deal with them as they come out. And with our brand mix sometimes, there is a greater impact of recall than some other times.

Excellent. Thank you very much, gentlemen.

Ravi Shanker, Morgan Stanley.

If I can just follow up on what you said earlier about the M&A, are you seeing any signs of cracks or just openings of doors with the sellers who are more willing to sell or maybe in valuations coming down a little bit? Because it did seem that the market was pretty clogged up about a couple of months ago?

I don't know that we could go that far. I just go back to it is -- the SAR is strong. Dealerships are making a lot of money. We find it is a lot of work. It is a lot of work to find a deal that makes sense. No, they're not lining up at our door to sell by any stretch of the imagination.

Got it. So the dealer you just did was more opportunistic than open [the flood gates]?

Very much so. We have relationships with -- there are a number of stores that we are interested in. We have relationships with the potential sellers. I call it, we do a lot of lunches. And -- but these things will happen at their own pace. But we -- what we have done and here is how we think about it, we've got a capital structure that will let us do deals. It will let us do sizable deals if they present themselves. And our people out in the store are doing a phenomenal job of executing. This transaction that we closed over the weekend was a very good -- we see it as a training in part -- it's a training cycle for us. We've demonstrated that we can parachute in and convert these stores very quickly and fold them into the Asbury systems. So when the opportunity presents itself, we are very well prepared to jump all over it from both a financial perspective and an execution perspective. So when they come, when we see the right deals, we will make them happen. But we don't control the pace. That is my point. We can't force the seller. We can only be ready when a seller presents themselves.

Understood. And also on the F&I, one quarter into the CFPB rules being enforced, are you seeing any movement at all on the part of the banks to maybe change the way deals are done or is it normal service?

No that is a great question. We are seeing some changes at the banks. I would back up and say this -- we don't have a lot of visibility. In fact we have virtually no visibility into where this is going. What we do know is that we have limits or caps in place on the F&I product, and the rates that we offer to our customer, and the banks do as well. I would say this is just a gut thing. We don't have the statistics. But it does feel like the banks have become a little more, I don't know if diligent is the word, or focused, that we are seeing more caps in the stores on transactions. So it is almost as though there is some preparation that is already happening. I don't know if Michael, you have anything to add to that?

Yes, again, the banks are in an anticipation mode, and to echo what Craig said, we have very little transparency into what is going on at the government level, but I would also emphasize that it's -- we are -- as a model, the retailers are quite resilient. And that we will deal will whatever we need to deal with. We have cash in place, as Craig said. And we still function quite well with all of those caps that we have had in place for years.

So if I can clarify, the caps that the banks are putting in place are compatible with your own caps, meaning that nothing is eating into the F part of your F&I business for now? Or are you seeing some in-roads?

Every deal is unique. But so maybe I will just give you an example. You may see a bank offer a rate on a transaction, and say that -- and they will cap the spread. Here is the rate that we're willing to offer and you can't take a spread any greater than x.

Okay.

And in some cases those caps will even be tighter than our caps.

Understood. And this is still an evolving situation, so -- I wanted to [allow] -- the dealers have been saying that there hasn't been too much of an indication. You are seeing the first signs of something moving, so we will just have to wait and see how far the banks will go in terms of enforcing this?

And you're right. And like Michael said, it is a very resilient, this front-end yield is like a balloon in our mind. You can push on it in one place and it expands in another place. It is amazing to me with our front-end yield, on that $3,000 range has been there for probably five to seven years. Very steady growth but at different times it comes from different places. And if there is a shift here with the way we finance transactions, that will put pressure on us to try to find another way to try to keep that front-end yield at about $3,000 a unit.

Got it. Understood. Very helpful. Thank you very much.

Bret Jordan, BB&T Capital Markets.

A question on the tire program and maybe some color on recent trends in that program and maybe what the impact of the tire program on the service gross margin is and then the lower margin category that you see pricing changing, as you've had some success bringing customers in the door in that category?

So this is Michael. So again, from day one, the tire program was put in place as a retention tool. So our margin on the tire business is very low. It is sub 10% with just the tire sale itself. However, we have known from the tire industry and work that we've done, that for every $1 of tire that you sell, at some point in time, that customer will come back to you and spend $1.50. So we make a very small margin on the original $1 but we make 50% to 60% on the incremental $1.50 we get. So we are beginning, we don't have all the data yet, but we have studied the pilot program that we put in place, and that data, we are looking at, we're seeing customers come back at a faster rate. They are doing not just what we would call tire maintenance. They're not just coming back to get front-end alignments, although they are coming back to do that. We are seeing them come back in to have lube oil filter work done, brake work done, tune-ups, that type of nature. So it is a long-term project. Again, we will -- we have known since the beginning, we will suffer with the very small margin on the sale of the tire in anticipation of bringing the customers back in for the higher margin business on both maintenance and heavy maintenance as they come back to us.

