Group 1 Automotive Inc (GPI) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thanks for holding and welcome to the Group 1 Automotive Incorporated 2009 third quarter financial results conference call.

Please be advised that this call is being recorded. I would now like to turn the call over to Pete DeLongchamp, Group 1's Vice President of Manufacture Relations and Public Affairs. Please go ahead.

Thank you, Kevin, and good morning, everyone, and welcome to today's 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 to risks associated with pricing, volume, and the conditions of markets. Those and other risks are described in the Company's filings with the SEC over the past 12 months. Copies of these filings are also 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.

On the call today is Earl Hesterberg, our President and Chief Executive Officer; John Rickel, our Senior Vice President and Chief Financial Officer; Lance Parker, our Vice President and Corporate Controller.

I will now hand the call over to Earl.

Thank you, Pete. And good morning, everyone.

Before I ask John to provide details on Group 1's financial results, I would like to provide you with my perspective on what transpired during the third quarter. Our third quarter results were driven by a combination of our cost-cutting efforts over the past 12 months, which were amplified by a substantial gross profit lift in August from the cash-for-clunkers program. Surprisingly, a majority of the customers that bought vehicles from us under the program had strong FICO scores; and many paid cash for the balance of the new vehicle purchased.

These were conservative individuals that probably would not have been in the market near term, but could not pass up the great value represented by the government's offer. Given that many of the sales under the program were to these customers, we do not believe that an overwhelming percentage of these sales were near term pull ahead.

To that point, according to J.D. Powers, the September SAAR came in at $9.3 million; which was only down about 3% from the three month's average prior to the program's launch. We're not seeing any significant change in retail traffic so far in October, and our current projections put the SAAR at 10 million to 10.2 million units for the year.

We also saw that many of the customers who came into our stored had vehicles that did not qualify for the program. We were still able to put many of these customers into either a new or used vehicle, confirming that the slower sales levels for most of this year have been more a function of lack of traffic instead of a credit issue. In addition, we have found that whenever there are incentives offered on new vehicles by manufacturers, lenders, or in this case the government; we're typically able to retain more margin.

We were also able to retain manager because our inventories were already in good shape going into the quarter. As a result, our same store new vehicle gross margin grew from 5.8% in the second quarter to 6.7% this quarter. Even with the uplift to sales the cars program provided, it was not enough to improve sales to last year's level. New vehicle revenues fell 16% on 11% fewer units from the prior year period. As I indicated earlier, we were able to put some of the customers whose vehicles did not qualify for the cars program into used vehicles, resulting in sequential growth of 3% in unit sales from the second quarter.

Same store used vehicle retail revenues were down 1.3% from the same period a year-ago; while margins held relatively flat from the second quarter and prior year periods. Although the 10.3% same store retail margin is within our normal expected range, we did continue to see some pressure as we were forced to replenish inventory with higher cost vehicles from auction.

Remember the boost from the cars programs sales did not provide us with any used vehicle sourcing benefit; as all the trades under that program were required to be scrapped. We did benefit again this quarter from strong wholesale auction pricing with our average used wholesale unit generating a $153 profit. While we were pleased to achieve this result, we believe it's a function of the present strength of the wholesale market and more normalized results are closer to break even.

Our parts and service business continued to remain stable in the third quarter. Same-store revenues were relatively flat compared to the prior year period, but increased from the second quarter. Margins were up both sequentially and compared to the 2008 third quarter results to 53.7%.

Finance and insurance same store revenues fell 19% as retail unit sales decreased 9% and the cars program hampered finance penetration rates. As I mentioned earlier, many of the cars customers paid cash impacting finance penetration rates, resulting in same store gross profit of $955 per retail unit, which was down from $1,073 in the prior year.

As previously announced, we expect selling, general and administrative costs to be $120 million lower than they were in 2008. Based on our projected $10 million to $10.2 million SAAR level. We're on target to realize this goal with expenses $113 million lower on a year-to-date basis than they were at this time last year.

It's anticipated that 25% or $30 million of these cuts will be permanent. The remaining 75% will be split with 30% directly tied to sales levels and the remaining 45% related to items like headcount and other semi-variable expenses that will come back on a more gradual basis. I, again, want to thank you everyone in the organization for the contributions they have made and are continuing to make to help us achieve this goal.

The other key point that was demonstrated during the quarter, was the benefit of all the restructuring actions to leverage the business. With the significant cost reductions we have made, any sales increase has an immediate and noticeable benefit. To put that in context, the last time Group 1 earned over $0.70 in a quarter was in the second quarter of 2008 when the annual industry sales rate was running at nearly a 15 million unit pace.

Now let's look at inventory and brand mix. It's no surprise that the cars program significantly reduced inventory across the country, especially in mid-line import brands. On the second quarter call, we told you that we had a 55-day supply of new vehicles in total with a reasonable balance across all brands. At the end of the third quarter, our inventory was at a 44-day supply in total, with our import inventory at 36 days or about 10 days below target.

