Asbury Automotive Group Inc (ABG) 2015 Q4 法說會逐字稿

Good day and welcome to the Asbury Automotive Group Q4 year-end 2015 earnings call. Today's conference is being recorded. At this time I'd like to turn conference over to Mr. Matt Pettoni. Please go ahead.

Thanks, operator. And good morning, everyone. Welcome to Asbury Automotive Group's fourth-quarter 2015 earnings call. Today's call is being recorded and will be available for replay later today. The press release detailing Asbury's fourth-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 Chief Executive Officer; David Hult, our Executive Vice President and Chief Operating Officer; and Keith Style, our Senior Vice President and Chief Financial Officer. At the conclusion of our remarks, we will open the call up for questions and I will be available later for any follow-up questions you might have.

Before we begin, I must remind you that the discussion during the call today is 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 2014, 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 CEO, Craig Monaghan. Craig?

Good morning, everyone. We are pleased to announce another record quarter. We delivered adjusted earnings per share of $1.31, a 22% increase from last year's quarter. The fourth quarter caps off a solid year for Asbury. Let me touch on a few records we set in 2015.

We grew revenue to $6.6 billion. We retailed over 188,000 vehicles. We generated over $300 million in income from operations. We achieved an operating margin of 4.6%. And we delivered adjusted earnings per share of $5.57.

In addition, we invested for the future by deploying over $100 million in land and buildings, including a four-store realignment in Georgia which enables us to launch an open point in 2016. And, finally, we repatriated over $300 million to our shareholders and reduced our share count by 13%.

Despite all these achievements there's growing concern across the industry regarding margins on new and used vehicles. As a Company, we began to experience margin erosion early in 2015. As the year progressed, this pressure continued and had a material impact on our fourth-quarter results.

As always, we will continue to seek opportunities to become a stronger and more efficient company. We will continue to focus on growth opportunities in used vehicles, F&I, and parts and service. For 2016 we are planning our business for a low to mid $17 million SAAR. Going forward will continue to execute our two-part strategy -- driving operational excellence and deploying capital to its highest returns.

Now I'll turn the call over to Keith to bring us through our financial highlights. Keith?

Thanks, Craig, and good morning, everyone. This morning we reported record fourth-quarter adjusted EPS from continuing operations of $1.31. This represents a 22% increase from last year.

Income from continuing operations for the fourth quarter of 2015 was adjusted for a $13.5 million pretax gain on divestitures, or $0.34 per diluted share. Income from continuing operations for the fourth quarter of 2014 was adjusted for a $31.9 million pretax loss on extinguishment of long-term debt, or $0.66 per diluted share.

During the quarter we experienced a favorable tax rate of 37.2% compared to 39% in the fourth quarter of 2014. For the full year of 2015 our effective tax rate, adjusted for items disclosed earlier this year, was 38.3%. Going forward we expect our effective income tax rate will be between 38% and 39%.

For the quarter, same-store revenue increased 7% and same-store gross increased 4%. The declines in new and used vehicle margins during the quarter puts pressure on our cost structure, resulting in a 50 basis point increase in SG&A as a percent of gross profit to 70.5%.

For the year SG&A as a percent of gross profit came in at 68.8%. However, for 2016 planning purposes we believe it will be more appropriate to utilize our SG&A ratio over the second half of 2015, which approximated 70%. Obviously, this ratio will fluctuate quarter to quarter based on seasonality of the business and our ability to generate gross profit in each reporting period.

In terms of capital deployment, for the full year of 2015 CapEx totaled $72 million. Our expenditures included $54 million associated with our core annual CapEx plan and $18 million on recent renovations of recent acquisitions and construction which enabled us to move out of leased facilities. In addition, this year we spent $30 million for property purchases in anticipation of future dealership relocations.

For 2016 we are planning for $80 million of CapEx, which includes $45 million associated with our core annual CapEx plan and $35 million of CapEx associated with acquisition renovations and construction, which will enable us to move out of leased facilities. In addition, we will continue to seek opportunities to purchase real estate currently under lease and acquire properties in connection with future dealership relocations.

