Penske Automotive Group Inc (PAG) 2006 Q2 法說會逐字稿

Good afternoon, and welcome to the United Auto Group's second quarter 2006 earnings conference call. A press release which details United Auto's second quarter results was released this morning, and is posted on the Company's website, which can be viewed at www.unitedauto.com.

The call today is being recorded, and will be available for replay approximately 1 hour after completion, through August 1. Please refer to United Auto's press release dated July 14th, 2006, at www.unitedauto.com for more specific information about how to access the replay.

I would now like to introduce Anthony Pordon, Senior Vice President of United Auto Group. Sir, please go ahead at this time.

Thank you, Matt. And good afternoon, everyone. Welcome to the UAG second quarter 2006 conference call. Joining us today for the call are Roger Penske, our Chairman, Bob O'Shaughnessy, our Senior Vice President of Finance, J.D. Carlson, our Controller, and Jim Davidson, our Executive Vice President of Finance from our New Jersey offices. At the conclusion of our remarks today, we will open the call up for questions. I will also be available by phone to answer any follow-up questions that you may have.

Before we begin today, I would also like to remind that you statements made in this call may include forward-looking statements regarding United Auto Group's future reportable sales and earnings growth potential. We caution that you these statements are only predictions, which are subject to risks and uncertainties, including those relating to general economic conditions, interest rate fluctuations, changes in consumer spending, and other factors over which management has no control. Our actual results may vary materially.

These forward-looking statements should be evaluated together with additional information about United Auto which is contained in our filings with the Securities and Exchange Commission, including our 2005 annual report on Form 10-K.

At this time I would like to introduce our Chairman, Roger Penske.

Thank you, Tony. Good afternoon, everyone, and thanks for joining us again today. I'm pleased to report the second quarter represents a record performance for UAG, which includes double-digit increase in revenue, gross profit, income from continuing operations and related earnings per share. During the quarter our revenue increased 11.8% to $2.9 billion. We had a gross margin increase of 20 basis points to 15.2.

Our income from continuing operations increased 15% to $36.6 million, and related earnings per share increased 15% to $0.39 per share. Our Q2 performance was highlighted by same store retail revenue growth of 2.9% and a 51 basis point increase in the relative contribution of our service and parts business, which represented 10.9% of our total revenue. We also had an 8.5% increase in same store used retail revenues. And a 36 basis point increase in the gross margin of our service and parts business.

Let me give you a little more light on Q2. Revenue increased 11.8%. Our new vehicle revenue was up 7.3 overall. Used was up 18.3. F&I up 14.9. And service and parts up 17.3. Just to give you a little bit of insight on selling prices of our new and used vehicles. New selling prices were up $344 to $33,160, and used was up $1,253 per unit to $27,898. And just to put that in perspective, approximately $21,000 average in the U.S. and 46,000 in the U.K.

I'd like to point out that we did face some margin pressure on used vehicle sales in the U.S. F&I per unit increased 6% to $923. The growth in our service and parts operation continues to reflect the continuing success of our investment strategy in the back end of our business, our parts and service.

The dealerships, where we invested in expansion of our fixed we are experiencing tremendous growth. We talked about it before, but I guess I would give an example. Our Scottsdale 101 Auto Complex in Phoenix, which we completed at the end of 2002, we are generating in excess of 50% more fixed gross than we did prior to the investment. Then you go on to San Diego, where we have the 4 major dealerships there that we redesigned. We've seen a 47% increase in our fixed gross compared to the original facilities.

Also, we are seeing great fixed absorption ratios. In fact, at Mercedes Benz in San Diego, we are at 100% plus. Lexus is at 90. Toyota and BMW are at 80%. As you know, the fixed absorption ratio measures the amount of dealership fixed expenses covered by service and parts gross profit. I just want to point out that the incremental costs associated with the expansion of these facilities is included in the ratio. So overall, we've hit the mark and I think we've got a real opportunity as we go forward with these particular campus locations.

In the second quarter our international operations represented just about 30% of our total revenues and 24% of our operating income. On a worldwide basis, foreign and premium brands were 92% of our revenues, with premium brands representing 59%. The domestic big 3 represented 8%, but if you looked at it just in the U.S., foreign nameplates were 90, and the big 3 were 10% of our overall revenue. Looking at brand mix, I think it still continues to be a key differentiator for UAG.

As a result of our mix and strong operating results our stores in the U.S. outperformed the overall market during the second quarter. In the U.S., foreign nameplates gained another 3.4 market share points over the prior year. You can look at our brand mix percentages, it was attached to the data sheet in our press release this morning.

Same store performance for the quarter. Retail revenue was up 2.9%. Our new retail was flat. Used was up 8.5. Service and parts was up 7.6%. And F& I revenue was up 8.1. As I noted, our overall same store new business was flat during the quarter. In the U.S. our same store new revenue was actually up 2.1%, while we saw internationally, primarily in the UK we were down 7.6.

