Group 1 Automotive Inc (GPI) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Group 1 Automotive second quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode. Following today’s presentation, instructions will be given for the Q&A session. If anyone needs assistance at any time during the conference, please press the star followed by the 0. As a reminder, this conference is being recorded Tuesday, August 1, 2006.

I would now like to turn the call over to Russell Johnson of Fleishman-Hilliard. Please go ahead, sir.

Thank you, Eric. Good morning, everyone, and welcome to the Group 1 Automotive 2006 second quarter conference call. As we mentioned in today’s earnings release, you may refer to slides that are posted on our investor relations website at www.group1auto.com during this call.

Before we begin, I would like to make some brief remarks about forward-looking statements and the use of non-GAAP financial measures. Except for historical information mentioned during the conference call, statements made by management of Group 1 Automotive are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve both known and unknown risks and uncertainties, which may cause the Company’s actual results in future periods to differ materially from forecasted results. Those risks include, but are not limited not, risks associated with pricing, volume and the conditions of the markets. Those and other risks are described in the Company’s filings with the Securities and Exchange Commission over the last 12 months. Copies of these filings are available from both the SEC and the Company.

In addition, certain non-GAAP financial measures, as defined under SEC rules, may be discussed on this call. As required by applicable SEC rules, the Company provides reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures on its website.

I will now turn the call over to the President and CEO of Group 1 Automotive, Earl Hesterberg.

Thank you, Russell. Good morning, everyone, and welcome to the Group 1 Automotive 2006 second quarter conference call. Joining me on the call today are John Rickel, our SVP and CFO, Randy Callison, our SVP of Operations and Corporate Development, and Wade Stubblefield, our VP and Corporate Controller.

In a minute, I’ll turn the call over to John to present our financial results. After John is finished, I’ll discuss our four-year earnings guidance and then open up the call for questions.

Overall, we’re pleased with our financial results for the second quarter. They reflect the hard work that our operations team has continued to put forth. Net income increased to $24.9 million, a 37.5% increase from the second quarter of 2005. On an EPS basis, we registered a 33.3% increase to $1.00 per diluted share.

Of particular note is our continued improvement in used vehicle gross margin. This increased to 80 BPs, while same-store used retail sales expanded 4.7% as compared to the second quarter of 2005. Our management team has remained focus on our used vehicle business and continues to drive company-wide usage of our new American Auto Exchange software.

We saw continued improvements in our SG&A expense during the second quarter. Expenses decreased 4.9% from the same period last year to $182.9 million. This resulted in a 50 BP improvement to 11.7% of revenues and a 500 BP reduction to 75.1% of gross profit year over year. This decrease was driven primarily by increases in overall gross profit, as well as lower personnel-related and advertising costs and the increased operating efficiency we realized from the initiatives we implemented this year. I’m pleased with the improvements we’ve made in these areas.

We had mixed same-store results with a 60 BP improvement in total gross margin to a 1.7% decline in total revenues. Gross margin increased 30 BPs for new vehicles to 7.3% and 90 BPs for total used vehicles to 9.8%, on 2.5% and 1.6% lower revenues, respectively. Finance and insurance revenues were down 2.4%, partially reflecting an increasing mix of import business and increased use of [inaudible] financing, while parts and service revenue increased 2.6%.

Clearly, we’re still not happy with our overall same-store sales performance for the quarter. Much of the issue is driven by falling domestic sales, consistent with overall market trends. This continues to reinforce our focus on moving on mix more towards import and luxury brands going forward. We still have some work to do, however, on improving overall same-store sales.

Turning to brand mix, during the second quarter, Toyota, Scion and Lexus brands continue to be our top sellers, accounting for more than 1/3 of total new vehicle sales, followed by Ford at 15.9%. Import and luxury brands increased to 68% of our mix during the second quarter, with domestics declining to 32%. This is a 700 BP shift from 2005, when import and luxury brands accounted for 61% and domestics 39% of unit sales.

Above all, our results show that the strategic initiatives that we announced late last year are delivering the results we anticipated. Streamlining our operating structure is helping us to work smarter and to place accountability and responsibility within our Company in the right places.

In addition to these initiatives, we continue to find opportunities that will improve our bottom line. For example, we recently completed a $287.5 million convertible debt offering. It gets us lower-cost funds to manage our business with. John will go into further detail about this later on in the call.

On the acquisition front, I’m pleased to announce that we’ve added a large Toyota/Scion dealership in Los Angeles to the Group 1 family. Acquiring our second Toyota/Scion dealership in this large import market is consistent with our strategy of focusing on import and luxury stores in growing areas of the country.

Additionally, we added a Suzuki franchise within our existing Miller Automotive cluster of dealerships in the Los Angeles suburb of Van Nuys. The estimate is that these two franchises will generate approximately $133.6 million in annual revenues. To date, we’ve added five franchises, with approximately $263.7 million in annual revenues towards our full-year $500-million target.

We also recently disposed of a Chevrolet franchise in Colorado and a Kia franchise in California. These two franchises generated $59.9 million in revenues during the trailing 12-month period. In total, we’ve disposed of 12 franchises, with $194.3 million in trailing 12-month revenues, achieving our $190-million full-year target. Although we have other dealerships we’re looking to sell, we do not anticipate closing on any further dispositions this year. We will update you if this changes materially.