With respect to divestiture activity during the quarter we sold the four franchises, representing approximately $120 million of annual revenue. This resulted in a $13.5 million pretax gain and approximately $30 million of cash proceeds. This was part of the strategic realignment with one of our manufacturing partners and enabled us to reallocate the capital to higher returns.

Turning to share repurchases, during the quarter we returned $44 million to our shareholders through share repurchases of approximately 571,000 shares. For the full year of 2015 we reduced our share count by 13%. And at its meeting last week the Board reestablished our share repurchase authorization to a total of $300 million.

During the quarter we issued $200 million of additional debt by adding onto our 6% senior subordinated note due 2024. The effective rate of the add-on was approximately 5.25%. After this issue issuance we ended the quarter with total leverage just under 3 times.

The bond add-on improved our liquidity position, with the majority of the proceeds being Vested in our floor plan offset accounts and used to pay down our used vehicle line. From a liquidity perspective we ended the quarter with $3 million in cash, $137 million available on floor plan offset accounts, $88 million available on our used vehicle line, and $165 million available on our revolving line of credit. Going forward we are committed to remaining within our targeted leverage range of 2.5 to 3 times, and we will continue to deploy capital on an opportunistic basis.

Now I will hand the call over to David to discuss our operational performance. David?

Thanks, Keith.

In an increasingly competitive market, during the fourth quarter we increased total revenue 9%, grew total income from operations 6%, and delivered an operating margin of 4.2%. For the balance of my remarks I would like to remind you that everything I will be covering with respect to operational highlights will pertain to same-store retail performance compared to last year's fourth quarter.

New vehicle revenue increased 6% and our new vehicle unit volume increased 5%. Our new vehicle gross profit declined 4% due to a 60 basis point drop in our new vehicle margins to 5.5%.

We have been experiencing margin pressure since early 2015. The pressure began mainly in mid-line import brands which were primarily impacted by a shift in consumer preference from cars to trucks and lower gas prices. The shift continued into the second half of the year and spread to both domestic and luxury brands. The demand shift has resulted in a buildup of sedan inventory. We believe that until supply and demand are balanced we will continue to experience margin pressure.

We ended the fourth quarter with 739 million of new vehicle inventory, or a 62-day supply on a trailing 30-day basis. Though our overall inventory levels are in line, our car-truck mix is not where we would like it to be.

Turning to used vehicles, retail unit volumes increased 4%, and retail gross profit declined 3% due to a 70 basis point drop in our used vehicle margins to 7.5%. We believe we can maintain used vehicle margins at these levels. Our used vehicle day supply is 30 days, which is at the lower end of our targeted range of 30 to 35 days.

Turning to F&I, our fourth-quarter F&I revenue grew 9%. F&I per vehicle retail for the quarter was $1,426, up $55. The lending environment remains favorable.

Turning to parts and service, in the fourth quarter our parts and service revenue grew 7% and gross profit also grew 7%. This was driven by a 5% increase in customer pay gross profit, 12% increase in reconditioning gross profit, and an 8% increase in warranty gross profit. Our parts and service margin remained essentially flat at 61.9%. For the next year we believe we can continue to grow our parts and service gross profit in the mid single-digit range.

Finally, we would like to express our appreciation to all of our teammates in the field and in our support center who continue to produce best-in-class performance in many areas. Our Company continues to deliver record results and this is a direct reflection of your passion and dedication. Again, thank you.

We will now turn the call over to the operator and take your questions. Operator?

(Operator Instructions)

Rick Nelson, Stephens Inc.

Thanks, guys. Nice results. A question about the margin erosion. It seems to be the hot button in the sector. It spilled over to domestic vehicles this quarter. Can you comment there?

And how long you think it is going to work through the sedan inventory to really right-size and get the inventory more in line with what the customer wants, the trucks, SUVs and crossovers?