Have you seen any change in the trajectory of tires this year? It has been a tough category for a couple of years. Do you see people accelerating their pace of purchase in 2013?

Our tire program has grown a little bit this year. We put some fairly aggressive numbers out there. We had a substantial increase in '12. We have seen an increase this year, it has not been at the same pace as we did last year. We didn't think it would be. But it has not been there. But we're not seeing a -- what I would call a tightening in that market. It is very consistent. We've had a reasonable consistent growth in that. It is a function of promotion. It is a function of awareness, point of sale material, and some marketing and advertising to that. But I've not seen a tightening on that, no.

Okay and then one last question. In your prepared remarks, you said a 1.5 times rate of loyalty for the tire program customers. Is that 1.5 times average spend or is that frequency of return?

That was frequency of return.

Okay. Thank you.

David Whitson, Morningstar Equity Research.

A couple of things. Could you first just repeat the amount available on the credit line as part of that $408 million liquidity?

On the credit line, yes, $233 million.

$233 million. And going back to the CFPB question, can you talk a bit about why -- what exactly is advantageous for the consumer here? Is it just the higher probability of getting financed than them going to the bank directly or are they also getting a lower rate or what?

This is Michael. I will take a shot at this and then Craig from there. We do indirect lending, which is the portion of the world we live in, where we provide the service for the consumer, called indirect lending. We do that as a very strong benefit to the consumer for a couple of reasons. Number one, in many cases, we can help them get a rate with a bank that they may or may not be able to get on their own. But more importantly, we can do it for them, we can help them, it is most expeditious the way that it is handled. The banks deal with it the same way. They don't have to carry the staff needed to process the initial contact with the consumer, the credit application, the stipulations, that is all handled at our level. So it is advantageous both for the banks but it is extremely advantageous for the consumer. They don't have to do the shopping as much. They don't have to go to a variety of places. We can do that for them. So we do the indirect lending part of the business as very much a consumer advantage. And again, we don't know where this will go, but right now, we do believe that we provide a substantial service to the consumer.

And I would just jump behind Michael and say if you with were to sit in a store and watch what happens today, essentially with the systems that we have in place, the consumer's application will electronically be transmitted to multiple banks. Come back on their screen, and typically within, I would say minutes, again depending on the quality of their credit scores and things, but within minutes, there could be offers from five different banks, with a loan for the consumer. So from my perspective, it creates a competitive environment that helps to get the customer, at a price that they may not be able to achieve if they're out there on their own going from one bank to the next bank to next bank, if they were willing to even pursue it that aggressively. The other thing that is beginning to happen and will continue to happen over time is this process is becoming very efficient. As the customer's information goes into the system, we are approaching the point where that information goes electronically to the banks. We are starting to get away from the big paper chase. Banks can make decisions, many of those decisions can be highly automated. In some instances, we can get an approval within a matter of minutes and be funded, certainly, within 24 hours. Now that is not across the board. But that's where the industry is going and that is going to take out costs for everyone, and not only be in our best interest, the bank's best interest, but also the consumer's best interest, to have a much more efficient system.

That's helpful. And on the accounting then, is there a brief moment at the point of sale where you guys are the lender and then you sell the loan to the bank or are you purely an intermediary?

No, we're purely an intermediary here. There is no point at which we accept that credit risk.

Okay. And switching gears. Have you given any -- or are you willing to give any guidance on maybe several years out, on what your new vehicle market share could be for the whole US industry?

No, no, we're such a small player, the consolidators as a group have less than 7% of the industry. And we're just a small part of that group. The way we look at our business is the SAR will be what it is. It's -- we know this is a cyclical industry. It moves up and down. We can't control it. Our responsibility is to make sure we're doing the best job we can as executors and capital allocators. And that's what we're focused on. We treat this business like we own it. And we run these stores as well as they can be run and we want to make sure we are very prudent in the way we allocate our shareholder's capital. And that's our game. That's all we can control.

Okay. That makes sense. Just very quickly, a little bit on commentary on why new vehicle gross margin was down 50 bps?

Yes, this is Michael again. There is a substantial amount of pressure in the mid-line import market. Again, what I would call the Camry, the Accord, the Malibu segment. There is just a lot of product, great product out there, and there is a substantial amount of push for the manufacturers' market share, which then it is felt at the dealership level and dealers are very aggressive. It is a very good time to be in the business so there's a lot of product that is being sold and with that, there sometimes comes an excessive amount of push on the sale price and we're all in the industry seeing that right now.

Okay, that's helpful. Thank you.

Well, we understand that was our last question. Just want to say thank you. We appreciate everybody's time. And thanks for being us with this morning. Take care.

Thank you. That does conclude our conference call for today. We do thank you all for your participation.