This was really due to the new vehicle market in the UK, and I think that when you look at new vehicle in the UK, then you look at same store used revenues were up 9.1%, which helped us with our results over there during the quarter. I think this really demonstrates the flexibility of our business. Overall in the U.S. our same store retail growth was 4.1%, and again we were flat internationally, due to the vehicle market primarily in the UK.

Let me just talk a little bit about interest expense. We certainly feel the effects of rising interest rates. Our floor plan interest increased 3.1 million in the second quarter, and our overall floor plan interest expense increased 31.1% to 17.2 million, including a 22% same store increase to 15.9. Our other interest decreased 6.2% to 11.5 million, which is due in large part to the interest savings resulting from the convertible notes that we issued in January of 2006.

Looking at the balance sheet, total inventories were $1.4 billion, up approximately $200 million compared to June of '05. On a same store basis, our vehicle inventory was up $91 million versus '05. At the end of the quarter new, we had 53 day supply worldwide, used was 30. In the U.S. our new vehicle supply was 56 days versus 71 days for the U.S. market, and our used was 33 days.

Moving on to CapEx, for the first 6 months, our net capital expenditures were $88 million. That was really 110 less proceeds from sale of leasebacks of 22 to give us 88. We expect to complete another 50 to 70 million of sale leasebacks during the balance of the year. And after these proceeds we expend the net spend on CapEx will be approximately $100 million. And just as a data point, our depreciation annualized will be probably about $45 million for 2006. Looking at the leverage at the end of 6 months in our debt to cap was 37%.

We had approximately $720 million of non-vehicle debt, and that consisted of $300 million of 9 and five-eighths 10 year senior subordinated debt, with a call provision in March of 2007. And then of course, we issued $375 million of 3.5% senior subordinated convertible notes in January. We had approximately $45 million out under other credit agreements and borrowing arrangements.

As of June 30th, we had approximately $600 million of floating rate availability under our credit agreements on a worldwide basis. 43% of our total debt, including floor plan debt, was fixed, at a weighted average interest of 6.1%, and a weighted average maturity of 4.4 years. So our balance sheet, I think, is in pretty good shape and we have significant dry powder for future acquisitions.

Talking about acquisitions, we acquired 6 business year-to-date with about $600 plus million of analyzed revenues. And during the quarter, we closed on Motorworks BMW [Mini] in Minneapolis, which we expect to generate approximately $80 million over the next 12 months in annualized revenues. Motorworks gives us an entrance into the Minneapolis market, which we think is a strong market and has the corporate headquarters, as most of you know, of 3M, Target, Best Buy, General Mills and Northwest Airlines.

We continue to see attractive acquisitions, not only in the U.S., but also internationally, and we will continue to monitor those and keep you posted. Also we are looking at locations and franchises that were not meeting our requirements or have high potential corporate ID requirements, which we will put up for divestiture and we will move those out accordingly.

Looking at earnings guidance which we reported this morning, we reiterate our 2006 projections from continuing ops in the range of $1.35 to $1.40, and obviously that affects the split we had back earlier in the quarter. We also provided guidance with respect to the third quarter, during which we expect earnings from continuing ops to be in the range of $0.37 to $0.40.

As outlined in the call we had in April, our guidance assumes the same store growth of 3 to 5%. If you look at the first 6 months we are at 3.3, so we are pretty much in the range at least for the first 6 months. Acquisitions of 600, $800 million, we're in the range there. The impact of our convertible note offering -- and just from a data point, we are looking at 94.6 million shares outstanding for the year.

Let me talk a little bit about Smart. I've had lots of questions about Smart. So I thought I would give you a little color on the Smart proposition. First, we will be the exclusive distributor for the Smart ForTwo product in the U.S., Puerto Rico and in Hawaii.

Many of you have heard about Smart. It's a car that's loaded with a lot of safety features. It gets over 40 miles per gallon, so I would expect, in this type of a fuel environment, it would be a great buy. It's built in France, at Hambach, France. They've got capacity of 140,000 vehicles today. They can stretch that plant to 200,000. They've done a lot of re-engineering there on their people, both not only at the manufacturing plant, but in Stuttgart, to take costs out. It only takes 8 hours to build a Smart vehicle, so when you look at that particular statistic, I think it's quite attractive.

There's been lots of success on the ForTwo in Europe. It's today, as I understand it, sold in 36 countries. And there's approximately 750,000 units in operation. So lots of experience, and we look forward to the new updated model that we will sell in the future. The ForTwo as you might know, or some of you know, is sold in a diesel version in Canada today. They expected to sell about 1,500 units the first year, and they actually sold 4,000. I spent some time up there with our team a couple of weeks ago, and they were very, very bullish on the product, and in fact they are having a very good first 6 months with it. And based on the initial responses from our website, www.smartUSA.com, we've seen a tremendous positive response to the brand and the announcement.