Inventories were also down in the luxury and domestic brands, but to a lesser degree. On an absolute dollar basis, our inventory was down $76 million from the second quarter to $299 million. That equates to a total inventory of 9,000 units at quarter-end. To put this in perspective, we had 22,000 units in stock at the end of the 2008 third quarter.

We anticipate replenishing our inventory back to a 60-day supply in November, but are being conservative with our ordering to prevent getting too heavy as we head into the lighter selling winter months. We continue to run our used vehicle inventory at a lean level of a 29-day supply, as sourcing vehicles profitably continues to be challenging in this environment.

The cars program also caused a temporary shift in our brand mix during the quarter, pushing sales to smaller, full efficient vehicles under $45,000. Mid-line import sales grew 560 basis points from the prior year period, accounting for 62% of unit sales. While luxury sales fell about three percentage points to 23%. In total, import and luxury brands grew to account for 85% of our new vehicle unit sales while domestic branded sales fell slightly, contributing the remaining 15%.

Our car/truck mix was also impacted by the cars program during the quarter, shifting our sales mix away from trucks. Cars accounted for 62% of our unit sales for the quarter. Looking at our top-selling brands. Our Group 1's new vehicle unit sales, our top selling brands were Toyota, Scion and Lexus at 39%; Nissan Infinity, 14%; Honda Acura, 12%; and BMW, which contributed 9% to the new vehicle unit sales. The remaining new vehicle sales included Ford with 8%; Mercedes-Benz, 5%; and Chrysler and GM unit sales of 4% and 3% respectively.

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

Thank you, Earl. And good morning, everyone.

For the third quarter of 2009, our adjusted net income from continuing operations was $16.8 million or $0.71 per diluted share; which excluded the following: a $461,000 non-cash after tax impairment charge primarily related to one of our real estate holdings; a $393,000 after tax gain on the repurchase of 5 million of our 2.25 convertible notes; and a $1.6 million income tax benefit resulting from an election that we made in the current quarter, allowing us to reduce the income tax liability that we'd previously provided.

On a comparable basis, adjusted net income from continuing operations increased 105.2% or $8.6 million from $8.2 million in the third quarter of 2008. Our results for the third quarter of 2009 were positively impacted by our continued progress towards cost saving target of $120 million. For the third quarter, we reduced SG&A expense by $26.7 million from the same period a year-ago. Our consolidated personnel-related expenses declined $14.2 million in the third quarter of 2009; while our advertising expense decreased $5.3 million compared to 2008.

Other SG&A expenses decreased $7.7 million, primarily related to reductions in both vehicle delivery expenses and outside services. On a year-to-date basis, we have reduced our SG&A by $112.8, reflecting the cumulative impact of our recent cost savings initiatives. As a reminder, we begin implementing our expense reduction initiatives during the third quarter of 2008 in response to signs that economy was slowing.

As business worsened following the Lehman bankruptcy on September 15th, we increase and further accelerated our cost-cutting efforts in the fourth quarter of 2008. As such, we're unlikely to realize comparable expense reductions for the fourth quarter of 2009; but based on our results to date we remain comfortable that we'll achieve our 2009 SG&A savings target of $120 million.

In addition, the U.S. government sponsored cars program also had a positive effect on our third quarter results. We sold 4,874 new vehicles under the cars program; and at this point, have collected on all amounts owed under the program. Although the cars program did provide a 30-day increase in sales, this was not enough to bring the full quarter back to last year's levels. Compared to the same period a year-ago, revenues from each of our business lines declined in the third quarter of 2009, resulting in a consolidated revenue decline of $187.3 million or 13.1% to $1.2 billion.

Our new vehicle sales decreased $149.6 million or 17% on 12.6% less new retail units. Our retail used vehicle revenues declined $7.7 million or 2.9% on 5.9% fewer retail units; and our wholesale used vehicle business decreased $15.5 million on 11% less units. Revenues from our finance and insurance business decreased $9.1 million, primarily reflecting the impact of lower new and used retail volumes. Finally, our parts and service business declined $5.3 million or 2.8% in the third quarter of 2009 compared to 2008.

Our consolidated gross margin for the third quarter of 2009 increased 100 basis points to 17% on the back of margin improvements in our new, used and parts and service business lines; as well as the continued shift in revenue mix toward our higher margin parts and service business. New vehicle margins improved 40 basis points in the third quarter of 2009 to 6.7%, while total used vehicle margins increased 80 basis points to 9.2%. And parts and service margins improved 50 basis points to 53.7%.

Within the total used vehicle results, used retail margins were down 30 basis points to 10.3% and used wholesale margins improved 460 basis points to 3%. Despite the fact that our consolidated gross profit declined $77.6 million or 7.7%; our SG&A expense as a percent of gross profit, improved 580 basis points from 82.4% in the third quarter of 2008 to 76.6% in 2009. Compared to the second quarter of 2009, our third quarter SG&A expense as a percent of gross profit, improved 250 basis points.