Now, a quick word about inventories. Our total new vehicle inventory, as of June 30th, held a 62-day supply. We saw slight declines in our import and luxury inventory day supply; however, our domestic inventory grew to a 93-day supply from first quarter’s 91 days and 83 days at the end of the second quarter last year. This is related to our lower-than-expected sales levels for our major domestic brands during the second quarter. We are taking steps to bring our inventory more in line with our 75-day domestic target, including scaling back vehicle orders. Our supply of used vehicles at quarter end increased to 29 days, from 28 at the end of the first quarter.

I’ll now ask John to go over our financial results in more detail. John?

Thank you, Earl, and good morning, everyone. As Earl noted, second quarter net income increased 37.5% from the same period a year ago to $24.9 million, or $1.00 per diluted share, on revenues of $1.6 billion. This brings our six months results to $47.2 million, or $1.91 per diluted share, a 44.4% increase from 2005 on $3 billion of revenue.

On an overall basis, gross profits for the quarter increased 1.5% from the prior year to $243.7 million, reflecting improvements in new and used vehicles, as well as our parts and service operations. These increases, along with a 500-BP reduction as a percent of gross profit in our SG&A expenses, contributed to an 80-BP increase in our operating margin to 3.6% and a 70-BP increase in our pre-tax margin to 2.5%.

I’d like to now discuss some of our specific same-store results. New vehicle revenues decreased 2.5% on a 2.2% decline in retail unit sales, primarily reflecting continued weakness in most of the domestic brands. Specifically, our domestic new vehicle unit sales in revenue decreased approximately 15%, which we believe is consistent with the total retail sales performance by the respective manufacturers. However, increases in sales and profitability at our Toyota dealerships, along with our ability to retain more gross profit per unit from our domestic sales, resulted in a 30-BP improvement in our new vehicle gross margin to 7.3%.

Used vehicle retail revenues increased 4.7%, and total used gross margin expanded by 90 BPs to 9.8% on a 3.5% decrease in total used vehicle unit sales. Our wholesale unit sales decreased by 11.1% versus last year, which was a key factor in the total used vehicle sales decline. We continued to see our revenue from wholesale and excess for slower moving used vehicle inventory decline because we’ve been more selective in our used vehicle acquisition process and continue to retail more of the units acquired at higher margins. As we manage our entire used vehicle fleet and keep optimized overall used vehicle value, our results from wholesaling activities will fluctuate.

Parts and service revenue increased 2.6%, while gross profits increased 2% over the prior year, but our gross margin declined slightly to 54.4% as compared to Q2 2005, a slight increase from the 54.1% we saw in Q1. We saw increases in both our wholesale and customer parts and service business; however, our warranty revenue decreased, consistent with what we experienced in Q1, as we benefited in the first half of last year from some specific manufacturer quality issues that were remedied during late 2005.

Finance and insurance gross profit was 2.4% lower, and total new and used vehicle retail unit sales declined to 0.7%, resulting in gross profit per retail unit decreasing 1.7% to $929 from $945 in the prior year. This decline primarily reflects the impact of a shift in incentives from the domestic manufacturers and Toyota to more [inaudible] financing, which tends to limit our fee income.

On a consolidated basis, SG&A, as a percent of gross profit, declined 500 BP to 75.1%. The primary drivers of this decrease were changes in variable compensation pay plans and personnel reductions. In addition, we continue to see decreases in our level of advertising spent, consistent with our declining mix of domestic sales, which tend to require greater advertising support.

We also had a $2.1 million net [inaudible] to benefit from the combination of the following items: first, the business interruption insurance proceeds we recognized this quarter, and other adjustments to our loss estimates related to Hurricanes Katrina and Rita, for $6.5 million; gains on the sale of two dealerships we disposed of this quarter, $1.2 million; partially offset by severance payments totaling $1.1 million; and the net settlement cost to our lease termination in New Orleans of $4.5 million.

On a same-store basis, SG&A results improved 290 BPs as a percentage of gross profit, primarily as a result of the personnel and advertising initiatives noted above. The quarter’s same-store results were negatively impacted, however, by the $1.1 million severance charge noted above and approximately $600,000 in additional compensation expense as a result of our adoption of FAS123, the new stock compensation accounting standard. We continue to expect the full-year impact to be approximately $3 million, or about $0.10 per share, as we previously estimated.

Same-store rent expense for the quarter was $15.1 million, an increase of 9.1% over the prior year, primarily as a result of 2005’s [inaudible] transactions, worth about $900,000, and rent on facilities under construction, which under the prior accounting guidance was permitted to be capitalized, worth about $500,000.

Finally, as we discussed last quarter, we are progressing on our conversion to a full-source provider for our dealer management system software. Although we are unable to recognize the potential related exit costs until we cease using the existing software, we’ve estimated the future charge to Group 1 for exiting the contracts could be in the range of $3 to $4.5 million, with the majority of these costs likely to be incurred between now and the first quarter of 2007.

Same-store floorplan interest expense increased by $3 million for the quarter to $12.6 million. This 31.5% increase is attributable to floorplan interest rates that were approximately 206 BPs higher partially offset by average floorplan debt balances that were $60.2 million lower. Our average borrowings benefited slightly during the period from the net proceeds of our $287.5 million convertible debt offering that I’ll discuss more in a minute.