Rick, this is David. I will take the first shot at that. I think as it relates to the domestic, in the fourth quarter there was some of our OEM partners that shifted their incentive programs to more volume-based. We chased some volume numbers. I don't think that will continue into 2016. You never know what they are going to do with incentives but we made the most of it with our volume in the fourth quarter.

How about getting sedan inventory reduced and beefing up used trucks, SUVs and crossovers? Do you think these pressures are going to linger for the first half? Do they go beyond that?

We hear from our OEM partners that they are shifting production more to truck from car. From our perspective, we have a wide array of vehicles.

Our days supply in cars in some models can be over 100 days, and in some cases with our trucks we could be under 30 days. We're getting closer to balance but we are not in an ideal situation yet.

To go back to [terrors], if you can talk about the strategy there, and is there more of that to come? It sounds like you've got some nice gains on those dispositions and freed up some capital to redeploy.

Yes, Rick, it is Craig. That's exactly what had happened in this case. Like Keith mentioned, we are working with one of our manufacturing partners who has a philosophy of trying to cluster. They have numerous franchises in more of a concentrated area. In this case we divested of some franchises where we didn't have that kind of a presence and are actually expanding our footprint. It is here in Georgia where we will have more of a concentrated presence.

We think it is a very attractive market for us. It is our home. And we think we're going were going to be able to generate some pretty attractive ROIs on this group of assets going forward. So, it is a good trade from a shareholders' perspective.

Thanks for that, Craig. I would also like to ask about Q auto. You've been at it now for a while. If you can share any of the economics and the growth plans there.

Rick, Q had a loss, $0.02 in this quarter. It had been losing somewhere in that $0.01 to $0.02 range, so we are right where we thought we would be. I would say it continues to be something that we feel very good about. It is a laboratory, and we shouldn't kid ourselves, we continue to learn.

We've been changing some of our marketing efforts at Q. We've co-branded one of the stores with the local regional name. But I think we need some more time. I think this is the year for Q, 2016, where our internal objective is get it to the point where those stores are generating an attractive ROI.

There's three stores. One of the stores is doing much better than the other two at this point. Our larger format store is actually the store that's giving us the most challenge,. But we think there still an opportunity there and it's something we're going to continue to pursue.

Great. Thanks a lot and good luck.

Brett Hoselton, KeyBanc Capital.

Good morning everyone. This is actually Irina Hodakovsky on for Brett Hoselton. How are you? I wanted to ask you a little bit about the Toyota announcement recently. You have a sizable exposure to that brand. There are supply disruptions that some are saying, from the Toyota themselves, that there may be larger and worse disruptions than the 2011 earthquake. Anything you can give us in terms of expectations there and how we should anticipate the flow of product from Toyota?

Irina, this is David. We haven't heard that from our partners yet. We are anticipating some delays but certainly not to that magnitude at this point.

Thank you very much. Any news on the Takata announcement. They increased the number of airbags. Toyota also issued a statement to its retailers in terms of liability. Anything you can give us on that?

The Takata airbag issue has been out there for a while. They've certainly increased it recently with the actuators. It's affected Honda, as well. We anticipate that that will probably be a 45-day to 60-day issue before we get the parts and we can start replacing them.

Thank you very much. Great job.

Bill Armstrong, CL King & Associates.

Good morning, gentlemen. Just going back to the gross margin pressure on the domestic brands, you mentioned that some of the OEMs had put in some volume-based incentives and you don't think this will continue. Have they already been discontinued, these particular incentive programs, or is that something that you expect to happen in the near future?

What we are seeing right now it is more in line with what we've seen in the past. I would say it has stabilized and not what we saw in the fourth quarter.

Okay. And then, conversely, on the mid-line imports, obviously that's where you saw most of the gross margin pressure through the first nine months of the year. The year-over-year decline in the fourth quarter was actually pretty small. Anything to call out there? Are we maybe finding a floor, perhaps, in margins on the mid-line imports?