Consolidated floor plan interest expense declined $3.7 million or 33% in the third quarter of 2009 to $7.5 million as compared with the same period a year-ago; primarily reflecting a $425.3 million reduction in weighted average floor plan borrowings. Other interest expense decreased $1.9 million or 20.5% to $7.3 million for the third quarter of 2009. As consistent with our priority to strengthen our balance sheet, we reduced our weighted average borrowings of other debt by $106.9 million.

The decline in weighted average borrowings primarily reflects the cumulative buybacks of 104.7 million of our 2.25 convertible notes executed since the fourth quarter of 2008; as well as a $15 million reduction in our acquisition line borrowings from September 30, 2008. For the third quarter of 2009, our consolidated interest expense included $1.1 million of additional non-cash interest expense related to APB 14-1. As a reminder, our covenant calculations exclude the impact of the change in accounting as a result of APB 14-1.

Manufacturer's interest assistance, which we record as a reduction of new vehicle cost of sales at the time the vehicles are sold covered 76.7% of total flow plan interest expense for the third quarter of 2009, up from 65.7% in the third quarter a year-ago primarily as a result of reduced inventory levels and faster inventory turns.

Now turning to same store results. In the third quarter, we had revenues of $1.2 billion which was an 11.8% decline from the same period 2008. Consistent with our consolidated results, the positive impact of the cars program was unable to fully offset the weaker economic environment. Even with the lift provided by the cars program, the overall SAAR rate for the third quarter ran at $11.4 million, compared with $12.9 million in the third quarter of 2008.

Overall, our same store new vehicle unit sales decreased in each of the major brands that we represent, resulting in a unit sales decline of 11.4% in the third quarter. Because the cars program encouraged purchases of smaller and more full efficient vehicles, our new car sales were done only 2.6% while new truck sales declined 22.7%.

We also saw our average new vehicle selling price decline to $29,057 from $30,628 a year-ago, as smaller cars represented a larger portion of sales this quarter. In aggregate, our same store new vehicle revenues decline $137.7 million or 15.9% in the third quarter of 2009. Generally, we believe that our new vehicle results are at least consistent with the retail performance of the brands that we represent in the markets that we serve.

Same-store revenue dipped 1.3% in our retail used vehicle business to $254.7 million in the third quarter of 2009 on 4.2% less units. Our same store wholesale used vehicle revenues were down $14.6 million or 25.3% compared with the same period a year-ago. The cars program is responsible for a portion of the decline in our wholesale used vehicle business since the vehicles we took in on trade under the program were required to be destroyed and sold for scrap value. Some of these vehicles would have otherwise been sold as wholesale units.

In addition, our same store wholesale used vehicle revenues declined as we continued to do a better job selecting units. Our same store parts and service revenue dipped less than 1% in the third quarter of 2009 as a slight uptick in our customer pay parts and service business; and a 4.8% increase in our collision revenues was offset by a 5.5% decrease in wholesale part sales and a 2.4% decline in our warranty parts and service revenues.

Our same store F&I revenues were down $8.7 million or 18.9% in the third quarter of this year compared to the same period a year-ago. This decline generally reflects the decreases in new and used vehicle sales volumes, as well as lower penetration rates and lower amounts financed. As Earl mentioned, the cars program negatively impacted our finance penetration rate since it attracted a higher mix of cash customers.

In addition, it skewed our vehicle mix to less expensive, small cars which negatively impacted amounts financed. Overall, our F&I for retail unit declined from 1,073 to 955. In the aggregate, our same store gross margin improved 100 basis points to 17% reflecting an improvement in each of our business segments; as well as a favorable shift in our same store business mix to the more profitable parts and service business segment.

On the new vehicle side of the business, gross margin expanded 30 basis points to 6.7% as the combination of stronger demand and lower inventory levels improved the pricing environment. Total same store used vehicle margins improved 80 basis points from 8.4% in the third quarter of 2008 to 9.2% in 2009. Within the total used vehicle business, same store used retail margin declined 30 basis points to 10.3%; while used wholesale margins improved 420 basis points in the third quarter of 2009 to 3%.

Our total same store gross profit for used unit improved $113 to $1,222 in the third quarter of 2009; reflecting improvements of $3 per unit in our retail gross profit and $228 per unit in our wholesale gross profit. Our same store parts and service margin increased 40 basis points to 53.7%, reflecting a shift in the mix of our parts and service business towards the more profitable customer pay parts and service and collision segments.

As I mentioned earlier, we implemented substantial cost-savings initiatives over the last few months of 2008 and the first few months of 2009. We continue to realize the benefit from these actions in the third quarter of 2009; and as a result, our same store SG&A expenses declined $23.8 million or 12.8% to $162 million. Substantial progress we have made in expense reductions this year, was more than enough to offset the decline in same store gross profit that we experienced in third quarter; and as a result, same store SG&A as a percent of gross profit improved 560 basis points to 76.4%.

Now turning to liquidity and capital structure. We have generated $100.7 million of cash flow from operations on an adjusted basis during the first nine months of 2009. As a result, we had $14.9 million of cash on hand as of September 30, 2009. In addition to our cash on hand, we use our floor plan offset account to temporarily invest excess cash. These funds totalled $71 million, bringing total immediately available funds to a total of $85.9 million at quarter-end. Further, we had an additional $146.9 million available on our acquisition line. As such, our total liquidity at September 30, 2009 was $232.8 million.