Manufacturer floorplan assistance, which we recorded as a reduction to new vehicle cost of sales as [inaudible] sales, totaled $9.3 million, proving 74.2% coverage of our total floorplan interest expense for the quarter. This level of coverage was down from 97.1% in the second quarter of 2005.

Partially offsetting our increased floorplan interest expense is a $700,000 decline in consolidated other interest expense for the quarter to $4 million. This 15.1% decline is primarily attributable to average debt balances under the Company’s acquisition line of credit that were $63 million lower than in the prior year period. Although we expect our acquisition line to remain undrawn for the balance of 2006, we will have incremental expense relating in part to our convertible notes going forward.

The Company’s effective tax rate for the quarter was 36.3%, as compared to 36.9% for 2005. Our second quarter 2006 rate benefited from adjusting our expected full year of 2006 rate from 38% to 37.1% due to a 90-BP benefit related to our ability to recognize the employment credits for retention of our employees affected by Hurricanes Katrina, Rita and Wilma and the hiring of new employees affected by Hurricane Katrina and residing in designated disaster areas. Our rate, excluding this benefit, remains at approximately 38%, an increase over the prior year, primarily due to the impact of adopting FAS123 and a change in the mix in our taxable state jurisdiction.

Now, turning to liquidity and capital structure. As a result of paying down our floorplan borrowing at June 30th, with net proceeds from our 2.25% note offering, we had $791 million of total availability under our credit facilities for floorplan financing. We can re-borrow approximately $195.3 million of this amount, and have an additional $186 million available under our syndicated credit facility to use for acquisitions, working capital and general corporate purchases. Our availability has increased $203.2 million since March 31, primarily as a result of the issuance of our convertible notes in June.

With respect to convertible notes, as you may recall, in late June we issued $287.5 million of 2.25% senior convertible notes. Our net proceeds from the offering were approximately $281 million. We used $50 million of these proceeds to repurchase 933,800 shares of our common stock at an average price of $53.54 per share. We also used $35.7 of the proceeds to purchase a convertible note hedge, which not only takes our effective conversion price of $59.43 per share to $80.31 per share for a 50% premium for our closing stock price on the day we announced the transaction, but also, on an after-tax basis, it was actually economically positive from a net cash flow perspective.

Finally, as noted earlier, the balance of approximately $195.3 million of the proceeds were used to pay down a portion of our syndicated credit facility. Since the potential dilution of varying future levels of our stock price can be difficult to explain, we’ve included in our investor presentation on the Company’s website a slide, slide number 30, depicting the potential net diluted impact upon the conversion of the notes and the convertible note hedge.

The net effect, however, is that we will experience dilution, for accounting purposes, once the conversion criteria has been reached, based on the conversion price of $59.43 per share, even though, for economic purposes, actual dilution does not incur until our share price reaches $80.31 per share. We are not permitted, for accounting purposes, to factor in the anti-dilutive nature of a lower-strike call we purchased until we actually exercise the call option.

The issuance of the convertible notes, along with the three interest rate slots we entered into in December of 2005 and January 2006, brings our current total fixed portion of our borrowings to 67.1%. As of June 30th, our total long-term debt to capitalization ratio was 40%, up from 19% at March 31, reflecting the issuance of the convertible. We continue to expect full-year 2006 capital expenditures to be about $80 million on a gross basis and about $35 million on a net basis.

For additional detail regarding our financial condition, please refer to the schedules of additional information attached to the news release, as well as the investor presentation posted on our website. With that, I’ll now turn it back over to Earl.

Thanks, John. As I mentioned earlier, our results show that we’re making real progress as we implement the strategic initiatives we announced late last year. Looking at the remainder of 2006, we are reaffirming our full-year earnings guidance of $3.40 to $3.70 per diluted share. With respect to the assumptions underlying our revised guidance, we now expect an additional 25-BP increase in interest rates during the remainder of 2006 and continue to project that the full-year negative impact of FAS123 to be approximately $0.10 per share. We are forecasting approximately 24.4 million diluted shares outstanding.

Although we believe we’ll continue to realize significant cost savings year on year, we don’t expect to attain significant improvement from our first half 2006 SG&A levels during the remainder of 2006. We expect to continue to narrow our remaining cost gap versus key benchmarks during 2007 and 2008.

Based on the selling pace of the last few months, we are reducing our industry outlook to 16.5 to 16.7 million units. While sales are still good overall, it is becoming apparent that the pace is slightly below what we experienced in 2005. Group 1’s talented management team has delivered solid YTD results, remaining focused on our objectives while executing our strategic initiatives. We will continue our implementation pace while exploring additional opportunities to reward our shareholders.

That concludes our prepared remarks. We’ll now turn the call over to the operator to begin the Q&A session.

Thank you, sir. [Operator instructions] Our first question comes from John Murphy with Merrill Lynch. Please go ahead.

Good morning, guys.

Morning, John.

Just a question on the guidance. Do you guys feel like you’re being conservative in the second half of the year? I mean, and specifically, do you believe the SG&A levels of about 76% of gross will hold tight in the second half of the year?