It certainly feels that way. I also think their car and truck is getting more into line, as well. We all do better with truck than we do with car. That helps.

Got it. Okay, thank you.

Steve Dyer, Craig-Hallum.

Thanks, good morning, guys. When you look at the off-lease vehicles you expect to have coming back this year obviously a lot more than last year, how do you see that playing into things, new and used margins?

We see it as a good opportunity. Most of them will be CPO vehicles for us. They will come mainly over a six-month period. We look at that as an opportunity for us.

Okay. Then as you look at acquisitions, obviously private sellers tend to get the news or adjust their valuation expectations probably later than the stock market does. What are you seeing out there in terms of valuations? And with your stock down this much, where does the focus on capital allocation look to you to be directed?

Steve, it is Craig. You made the right point. With our stock trading where it is today buying our stores via share repurchase becomes a pretty attractive option.

You are right, sellers typically are looking at selling their stores off of a trailing 12-month earnings, and typically are looking at where evaluations have been over the past 12 to 24 months. What I'd just come back to is, in this environment where our stock's now trading DVD but on multiples that are lower than we've seen in quite some time, buying our own stores seems like a pretty attractive alternative at this point.

That doesn't mean we don't talk to people. We are still talking to potential sellers. But the bogey for us is, it always starts with what investment opportunities do we have within the existing stores. Then there's share repurchase, sets a hurdle. If we can beat those hurdles with acquisitions we will go after them. But right now that's a tough hurdle to beat.

Is there any consideration in terms of looking at acquisitions to balance the mix a little bit with domestic, more truck, SUV business? Does that change the way you think about multiple or not?

Absolutely. The last three acquisitions we've done have all been very sizable Ford stores. The domestics have been trading at a discount to the other franchises in the market. Those were very attractive. And we were able to purchase those stores at significant discounts to where we traded, so those acquisitions made sense.

But since that time, our multiples have come off substantially. It causes us to pause when we think about whether or not we'd chase an acquisition versus buying our own stores. But we will be opportunistic, like you said. If we find transactions that make sense we will go after them.

We've got an infrastructure in place here that we are very happy with. We integrate acquisitions very quickly. We've got a centralized back-office shared-service environment that enables us to bring synergies. So, acquisitions when the price is right make sense and they are always of interest to us.

Got it. All right, thanks, guys.

Michael Montani, Evercore.

Hey, guys, good morning. Just a housekeeping question and then a few strategic ones. One was, I don't know if you've shared in the past, but could you break out the split that you have today between SUV, truck and sedan?

As far as our sales or inventories?

The sales that you would have now.

Sales is roughly 50/50.

Okay, in terms of unit split. Then, if I could, on sub prime, what would the penetration be both for the new side as well as the retail used?

Overall, subprime represents about 10% of our business.

Okay, great. One follow-up -- on the used margin side it sounded like there's some view that perhaps those are stabilizing a bit, but then also there's potential pressure from the off-lease vehicles to ASPs. So, can you just help us to understand the outlook there as we move through the rest of this year and what could give conviction that maybe we are getting some stability on those margins?

Maybe I could start with that because I think we need to put it in perspective. We are essentially traders. We are trying to only hold those vehicles for 30 to 35 days. And if we can turn them quickly, where the broader market goes with respect to pricing is not that big of a concern to us. The game for us is to get the car, get it reconditioned, get it back on the front line and move it quickly. In some cases it means getting it to the right store.

But if the entire market is moving up and down reasonably slowly or on its normal seasonal trends, where those prices go are less important to us than it is our ability to turn it quickly. So, I would just put that perspective in place first.

And then beyond that is if there's additional product coming to market, that can obviously create supply and demand pressure, but it also can create an opportunity for us to see a more attractive car than we might see otherwise. I don't know, David, if you've got anything to add.

No, I agree. These are all going to be CPO cars, for the most part, for us. That's a good value proposition for our customers and a good opportunity for us.