In fact, we received over 200,000 hits to the website, and more than 8,400 people have registered to receive information about Smart and possibly purchasing a Smart. So that's a pretty good indication just in a short period of time. The other thing I think is really interesting, we had 400 requests for information already about becoming a Smart dealer. And I think that's exciting for me, because it's going to give us an opportunity to really pick the best that's out there.

As you know, UAG is familiar with a brand because of our worldwide footprint, we've been selling Smart from our Mercedes dealership locations in the UK for the last several years. We expect to set up our distribution system on Smart over the next 12 months. Initially we expect to appoint -- we've announced 30 to 50 retailers. That could go up or down, based on as we look at the interest out there. Then we would have a seconds wave, which could take us possibly to over 100. I think you've seen the announcement, Dave Schembri has joined to us lead the Smart efforts as President. He was part of the Mercedes Benz team. I met him when he first was a regional manager on the West Coast for Mercedes.

And he brings knowledge of Mercedes. He also brings knowledge of the Smart product, because he was on that program prior to it being stopped back here a number of months ago. So I think that with Dave -- and we have also identified other people within the organization. Russ Hill will come out of the field, will work with us on the Smart brand, along with some other key people within the team.

We expect to sell vehicles the beginning of the first quarter of '08. This will be the successor to the vehicle that's currently being sold in Europe and Canada. And the new model will be really completely redesigned in most areas, including an improved powertrain. It will have a number of enhanced technologies. Obviously, this is a vehicle that was initially designed and produced 7 years ago. But it will retain the basic look that you see today on a ForTwo. We think that what's going to be nice, we will have a number of vehicles which will meet the European specs to show in this country early next year, and it will give us a chance to go into the markets to show interested dealers, and maybe even many focus groups information on the vehicle. So it gives us a real chance to ramp up. We think it's a great opportunity for us, at UAG.

It again shows some diversification from just selling retail in the U.S. Obviously international expansion, expansion into Mexico, into Germany, and now Smart I think, it gives us some differentiation. I think the most important thing is, if you're interest to keep up current on what's going on, just register on the website. We've also -- [Ken Kentonville], who was my key guy for the Super Bowl in Detroit, is going to head up the PR effort and Bud Denker, who heads up our marketing will be involved on the team. And Tony has also taken on some responsibility. So what we are trying to do is keep our costs down, and yet ramp up with people who know UAG and also understand Smart. So stay tuned for further details.

Before I open up the call for questions, I would like to note that our business continues to perform well, and that the second quarter demonstrated, I think, the success of our overall strategy. We've been together here for a number of quarters. Despite the challenges, rising energy prices, interest rates and market dynamics, our business performed exceptionally well. As you know, we strategically structure operations to meet market demand.

We will continue to follow the same formula that's proven reliable over the last number of years. We've invested to build a great business. Again, as you know, Penske has over 200 million invested themselves. We've developed a strong talent base. I think we have some of the lowest turnover metrics in the retail auto sector here in the U.S. and certainly overseas. We've implemented many new initiatives to build a greater transparency throughout our organization. We are looking forward. We have many positive trends that will help I think sustain our strong business model.

Later this year we will complete our Turnersville and Inskip Automall project. These have been under construction and in planning for over 3 years, and this will give us the chance, hopefully, to build locations that have had the same traction or have gotten the same traction we have in some of the other projects out west. So again, looking forward to the launch of Smart in 2008. And let me open it up for questions at this time. Thanks for calling in today.

[OPERATOR INSTRUCTIONS] Joe Amaturo.

I was just wondering if you could touch on the the F&I per unit , what that performance was, excluding the Sirius warrants?

We had about $24 in Sirius warrant and 32 last year.

And then with respect to the Smart dealerships, of the 50, how many of those do you think will wind up among the publicly traded retailing groups?

Well, Joe, I don't think that whether you are an owner-operator or you are a public company makes any difference. I think what we are going to do is see who has interest. There's some publics that have come to us with interest, and some haven't, at least to date, that have at least registered with us. I feel that there will be a good mix across the country. We've seen some very interesting proposals.

We really haven't gone out and answered anything specific, but there's been a lot of interesting proposals that have come in to date. So it's going to be a lot of fun for me to look at who we think are going to be the best guys in the market. It's going to put a lot of pressure on our people, too.

And then just lastly, was there an FX impact on new vehicles same store sales comps? And if so, what was that?

We had a negative $12 million in revenue, so it was nominal. There was no impact on earnings or on EPS.

Okay. Great. Thank you. Good quarter.

Rick Nelson, Stephens.

Thank you. Good afternoon. Congratulations, too.

Hey, Rick, how are you?

Good. Roger, can you talk about the overall operating environment in the UK? What is going on there? And we are getting closer to that September registration period, and wondering was see ahead for UAG -- ?