John, we’re assuming that’s the basic range that we’re operating under now. We don’t have any other knowledge that would indicate otherwise. The critical issues for I think all of us in this industry is the overall level of sales activity, and it’s specifically that of the traditional Detroit three, what we would call the “domestic brands.” And the industry is down a notch from last year. I think that’s been clear in the first six months data. I think we’re all anxious to see the July sales results here in the next day or two.

And the sales of the domestic brands in the second quarter were much lower than we expected. Clearly, last summer there was atypical activity with those employee purchase programs, so we all expected sales by the domestic manufacturers to be lower this summer than last summer, but the sales rates of the domestic brands was below our expectation in Q2, so we need to see something that’s going to move those domestic sales up a notch or two to get real bullish on the industry again.

So of the three factors that are sort of negative when you talk about softening sales, do you expect excess inventory, a ramp up for incentives, or just a general slow selling rate in the front end of the business – to pressure the front end of the business, or is it really all three of those factors combined and it’s unclear which way we’re going to go?

Well, the most important factor to me is the sales traffic, the retail sales traffic into the domestic brand dealerships, and you have to look at the recorded sales performance for the domestic brands – actually, all brands, but in particular the domestic brands – and look at what the real retail sales level is.

For example, in June, my recollection is – you guys can correct me if I’m wrong – Ford reported sales down 4%. Well, but if you cut it deeper – in fact, I think maybe even the Merrill Lynch report does this – the retail sales were down 10%. Well, that’s the business that comes through our dealerships. So I think when you look at those domestic brand sales for the first half of the year, and today we’re talking about the second quarter, the actual sales rates, retail sales rates for the domestic brands, are lower than that top line number that many people see in the press.

Then if you switch gears and look at the used markets, you guys are doing reasonably well there, except from what we’re hearing, that the retail used market is tough. I mean, is that a function of your increased focus on used and – really, your wholesale sales are down quite significantly, which is a good thing; I mean, is that the focus of your inventory management there?

Yes. You actually beat me to the answer. I think one of the real key factors, when you look at what’s happening in our used car business, is how many fewer units we have to take to auction now or wholesale. I mean, basically we do our wholesaling through auctions. And so that is really positive for our margins and shows we are running our business a lot better.

And yes, I think the used vehicle market is probably a little tougher than it maybe was at this time last year. I think one of the issues is that we see the shift in the used vehicle retail market similar to what you see in the new vehicle retail market, and that is to more fuel-efficient vehicles, so there’s a lot of competition to buy good fuel efficient cars or smaller SUVs, and the big SUVs continue to be a bit of a challenge. So I think that has a lot of activity in a smaller segment of the overall market, the used vehicle market, a lot of competition for Corollas, Civics, Altimas and things, both at a trade-in level and at the auctions.

And just one last one on parts and service. I mean, the margin there, the gross margin, was a little bit light relative to our expectations. What was going on there, and is it a possibility that that’s going to be cranking up in the coming quarters?

Well, I think there’s a big up side for our company in parts and service. I think our growth rate on that return is acceptable. If you look inside our numbers, our customer pay service business was up about 5%, but most of that was offset by a decline in warranty business. But I’m encouraged by a 5% increase in our customer pay portion, although I must say, as we become more an import brand company, importing luxury brand company with growing units in operation, I think we have a lot of up-side there, and that’s one of the things we’ll be pushing on in the next year or two. John wants to say something.

John, this is John Rickel. The other thing I’d say is basically it’s a bit of a mix effect on the margins. We’re basically growing both parts of the business, parts and service, but parts continues to grow slightly faster than the service, and obviously the margins are higher on the service piece of it, so just when you average those two out, you end up a little bit down on margins.

Just one last question, John. On the 2-to-1 primer, the items that net out to the $2.1 million net benefit, can you just break out of that last of four what was included in SG&A?

Those were all included.

Okay, the whole $2.1 [million]. Okay, got it. Thank you very much.

Our next question comes from Rick Nelson with Stephens, Inc. Please go ahead.

Thank you, and good morning.

Morning, Rick.

How should we be thinking about post-hurricane demand? What kind of factor in the current quarter is that event, and how should we be thinking about it compared to going forward?

Rick, I think it’s still a factor because our New Orleans market is still atypically strong, although I believe we’re starting to see a diminish in recent months, and I think it will continue to diminish. I have to say I think the previous year we’d been hit in Florida by some of those hurricanes and have enjoyed some pretty nice post-hurricane sales there, and that appears to really be behind us now. That seems to be getting back very close to pre-hurricane levels in our stores. We don’t have but four stores in Florida. But yes, I think there’s still a little bit of plus business that we enjoyed in the second quarter, particularly in New Orleans. Maybe a little bit in Houston, but primarily in New Orleans.

Is there any way to quantify how big a factor that was?

Not that I can do in my head here. I’m looking to my team. It’s awful hard. I guess we’d have to turn it back several years. But I think New Orleans has never been much more than 4 or 5% of our total sales, so I don’t know how that math works.

Yes. I mean, Rick, this is John Rickel. I mean, at the end of the day, it’s only four stores in New Orleans. It was a plus, but in the scheme of things, we don’t believe it really was material in the second quarter.

Okay. July sales are going to get reported by the manufacturers this afternoon. Any early rates in terms of what you’re seeing there?