Okay. If I could, a quick one for Keith, which is just on the interest line item between floor plan and other interest -- had a decent spike there, and obviously you guys had an issuance there. So, I get that. But just moving forward, is there anything you can share? How should we think about those interest line items moving forward?

Yes, obviously we are caring the additional $200 million of bond so that's going to increase our interest expense. Matt can work with you offline to make sure you have that accurately reflected.

As far as floor plan, we do have a little bump in rate here. Our inventories on a dollar basis are up a little bit, so there will be a little more carry in floor plan. In addition, I know you're aware of this, Mike, but we park a lot of our available cash in our floor plan offset accounts. Our ability to do that over time depends on our cash balances, so that also will have an impact going forward. So, that's something you will have to model in over the coming year, as well.

Okay, thank you. The last one I had was just in terms of the expense management side, AutoNation had mentioned the desire to cut back a little bit on advertising spend in an effort to better manage that for the environment. I'm wondering how you guys think about the trade-off between market share versus expense management, and just how to think about that given the GPU environment that we are in today.

Mike, that's a great question. I'd start that question off and say that our philosophy has always been one of continuous improvement and cost discipline. I would argue that that's reflected in our margins. We try to run a lean shop. The environment that we are in today, where we've got this margin pressure and we will double down again and we will go back and look at every dollar we spend on advertising, we'll look for every opportunity we can find to be more efficient in everything we do.

But then again, like we said earlier, we think we are on a path to sell somewhere close to 17.5 million cars this year. That means that we're going to have to have the manpower to do that and the systems in place, everything else that we need to do so.

I wouldn't say that we are sitting here, by any means, getting ready to initiate a major restructuring or a major slash in our advertising spend. We will be disciplined with it. You will see it continue to shift to more of a digital spend. But I don't think you should expect any major shift in the way we go to market with our brands and our product.

Great. Thank you guys, and good luck.

Rod Lache, Deutsche Bank.

Good morning guys. It's actually Mike Levin on for Rob. I just wanted to follow up again on -- I know these are recurring questions here -- but when you are talking about continued margin pressure, do you see the year-over-year declines staying in this same magnitude we saw in the fourth quarter, at least through the first half of 2016? Or are we talking about more stabilization at these levels?

Mike, it is Craig. Let me start and maybe David or Keith wants to jump in. I think we would argue that fundamentally our margins are a function of supply and demand.

Right now there's tremendous demand for what we classify as trucks, there's less demand for cars, and that's causing this pressure. Until that supply and demand balance is corrected we believe we will continue to see the kind of pressures that we are seeing today.

I think once we come into more of a balance, I think there's a chance for these margins to possibly even recover, but that could be a quarter or two a way. Now we are getting into the bigger issues of what's the state of the global economy, the housing market, employment, production levels, et cetera. It is a lot bigger than us. We don't have a crystal ball that allows us to see that far into the future, so what we do is we just keep our noses to the grindstone and try to control the things that we can influence.

Got it. On the used cars coming off lease and in trade-ins, my concern is maybe less on the volume coming back in but more the mix. Two, three, four years ago, the mix was much more shifted towards cars. So, the used vehicles you are going to see coming back on trades and off lease are probably skewed more towards cars that the current demand environment could possibly support. Is that going to exacerbate any mix problems you might have in terms of used margins from here?

This is David. I would say you are directionally correct. I would look back and say we've been seeing that for a while.

We are taking in a lot of cars now, more cars than trucks, and we are having to turn them. And you've seen a little bit of pressure on our margins because of it. It is pretty much why we said we're going to maintain those levels because we don't see that shifting much in the near future, the mix.

Okay, thanks for your help, guys.

James Albertine, Stifel.

Great. Thanks for taking the question and good morning, everyone. It's been about six or seven months since the Honda announcement they were going to cap their discretionary markup on dealers. And we just saw Toyota settle with the CFPB and DOJ this week. Any insight in the last few months of Honda carrying this out, and considerations we should think about with Toyota now jumping in?