Well, I think we had a strong March, we are counting on a strong September. The market, from a consumer perspective, has been down. There's lots of dynamics. The corporate market in the UK where many people get their compensation through cars being provided for them, is one that we are all in. And I think we backed off a bit during the second quarter, because some of the pricing was getting ridiculous. And we said, look, we want to maintain our margins and keep going. But overall I think that our mix is very, very good. We are all premium there, other than we have some Toyota business there. The market was off about 3.7%, and I think it was off about 4% year-to-date.

So I don't see the pressures on SUVs or gas prices and interest right now. I don't hear those kind of noises over there, that you might hear in the U.S. So to me the market is volatile, there's no question about it. Acquisitions are going on over there. Their block exemption continues to get some of the owner-operators to want to sell their businesses, so we are trying to be quite active there.

Can you just segue to the acquisitions, talk about the climate both in the U.S. and the UK and what sort of multiples we are looking at? A number of dealers I know, are searching for those import labels. Do you see more sellers as the business becomes more difficult?

Well, I guess what I see here in the U.S. is that many of the individuals who have been in this business a long time now realize that there has to be a significant capital expenditure made to meet the requirements of the OEMs. So the old days, you'd spend $750,000 in a refurb. Today, you have got to spend $10 million or $15 million to build a facility. In fact, I think a Lexus facility was just built in Newport for $75 million.

So to me, those are creating some opportunities. And these are really individuals who might have contacts with us, might have contacts with the other publics, or even some of the larger private groups. And I think the multiples are pretty much the same. I don't see multiples going out of the sky. We are probably paying 4 to 6 times in the U.S. depending on the brand.

And you probably, if you look at the UK, the multiples still are less, from the standpoint of if you buy individually. I know there's been some big transactions over there, from when Pendragon bought Vardy. In fact, if you just look at that alone, it puts almost a $900 million value on our Sytner acquisition over there. So that is pretty much where it is.

I think there's opportunities here and there's opportunities internationally, and to me, I don't run into the other public companies typically. There seem to be enough people wanting to sell. And some brokers are probably offering it up to multiple people. But today I don't see a traffic jam or something that's driving the price out of sight.

Thank you for that. Lastly on inventories, the 53 days is a step up from what you reported last quarter, I think you were at 42 days.

That's because I think we had in March with the UK, you follow me? You have the big sales month there, so that's probably what will drove that up. But we are in good shape. When I looked at inventories, just to give you a flavor. I looked -- I did this before the call. Mercedes Benz, we are at 46 days versus the OEM at 50. We are at about 100 days on our Chrysler Jeep. Audi, we are flat, pretty much 60 days compared to what they have. Porsche, we are flat.

When you look at Toyota, you've got a 9 day supply of Camry,30 day Scion, 12 day Yaris, and 5.9 days on Prius. Honda Civic and Fit are about 10 days. So we really at this point, feel that we will get out of our current '06 inventory, and be able to roll into '07 in good shape.

Do you think the industry is heavy or weak?

I can't give you an answer that I really thought about. I'll get back to you. As far as the industry is concerned, I guess it will be interesting to see the sales data, what we see here July and August. There's lots of incentives out there, but when you look at, I think Tony said, if you go back 5 years, you probably have had a 68 day supply, and you know the industry is running now over 70. So there's some deterioration. But I think there's lots of action out there with some incentives. And yet you are seeing the -- some of the domestics, Caliber, and cars like that are flying really off the shore. And the good news is that where you have car vehicles, and V6s and 4 cylinders, we are seeing those vehicles move quickly.

Even all -- I would say all nameplates, foreign included, SUVs and some of these heavy trucks, where we've seen them slow down. So I think it's the ability of the OEM to be able to get more of the car product and the probably 4 cylinder, 6 cylinder engine and maybe even some diesels if they have them into the market. Obviously the hybrid, the Prius, is probably as hot a product as we have out there.

Gas prices affecting the mix. Thanks a lot.

Edward Yruma, JPMorgan.

Thanks for taking my questions. Roger, can you talk a little bit about trends intra-quarter? Was there any noticeable acceleration or deceleration in sales during the quarter and kind of regions that performed well, and others that did not? Couple parts there.

Let me say this. You always comes off, it seems that you always come off the first month of the quarter, you have got to get your traction, and I think that April probably was weaker than March. I think May and June finished strong. We were real happy to see the UK finish up in the end.

We had strong business in Mexico, and our super premium luxury dealership in Germany had one of the best quarters they've ever had. So I think internationally, the business was decent, other than the new car market being flat, flat in the UK. The Midwest is probably the toughest. We see California and certainly down south. Texas has been much better for us with our business there year over year. So it's difficult for me to say that there was something that was outstanding. Personally I would just say that primarily Midwest would be weak.

Great. And can you also talk a little bit about what you've got going on in the used business? Obviously you've seen some fantastic momentum there. What are doing right and how sustainable are some of those trends?