No. I’m anxious to see them, too. I think it’s been pretty well public knowledge that that first weekend, the July 4th weekend, there was some pretty decent activity. GM had a sale that came to do some business for them and drive some traffic in the market. But I have to say that after that, I’m not really aware of anything that’s been sparking the market, other than the usual Toyota/Honda business seems to roll on Mercedes BMW, but I haven’t – I’m not aware yet of anything that’s remarkably different about July.

Okay. On inventories at a 62-day supply, could you break that down between domestic and import?

Randy Callison can do that for us.

Hello, Rick.

Hi.

The 62 days – domestic sits at 93 days, imports sits at 43 days, and luxury sits at 38 days. If you want to drill down into the domestic, the 93 day inventory, the biggest opportunity for improvement is DaimlerChrysler, which sits at 103 days, Ford is at 90 days, and General Motors is at 74 days.

And those price-for-employee programs, are they working at all?

I don’t have any evidence yet that would say that they are, but let’s see what the industry sales data is. And quite frankly, I don’t have final sales data for our stores yet. Obviously, when you close on a weekend – and yesterday the month closed on a Monday, which is basically the tail end of a weekend – a lot can happen in that last weekend, so I can’t give you any real solid, actual data, and I don’t want to just report anecdotal.

Okay. Thank you.

The next question comes from Scott Stember with Sidoti & Co. Please go ahead.

Good morning.

Morning.

I believe you gave a breakout between foreign and domestic, I believe, if I heard you correct, a 15% decline. Was that in domestic new car sales? And if you can maybe clarify that between domestic and foreign as far as comps go.

Yes, Scott, the 15% decline was on our domestic sales for the quarter.

And what were imports?

They were up, and it, obviously, varies across, but on average it was up 8%.

Okay. And you guys have been able to – obviously, you’ve done a very good job of turning things around. Most of it’s come on, obviously, cutting costs to streamline the operation. A couple of things that you mentioned on past calls – one of them is the certified pre-owned opportunity, to expand that, and also in parts and service – you brought in somebody to maybe reinvigorate that business. Could you talk about those two initiatives?

Yes. First, on the used vehicle business, we still have a lot of up-side on certified pre-owned. We have a massive range between our top-performing stores in certified pre-owned. We still only sell about 15% of our used vehicle business in certified pre-owned, and as we – right now, our top priority is to get our people managing their used vehicle business with that and using the software we’ve provided. And one of the next logical steps is to work on the mix of merchandise we sell and increasing our used vehicle sales, and I believe that certified pre-owned enables us to do that. We have some real good experience compiling that in our big Toyota store here in Houston. It has gone from selling 20 or 30 a month to 100 or more a month just in certified pre-owned Toyotas, and I think that’s indicative of what we’ve been doing in more stores.

On parts and service, let me turn it over to Randy, because our new VP of Parts and Service, Wade Hubbard, is working for Randy.

Scott, Wade got here 90 days ago. He’s been very busy during those 90 days. He’s been out visiting with stores, as he should. He’s done some very good work on working up some metrics store to store. He’s put together a counsel of our top – one each from our five regions – our [inaudible] directors. He’s really drilling down into what we historically have done and looking at the opportunities that we have and kind of rating those from top to bottom. So we’re very excited about that and think it’ll have a significant impact in the future.

So obviously, were just both of these initiatives more 2007 items?

Yes. On parts and service, I would think it would be 2007 before we would have concrete initiatives in place. I mean, Wade’s only been here a little over 90 days, I think, so although we would like things to move more quickly, parts and service is really more of a process-structural business, and one of the things we want to really capture is the units and operation growth from these import and luxury brands.

Okay. And you mentioned certain systems that you’re going to be canceling contracts with and certain fees that you would be incurring I guess through the first quarter of ’07. Could you maybe just talk about those a little more, describe that they are again, and are those fees included in your guidance for the year?

Yes. Scott, this is John Rickel. It’s basically consistent with what we talked about when we announced the strategic decision to go to ADP as the sole DMS supplier and canceling contracts with other DMS providers. The $3 to $4.5 million are those contract exit costs that we anticipate potentially incurring as we do that. Primarily, the second half of 2006 – there may be a little spillover into the first quarter. And, yes, that is in the guidance.

Okay. That’s all I have for now. Thank you.

Thank you.

The next question comes from Matthew Fassler with Goldman Sachs. Please go ahead.

Thanks a lot, and good morning.

Morning.

Couple questions. First of all, I’d just like to dig a little deeper into the deceleration in F&I same-store sales growth. If you could just give us a little more color on some of the factors that influenced it. You talked about import penetration and mix. If you could just kind of allocate I guess the deceleration to the different drivers and talk about your expectations going forward.

Matt, this is Randy.

Hi, Randy.

For the second quarter, our finance penetration, which is a major driver of our finance income, remains very strong. We came in at 70.4% penetration based on all retail units sold. Where we lost ground was in our finance income per contract. That’s actually the biggest sling between the quarters, and that’s directly attributable to the increase in subsidized financing incentives by the manufacturers. As you know, when you have a subvented rate, we get paid a flat fee, which generally is lower than our regular commissions that we earn on a fiscal finance contract.

Fair enough. And that was on the lot – that mix, in terms of vendor financing and vendor promotions, I guess, intensified from Q1.

Yes.

And your expectation for the rest of the year? Any sense as to how they’re going to come at it?

I don’t have – I mean, it depends on how they want to incent the market.