During the third quarter, we used the cash generated and available to repurchase another 5 million of our 2.25 convertible notes; and to pay off the remaining $30 million that was outstanding on our acquisition line as of June 30, 2009. In total for 2009, we have reduced our non-floor plan related debt by $112.4 million.

As a reminder about our capital structure, we do not have any near term liquidity pressures. We face no significant debt refinancing decision until March 2012 when our revolving credit and real estate facilities expire. Further, our 8.25 senior subordinated notes mature in 2013 and our 2.25 convertible notes are first putable in 2016. We have updated financial covenant calculations within each of our debt agreements; and as of September 30, 2009, we were in compliance with all such covenants. In fact, due to our positive operating results in the third quarter, all of our covenant ratios improved from the previous quarter.

With regards to our real estate investment portfolio, we own $383.3 million of land and buildings at September 30, 2009, which represents approximately 35% of our total real estate. To finance these holdings we have utilized our mortgage facility and executed borrowings under other real estate specific debt agreements. As of September 30, 2009, we had borrowing outstanding of $190 million through our mortgage facility with $45 million available for future borrowings.

With regards to our capital expenditures for the third quarter, we used $2.4 million to construct new facilities, purchase equipment and improve existing facilities; bringing our total capital expenditures for the year to $11.7 million. We continue to critically evaluate all planned future capital spending working closely with our manufacturer partners to maximize the return on our investments and anticipate that our 2009 capital spending will be approximately $20 million. For additional detail regarding our financial conditions, including specifics regarding our covenant calculations; 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 back over to Earl.

Thanks, John.

Before I get into our key modeling assumptions and guidance for the balance of 2009, I want to talk a bit about how we see the industry moving over the next several months. Although the new vehicle inventory availability will support fourth quarter sales better than late August and September, there is still no evidence of significantly improved consumer spending. Therefore, we're not expecting appreciably higher traffic and sales levels in November and December.

Like most companies in our industry, we do expect a gradual improvement in the industry sales in 2010; and feel we're well-situated to benefit from any increase in sales levels. Now the revised key assumptions for 2009 modeling purposes, are an industry seasonally adjusted annual sales rate of 10 million to 10.2 million vehicles. A total year-over-year reduction in SG&A expenses of $120 million at projected SAAR levels. A tax rate of 38%; estimated average diluted shares outstanding of 23.4 million; and capital expenditures of approximately $20 million.

Fourth quarter same-store assumptions: our new vehicle margins of 6.0% to 6.5%, used vehicle retail margins of 10.0% to 10.5%; used vehicle wholesale margins at about breakeven; flat parts and service revenues; finance and insurance gross profit at $925 to $950 per retail unit. Using these assumptions, we're revising our 2009 full-year guidance to a range of $1.66 to $1.76 per diluted share. This range includes the effect of APB 14-1 and excludes any future acquisitions or dispositions with our potential exit charges as well as any potential one-time items.

That concludes our prepared remarks. In a moment we'll open the call up for Q&A.

I will now turn the call over to the operator to begin the question-and-answer session. Operator?

Thank you very much. (Operator Instructions)

First up, we'll go to Matt Fassler, Goldman Sachs.

Thanks a lot, and good morning. I did not expect to be first here.

Two questions--I guess three questions, if I could. First of all, Earl, if you could give us a little more color on how you think the new car margin story plays out here, and to the extent that they are taking a bit of a step back; is that a function of the unusually robust margins associated with the clunkers program?

Yes. I think it's two factors, Matt. One is inventories are building again. Vehicles have been coming back into the market in the last month or so, and they will again over the next month or two. So inventories are coming back to a more normalized level, and we're heading into slower selling months, November and particularly the first three weeks of December tend to be some of the more challenging times of the year, even in a good market. So I think it's just those two factors.

Got it.

Second question, what is your thought process on expenses? You kind of spelled out the gross margin and some of the other metrics and sales metrics, of course, for the fourth quarter; but can you just give us some color on your expense assumptions, and whether we should be cautious about drawing conclusions from what you were able to do in Q3 with the volume that the clunkers program put through?

Yes. I think our expense reduce rate clearly is going to slow down because primarily we got so much expense out beginning in the fourth quarter last year. And there was that windfall of gross profit in August that even as the market strengthens, isn't going to be replicated, I wouldn't think, until next spring or later than that. So I think the combination of those two factors is going to start to diminish the expense leverage; but we're starting to run a much leaner organization; so our goal is to keep it lean and continue to look for more costs; and we always know there's always more cost.

Got it.

Sorry about that Earl. And then finally, it sounds like you are guiding to acceleration in the fourth quarter from the pre-promotion levels. What do you think it takes to get traffic back to more traditional levels? You suggested the credit was not the barrier, perhaps it had been? So what needs to happen for the consumer here to start getting the SAAR back to its levels.