Well, I think when I look at used, a couple of things have really been pointed out. Our margins today are down slightly when you look at used overall. But I think the key thing is, we have as I talked earlier, a $21,000 average used car revenue on a per unit basis in the U.S., and 42,000 -- I said 46 in the call, but it's 42,000 in the UK. Because many things over there, what we have is, we have to take the new vehicles, we make them demonstrators, and that gives us a higher sales price. But I think that we are now trending to look at some lower priced vehicles. I've studied some of our peers. I've looked at CarMax specifically. If you look at their average sale price, it's $17,000.

So we are selling a car in the U.S. that's average 4,000 more than that. So I think with taking some of those 42,000 wholesale units, and maybe taking 4 or 5 of those and keeping them, maybe we won't register them as factory preowned with a certified program. But we would look to sell some of those -- I was at a Honda -- one of our Honda dealerships yesterday, and they were having a real good month. And they've trended to reduce the type of vehicle they typically would wholesale.

I think that's key. We get a real benefit now. Honda has made a decision to now finance non-Honda vehicles that we trade in, so that's helped us at our Honda dealerships. So we see some things on the used car side that we can certainly do a lot better.

Thank you very much.

Matt Nemer, Weisel Partners.

First question is on SG&A, it looked like it was down about 60 basis points as a percent of sales if you take out rent from both periods, and I'm wondering how much of that is the change in the improved gross profit percentage, and how much of it could be any cost reductions?

I think obviously, we got the benefit of gross because of parts and service. I've been beaten up on SG&A now for -- I'm glad it went down when you look at it. I think we've had some benefits on insurance costs, where we have -- we are self insured in a lot of these areas, so there's some benefit there during the quarter. I think we are not cutting our advertising. A lot of people say, well, just cut your advertising, and your SG&A will come down.

The issue is sales commissions are in SG&A, and it's very, very difficult where you have hot models to start changing sales programs and commissions. So we get driven up and down based on that from time to time, but I think we are trying to be prudent in where we are spending our money from an SG&A perspective. Our legal costs are in line. I think in our collections, our accounts receivable, we have had very few write-offs in those areas. So overall I think we are in pretty good shape.

And then secondly on the Smart Car Initiative, I'm wondering if you could give us some sense, I know it's early, but what are the incremental costs that you expect to hit UAG in 2007 as you ramp that up, above and beyond what's already in your operating structure? Maybe the hiring of Dave and some of the other staff, what's the total expense you expect?

Dave came to work for free. Just kidding you. No, we have, as I say, primarily as we go through the balance of this year, will be salary related with the people, some we are bringing in from the field, and others we will bring in from the outside. We will have those ongoing, obviously, and there will be some website and promotion and PR activities that will take place. As we go into '07, we will obviously have to start developing our network in the field. I don't see big CapEx expenditures for the distributor at this point. The cars are manufactured overseas. We take title to them, and then we will distribute those through a logistics source which we will use.

To me, the big cost will be -- will ultimately be the marketing and promotion which will be variable, and we really haven't tied that down yet until we get closer to launch. We will have auto shows next year. The cost of those obviously, will be borne by us. But those things will be in the normal course of business. I think at the end of the day, we've got IT that we are going to have to develop. We are going to have a warranty system. We will have an ordering system. We are now looking at ways to be most efficient as we go forward. So I think from an overall cost perspective, our goal is not to materially impact our business until we get really rolling with a product in the first quarter of '08.

Okay. And then lastly, if you can give us some historical perspective on what you've seen in terms of import and luxury vehicles, what's been the consumer response to those vehicles during a cyclical downturn over the longer time period?

I guess -- ask me the question again.

In a recessionary environment or a weaker consumer environment, how have historical trends held up in terms of luxury premium vehicles, both I guess on new car sales and maybe even on used and in the service department?

Well, I think you are going to see the service department pick up, because if people aren't buying new cars, they are coming in and will be fixing their cars. I saw that in the trucking industry, when we had big high sales of heavy-duty and then it dropped, our service business typically up following up. And of course, that's good for us, because it's our high margin business. I don't think the premium luxury business will be generally affected, at least to date.

We are seeing those same people coming in that have the capital, they are willing to lease, that have good jobs. And the residual values which have been established by and by some of these premium brands I think will hold the market quite well. So the ability to sell in a little tougher environment should be okay. But, look, I'm probably not the guy to answer that question completely. I will get Tony or someone to do a little more research.

What I look is, have a good back end, good parts and service, where it gives us the gross, and we will be able to withstand some fluctuations. I will say this, that today SUVs, no matter what brand where we are, they are a little softer than cars are.

So the ability to move into the vehicle side is important, and I think that the strength of a lot of these premium luxury guys has been their car business, not just the SUVs. Remember when you look at luxury brands, 40 to 50% are leased. In fact, our lease business is up about 16% year-over-year, if you just took a data point as far as the number of cars leased versus that were financed.

Interesting. Okay. Thanks very much.

Scott Stember, Sidoti & Co.

Can you maybe talk about the F&I growth in the quarter, maybe break it out with traditional financing growth versus other products?