Gotcha. Fair enough. And then I guess another question, if you could just sort of recap the one-time items for us. You did it once, but if you could just line them up one more time and talk about the different pieces just as we try to ascertain what to exclude as truly a non-recurring here would be very helpful.

This is John Rickel. Let me go through the pieces. I think some of these you can debate whether or not you want to call them one-timers or not, but clearly we want to be transparent with what’s in there. With our math, $2.1 million was the positive benefit, and it was from four main items. The first was the business interruption insurance proceeds from basically hurricanes Katrina and Rita was $6.5 million. There was also a gain on sales of two dealerships that we disposed of in the quarter. That was $1.2 million, and then the partial offsets for severance payments of $1.1 million, and then the net settlement cost of our lease termination in New Orleans of $4.5 million.

Gotcha. Just a couple of follow-ups to that. From the business interruption insurance perspectives, the payouts are done and you’re now fully caught up?

Basically. There is probably a little bit more spillover into third quarter. These are obviously very complex claims. A lot of negotiations with the insurance companies as to whether it’s wind or water, and there are various deductibles that go with that, so there’s still a little bit of tail that potentially spills into third quarter, but by and large, yes, this has got the majority of it done.

And from the severance perspective, I guess that that’s kind of tied into the cost rationalization. Are you basically through that, those changes as well?

Yes. Most of that relates to rationalizing our management structure. And, no, I don’t think we’re finished with that yet.

So there could be – you’d have some recurrence in those charges going forward.

That’s correct.

Understood. And then finally, you do continue to make progress on your SG&A relative to gross margin, and you talked about your comp plans. If you could just talk about sort of the traction that that’s getting in the field. That seems to have taken hold quite nicely, but just the degree to which your sales force and your people out in the field have adapted to it and are moving forward with it.

Well, I’d have to say – this is Earl. Sorry, I should identify myself when I speak, although you probably know my voice by now. I’ve been told it’s distinctive. But, yes, one of the most pleasant surprises I’ve had is how our field team and our operations team – how quickly they implemented a lot of the rationalization and really started to eliminate waste and increase efficiency. The first quarter was a pleasant surprise to me how quickly we got the best part of 500 BPs out of that key cost area and how they’ve maintained it. And this is not – we have done this without changing radically the way we handle the front-line salespeople. This is mostly management structure and how we operate.

And one of the challenges in operating a large organization, particularly a public company, is getting the people to think of the money as their own money and really to work for the shareholders and everybody that the shareholders [inaudible]. It has been wonderful how our people have taken to that.

Great.

They’re driving it. I mean, they’re driving it for us, so it’s really been a key to what we’ve accomplished this year.

Terrific. Thank you very much.

Our next question comes from Rich Kwas with Wachovia Securities. Please go ahead.

Hi, good morning.

Morning, Rich.

I wanted to ask about SG&A from here on out, just not necessarily this year, but as we look at ’07 and beyond. With the mix shift going away from trucks and you probably getting less profit per vehicle potentially as the mix shifts, do you still think you have a 150- to 200-BP opportunity over the next couple of years from kind of current levels SG&A gross profit?

Yes, Rich. This is Earl. That’s a good point, and I know all of you know more about the automobile basis than I do, so [inaudible] been a 300 BP shift from trucks to cars in the industry in the first half of the year. At least, that’s the JB Powers number through the end of June. And quite frankly, I think our shift from truck to cars has been a little more than that, maybe closer to 400 BPs, so we’ve been able to actually expand our gross margins on vehicles during that kind of headwind.

But I think we all know that that makes it even more important for us to operate a lien structure as we move forward, so I don’t know that we’ll be satisfied in stopping when we get the next 100, 150, 200 BPs across. I think it’s quite possible we may have to go beyond that. But the way that we’re trying to approach it in our company is one bite at a time. I’ve been real happy with that first big bite the team took this year, but it’s not the last bite, and we know that there’s a lot more we can get, and we will get it, but it’s going to take time, and it’s most likely that the next significant reduction really won’t occur until next year, because as you know, most of our personnel cost structure gets locked in from year to year in terms of day plans and so forth.

Okay. And so even with kind of we’re assuming just a greater passenger car mix, you’re still comfortable that you can reduce costs or maximize your [inaudible] SG&A costs and lower that ratio?

Absolutely. I think we have to, Rich, and I should talk about the other side of the equation, because I don’t want people to get the impression that the lynchpin of our prosperity is reduced in the level of pay of our people. What we need to do is grow this business, because the real key metric we all look at is our SG&A cost as a percentage of our gross profit, so that’s why we need to grow this company, and that’s why the increasing import and luxury brand business is so important to us. We’re adding another big Toyota store this week. Disposing of the under-performing stores is very important to us. So we have to push the overall gross profit line just as hard we work the cost lines, and we frequently talk too much about cost and not enough about increasing our gross profit.

And then on the used vehicle software, could you just give us an update of where you are with that with training and adoption rates?

Yes, Rich. We do have American Auto Exchange in every store now, and every store is very focused on improving their utilization of that software. We’re benchmarking store to store. We do some of that here from corporate; some of it occurs in the field. It will be a process that will occur over a long period of time. But we are getting better.