Well, we all know it's consumer confidence, but none of us really know what the main factors are that get the consumer confident; and clearly things like unemployment and there is still some issues in the housing market, although we seem to seen more positive data on that all the time. I look at things like Wal-Mart and what their level of business is. That is really America, and when those people are only buying necessities, then we're probably not back in a robust car buying market.

So I would watch what middle America does. I think Christmas shopping will also be a good indicator. I think there is a lot of anticipation about how the Christmas shopping season is going to go and that is really upon us. So I think we'll be able to see some clues as to what our likelihood of getting a significant uplift in car traffic when we see how people buy their Christmas gifts and their day-to-day necessities; and start to buy some non-necessity items again, electronics and things like that. So I'm waiting for that too. I believe we're all optimistic, but I just think the speed of the recovery is what is in doubt.

Got it. Thank you so much.

Next up is John Murphy, Banc of America-Merrill Lynch.

Good morning, guys.

Good morning, John.

Maybe a follow-up to Matt's question on what gets sales going. It sounds like also credit availability, what we have heard from a lot of dealers is a bit of an issue. I know you guys have commented it's not too big a wait on demand, but I'm just wondering what you're seeing loan-to-value ratios in the loans that you are originating at your dealerships? Is there anything changed there, better or worse?

No. They're still significantly more conservative than they would have been a year-ago. I don't think they really affect our sales volume. I think they affect our F&I performance to a certain degree. We just don't have enough room in the deal to sell some of the vehicle service contracts or things like that. It's just tougher to structure a deal; and also puts a little pressure on grosses sometimes. The last few hundred dollars that don't get financed sometimes come out off our gross margin.

So I just think that continues to make it a little challenging on our gross--new vehicle gross profit, used vehicle gross profit and F&I. We have been dealing with the situation now for the best part of a year; and that is the new reality, but it hasn't really changed much and I certainly wouldn't look for it to change much in the fourth quarter.

Got it.

And if we think about the fourth quarter as far as mix goes, obviously you had a much higher mix of cars in the third quarter than you traditionally would. Will the mix shift back towards trucks help offset some of the cash-for-clunker margin boosts fading away? I mean, how do you think about mix going into the fourth quarter? Is there going to be a big positive or nothing much to talk about there?

I would say there is a slight positive. There's a definite shift back toward trucks; and of course, we have a lot of Texas/Oklahoma business, so it's already moving back toward trucks. 62% cars is--for our company is atypically high; and we should be several percentage points back toward the truck side, I would think, in the fourth quarter.

Also, in the pricing environment from two perspectives. First on new. Are you seeing any new aggressive incentives or is there still relative the restraint there? And then second, on used. What are you seeing on used prices through October; and do you still see strength there on the used side?

There is some aggressive incentives in place; in particular, Toyota is very aggressive in the fourth quarter. Haven't really seen a lot of result from that yet, just because the inventories were so low for Toyota coming into October. But Toyota is very aggressive in the market. And I expect--in fact, even in the last couple of the days I think Nissan has announced some actions at least in some markets. So I expect that is going to heat up, actually, over the next two months.

Problem being is that it's not a traditionally big selling season in November; but I certainly don't think there is any lack of aggressiveness at the moment by the manufacturers. And the used vehicle question is an interesting one, because in the last couple of weeks we have seen the markets start to turn at the auctions.

And you expect that in the winter or going into the winter season anyway, but I would also have to say that we have had an unprecedented run up with month after month of improving book values, guidebook values for used vehicles. That is changing. The used car market is slowing down, certainly in terms of of value.

Not a big surprise; but, again, we have had a little tailwind with--we had a little over $150 a unit wholesale profit in Q3; and as we look back, we know that is not typical. So we're going to have to deal with the little shift in the used-car values, I think, coming into the winter also.

Okay.

Lastly just on guidance, if we think about the fourth quarter. The way that you are thinking about the SAAR would imply a low 10 million unit SAAR for the fourth quarter, which sounds reasonable. That would equate to about a 2.4, 2.5 million unit actual number, not seasonalized or anything, but an actual 2.4 or 2.5; which is not too far off where you were in the second quarter.

So if we look at the second quarter being in the ballpark of $0.40 and upper end of your guidance only implying $0.41, it doesn't seem like there was a lot of progress made at least in the way that you are thinking about the guidance right now from the second quarter to the fourth quarter. Is this just a conservative outlook, or do you really think that this is realistic? And are there any levers that you might pull potentially in addition, to what you have done already on the cost side? Is there anything else you can do?

Well, there is always more we can do, John.

I think the major factors are the windfall we got from cash-for-clunkers, which I think was both margin and volume. But also it was a little bit of a used vehicle tailwind, because our used vehicle sales shouldn't have been that strong. John has made a lot of attempts to try to quantify the benefit that we got from the cash-for-clunkers, and it's awful hard to do because the tentacles get into used vehicles and pre-delivery expense, and things like that. But I think there was at least a $0.15 tailwind we got from cash-for-clunkers.