Well, what we typically have of course, is the commissions that we get on the F&I. And to me, probably about 60% would be commissions directly related to the F&I. That would be the finance and insurance, and then the balance would be your extended warranty, your gap, LoJack and other products. What we have done is have a limited menu on those, and with our eMenu selling, we see some better penetration. It's interesting, we've got about 16 stores which we have now piloted on a true eMenu basis, and we are seeing better productivity out of our F&I people with that. So I think that's helped us. I think I said earlier that we had $24 per vehicle on Sirius versus 32 last year.

And on the parts and service side of the business, you guys have done a successful job of increasing your base with the number of these automalls. Going forward, are you guys taking a look at how much will you need to do, as far as adding versus trying to squeeze some more utilization out of the capacity that you have?

Well, what we are going to do now, I mean these bigger campuses are done. Interesting, we will be looking at if we have to go to 2 shifts. Obviously we are trying to be open 7 days a week where the laws allow that in the particular markets, because of customer preference. We will add bays where we need to. We are getting a big new body shop opening in San Diego, which will give us more expansion.

We are going to add body shops where we have multiple dealerships, where today we don't, because we think that's another way to add gross profit, helps the parts business and gives us a closer connection with our customers, when we have the body shop rather than sending to it a third party. So I see the expansion leveling off. Obviously as we make acquisitions, we need to upgrade some of those shops, but we are being selective where we go now to be sure when we do build or we do buy something, that we do have the land and can build the right expansion plans into the acquisition.

And the last question, I'm not sure if you answered this before. But just any general comments what you are seeing in July so far on the new car sales front?

I've talked to our guys around the horn in the last couple of days, obviously, figured that might be a question. I think July is tracking pretty much the way July has been in the past. I think the key thing is the Camry, certainly the Scion and the Prius are hot. Lexus, ES, IS. The Mercedes S class. The Formatic, everybody is looking for Formatics in the east. The GL is good. The CLK. The Honda Civic probably is one of the hottest vehicles out there right now. You just cant' get them in 4 cylinder availability. The Chrysler Caliber. In fact, we just -- I didn't mention it earlier in acquisitions, we just signed a letter to buy a Cadillac franchise in the Northeast. We see that continuing to give us the returns we want. So I would say overall, other than the point I made earlier that leasing is increasing, we are going to have to just watch the SUV population inventory as we end the year.

One other thing that I didn't mention, was that we've had an issue with Nissan during the quarter. Nissan had a problem on their 4 cylinder engines, so we have not been able to sell the Altima and Sentra during the quarter that had 4 cylinder engines in them. So they have taken those back. So we probably lost $350,000 of gross profit during the quarter because they couldn't sell those vehicles. That's something we hope we can get back on track as we move into August and September.

That's all I have. Thank you.

Jerry Marks, Autoretail.com.

I just wanted to, not belabor the F&I too much but if I heard you correctly the number from Sirius went from something like 2.2 million last year from 1.8 million per vehicle numbers, just wondering if that was because of a lower stock price, or was it lower penetration rate?

Lower stock price.

Okay. So your penetration rates could still be -- ?

The penetration is fine. You've seen the stock is down.

Yes. And so then if I'm looking at this right, you had over a $50, probably $60 increase if I x out the Sirius adjustment in F&I per vehicle. I heard you mention those eCommerce initiatives. Is there anything else that caused such a spike in that?

The only thing, is Steve McAuley, who heads up that area, we have added 3 more people in the field that I think are doing a good job. And one of the areas we had high turnover was in F&I, and we've really put in a program to try to get better traction there, and I think there are fewer flats during the quarter.

Fewer flats, I'm sorry.

Where you just get paid a flat amount from the OEM for transactioning a piece of business.

Oh, right, because of the employee discount.

You've got it.

And then I heard you mention about some of the improvements that you are trying to do on the used vehicle side for your margin, but you kind of alluded that there was pressure in U.S. What exactly was going on in the second quarter in the used market?

I don't think there was pressure. We had a great used month. I'm just saying that we are looking at today, when you look at margins, we don't make many more dollars on selling, say a $25,000 vehicle than we do on maybe a 15 or $16,000. So to me, if we go forward and look at some of these lower priced vehicles, might may be an opportunity.

I think that our gross profit was only down $50, if you looked at this quarter versus last, it was about 2 grand. And in the UK, it was -- they were in fact up $60. So overall it was flat when you look at a gross profit per transaction. What I've got to do, is try to maintain that gross profit per transaction, and have a lower selling price, or get more when I have a higher selling price. I haven't been able to get that done.

Given your brand mix of 90% premium foreign luxury vehicles, you wouldn't be able to get down to CarMax of 17,000, then. Right?

Well, it depends. They buy their cars just like we can buy them. I'm not sure I am going to come back and say it's 17,000. But when you look at that, we are significantly higher, and even some of our peers are lower. If we have CPO, which drives that up, too, which I don't know that CarMax has those today.