And then just, Earl, your comments on lowering the full-year sales here to 16.5 to 16.7. I guess were you looking – do you think there’s any upside to that, or do you think that’s pretty firm? Just given your comments earlier, it sounds like you’re pretty comfortable with that given where we are with domestic sales right now.

Yes. Unfortunately, Rich, I think that is, from what I know now, the most accurate number I could put on it. I’ve been disappointed. I’ve been waiting for a number of months for the domestic branch to attack the market more, and yes, we’ve seen some activity, although a lot of it is not really attacking the market; a lot of it is addressing inventory imbalances that the manufacturers created. But I had really thought that there would be a lot more aggressiveness come summer, starting in, say, May, and I just haven’t seen it.

I just haven’t seen anything move the market, and although we’re certainly moving our company quicker than I expected – although some of that’s been unintentional – to a heavier import and luxury brand concentration, we’re still 32% domestic business, and I would just like to see a higher level of domestic brand retail – not fleet, retail business, and it just hasn’t come. That’s the main thought process we’ve had with that industry projection, Rich.

And finally, John, the conversion to ADP, the $3 to $4.5 million, is that incorporating – when you talked about 76% or somewhere around there for the rest of the year on SG&A to gross profit, is that included in that when you’re talking in that context?

No, Rich. The 76% is kind of the run rate. Obviously, the $3 to $4.5 [million] that I answered previously is in the guidance, but I would, for your modeling purposes, put kind of 76% on SG&A and then the $3 to $4.5 [million] on top of that.

Okay. Great. Thank you.

Our next question comes from Matt Nemer with Thomas Weisel Partners. Please go ahead.

Morning, everyone.

Morning, Matt.

The first question is on the – can you comment on the regional performance that you saw? It sounds like the Northeast has been pretty weak, but I’m expecting that Texas was strong. I’m just wondering what you were seeing.

Well, generally I can comment, although I have to say that primarily the performance is more brand-driven than region-driven. Texas and New Orleans continue to be strong, but beyond that, it’s more a function of where our domestic brands are located. For example, in the Southeast, we’re heavy domestic brands, so our performance in the Southeast, outside of New Orleans, hasn’t been what it was a year ago, for example. The Northeast region, while the economy may not be so strong, is where – we’re almost all import up there, so our business isn’t that bad. So it’s pretty much more an issue of brand with us than it is region right now, other than what I pointed out.

Okay. And then on the wholesale gross profit, that actually came in a little bit lower than what we were thinking given the rollout of the Auto Exchange software. Is there something that we’re missing there?

This is John, Matt. It’s basically, I think, a function of how we’re utilizing the software. I actually look at it as a bit of a positive, that with the reduction in units that we’re sending to auction, we’re doing a better job of retaining the good units for our own retail sales, and we saw that in higher retail numbers for us. So I think it’s just basically a function of utilizing the tools, keeping the good units and actually retailing them, which is what we want to do going forward.

Got it. That makes a lot of sense. And then turning to S&I, I guess what I’m wondering is do you see this as a temporary move down, or do you think this is more of a permanent shift driven by the move against loan markups and maybe even an increase in lease penetration?

Matt, it’s probably described as a movement within a band. As the manufacturers bring out subvented programs, that drives your S&I down a bit. But also, remember there are two parts to the gross profit on a car deal: there’s the back-end gross and front-end gross, so to a degree you pick up front-end gross when you have a decline in back-end gross. But it’s definitely not a permanent change.

And are those finance contracts or leases? I mean, is that a bought deal, or what are you seeing in the mix of leased versus financed?

Leasing has been increasing all year. This is Earl. And so I think that’s true across the industry, maybe a little bit more in import and luxury brands. But we’ve seen leasing for some time now moving back up to higher levels in the industry. We’ve seen that in the stores, as well.

Okay. Thanks very much.

The next question comes from Jonathan Steinmetz with Morgan Stanley. Please go ahead.

Great, thanks. Good morning, everyone.

Morning, Jonathan.

A few questions. A lot of it’s been covered. On the same-store SG&A walk, the slide 12 that you provided, a couple of questions on the personnel, the $5.8 million reduction. Is the $1.1 million severance included in that? Therefore, if I back it out, it would actually be more of a benefit. And then within that, Earl, how much of this is related to sort of lower management compensation in aggregate versus sort of at the store level on the salesperson or general manager’s side?

Well, first of all, yes, it was included in the number. That was an answer to your first question. So, yes, it would have looked even more favorable had it not been in there. And most of this is the rationalization of going from 15 field managers or 13 field management points to 5, and so it’s just an overall management cost structure, and because in addition to those 15 or 13 platform leaders we had prior to the shift we also had duplicative human resources people, payroll structures, in some cases facility management, finance teams and so forth. So the majority of this is above the dealership level.

Okay. And you talked about inventory at the D3 level being high. Can you talk about which specific product segments you think your inventory is heavy on? I mean, is it fair to think you have a few too many domestic pickups and large SUVs and that kind of thing lying around?

Yes, I believe that’s directionally correct, although I don’t have the data in front of me, Jonathan. For example, our experience is the Ford car business isn’t so bad, the Fusions, the Mustangs and so forth, but F-series is not what it was last year, and the SUV challenges have been well chronicled. I think we found the same thing with Dodge trucks, for example. GM may be a little different because of the new SUVs. There’s some strength in sales rates and grosses on the General Motors SUVs. But as Randy mentioned, our inventory levels, relatively speaking, are lower on GM than they are on the other two domestic brands. So directionally, it is the truck/SUV issue, other than with the possible exception of General Motors SUVs.