And when you look at seasonality in a softer used-car market, particularly, some pressure on wholesale profits that--and the seasonality of the fourth quarter, I think our guidance is still--we'll still have to work to hit our guidance. I think we'll still have to perform at a strong level. We're only projecting about $7 million more of SG&A reduction on an absolute basis, but that is just a function of when we began our cost-cutting 15 months ago or so.

Thank you very much.

And we'll hear next from Scott Stember at Sidoti and Company.

Morning.

Could you flesh out the parts and service just a little bit more? What was the slight increase in customer pay that you referred to?

The customer pay was up on a same store basis just about a half a percentage point. I believe it was 0.4,, but our margins were up in customer pay a couple percent. Our warranty was down about 2.5%. Our wholesale parts were down about 5.5%; and our body shop on same store was up around 5%. So the parts of the business that we are pushing the most, collision and customer pay, performed the best, which was good to see; and there is a positive margin impact from the customer pay margins being up and that being a little bit more of our business.

On the collision side, could you maybe speak to the 4.8% increase?

It seemed to me it was up somewhere around 5%. Yes. We have invested in several body shops over the past year, and made them significantly bigger and more efficient. And so some of that has started to come through.

Now that is 47% roughly gross margin business, which is a little below average; but it's certainly better than wholesale parts business, which was down. So there is a little mix there between collision and wholesale, but we are growing and want to continue to grow our collision business and have invested money to do so.

Anything that you could talk about within the collision business from an industry standpoint? With miles driven up, are you hearing anything to the effect that that is driving business as well?

Well, that is one factor to the positive side; but unfortunately, there is another factor to the negative side, which is in these difficult economic times sometimes customers take their insurance company check and put it in their pocket instead of repairing their cars. So it's a little hard for us to sort out the overall collision market dynamics; but what we're trying to do is capture more of the market share that is available by having larger, more professionally run shops and that is what I think has been the factor in our business.

Okay.

And could you just talk about how California is doing?

Unfortunately, I got some data on California yesterday and two of the major manufacturers in October were traveling about 15% below the same month last year. So that would indicate to me that California is still not doing very well.

But I will say that California had a disproportionately strong performance under the cash-for-clunkers program, and I don't know if that is because there were a lot of old cars out there or the market is very value-sensitive, looking for a deal. So it certainly had some good performance there in the heart of the third quarter, but it doesn't seem to be anything going on in our stores right now; and I think our stores represent 13% to 14% of our total corporate sales.

And last question to talk about Texas and Oklahoma and what you are seeing there?

Interestingly enough, that is our weakest market; and I think a lot of people don't really understand. But in Houston, which is obviously our headquarters and one of our core operations. Through nine months, the Houston automotive market, the total industry sales are down 30%. And I think a lot of people don't realize that ; and I don't know if it's a time lag from the reaction of the energy companies to softer business in their industry. But it is our weakest market right now, in particular Houston and to a lesser degree Texas and Oklahoma. With the northeast being much stronger for us, only down year-to-date, Boston, for example, that total market is only down 14.5% through September.

Scott, this is John Rickel.

What Earl is describing is kind of on a year-over-year perspective. As we've discussed though, on an absolute basis, we're still happy with the overall results out of the Houston market; but what Earl is describing is the year-over-year impact of the falloff in sales.

Got you. Thanks a lot guys.

We have a question now from Rick Nelson at Stephens.

Good morning, Rick.

Good morning.

What are your thoughts about acquisitions given your strength on the balance sheet?

Well, we are nearing the point, Rick, where we have the financial ability to acquire again and so, we have for some period of time been evaluating opportunities. But generally speaking, pricing in the market hasn't come down far enough to offset the reduced near term profit potential in many of these stores in this market or the capital expenditures required. So I think we're starting to shift into an environment where acquisitions will be more likely for us; but I don't think it's completely ripe acquisition market at the moment.

Earl, would you seeking to luxury main or mid-line imports?

Both of those. There has been really no change in our philosophy on the brands since the acquisition market, basically, shut down. It would primarily be imported in luxury brands, though there is probably a better business case for Ford dealerships if you could find the right cost structure in a market where you thought you could grow that business.

How about the leverage ratio? If you did step up acquisitions, how far would you be willing to push the ratio?

Rick, this is John Rickel.

Certainly, where we're at today, we're sitting at kind of 2.8 times on the third quarter results. I think going forward, we would be comfortable, kind of maintaining in that range. We're generating enough cash right now that we could certainly get back into the acquisition mode without really having to push the leverage ratio up too much

Thank you for that.

And if you could comment also on October tails, maybe as it relates to the momentum in September and where you stand with inventory levels at this time, given your 60-day target? I think you mentioned you were at 29 days at the end of the quarter.

Yes, Rick, October sales are likely to be a notch better than September, but not because of better customer traffic, merely because of better vehicle availability. There was just--most of our volume brands were very short of inventory throughout the month of September and those vehicles are now coming in.

So I think sales will be a little better on October on a retail basis because of inventory availability. I also think the SAAR may look a little better. It appears to me that fleet deliveries are occurring again; not that that is a part of our business, but I think when we look at SAR, we may see some support in the October SAAR rate from fleet deliveries as well.