Good point. Last question. Roger, just in terms of the Smart program, I heard you talking about how you might have some public competitors in there. Have you give a thought about how much percentage might be UAG dealerships, and why you would choose to use outside dealers where you might not be able to put the UAG systems and processes under independent ownership?

We are the distributor, and what I need to do is put my distributor hat on, which is important to UAG, and be able to effect a distribution system that is efficient and has the best representation market by market. Obviously, hopefully UAG will qualify in some of those markets, but I don't see a preponderance of UAG. I see a real mix throughout publics and even owner-operators, based on the -- at least the interest we see so far. It's early on, until we sift everything out and look at what people have. I want to look at CSI, want to look at locations, facilities, et cetera. And we'll have a real good team that can do that for us. We had the same job to do when we owned Detroit Diesel.

That's a very different business model than the UAG core business, because it's a distributor versus a retailer.

It's a distributor, certainly. And I think we need to run it that way, and we will have a group of people that are dedicated to the wholesale side, and we will also have a group of people that are dedicated on the retail side, the way we are operating today.

That's all I had. Thanks a lot, Roger.

John Murphy, Merrill Lynch.

Just a follow-up question on the Smart deal here. How do the economics work? Is it purely per unit delivered, or is there a base revenue that you are going to get from Mercedes or DaimlerChrysler? How is that going to work on the payment side to you.

Well we buy a Smart vehicle FOB Germany for x-number of dollars. And then what we do is establish a margin on that vehicle which is for the distribution side, and also provides the dealer with a margin. And we have not announced those margins to date, but that's where we would generate our gross profits. Then we have to take all of our expenses of running of business out of that margin we make on each car we distribute. And then the dealer obviously has a piece also based on his costs and his sales price.

How do you envision the actual dealer? Is it going to be a regular size dealership, a small dealership, is the investment going to be a lot lower or a lot higher, or on par with a typical dealership?

Well, if you looked at the Scion model, they have a shop on shop or center in center where they actually took a space within the existing dealership, and provided marketing and vehicle display areas. We think that's probably the most effective to use, because it will be lower cost for the dealer. You will have to have signage. You will have to have salespeople trained, technicians trained. And then where we can't -- we would not be able to co-mingle the brand, other than with DCX. And then if there's other people who want the brand, and are willing to establish a single location for it, it could be on an existing site with numbers of franchises. But we will look at those individually. So we are trying to make the investment be very economical.

I think the key thing here is let's get the right dealer with a reputation in the marketplace, and let him come up with the most commercially viable situation for us to look at. And then that's what's going to be the deciding factor, because what I don't want to do is end up with having to spend the kind of money you have to do for a full blown operation. We are going to have 3 models. We don't need the space that you would need if you have 18 or 20. We already have a distribution warehouse we can use out in the Midwest for parts. We are going to use our SOS operation that we have for our customer assistance center in Reading, Pennsylvania. We've used this very successfully to support our truck leasing in Detroit Diesel, so our customers can have a connection 24 hours a day.

Then maybe switching gears, you said something very interesting about San Diego and having greater than 100% fixed coverage in your Mercedes dealership there. When you get to that level, does that give you on advantage over other local Mercedes dealers, or as this happens in other brands on the new vehicle side? I mean, would you price -- would you be more competitive on pricing on a new vehicle as you cover a higher and higher percentage of your fixed cost?

I don't think so. In fact, I would hope you would maintain the gross, because what is happening is if you have that many satisfied customers coming in, that means you must be retaining a lot of the service business, and they probably don't want to move for $200 or $300. So, to me you are going to sell the buying experience. Quite the contrary, I would hope it would drop to the bottom line. Are we are seeing, quite honestly, we are seeing that at stores like, the bigger stores that have made the investment, that rent factor I think at Mercedes in San Diego is almost $200,000 a month, so it's a big operation.

That can actually be a double whammy on the positive side there.

I would hope so. Yes. I think so.

Just one last question on the incentive activity. You mentioned incentives seem to be ramping up. You've been in this industry for a long time. Is this incentive activity that we are seeing now more characteristic of your typical model year end clear outs? Or is this sort of more the recent insanity of the big 3? What's your opinion on that?

Well, I think if you look at incentives overall, I think they are down on average. Now, some manufacturer might be up. But to me, I think this is -- they are looking at inventories, they are looking at the pipeline what they've commit to do vendors, and they have got to move this product through the system. So obviously, they are going to put on different buy programs, Toyota has programs, other people have programs right now. But to me, I think it's just part of the business, it's part of the DNA of the business. Some people might be more aggressive because they have got higher inventories or higher commitments from the standpoint of the market. There's no incentives on Caliber, and that's a great product that DCX put out.

And then just 1 last one. As we move forward and rates either stay where they are, or maybe actually crank up a little bit, the real estate market might weaken a little bit, the new car market clearly is showing some signs of weakness. Do you foresee a more attractive acquisition market or lower multiples if you will, on private transactions in really the next 6, 12, 18 months out there?