Let me start with that and, again, maybe someday else wants to hop in behind me. We are still learning exactly what the Toyota plan is in detail. We understand it broadly. I would say at this very peliminary level I don't think it is a whole lot different -- it's going to mean a whole lot to us, I'll put it that way.

We've managed through the changes we saw at Honda. Obviously there have been changes with Ally and some of the other lenders in the marketplace. We are talking about caps that are in the 125 basis point range. In some instances there can be fees that are passed to the dealers, or there can be below the line opportunities for the dealers to make additional money.

But we've managed through what we've seen so far, I think well. I think it is reflected an our F&I PBRs, that we've managed it well. And I think we will manage through this Toyota situation in the same manner.

Craig, I appreciate that, it is very helpful. If I may ask another housekeeping item, and just in the spirit I might as well ask a margin question since everybody else has. Domestic, I would say based on what we saw last week from your peer, and their domestic operating income was actually quite impressive, I think in general people were feeling like premium luxury might have been the issue this quarter. So, to see your margins on domestic come in as much is they did was interesting.

I know your overall mix of SUVs and trucks versus sedans is sort of 50/50. Is there something funky about your markets on the domestic side where you might be over-indexed to Fusions and Malibus versus F-150s and Silverados?

No. This is David. I would not say that, James. I would say we don't have as many domestic stores in major metros like our peers do, the one you are specifically mentioning.

And I think we went into the quarter not knowing what other issues we may or may not have as the month goes and how that can impact the business. And you start this quarter off aggressively chasing the volume as best you can. We didn't hit the weather and we probably were more aggressive than we needed to be.

James, I would just follow it up, I think in the fourth quarter, particularly, there were some incentive programs that encouraged us to make sure that we were getting some volume. As a result, like you see, we did, we got the volume. Maybe we got a little too aggressive and it had an impact on our margins.

I appreciate that additional color. And then one last one -- we are living through the shift in sentiment, as you all are. I think, again, with your peers' announcement at the beginning of January, we heard you guys at the industry conference in Detroit. And we've seen some lenders come out, in fact, and say that there's some ramping and delinquencies and some tightening on the, if you will, subprime side of the market.

I just want to understand. If we need to build in, just for the sake of argument, build in a recession scenario, I think you are a much better company and your peers are much better companies than they were last time we went into recession. How should we think about the sensitization as you go into -- if we do go into a recession -- what areas should work, what areas should fall off, and how much?

Maybe the right way to ask this question is, for a 10% decline in SAAR, what kind of EPS growth can you show? Or what happens to your bottom line in that environment now? Because it feels like you are a lot stronger of a company.

James, we are clearly a much stronger company than we were the last time around. You can see it in our balance sheet. Let me start with maybe the balance sheet and try to help answer your question. Last time around we quickly found ourselves looking at leverage that was well beyond 5 times. We did not really have much cash.

Today we sit here with, our total leverage is at 3 times and, like Keith mentioned, we've got a very strong balance sheet and a lot of liquidity that we could put to use. In addition to that I think we have far fewer leases that could potentially burn us in a downturn scenario.

We're getting to the point where the vast majority of our properties are owned. I think the concern about covenants today in a downturn is considerably less than any concerns we would have had then, so I will take that chapter, if you would, and put it away.

Then when you look at the operating side of the business, again I think we've built a lot of efficiencies in. We've got a better control environment. Keith and his team have done a good job on our shared services. We have much better visibility into what's happening in the business. And I think we are much more efficient about how we process these transactions to the back end of these stores.

So, then you get to the core side of the business. As you know, our cost structure is highly variable. Essentially everybody in the store is paid on some type of variable compensation, whether it is a commission on a salesperson or it's piece work in parts and service.

So, if you are in an environment where the SAAR drops and the activity level in the store drops, our costs tend to drop, as well. They may not drop immediately on a one-for-one basis but those costs will drop. And we saw about last time around. Again, I think we feel pretty good about where we are.