The sequential improvement we saw in service and parts, same store in the quarter. How much of that was driven by internal with the increase in units and is that improvement sustainable as we move into the fourth quarter?

Yes, Rick. This is John Rickel.

There was a piece of it that was internal;, but the other piece that we think is sustainable beyond that is the mix shift with us growing the collision business. The collision margins, as Earl indicated, 47% are pretty strong. And basically as the wholesale business dropped off a bit, we got the benefit of the mix shift from the lower manager parts of parts and service to the higher margin customer pay in collision business. And we do think that piece is sustainable.

Great. Thank you. Good luck.

Thanks.

Moving on now to Derrick Wenger at Jefferies.

Yes.

What do you have available on your bank facilities, and what are the letter of credits drawn against it? And then also your capital expenditure outlook for the fourth quarter and next year?

Yes. This is John Rickel.

We really haven't provided a 2010 outlook on CapEx. For this year, what we have said was somewhere on the order of about $20 million, and we spent $12 million year-to-date. So it would imply about $8 million on CapEx for fourth quarter.

On the bank facilities, there is about $17 million of letters of credit that are outstanding. Overall we have a $1.150 billion available on our revolving lines for financing new and used inventory. And at the end of the September, we had $357 million drawn against that. And on the mortgage facility, that is a $235 million facility and we had $190 drawn against that. So there is $45 million availability on the mortgage facility.

Thank you.

And the acquisition line there is $350 million available there and we had nothing drawn. The acquisition line was fully paid off.

We take the next question from Matt Nemer at Wells Fargo Securities.

Good morning, everyone.

My first question relates to Q4 guidance. I was just wondering why you think the new vehicle margins could be down sequentially given the mix shift potentially back to trucks, and I would think away from the high-volume, but low-dollar margin vehicles like Camrys and Accords?

I think it's because of all dealers in the market will again have a supply of vehicles, either adequate or excess supply, as they look at going into the year-end in inventory, taxes, or whatever they look at when they go into year-end. So it's just a function of there being more vehicle supply. Not just in our dealerships, but the competitive dealerships and there are still a lot of dealers struggling across the U.S., and clearly we're not struggling. I think you can tell from our financial results we're quite stable, but the independent dealers across the U.S. are still under an awful lot of financial pressure; and once they get inventory on their lots, they will take any deal.

And then on the same topic. You have got your F&I per unit down sequentially. Again, it would seem like the mix shift away from the cars program back to higher ASP units and less cash financings would drive that number a little bit higher sequentially.

Yes, Matt, this is John Rickel.

It's basically, we have seen a trend of that level coming down as the loan devalues have made it more challenging, as Earl indicated, to sell some of the back-end product; and basically, just trying to take a bit of that into account as we're trying to do the guidance.

Okay.

And then again, on the same topic. You have wiped out the wholesale profits, is that--do you think that used vehicle prices, obviously, they have stalled out; but do you see kind of wholesale market prices actually reversing and coming back down; or do you think that the lack of supply in the market keeps them relatively steady at this new higher level?

Well, as I said the last two weeks, there's been an excess of supply in the market. There's cars not selling at auction now. And I also think as these fleet deliveries resume in the fall, the rental companies defleet as do--you also have a lot of off lease vehicles at the end of the calendar year, which is a historic matter. So it appears to me that it's likely that the price valuations are going to reverse.

Got it. And then two more quick ones.

On mid-line import inventory, is there anyway to calculate or think about what that may have caused in terms of lost sales during the quarter? You mentioned that as that inventory starts to come back in, you think it will drive an improvement in sales?

Unfortunately, I would only be guessing to try to quantify lost sales, but there were lost sales clearly under the clunker program in both August and early September. And I think there were lost sales across the industry, but I really wouldn't be able to give you a very intelligent guess as to what that might have been, Matt.

Then lastly, on your operating expenses. As gross profit improves over time and hopefully the SAAR level improves over time, how should we think about the semi-variable expenses coming back into the system? Is it a stair-step function? Are there certain SAAR levels, if we get to 13 or 14 where you rehire another new or used vehicle sales manager? How should that sort of flow back in over time?

Matt, this is John Rickel.

That is a tough one to answer in any sort of formulaic approach. We've got two bookends. There's 25% of the $120 million that are permanent out of the cost reductions that are gone from the cost base going forward. On the other book end, there's 30% that's pretty variable that comes back in directly with volume.

The battleground is really, as you indicate that 45% of the $120 million that's semi-variable; and it's really up to us to try to hold back and be as conservative as we can on putting that back in; but clearly as volumes come back in, there's chunks of that that's going to come in. But I can't give you, at this level there's this amount of it comes comes back in; it's really going to be our challenge to manage that as tightly as we can.

But philosophically do you feel like there has been a change in the way you will run this business over the next, say, five years? And it will be run at the store level in a much leaner fashion; or do you think as the SAAR gets back to 14, 15, that the expense ratios will be sort of similar to historic levels?