Well, let me say this. If people that are dealers today, and don't have relatives or siblings who want to stay in the business, and they see the marketplace softening, I'm assuming that the rates, the multiples might go down. But I think it's very -- they're individual properties, individual businesses. And it depends on if you are in a market where you have got scale, you will be a lot more aggressive than just coming into buy 1 store. I think it's location by location. I don't feel that there's a model that you go out and say that we are going to be able to buy better over the next 12 months.

I think there's going to be opportunities. And the good news is we certainly, from a UAG perspective, have not seen any slow down in opportunities. It's just us trying to pick the right ones. The Minneapolis thing was a perfect example. It gets us into a fertile market for us. It gives us some strength in the Midwest. And we certainly like that entrance, and we are going to hope to make more acquisitions there.

Thank you very much.

Rich Kwas, Wachovia Securities.

I just want to ask, the guidance, $1.35 to $1.40, what is the interest rate assumption there going forward, are you assuming anything more?

Well, we had assumed a 25 basis points per quarter for all 4 quarters. I think we've had 100 in the first 6 months. I'm hoping it stops. So in our model we are showing 100 basis points for the year, so if it goes up some it could have some impact negatively on us if we don't watch our inventory.

Okay. And then on the entry level luxury market, are you seeing any discernible negative trends in kind of the BMW 3 Series, Mercedes C-Class, any of that? Are you seeing any of that?

Well, 3 Series has been a hot vehicle. I think C has never had the traction that the 3 Series has had. You've got the IS. You have got with Lexus, these cars are good cars. We are getting a new buyer, you follow me? We are getting someone that might have driven a different vehicle 25 years ago at that age level. I think we are seeing those vehicles being quite attractive. Then you get the performance models. You get the Ms at BMW. You get the AMG, some of the Brabus Brabus You get the AMG, some of the Brabus Brabus You get the AMG, some of the [Brabus] stuff overseas. There still seems to be people that want to load up these vehicles, and they are quite attractive.

Okay. So no negative trends there?

You know something, I would rather have someone come back and give you that. I don't know any as I sit here today.

Okay. And then finally, weather in the Northeast. In late June it rained a fair amount. Any impact, discernible impact? You didn't mention it, so it doesn't sound like there was much of an impact.

Well, I didn't want to give you a weather report. Obviously, we got hurt in Washington, at Tysons. We were down for about 3 or 4 days there, and it didn't help our construction. What was going on in Turnersville and up in Inskip. But again, we are going to have some ups and downs. We had some good guys and we'll have some stuff that isn't so good. But there was nothing there that I could point out, it certainly didn't help us. But again, we waded through it.

Thank you.

Jonathan Steinmetz, Morgan Stanley.

A couple of questions on the Smart, and then a couple housekeeping-type items. First on the Smart, Roger, when you talk about a store in a store, if that were a UAG dealership, what are you talking about in terms of investment? I mean, is this a question of hundreds of thousands of dollars or that kind of thing, or is it more than that?

I would hope it's around, between 200 and 250,000. That would include signage. That would include what you have to do infrastructure, inside and outside. So we are not talking millions of dollars, for sure.

[inaudible] on the margin or does this just effectively get negotiated, or do you give up any upside in exchange for some caps on the downside as well?

I missed the first part of that question.

If this were a real home run, if the volume is 2 or 3 times what anybody is thinking it's going to be, does the margin get constrained in any way shape or form? Do you give anything up on the upside? Or does it just sort of work on a variable basis and you just keep going with it?

The transaction that we've negotiated with our DCX partners is there will be a margin which we get. And then obviously, you will look at it on an annual or every couple of years. But at this particular time, it's if the margin stays the same you sell 1 vehicle, or you sell 100,000 vehicles.

Okay. And just housekeeping-wise, you gave a 2.1% comp I think on new in the U.S. Do you guys have a break down between units and price there?

I don't have that with me. I will get Tony to give it to you. I will get him, in you want to call him, he can get you that number.

Okay. And just lastly, where do you see the CapEx trending as we go into '07, '08 as some of the bigger projects get behind you?

Well, Inskip is done. Turnersville is done. We have got a major project going in Jersey City now with Nissan and Toyota, which we need to complete. We have got the Lexus of Edison, which is probably 20% done. That will be a project we will have to complete. And in the UK, we've got a couple of BMW stores which will be relocating during the next 12 to 18 months. But I see the big numbers coming down.

Now also, if we make acquisitions, you are going to see that impacting. We did the acquisition with Cush in northern California, or actually in Escondido, and we have got some CapEx going on there. We moved Audi into the Escondido Automall. We are going to do some freshen up of the Honda store there. So there's work to be done. But we won't have these 80, 90, $100 million projects -- at least I don't have any. I would like to announce one because that means we made a good acquisition, but at the moment, I don't have one.

Okay. All right. Thank you very much.

Thanks, everybody.

Thank you. I'm showing no further questions at this time.

Thank you very much for joining us today. Bye-bye.

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