The question about how would you model and 1 million SAAR decline or 2 million or 3 million, I might leave that to you and Matt Pettoni to talk about. But you've got to make a lot of assumptions other than just what's happening with the SAAR. You've got to make some assumptions about what's happening in used. Our view is that used tends to hold up a little better than new.

You've got to make assumptions about how hard parts and service would fall, over what period of time, over what duration. Parts and service tends to be pretty stable. Last time around we saw some decline as the recession got very deep. But if you had more of a mild recession I don't know that you'd see much of a decline at all.

You've got to make your interest rate assumptions, as well. So, there's a lot to it but I'd sum it up and say we are in a helluva lot better position today than we were last time around.

I know it was a super broad question and I wasn't looking for a specific EPS trigger or anything but I really appreciate that color. It is incredibly helpful. And best of luck in the first quarter.

John Murphy, Bank of America.

Good morning, guys. Most of my questions have been answered but I do have one last one. And I think this is important on the gross margin. It seems like everything we're seeing right now is a function of mix and balances that are creating some excess inventory in luxury on the car side. That's largely understandable.

But I think there's a lot of concern that there might be some actions that are being taken by automakers to pressure your margins at the expense of them getting better pricing realized to them. I'm just curious, are you seeing any change in your relationship with the automakers or the way they're delivering inventory or the way you deal with pricing to them or with them? Because that seems to be the big concern, that something has changed here.

I think a lot of automakers hear what you are saying, and I very much agree with it, that there's a lot of leverage you can pull to offset the pressure on new vehicle grosses. So, they may view the world as you guys are doing just fine, you're going to find other ways to make money, so they can pull some of these grosses back and put it in their pocket. So, I'm just curious if you are seeing any change in the relationship or the way you deal with them?

John, the manufacturers are probably, without question, our most important partners. We're in this together. We have very good relationships. We work hard to maintain those relationships. And I think that's the most important part.

I will go back to what I said earlier. I think fundamentally this margin pressure is a function of supply and demand. If we don't have the right product on the lot, those inventories will build. We will work to try to move them off the lot. We will take hits, as we've seen in this quarter. But we're in it together.

One thing I would say is that incentives have become very complex. We are not in the old world where it was if you sold a vehicle there was $300 on the trunk. There's a lot more to it now.

Those incentives are structured in such a way, I think, to encourage us to be better operators. And I'm not sure that's all bad. So, bottom line, I think, just fundamentally, if we can get the supply and demand balance right, I think as an industry we will all be in good shape and we will continue to roll forward.

Okay. And then, just lastly, on floor plan assistance, have there been any change in terms, either shortening or lengthening or padding of floor plan assistance to help out with the car inventory?

No, John -- this is Keith -- we are not seeing any changes in the normal processes.

Okay, great. Thank you very much.

Paresh Jain, Morgan Stanley

Good morning, everyone. Just a couple of broader industrial level questions. First, on the credit environment, and loan terms in particular, we've seen that loan terms have expanded quite a bit in recent years, and it seems like they will keep on expanding. It's obviously helping volumes today but is there anything about that trend that worries you and the dealer community in general?

Paresh, this is David. Naturally we would like to keep the customer on the shortest cycle we can to see them back again purchasing other cars. WIth the low interest rates and the simple interest loans, most people are okay. And even though the loans are longer in length you still have a trade cycle where people are not far off what it has been in the past.

Got it. And then a follow-up on the blended GPUs. They are still close to record levels -- and I'm including F&I in this, as well. So, despite the decline in new and used, you see them quite high, especially when you compare with pre-recession levels. So, some of this decline in used and new is obviously cyclical factors that play in a very fragmented market. But are dealers also getting used to higher F&I contribution that is driving some of this aggression with new and used GPUs?

I think you are talking about the number we call total deal.

Yes.

Essentially which is, for everybody who is not familiar with it, it's the gross that we make on new, used and F&I. That number -- we had some pressure this quarter, that number was down. But it has been, I would say, relatively stable, if not improving, like you said, over the last 10 years.