Well, my personal belief is that there is a permanent change in the way that we look at these businesses. And I think the entire industry fell asleep, because there wasn't a substantial recession since the early '90s. I guess there were a couple of mini-recessions in there; and I think a lot of the people operating automotive retail businesses today really didn't know how bad it could get and how quickly.

So I believe there is some permanent psychological change in management philosophy changes that we all need to have going forward. So I think we'll operate them on a leaner basis, and we're trying to use this downturn to learn how to use technology and intelligent management to sell more with less.

Great. Thanks very much.

We have a question now from Jordan Hymowitz at Philadelphia Financial.

Thanks for taking my question.

First--couple of questions. First off, when I talk to a bunch of lenders, they increasingly say that the loan to wholesale amount they are willing to do is going down and the points they are requiring is going up. So with that in mind, why do you think--or why do you think people think that the F&I per vehicle sold is going to reverse itself? It seems like that amount will trend down as the lenders are requiring more and more payments and less and less overadvances?

Jordan, this is John Rickel.

Basically if you look at our guidance, the fourth quarter number at 9.25 to 9.50 is down from where we ran in third quarter, which was 9.55. So we haven't actually seen it continuing tighten, but we haven't seen it get any better.

Okay. So you would kind of concur then?

Second, you didn't take in a lot of used vehicles with cash-for-clunkers because they had to be destroyed, and a lot of the used vehicles you take in normally have higher margins because you have auction costs and transportation. Would that also lead to lower used vehicle gross margins in the fourth quarter?

Yes, that was the issue we had--that was some of the pressure. We should have had better retail margins than 10.3% in Q3; and it's because we did have to go to auction and pay fairly high prices for some of the vehicles to supplement our low inventory. And that trend is going to--at least is continuing for some part of Q4 is--we're still having to go to auction to buy vehicles. Now, I mentioned a minute ago that it does appear that auction prices may be softening up as we speak. So maybe as we move through Q4, we'll be able to purchase a little more competitively at auction; but the dynamic you described was some pressure on our used vehicle margins in Q3.

Okay.

And next question is--and none of us are excellent at breaking the SAAR, or we'd all be in different jobs. But a lot of people are coming out and saying, like the last speaker of 14, 15 million SAAR; but it seems to me that almost 20% of the subprime financing--20% of the market which was subprime has been gone and unless (inaudible) and Triad and all these companies are coming back in business, it seems like there has been a permanent loss of about $3 million to $4 million in financing ability for cars. Plus, the rental car business is down 20% if you look at Hertz and Dollar Thrifty today. So my question is; again, no one is an exact guess, but do you really think a SAAR anymore than $13 million or $14 million in the next few years is even possible?

Well, I discussed this with a lot of people and I have heard a fairly prevalent opinion that it will be difficult to get back to the 17 million unit days over the next few years because of the financing issues you just mentioned, subprime being the biggest issue. But it appears that most of our manufacturers believe that over the next few years, it can get back to 15. It's that between 15 and 17 they seem to think is the challenge related to auto financing that may never be as easy as it once was, or at least not in the next decade. So that seems to be an open the debate. But most our manufacturers think it can get back to 15.

Okay. Okay. And you said as well that even if the SAAR picks up this month, do you know what the retail SAAR was as opposed to the overall SAAR; or estimated for September?

No, J.D. Powers does publish that, but I don't have that number in my head, Jordan. But, yes. The J.D. Powers report does break retail out for us every month, but I just don't have it in my head.

Thank you.

Now we'll go to JPMorgan's Ryan Brinkman.

Could you please comment on the order of magnitude of the recent used vehicle price declines? Is it much different than what would be seasonally expected at this time of year?

Couldn't say that yet and only got the report in the last few days; but the last couple of major auctions our people have attended and vehicles--quite a few vehicles have been no-saled. So that wouldn't be reflected in any guidebooks yet. So whether or not it's seasonal or beyond seasonal, I couldn't tell you yet; but we are very sensitive to it, because we have been expecting this to occur. And all of us are afraid of overreacting on new or used vehicle inventory in November. That is an annual risk, but until the next guidebooks come out, I don't think I could put a number on it for you.

Thanks.

Is there anything you can say about how demand is trending thus far in the fourth quarter?

Our traffic levels are not appreciably different than they were in September yet. I do believe I mentioned earlier on the call that there are some cases of, I think, a little bit better sales levels just because of better vehicle availability, as we move through the month of October. Whereas, we were short coming out of September in a lot of key brands. Toyota, in particular that the actual sales executed should probably be a notch higher. But no major uptick in traffic thus far at our dealerships.

Okay, thanks a lot.

Now we have a question from Ken Rivlan at Rubicon Partners.

Good morning, guys.

Just a quick question on the guidance, does that include an APB 14-1 for approximately $0.16?

It does.

Okay. That is all I have. Thanks very much.

Thank you.

With that, ladies and gentlemen, there are no other questions.

I will turn things back over to Earl Hesterberg for additional or closing remarks.

Thank you for joining us today. We look forward to updating you in February on our 2009 fourth quarter earnings results.

Once again, ladies and gentlemen, that will conclude today's conference call. Thank you, very much, for joining us. Have a good day.