Okay, great. Thank you.

The next question comes from Jordan Hymowitz with Philadelphia Financial. Please go ahead.

Hey, guys. Most of my questions have also been answered. Just a couple. The $2.1 million G&A benefit on a net basis, that’s about $0.05, so would it be fair to say you’re run rate in the quarter is about $0.95?

This is John Rickel. All else being equal, directionally, yes. You could argue that some of the VI money actually covered expenses that you had in the quarter, so you can – I guess the data piece of it, but overall I’d say that’s probably fair.

Okay. Second, you have a $0.20 benefit from the convert deal you just did. It was announced on the deal. How much of that will be offset, do you think, by rising floorplan interest cost, so to speak? In other words, what do you think the net benefit of that will be? Is $0.10 too optimistic?

Well, remember, the $0.20 was kind of a full 12-month period, and we only did it in June, so you’ve got to —

Right. I mean, going forward. I don’t mean this quarter.

Yes. Clearly, there is a bit of offset from rising rates. I don’t know that we’ve actually quantified that, because it depends on kind of where your perspective is on rates. But, yes, you would have a partial offset from further rising rates.

Okay. And on the $13 million in the quarter, do you have a forecast for what the year’s number will be on floorplan interest? I mean, would it be fair to assume that the number will probably be closer to $14 or $15 [million] in the next two quarters?

This is John Rickel again. Once again, we’ve got a couple of moving pieces. One, we’ve obviously got substantially lower balances right now because we’ve paid down with the proceeds from the convertible. That’s one of the reasons we were excited about the deal. We think it really sets us up in the proper positioning in a rising-rate environment. And at the same time, we have indicated in the guidance that we’re projecting for another 25-point BP increase in rates, which would partially offset those benefits, so net I would expect certainly for next quarter that full-plan interest expense should be down because of the benefit of the convertible.

Okay. And final question, you said 150 BPs in G&A would be your goal from the 76 level here. Is that 150 BPs over the next three years? Over the next year? What’s the timeframe on that?

I think it needs to be a shorter timeframe. This is Earl. I think it needs to be in the next one to two years.

Okay, so maybe by the end of next year?

That should be our goal.

Okay. Thank you very much.

You’re welcome.

Our next question comes from Greg Wilcox with Wachovia Securities. Please go ahead.

I had two quick questions. One, on your mix of imports to D3, where do you see that heading in ’07 relative to ’06 given that you’ve kind of met your dispositions for this year?

This is Earl. That’s a good question. A year ago, and for the last year, we’ve publicly disclosed that our goal was to move from what was closer to 60/40 import and luxury and domestic to 70/30, and quite frankly, we thought it would take us at least three years to get there, and partially because of the deteriorating retail performance of some of the domestic brands, we’ve gotten very close to 70/30 within about a year.

And also, obviously, we’re working acquisitions in import and luxury brands, and most of our – many of our dispositions have been domestic brands. Our target now is to take it to 75% import and luxury and 25% domestic. And how long that will take us – I don’t know that I want to get into timeframes now, since I missed the last one so badly. But that, again, if you look at [inaudible] biding our time, that’s our next goal. We’re continuing to stick with our $500 million – at least $500 million in annualized revenues and acquisitions this year, and clearly those would be targeted towards the luxury brands, so I think now our goal is 75/25.

Okay, great. And my other question was just on inventories at the D3. How did incentives fare in July relative to last year, and how do you see things maybe turning out in August and into the rest of the year?

Well, as I mentioned earlier, I just don’t have any data on July yet. It would be very, very good indication if we did see some increased retail sales levels for the D3, but we’ll wait and get our store data and the industry store data. But unfortunately, I just don’t see anything that’s sparking the market like we had last summer, so I don’t have any significant optimism for the D3. However, I’m very optimistic about these import brands – Toyota, Honda, and we see a very, very good second half for Nissan.

We under-performed in the first quarter with our Nissan stores. We’ve put a lot of effort into them in the second quarter. In fact, we had a tremendous May, and then we were hit with this Altima sales issue, which hurt Nissan nationally, but I think in the second quarter Nissan sales nationally were down 9.7% and our Nissan sales were just slightly up, not even 1% up, but we very much outperformed Nissan in the second quarter, which is something we intended to do. Now, it didn’t help our same-store sales performance, because I think we’re up .3% on Nissan, but we have some relatively good momentum in our Nissan stores, and I believe in the second half – there’s quite a bit new Nissan product – new Altima, new Versa, new Sentra, new Maxima and so forth. So we’re very optimistic about the import and luxury portion of the portfolio in the second half. There’s nothing negative in that part of the business.

Okay, thanks. Good luck.

I’m showing no additional questions in the queue. Please continue with your presentation.

Okay. Well, thanks to everyone for joining us on the conference call today. We really appreciate that. We look forward to updating you on our continued progress on our third quarter earnings call, which is currently scheduled for October 31st. Thank you.

Ladies and gentlemen, this does conclude the Group 1 Automotive second quarter 2006 earnings conference call. You may now disconnect, and thank you for using AT&T Teleconferencing.