What we've done -- as an industry, not just us -- we've been able to generate incremental F&I PVR to offset some of the long-term pressure that we've seen on both new and used margins. And it is roughly $3,000 a car. That seems like a number that the industry depends on in order to generate the returns it needs on the capital that's tied up in these car stores. And I would expect, as an industry, that's the kind of a number that we will continue to see as we go forward. Fundamentally, that's what justifies the investment in the dirt and the stores that make this whole thing work.

Understood, thank you.

David Whiston, Morningstar Equity.

Thanks, good morning. A question for you on in particular premium luxury sedans. Keep hearing about how there's a lot of -- obviously the inventory issue. But I'm also concerned -- is there a consumer confidence problem with the typical E-Class 7 series, F-Class customer? Are they just not feeling confident to buy that type of vehicle or lease that that type of vehicle right now?

David, I will start and then I think David Hult might have more to add. I think there's a broader issue that's happening here. If we were to got back 12 to 24 months a lot of these premium luxury vehicles were difficult for us to get.

A lot of production was down to China and some of the other developing countries. You don't have go back very far. We were being scrutinized as an industry to make sure that inventory from the United States wasn't leaking out and ending up in China.

The world has changed. There are very few inventory shortages now in the premium luxury side. Vehicles that we had a difficult time getting supply for are now readily available, not only in our store but in the stores of our competitors, and that has pressured margins. I think that may have more to do with the margin pressure than anything else. David might have different view. David?

The only thing I would add is, the only thing that's changed over the years is the luxury brands have brought a lot more entry vehicles into the market, which skews their overall margin because these are lower-end margin vehicles and they're more in volume. Those will certainly play a role in it.

And, naturally, there's the repressing. The E-Class is coming out. We are in a society where we are refreshing cars faster than we ever have. The consumers demand it. I just think it is the balance of the new models and the timing.

Okay. Over to Q auto, Craig, you've said several times that 2016, this is the year for it. But in the unlikely event that we do have a recession -- and I'm not expecting that but just in the unlikely event things got a lot worse very quickly, would you be willing to give Q auto more time beyond 2016?

I think we need to see where we are with Q auto. I can tell you that one of the things we have learned at Q auto is we do a fair amount -- the majority of the vehicles that we are selling in Q auto are subprime. If that came under tremendous pressure we would have to see exactly what it did to those stores.

Like I said earlier, it is very intriguing. What we're doing with some of our digital advertising at Q is really having some interesting impacts. We don't have a lot of capital tied up, so especially in the two, if you would, smaller format stores, it makes it easier for us to get to the point where we can get a decent ROI.

I would put it this way, we are not going to walk way from it if we think we are close to hitting that magic breakeven point. And I think it is going to boil down to our ability to get an incremental or 25 or 50 cars sold in a given store. And that's what we are very much focused on.

That's helpful, thanks. Since you mentioned the prime business area, can you describe the lending environment for those customers? It's still no problem getting them financed?

We have not seen any issues whatsoever.

Okay, thanks, guys.

Brett Hoselton, KeyBanc.

Thank you. This is Irina Hodakovsky again. Thank you for taking another one of my questions. Can you tell us a little bit about developments in Texas, how that market is doing relative to the rest of the country? Is there any sequential slow down or decline in that market?

Texas represents about 10% to 15% of our business, and we are starting to see some headwinds in Texas.

Can you speak to the magnitude of that slowdown?

It is minimal at this point.

Thank you very much.

Irina, I would just add that we only have one store in Houston so this impact that David is talking about is an impact that we are seeing in Dallas. But, like David said, there's some impact. It is undeniable. We will just have to see where it goes

Got it. Thank you very much.

You're most welcome. That concludes today's discussions. We appreciate all the questions. We think these are great questions. We're glad we had an opportunity to talk to you about the business, where we've been, where we are going. And we look forward to talking to you again at the end of the quarter. Take care.

This concludes your teleconference today. Thank you for your participation. You may now disconnect.